While it can be tricky to adapt conventional capital market hedging instruments to become Shariah compliant, Arqaam Capital has ventured into this investment space to meet rising demand from its clients.
Equity Derivatives Head Vineet Gupta told IFN Investor such client demand continues to be recorded in the group’s Dubai headquarters and offices in Egypt and Saudi Arabia – where this firm also handles trades in these conventional derivatives.
“That demand comes mainly from institutional investors, family offices and high net-worth clients who have a Shariah compliant mandate.”
Due to failures of highly leveraged derivatives, which triggered several financial crises in recent decades around the globe, Shariah rules tend to shy away from allowing such instruments under the Maysir (gambling) principle for being too perilous.
Vineet said Arqaam Capital consulted an international Islamic Advisory institution, which includes multiple Shariah scholars, to reformat the derivatives for Shariah compliance. He described the process as intricate, involving the organization of payments in line with the structure prescribed by the advisory firm. This adds another layer of complexity to these instruments, which already involve complicated modeling of factors such as volatility, interest rates, and dividends.
“Since it’s an overall Shariah compliant transaction, we have to execute commodity trades to reflect the replication of cash flows. In addition, we must hedge, and risk manage the option position just like we do for conventional options. What we offer are essentially call and put options.”
Adding steps for Shariah compliance did not deter the firm’s clientele as Vineet said the extra cost is very small as compared to the size of trades conducted.
“We have already traded around US$10-15 million worth of notional trades in Shariah derivatives so far and we expect to trade maybe five or six times of that value in the next year.”
As these are handled as over-the-counter transactions, Vineet said the single contract can value from as low as US$50,000 to US$3 million. “Like everywhere, the client comes in all shapes and sizes.”
On prospects, Vineet added: “We believe equity derivatives as an asset class and risk management tool are significantly underdeveloped in the region and offer a substantial untapped opportunity for MENA and we are excited to play a pivotal role in this evolution.”
