Modifications have been made to accommodate local law and religious principles, including those that guide nearly two billion people of the Islamic faith.
Roughly one in four, or 1.6 billion people, follow the teachings of the Quran, but restrictions within Sharia law prevent the application of interest in many cases or the transacting of business where there is a great deal of uncertainty as to the final result. These restrictions could block any meaningful attempt at managing one’s investment portfolio in today’s modern world since the cost of funds and risk are primary elements of any investment strategy, whether for buying and holding for the long term or actively trading over the short term.
The latter strategy obviously includes forex trading, and forex brokers have been wise to follow pronouncements from religious jurists and to offer special accounts, tailored to conform to the requirements of Sharia law. Islamic banking can be very complicated, requiring special attention at every turn, but jurists have generally ruled that retail trading in the forex “spot market” is acceptable, as long as special rules are not violated. These rules have their origins in preventing exploitation or the creation of uncertainty when an outcome is unknown.
Books have been written on these basic rules, but the two prominent ones that come into play in the currency markets are “Riba” and “Gharar”. A brief explanation of each from Investopedia follows:
“Riba” is a concept in Islamic banking that refers to charged interest. It is forbidden under Sharia, Islamic religious law, because it is thought to be exploitive. Depending on the interpretation, Riba may only refer to excessive interest; however to others, the whole concept of interest is Riba, and thus is unlawful. Even though there is a wide spectrum of interpretation on the point at which interest becomes exploitive, many modern scholars believe that interest should be allowed up to the value of inflation, to compensate lenders for the time value of their money, without creating excessive profit.
“Gharar” is an Islamic finance term describing a risky or hazardous sale, where details concerning the sale item are unknown or uncertain. Gharar is generally prohibited under Islam, which explicitly forbids trades that are considered to have excessive risk due to uncertainty. There are strict rules in Islamic finance against transactions that are highly uncertain or may cause any injustice or deceit against any of the parties. In finance, Gharar is observed within derivative transactions, such as forwards, futures and options, in short selling, and in speculation. In Islamic finance, most derivative contracts are forbidden and considered invalid because of the uncertainty involved in the future delivery of the underlying asset.
Whereas Riba applies to forms of interest that are usurious or exploitive, Gharar restricts aspiring Islamic forex traders to the single medium of retail “spot” forex, the primary access service provided by the multitude of global forex brokers. Within “spot” forex, however, the application of net interest differentials to overnight positions must be addressed in a special way. These special accounts go by many names – Islamic forex account, no-Riba accounts, or Sharia Law accounts. By making best efforts to appeal to all cultures and religious affiliations, the forex industry has displayed a willingness to be all-inclusive.
Author’s Introduction: Tom Cleveland has over 30 years of experience in the international payments industry and has served as CFO for various Visa International entities from 1980 until 1999, retiring with the title of Group EVP and Treasurer. Currently, Tom researches economics and investments and writes for ForexTraders.com.