Transcript Shari’ah Compliance Review

ISLAMIC PRIVATE EQUITY, DERIVATIVES
AND STRUCTURED PRODUCTS &
INVESTMENTS
Dr. Mohd Daud Bakar
President/CEO
Amanie Business Solutions
Islamic Private Equity Fund (IPEF)
• IPEF is a vehicle to enable the investors to invest in non-listed
companies at all stages of development but most likely the
mezzanine stage. Also, it intends to have a control over the
investee company.
Mutual Fund
Private Equity
Venture Capital
√ listed equities
√ non-listed equities
√ non-listed equities
√ redemption
√ close-end fund
√ close-end fund
√ no management
√ management
√ management
√ capital gain +
dividend
√ capital gain
√ capital gain
√ established
companies
√ potential
companies
√ start-up
©Copyrights reserved Amanie 2006
2
Shari’ah Issues of IPEF
• Investment guidelines-listed vs. non listed companies.
• Controlling position and the tolerable ratio of
conventional leverage.
• Co-investment in the investee companies.
©Copyrights reserved Amanie 2006
3
Structured Finance : An Overview
•
Encompasses all advance private and public arrangements
that serve to efficiently refinance and hedge any profitable
economic activity beyond the scope of conventional forms
on-balance sheet securities in the effort to lower the cost of
capital and to mitigate agency costs of market impediments
on liquidity.
•
Most structured investment:
i.
Combine traditional assets classes with contingent claims such
as risk transfer derivatives and/on derivative claims on
commodities, currencies or receivables from other reference
assets, or …
©Copyrights reserved Amanie 2006
4
Cont’d
ii.
•
Replicate
traditional
synthetication.
assets
classes
through
The premier form of structured finance is capital
market-based risk transfer whose two major asset
classes include asset securitization and credit
derivative transactions.
©Copyrights reserved Amanie 2006
5
Risk Transfer Instruments
©Copyrights reserved Amanie 2006
6
Illustration of Securitisation
• Via securitisation, the issuer raises funds by issuing
certificates of ownership as pledge against existing or
future cash flows from an investment pool of financial
assets in the bid to increase the issuer’s liquidity position
without increasing the capital base or by selling these
reference assets to a SPV, which subsequently issues debt
to investors to fund the purchase.
• Apart from being a flexible efficient source of funding,
the off-balance sheet treatment of securitisation also
serves :-
©Copyrights reserved Amanie 2006
7
Cont’d
i.
To reduce both economic cost of capital and regulatory
minimum capital requirements as a balance sheet
restructuring tool.
ii.
To diversify asset exposures
•
Credit derivatives, on the other hand, are financial
instruments that isolate and transfer credit risk. Based on
derivatives principle, they involved the sale of contingent
credit protection for pre-defined credit events of lending
transactions.
•
In their basic concepts, credit derivatives sever the link
between the loan origination associated credit risk, but
leave the original borrower-creditor relationship intact.
©Copyrights reserved Amanie 2006
8
Cont’d
• The protection buyer of a credit derivatives hedges
specific risk, in return for periodic premium payments to
the protection seller, who assumes the credit of a
financial contract isolated from the underlying
transaction.
• Credit derivatives include among others;
– Credit Default Swap
– Total Return Swap
– Credit Spread Options
– Collateralised debt Obligations
©Copyrights reserved Amanie 2006
9
Structured Product Under SC’s Guidelines
• Any investment product that falls within the definition of
“securities” under SCA which provides the holder with an
economic, legal or the interest in another asset
(“underlying asset”) and derives its value by reference to
the price or value of the underlying asset.
• The term “underlying asset” means any security, index,
currency, commodity or other assets or combination of
such asset.
©Copyrights reserved Amanie 2006
10
Cont’d
•
These structured product include:
i.
Bond Options
ii.
Credit Default Swaps
iii. Credit Options
iv. Total Return Swaps
v.
Equity Swaps/ Options
©Copyrights reserved Amanie 2006
11
Interest/Profit Rate Swap/Exchange
• Definition:
Involves exchanging (swapping) interest payments on
Floating-rate debt for interest payments on Fixed-rate
debt, with both payments in the same currency.
• Reason:
One party actually wants fixed rate debt, but can get a
better deal on floating rate; the other party wants
floating rate. Both parties can gain by swapping loan
payments, usually through a bank as a financial
intermediary which charges a fee to broker the
transaction.
