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Islamic Finance: Profit rate swap

07 October 2008

The market for Shari'a-compliant derivatives products is at a fascinating juncture and we are witnessing the embryonic stages of an OTC derivatives market.

Growth in demand for Islamic financing products generally has been prolific in recent years and the prospects for further impressive growth appear strong.  Innovation in the finance sector has allowed more entities the opportunity to structure their finances in a Shari'a-compliant manner. It is estimated that Islamic banking assets globally total approximately USD700-900 billion and McKinsey predicts that Islamic banking assets and assets under management will reach USD1 trillion by 2010.

As the Islamic finance market in general has grown and financing structures have become ever more sophisticated, a corresponding demand has arisen for complementary derivatives products. Specialist derivatives practitioners are now facing both an exciting opportunity and an interesting challenge, namely to produce products which provide parties with the unquestioned benefits of conventional derivatives (particularly with respect to effective hedging and general risk management) whilst also adhering to and respecting the core tenets of Shari'a.

At Allen & Overy, with a world leading derivatives practice in London and a well-respected presence in the GCC region (spread over three offices and with over 30 years experience on the ground) we have been well placed to lead the development in this field. This article will begin by examining key principles of Shar'ia and how the use of conventional derivatives products could be seen to run contrary to such principles. It will then, in considering the example of a Shari'a-compliant profit rate swap, explore how the combination of well-established commercial and financial arrangements and innovative structuring is helping to meet the growing demand for risk management products whilst also seeking to abide by the tenets of Shari'a.

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Download the article Profit rate swap (PDF, 201KB).

This article was first published in the October edition of PFI and the 4th October edition of IFR Magazines.