Standard Chartered Bank sees opportunities in Islamic derivatives products but is steering clear of hedge funds, another grey area of sharia-compliant finance, the head of its Saadiq unit said.

Afaq Khan, chief executive officer of Standard Chartered Saadiq, said Islamic hedge funds were at the edge of development of the industry and many Islamic finance experts were hesitant to approve them.

'Generally hedge funds are invariably involved in some kind of short selling and that is clearly not sharia compliant,' Khan told Reuters in an interview.   

He said derivative products, on the other hand were a necessary development to help the industry handle risk and could be used without engaging in any speculative dealings.   

Islamic scholars have traditionally been sceptical about hedge funds, saying long-short products involve speculation or short-selling. Under Sharia law, short-selling is banned because an investor cannot sell something that it does not own.

Ratings agency Moody's issued a note supporting the innovation of more derivatives products in Islamic finance on Tuesday. 'Derivatives are sophisticated instruments that can, if employed with care, enhance efficiency in Islamic financial institutions through risk mitigation, thereby making them more competitive as well as appealing to customers,' said Moody's senior credit office Anouar Hassoune in the note.

Moody's added that religious dogma is keeping some from engaging in Islamic derivatives products but if the industry hopes to compete with larger conventional rivals such as HSBC, UBS and Citigroup, derivatives will have to be more widely embraced.   

However, derivatives are another grey area in the Islamic finance industry, with scholars divided over their legitimacy; some see them as permissible instruments to hedge risks but others view them as speculative transactions, forbidden in Islam.

Some Islamic operators have used a contract known as Arbun to replicate call options. Islamic hedge funds also use this structure as a means of short-selling to help a hedge fund create a long-short strategy.

Khan said that the market shouldn't confuse derivatives as speculative products, in the same way that hedge funds are seen. 'There are a lot of misconceptions about derivatives,' he said. 'Speculation through derivatives isn't allowed but fixing the cost of production is allowed.'    

Standard Chartered Saadiq launched an Islamic commodity derivative product in the first quarter that allows corporations to fix the price of a commodity such as rice or steel.   

To help facilitate the creation of more derivatives, the International Islamic Financial Market (IIFM) in Bahrain co-created a template for over-the-counter Islamic derivative products. Standard Chartered, along with Bahrain's Arab Banking Corp. and Credit Agricole CIB, backed the contract.   

Khan, who sits on the board of IIFM, said derivative products for use in hedging risk were as far as he was willing to go at the moment and his clients were not placing hedge funds as a high priority. 'Hedge funds just aren't on my radar,' he said. - Reuters