Market volatility boosts need for Sharia-Compliant derivatives

June 12, 2026 (MLN): The sharp swings in commodity prices, profit rates, and exchange rates triggered by the Iran conflict have emphasized the growing importance of Islamic derivatives as risk-management instruments, according to Fitch Ratings.

However, the agency noted that adoption remains uneven across sectors and jurisdictions, with significant gaps still limiting the market’s development.

Fitch said most of its rated Islamic banks have incorporated Shariah-compliant derivatives into their risk-management frameworks, while usage among Islamic insurance companies remains limited.

The agency also observed that Islamic securitization structures and sukuk issuances are increasingly integrating hedging solutions, reflecting gradual progress in the market.

Despite these developments, Islamic derivatives continue to represent only a small portion of the broader derivatives industry across major Islamic finance markets.

The ratings agency highlighted that Shariah-compliant alternatives remain scarce in several key segments, including credit, equity, commodity, futures, and digital-asset derivatives.

Market growth is further constrained by a lack of standardization, infrastructure limitations, regulatory differences, and varying levels of market awareness across Organization of Islamic Cooperation (OIC) member states.

According to Fitch, conventional derivatives markets are also relatively underdeveloped across many OIC countries.

Data from the Bank for International Settlements (BIS) showed that combined over-the-counter (OTC) interest-rate derivative turnover in Saudi Arabia, the UAE, Bahrain, Malaysia, Indonesia, and Turkiye accounted for less than 1% of global volumes in April 2025.

The agency estimated that around 75% of Fitch-rated Islamic banks were either using or offering Islamic derivatives during 2025 and the first quarter of 2026. Adoption was particularly strong among Gulf Cooperation Council (GCC) Islamic banks, where usage reached 100%.

Commonly used instruments include profit-rate swaps, forward foreign-exchange contracts, cross-currency swaps, and, in some cases, commodity hedging products.

Fitch noted that these instruments perform functions similar to conventional derivatives by helping institutions manage financial risks and strengthen their credit profiles.

Banks that have not actively adopted Islamic derivatives are primarily concentrated in countries such as Indonesia, Jordan, Iraq, Nigeria, and Tunisia, according to the report.

Malaysia remains one of the most developed Islamic finance hubs globally, offering both OTC and exchange-traded Islamic derivative products.

Nevertheless, conventional derivatives continue to dominate the market, with Fitch estimating that Islamic instruments accounted for only around 1% of total derivatives activity in 2025.

In GCC markets, excluding Oman, OTC Islamic derivatives are increasingly available, though exchange-traded offerings remain limited.

Fitch pointed out that no derivatives contracts were traded on Saudi Arabia’s stock exchange during the first quarter of 2026 and most of 2025, despite the products having been introduced in 2020.

The UAE has emerged as a leading derivatives market among emerging economies. BIS data cited by Fitch showed that average daily OTC interest-rate derivative turnover in the country surged to approximately $68 billion in 2025, compared with just $4 billion in 2022.

This expansion elevated the UAE to the 11th-largest derivatives market globally. Further supporting market development, Dubai’s Virtual Assets Regulatory Authority introduced a framework in April 2026 governing exchange-traded derivatives linked to virtual assets.

Fitch also noted that nearly two-thirds of its rated Islamic banks held investment-grade ratings at the end of the first quarter of 2026, while roughly 80% carried Stable Outlooks.

The agency said most GCC Islamic banks have remained resilient despite the Iran conflict, supported by strong capitalisation, healthy liquidity positions, and solid financial fundamentals.

From a ratings perspective, Fitch views excessive exposure to market risks that are poorly managed as a negative factor. Conversely, institutions with moderate and effectively managed exposure to interest-rate, currency, or commodity risks may benefit from stronger risk assessments.

For both Islamic and conventional insurers, Fitch emphasized that protecting capital and earnings from large loss events remains critical.

While reinsurance remains the primary risk-mitigation tool, derivatives such as options, forwards, and futures can also play an important role in managing financial exposures and enhancing overall resilience.

Copyright Mettis Link News