DERIVATIVES – AN ISLAMIC PERSPECTIVE By A.I.MARIKAR

 

The recent Global Financial melt down which brought the near crash of several financial institutions worldwide  especially in the US and Europe , highlighted the dangers of Derivatives as an investment option . Most of the Financial institutions that needed massive state Bail Out in order to remain solvent at the height of the turbulence , carried substantial portfolios of Derivatives which at a time of crisis demonstrated very cruelly that they were mere worthless pieces of paper  with really no asset value . 

A derivative is not a product that  most investors understand clearly  with reasoned comfort. There is little transparency  in this business and the product itself is something which  even dealers of  derivatives do not fully understand so as to be able  to explain with clarity the full product dimensions  . It is by and large shrouded in mystery and is confined to Dealing rooms of vendors of this highly speculative financial product . The hallmark of this market is the mystifying  jargon that  everyone in the derivative vending business  use when marketing it . 

One thing is sure , and is amply explained by its name ‘Derivative ‘. It is something that is derived from another transaction and  every derivative per se , therefore  is not asset based . Explained in simple English it is an intrinsically empty vehicle  that is bought , sold  and enlarged with layer upon layer of further derivatives heaped one on top of the other . The whole superstructure  lacking the robustness of a tangible asset , is built on nothing but  asset emptiness .

The Insolvent US and European  Financial institutions realized this simple truth only after they were brutally destroyed during the financial melt down and were forced to go cap in hand to the Central Banks to beg for financial mercy .The reason , Their huge investments in Derivatives which at the time of financial turbulence , were like worthless Junk Bonds . It was only a speculatively created paper asset .

The world and more specifically the US , was warned well in advance of the impending financial crisis as a result of extensive use of Derivatives , by no less a person  than the then head of the Securities Regulatory authority  in the US , Ms Brooksley Born . 

Brooksley Born finished a brilliant academic career in Law at one of the Ivy League Universities in the US . After several years of legal practice in leading Law firms in the US , she was appointed the head of the US Securities Regulatory Authority .

It was at this time that derivatives were enveloping  the financial world by storm         

and very surprisingly it was kept outside the scope of any financial regulator in the US .

This was during the Bush administration era when Allen Greenspan ruled the roost as the  unquestioned financial guru and wizard . His business philosophy on the regulation of financial products  and markets was a simple one . He said that there must be little or no regulation of  financial institutions by the authorities because mature  markets usually self regulate . Institutions  and financial products that fail , are speedily eliminated from the system in such markets and only the resilient ones survive . It was this Greenspan dogma that created a lot of space for derivatives to flourish in the US . 

Brooksley Born however had serious reservations about Derivatives .It had carved out a mega market presence in the US and at that time it was a US Dollar 595 Trillion

business . To put things in perspective , China which has the worlds largest foreign reserves , has a mere USD 2 Trillion as foreign reserves . Brooksley Born very clearly contended that Derivatives with that kind of a market impact had to be brought under her regulatory authority and as a first step researched deeply into the product and its  market dynamics  . The more she researched the more it became clear to  her sharp mind that Derivatives were a creaking time bomb .She found that nobody knew , not even the specialists in Derivatives , as to what was going on in the markets . She found that there was little or no transparency in this business , it was like a cult churning out magic portions from inside a big black box .She contended that this was plain vanilla speculation belonging to the same league as gambling .As a thorough bred professional Brooksley Born realized the danger Derivatives posed to  US financial markets and to the safety of  the Trillions of Dollars invested in it by millions of Investors . She pushed hard to regulate Derivatives .

 But regulation went against the philosophy of the Allen Greenspan school of financial management , and there was strong opposition from a lot of the lobby groups especially the big business raking in profits from vending Derivatives . Brooksley did not relent .

She wanted a Congressional hearing  to discuss the  issue in view of its massive financial ramifications .At the hearing  , Allen Greenspan argued for leaving Derivatives unregulated . He articulated that the successful growth of  US financial markets was possible because of the Laissez Faire  , non interventionist policies of successive US Governments . He concluded that if derivatives  thrive , then it is best left alone and that the market must determine its ultimate fate . 

Brooksly Born argued strongly for regulation . She argued that the USD 600 Trillion  financial behemoth had to be caged . She exposed the total lack of transparency in this business and brought to  the notice of those in government that no one really knew what was going on in this highly speculative trade . She warned that if the financial  bubble should burst with the USD 600 Trillion in the Balance sheets of Banks and financial Institutions , a nightmare scenario would emerge , bringing most US big business to its knees and unleashing in the process massive financial shock waves ..

The US administration was strongly under the spell of the Allen Greenspan philosophy and was unwilling to put its trust on the relatively inexperienced  Brooksly Born .It decided to accept the advice of  their venerated financial guru Allen Greenspan . Derivatives continued to flourish unregulated .

Not wanting to sit on top of a calamitous time bomb , Brooksly Born quit as the head of the Securities regulatory authority . 

About 10 years later , with the onslaught on financial markets by  the global financial melt down , the predictions and fears that Brooksly born articulated about Derivatives were coming home to roost .Top US decision makers belatedly realised  that Brooksley Born’s very good advice was mistakenly not taken by the US administration . It was too late . 

Very recently Al Jazeera TV broad cast a program on derivatives and interviewed Brooksly Born on what she articulated about Derivatives during her tenure as the Securities regulator . She held firm to the views she expressed at that time and sadly reflected that a lot of the financial pain the world had to endure , could have been avoided or minimized if only the US administration had paid heed to her advice .

Al Jazeera TV also interviewed Allen Greenspan who is now in retirement . He confessed that  Brooksly Born was absolutely correct in her assessment of derivatives and that his Laissez faire financial   Model  of  allowing  unregulated financial markets to operate unrestrained , was seriously flawed . 

From a Sharia perspective , derivatives have two toxic and Islamically prohibited features. Firstly derivatives are not asset based and they always ride piggy back on another transaction . Investors are therefore not clearly told what the transaction is  and this introduces a large element of Garrar into derivatives trading .If A top regulator of the US financial administration in the person of Brooksly Born could not understand the working dynamics of derivatives, there is no hope that the investing public at large would comprehend this complicated financial instrument . Garrar is rejected outright in Sharia and derivatives therefore have no place in Islamic finance.

Secondly derivatives are essentially a speculative product , and all forms of speculative business is strongly rejected in Sharia . Speculative trading is a manifestation of the age old practice of gambling .This is unequivocally prohibited in the Quran and in the traditions of the prophet . Muslim investors must clearly distance themselves from this very unislamic and dangerously toxic  business of derivatives trading .        

Sadly Derivatives are still being bought and sold  and I can only recall Lord Acton’s profound words of wisdom when he said “ History repeats itself ,once as a tragedy  and then as a farce