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This chapter examines the sources and principles of Islamic law. A broad understanding of the sources and principles of Islamic law is prerequisite to an examination of the legal foundations of Islamic finance. Islamic law comprises a complex and vast body of doctrine that has taken shape in extremely varied circumstances for well over a millennium as part and parcel of an evolutionary process still vigorously underway. The chapter then describes the technical terminology employed by Muslim jurists across the entire field of Islamic law. All the technical terminology is in Arabic but exact or rough equivalents can be found in other legal systems. The chapter also looks at the legal concepts relevant to Islamic finance from a historical perspective as the point of departure for an exposition of the Islamic law of contract, for which they provide the conceptual underpinnings.

This chapter studies how conventional derivatives—especially futures, options, and swaps—have been or may be based on bay’ salam, bay’ ʻurbun, and other traditional Islamic transaction structures. Bridging the gap between traditional Islamic transaction structures and conventional derivatives continues to be among the most urgent challenges facing the global Islamic finance industry, not least to provide Islamic financial institutions with a crucial tool for risk management. Salam and ʻurbun clearly illustrate the nature of the challenge to create Shari’a-compliant derivatives. Paradoxically, it is their deviation from the standard conditions for a valid sale contract that allow them to function to some extent as proxies for conventional derivatives. Among jurists, a consensus (ijma’) emerged as to the validity of salam, although special conditions were imposed not only to minimize gharar (uncertainty) and the kindred contractual defect of jahl (lack of knowledge), but also to reduce the possibility of riba (unlawful gain). There is still considerable debate among the various schools of law as to whether ʻurbun constitutes a valid sale contract under the Shari’a.