Futures Contracts in the Saudi Financial Market: A Comprehensive Guide

Futures contracts are legally binding agreements between two parties to buy or sell a specific asset (such as a stock, index, or commodity) at a predetermined price, with delivery or settlement occurring on a known future date. Futures contracts differ from forward contracts in that they are standardized contracts traded on organized exchanges and are subject to central clearing and guarantees, with daily margin requirements.

In the Saudi financial market, futures contracts are still under regulatory development and have not been officially listed until the end of 2024, despite official trends to enhance derivative instruments in line with Vision 2030. Futures contracts are often referred to in Arabic literature as 'future contracts' or 'forward deals.' These contracts are primarily used in global markets to hedge against price volatility risks (such as oil, indices, currencies) and play a pivotal role in stabilizing advanced financial markets. In the Kingdom, the practical use of futures contracts is currently limited to some hedging transactions in over-the-counter currency markets or within limited government initiatives, with the absence of an approved trading platform for these contracts on local stocks or indices.

Despite the similarities in objectives between futures contracts and forward contracts, there are fundamental differences in mechanism and regulatory guarantees:

1. Futures Contracts: Standardized contracts that can be traded on organized exchanges, subject to central clearing and requiring daily margin. They provide high liquidity and transparency for participants.
2. Forward Contracts: Non-standard bilateral agreements conducted over-the-counter (OTC), often between institutions or companies, and are subject to higher credit risks due to the absence of a central guaranteeing entity.
3. Futures in Arabic literature may also refer to futures contracts, but the more accurate usage is that forward contracts differ from futures contracts in regulatory standards, pricing, and settlement.

In the Saudi market, current transactions are limited to direct contracts between companies or financial institutions, with no organized trading of futures contracts yet. This difference in regulation and guarantees leads to significant disparities in risk management, liquidity, and transparency between the two types.

Futures contracts play a central role in global markets, and their key functions can be summarized in the following areas:

- Hedging: They enable companies and investors to lock in future asset purchase or sale prices, helping to protect budgets from price fluctuations, especially in the commodities, energy, and agriculture sectors.
- Speculation: They provide opportunities for capital gains from price movements of underlying assets without the need to actually own them. Professional traders and hedge funds use them to enhance investment efficiency.
- Market Efficiency: Futures contracts contribute to enhancing transparency and liquidity, as they provide a proactive mechanism for determining future prices based on participants' expectations, supporting market stability and quickly reflecting information in prices.

In the Saudi context, these functions remain theoretical or rely on external markets, awaiting the completion of local regulatory infrastructure and the official activation of the derivatives market.

Global statistics indicate that the futures market is one of the largest financial markets in terms of trading volume and market value, with trillions of dollars traded annually on exchanges such as CME and ICE. For example, the average daily trading volume of index, commodity, and metal contracts reaches tens of millions of contracts.

In the Saudi financial market, according to Tadawul data until the end of 2024, no actual trading of futures contracts on local stocks or indices has been recorded, with trading volume and open interest at zero. This means that Saudi institutions and investors currently rely on external markets or alternative unregulated tools for their hedging or speculation.

Forecasts suggest that the introduction of futures contracts in the future will enhance liquidity in the Saudi market and provide advanced risk management tools, especially with the increasing role of institutional investment in the Kingdom.

Futures contracts in global markets are subject to strict controls by regulatory bodies, such as the U.S. Securities and Exchange Commission (SEC) or the U.K. Financial Conduct Authority (FCA). In Saudi Arabia, the Capital Market Authority (CMA) oversees the development of legislative frameworks for the derivatives market and is currently working on drafting regulations for futures contracts.

Some of the main challenges facing the regulation of futures contracts in Saudi Arabia include:
- The need to comply with Islamic Sharia regulations, especially regarding speculation and uncertainty in contract settlement.
- The necessity to qualify brokers and investors through training programs on risk management and the use of financial derivatives.
- Developing the technical infrastructure for trading futures contracts (electronic platforms, central clearing systems).

So far, no official announcement has been made regarding the launch date of the futures market, but official statements confirm that the authority is studying the best global practices and adapting them to the local market.

With the absence of organized futures contracts in Saudi Arabia, local investors and companies resort to other alternatives for risk management:

- Forward Contracts: Bilateral contracts conducted over-the-counter, often used by institutions to hedge against price fluctuations of commodities or currencies.
- Options: Provide the buyer the right (but not the obligation) to buy or sell a specific asset at a predetermined price, offering greater flexibility in risk management.
- Swaps: Particularly interest rate or currency swaps, widely used among banks and large corporations.
- Investment funds, sukuk, and bonds: Financial and investment instruments that help diversify risks.

Regionally, some Gulf exchanges have begun to develop limited platforms for futures contracts, such as the Dubai Financial Market and the Abu Dhabi Exchange, but trading volume remains low compared to global markets. The primary reliance of Saudi investors remains on external platforms like CME and ICE for trading futures contracts on oil, gold, and currencies.

