A STUDY ON HOW STOCK INDEX FUTURES CONTRACTS CAN BE LEGITIMIZED IN IRAN'S CAPITAL MARKET: A COMPARISON WITH SINGLE STOCK FUTURES CONTRACTS.

• Author: Soltani, Mohammad

Abstract

Following the 1979 Islamic Revolution in Iran, many Islamic experts believed that capital market transactions should be forbidden because they were similar to gambling practices prohibited by Islam. They argued that gharar (uncertainty) and gaming based on chance, as the constituent elements of gambling, are an integral part of capital market transactions, and such transactions are not allowed in Islam. However, a study of the history of the Sharia board members' views in Iran's capital market shows that, contrary to the dominant Islamic belief, a variety of transactions--including some types of futures contracts--became prevalent in Iran's capital market. Futures contracts are commitments of parties to buy or sell an underlying asset at a predetermined price on a specific future date. The article reviews the evolution of Islamic jurisprudence towards the legitimacy of "single stock futures contracts" (SSFs) as an example of transactions that were once considered gambling, and compare SSFs with "stock index futures contracts" (SIFs)--a transaction with a similar definition and function that is still prohibited. We argue that the differences between these contracts, including the differences in their underlying assets and settlement procedure, are not fundamental enough to justify Sharia board members' distinctive approach to gambling and legitimization issues. We propose that SIFs should be legitimized in Iran's capital market, as the same justifications that were used to legitimize SSFs can partly be applied to SIFs as well. Finally, the paper proposes some additional justifications for SIFs in an effort to cover the distinctive challenges that they create.

Keywords

Futures contracts, gambling, Iran's capital market, Islamic jurisprudence, Sharia, SIFs, SSFs, transaction legitimacy

1. Introduction

   After the 1979 Iranian Islamic Revolution, many Islamic experts believed that capital market transactions were similar to gambling practices prohibited by Islam and should thus be banned. (1) Contrary to dominant Islamic beliefs, however, a variety of capital market transactions have since become prevalent in Iran. In this paper, we analyze the evolution of Islamic scholars' attitudes toward a particular kind of futures contract (2) called "single stock futures contracts" (SSFs) (3)--a transaction that was once considered gambling in Islamic jurisprudence. The paper argues that SSFs have a similar structure as "stock index futures contracts" (SIFs), particularly from the perspective of Islamic rules on the elements of gambling. (4) We examine the reasons why the former has been legitimized by the Sharia board members of Iran's Securities Exchange Organization (SEO), while the latter is still considered to be gambling. Considering the major similarities, we ultimately argue that SIFs should a pari be legitimized in Iran's capital market.

   Maysir (gambling) has been banned in Islamic jurisprudence for centuries. (5) Gharar (selling something uncertain that cannot be described in accurate detail) and "gaming" can lead to contracts with gambling features. To eliminate these features from Islamic capital market transactions, we propose that Islamic capital markets should take three main steps for the creation and development of new products: first, establish a Sharia board; second, recognize the necessity and function of new products; and third, justify the new products according to Islamic rules.

   Islamic finance, like conventional finance, has a need for risk management against unexpected changes in prices. (6) New products and service innovations in Iran's capital market require approval from a Sharia board of the SEO (established in 2007) in order to access the market. Board members base their decisions on the legal and financial analyses provided by respective experts. There is often an absence of a uniform interpretation of Islamic law, however--especially when there is no clear ruling in the primary sources of Sharia, such as the Quran. Fortunately, although many product developments in Islamic capital markets gives rise to jurisprudential issues under Sharia, the history of capital market developments indicates that there is always the hope that new products can be legitimized. In our view, legal scholarship can contribute to legitimization efforts by introducing new ways, based on Islamic rules, to facilitate the acceptance of new instruments, such as SIFs, in Islamic capital markets.

   In this paper, we employ a comparative methodology to examine the evolution of the SEO's Sharia board members' opinions toward the legitimacy of SSFs and SIFs in Iran. (7) We supplement the comparative approach with a historical analysis of the legitimization of SSFs. In doing so, we attempt to contextualize why, in our view, SIFs in Iran's capital markets should be similarly legitimized. It is our hope that this mixed methodological approach might serve to persuade both governing bodies and Islamic scholars alike that transactions with similar structures ought to be treated similarly.