Futures contracts vary by type of underlying asset, and some of the most traded types globally include:

- Commodity Futures: Such as crude oil (WTI, Brent), gold, silver, wheat, and sugar. They play a pivotal role in hedging for producing and consuming companies against price fluctuations.
- Index Futures: Such as E-mini S&P 500, Dow Jones futures, and Nasdaq, used for hedging or speculating on the performance of overall financial markets.
- Currency Futures: Such as EUR/USD, GBP/USD, which are key tools for hedging currency exchange rate risks among multinational companies.
- Debt Instrument Futures: Such as U.S. Treasury bonds or European government bonds.

In the Kingdom, futures contracts could potentially contribute to hedging for oil and petrochemical companies and banks against global market fluctuations, in addition to the possibility of developing futures contracts on Saudi market indices (such as TASI or MT30) when the appropriate infrastructure is available.

The prices of futures contracts are subject to several considerations and economic factors, and the pricing mechanism can be summarized by the following equation:

Futures Contract Price = Current Asset Price + Financing Cost – Expected Income (such as dividends or interest)

The key factors influencing pricing include:
- The spot market price of the underlying asset
- The cost of owning or financing the asset during the contract period (such as loan interest)
- Expectations of returns or profits associated with the asset
- Supply and demand in the futures market

Practical example: If the current price of a barrel of oil is $80, with an annual financing cost of 5%, without dividends or discounts, the futures contract price after a month would be slightly higher to reflect the financing cost. In index futures, expected dividends during the contract period are added or subtracted from the final price.

Despite the advantages of futures contracts in hedging and risk management, they carry several risks that should be well understood:
- Price Risks: Exposure to significant losses when market prices move contrary to traders' expectations.
- Credit Risks: The possibility of one party or the trading broker defaulting, despite the presence of central clearing in organized exchanges.
- Systematic Risks: Market impact from significant economic events or liquidity shortages that hinder effective contract settlement.
- Sharia Risks: Some futures contracts may conflict with Islamic regulations if they involve uncertainty or uncalculated speculation.

Managing these risks requires:
- Understanding the daily margin mechanism and clearing procedures
- Using futures contracts as genuine hedges rather than pure speculation
- Reviewing the Sharia conditions of contracts and assessing legal and regulatory risks

It is always advisable to deal with licensed brokers and consult a licensed financial specialist before entering these high-risk instruments.

Saudi Arabia aims, under Vision 2030, to diversify financial market instruments and increase depth by developing the derivatives market, including futures contracts. Official statements indicate that the Capital Market Authority is currently drafting the necessary legislation and training brokers and investors.

The future launch of futures contracts is expected to include:
- Futures contracts on Saudi market indices (TASI, MT30)
- Futures contracts on major stocks (such as Aramco or major banks)
- Futures contracts on key commodities (oil, petrochemicals)

These steps aim to enhance market liquidity, attract global institutional investments, and enable local companies to access advanced hedging tools, thereby enhancing the competitiveness of the Saudi market regionally and internationally.

Introducing futures contracts into the Saudi financial market requires precise Sharia compliance, given the unique regulatory and jurisprudential environment in the Kingdom. Several points emerge here:

- Salam Contract in Islamic Jurisprudence: Allows the purchase of a described commodity at a known price to be delivered later, with precise conditions regarding the description of the commodity and delivery time (one year maximum). This contract can form the basis for some futures contracts on commodities.
- Jurisprudential Reservations: Some scholars believe that modern futures contracts, especially those characterized by pure speculation or cash settlement without actual delivery, may conflict with Sharia regulations (presence of uncertainty, speculation without tangible assets).
- Local Application: It is expected that future Saudi futures contracts will be designed according to Sharia-compliant models that adhere to Islamic governance and consider actual delivery or Sharia settlement upon maturity.

It is always advisable to consult accredited Sharia bodies and local Islamic banks before engaging in futures contracts.

Settlement methods in futures contracts are divided into two main types:
1. Cash Settlement: The financial difference between the contract price and the market price at maturity is settled without actual delivery of the asset. Common in index and currency contracts.
2. Physical Delivery: The seller must deliver the agreed-upon asset (such as oil or wheat) at the maturity date.

In global markets, most futures positions are often closed before the actual settlement date to avoid logistical complications. If futures contracts are introduced into the Saudi market, cash settlement is likely to be adopted for contracts on indices and stocks, with the possibility of physical delivery for commodity contracts in accordance with Sharia and regulatory controls.

Indicators suggest that the launch of the futures market in Saudi Arabia is imminent, given the official trends to develop the derivatives market and meet the needs of institutional investors and major companies. The market is expected to gradually start with futures contracts on indices or some leading stocks, then expand to commodities and currencies.

The success of the Saudi experience in this field requires:
- Building an investment culture around risk management and derivatives
- Close cooperation between regulatory bodies and Sharia authorities
- Developing advanced technical infrastructure and trading platforms

Activating the futures market will enhance the position of the Saudi financial market regionally and internationally, attract new institutional investments, and provide advanced hedging and financial planning tools for local companies and investors.