   There are a range of articles and books in several different languages, including Persian, Arabic, and English, on the Islamic challenges of futures contracts. Works by Zainordin et al, (8) Khan, (9) and Azmat et al (10), for example, provide a fairly comprehensive account of the Islamic futures contracts. These works, however, tend to not engage in jurisprudential debates over Iran's current capital markets, and are largely uncritical of the SEO's Sharia board members' perspectives. While there are also some works (11) that highlight the similarities between SSFs and SIFs, there have been no efforts, as of yet, to draw upon these similarities in an attempt to legitimize SIFs. Indeed, using inductive reasoning to legitimize SIFs in Iran's capital market has yet to be considered in legal scholarship.

   Our paper proceeds as follows: first, we explain why SSFs and SIFs are structurally similar. We then examine their similarities (and differences) in detail, with particular attention to the gambling elements common in these two types of contracts. At the following stage and with a legal history method, we demonstrate how the criticisms regarding the gambling elements were justified by the SEO's Sharia board members when legitimizing SSFs. We then conclude in arguing that analogous criticisms regarding the gambling elements of SIFs can be similarly justified in order to facilitate their legitimization in Iran's capital market.

2. SSFs and SIFs as Futures Contracts

   Futures contracts are a type of derivative securities that contain the following five conditions: an underlying asset, the contract size, due date, price, and the delivery or contract offset. They are called "derivatives" because the value of the contract is derived from the value of an underlying asset. Thus, there exists a mutual relationship between the underlying asset and its derivative regarding the fact that the price of the futures contracts is determined by its underlying asset. (12) For example, if we selected gold as the underlying asset, the value of a futures contract would be derived from the market price of gold. However, because a futures contract is a zero-sum transaction (13) between the parties, the net value of a futures contract is always zero. (14) This means that whatever gain the buyer achieves is exactly equal to the loss borne by the seller and vice versa.

   Historically, in the US, futures contracts were transacted on commodities. However, in the 1970s, wide fluctuation in the prices of financial assets paved the way for futures exchanges on such assets--a reason that once justified the emergence of the commodity futures markets. (15) Whereas commodity futures require the delivery of a physical commodity, financial futures require the delivery of a financial instrument. The first financial futures contracts were foreign currency contracts introduced in 1972 at the Chicago Mercantile Exchange (CME). Then, interest rate futures were introduced at the Chicago Board of Trade in 1975. Finally, SIFs were introduced in 1982 at the CME and the New York Futures Exchange (NYFE). (16) SSFs were not launched in the US until 2002. (17) Currently, futures contracts in US capital markets include shares, bonds, currency, commodities, and index, and the contracts follow daily settlement procedures of the clearinghouse. Conversely, the trend was rather different in Iran's capital market: following the legitimization of the commodities' futures contracts in 2008, Sharia board members legitimized SSFs in 2010 while SIFs have yet to be legitimized.

   2-1 Similarities between SSFs and SIFs

   SSFs and SIFs share many common features. (18) Here, it is worth noting that SSFs in Iran's capital market have the same definition and function as in western capital markets. (19)

   2-1-1 Definition

   2-1-1-1 SSFs

   SSFs or single stock futures contracts, also known as individual equity futures, are commitments to buy or sell the shares of a particular company at a specific price at a future date. (20) Put slightly differently, SSFs are "futures contracts on individual stocks". (21) They are contracts for the delivery of a particular company's stocks with a certain contract size on a specific future date. (22) These contracts are transacted based on a single type of share, which is why they are called single stock futures contracts. Similar to commodity futures, SSFs entail both the rights and obligations of the parties to take delivery or to deliver the underlying assets on their expiration dates. (23)

   2-1-1-2 SIFs

   SIFs or stock index futures contracts are agreements to buy or sell a standardized value of a stock index at a specified price at a future date. These contracts contain an overall reflection of market movements, which is used to predict future price fluctuations of the index. (24) Therefore, SIFs are transacted on a particular stock market index as the underlying asset. Investor...