©Copyrights reserved Amanie 2006
12
Features Of Interest / Profit Swap
• A swap of fixed-for-floating interest rate.
• A master agreement for fixed rate interest.
• A floating or variable rate which is reset periodically.
• A set-off (muqasah) exercise at every reset time to
swap a fixed-for-floating interest rate.
• Floating interest rate is to based on a certain
benchmark.
• The counterparty making fixed rate payments in a
swap is predominantly the less creditworthy participant.
©Copyrights reserved Amanie 2006
13
Proposed Islamic Profit Rate Swap
•
The above characteristics of the conventional interest
rate swap are to be maintained.
•
Therefore, it must consist of three important documents:
i.
Master Fixed – Rate Transaction.
ii.
Master Revolving Floating – Rate
iii.
Settlement Agreement.
©Copyrights reserved Amanie 2006
Transaction.
14
Cont’d
• The challenge in Islamic finance is to create a
mechanism which is floating and revolving to assist the
parties in their swap transactions I.e. to give floating rate
profit to the party who seeks to match their floating
payment obligations and to give fixed rate profit to the
party who seeks to match their fixed payment obligations
(in addition to achieve ‘Quality Spread Differential’ that
is spread between fixed interest rate and variable interest
rate.
©Copyrights reserved Amanie 2006
15
ISLAMIC PROFIT RATE SWAP:
AN OVERVIEW (A HYPOTHETICAL CASE)
• ABC Bank has floating rate funding and fixed rate
investment. In order to match funding rates with return
rate (investment), ABC Bank may decide to enter into an
Islamic Profit Rate Swap with a counter-party.
Stage 1: Fixed Profit Rate
• Step 1: XYZ Bank (counter party) sells an asset to ABC Bank
on Murabahah basis at a selling price that comprises both
principal and profit margin to be paid upon completion of
subsequent transaction I.e.
©Copyrights reserved Amanie 2006
16
Cont’d
• Step 2: An Asset Purchase Agreement is executed by the
two parties.
• Illustration:
Suppose the notional principal amount
intended is RM500,000 and the fixed mark-up is 5.75% for
2 years. The fixed mark-up profit rate amount is payable
every 6 months for 2 years (RM500,000 x 5.75% x 5.75% x
180/365 = RM14,178.08)
©Copyrights reserved Amanie 2006
17
Cont’d
Stage 2: Floating Profit Rate
• Step 1: Just prior to 6 months, ABC Bank will sell an asset
to XYZ Bank at a selling price of RM500,000 plus a markup based on CURRENT profit rate (agreed spread plus
current benchmark).
An Asset Sale Agreement is
executed by the two parties.
• Step II: Payment of selling price by both ABC and XYZ
Bank is netted-off.
• Step III: The net difference is profit, and is paid to the
receiving party as the case may be spelt out in the
settlement agreement.
©Copyrights reserved Amanie 2006
18
Cont’d
Stage 3
• Floating Profit Rate (Stage II) is repeated every 6 months
until maturity.
©Copyrights reserved Amanie 2006
19
Illustration
Islamic Profit Rate Swap Counter-Party
pays fixed profit rate
Islamic Depositors
Floating rate
©Copyrights reserved Amanie 2006
receives floating profit rate
Islamic Funding
ABC
Fixed rate
20
Equity Linked Notes (ELN)
• ELN is an instrument that provides investors fixed income
like principal protection together with equity market
upside exposure.
• An ELN is structured by combining the economics of a
long call option on equity with along discount bond
position. As for Islamic Equity Linked Notes, two
requirements are to be met:
– Equity must be Shari’ah compliant
– Option must be structured under the ‘urbun concept i.e.
down payment, earnest money i.e. this option cannot be
traded (at least from International Shari`ah Standard.
©Copyrights reserved Amanie 2006
21
Cont’d
• The investment structure generally provides 100% Capital
Principle Protection. The coupon or final payment at
maturity is determined by the appreciation of the
underlying equity.
• The instrument is appropriate for conservative equity
investors or fixed income investors who desire equity
exposure with controlled risk.
©Copyrights reserved Amanie 2006
22
Cont’d
Sukuk
©Copyrights reserved Amanie 2006
23
Cont’d
©Copyrights reserved Amanie 2006
24
Note on Islamic Option
• Illustration:
Islamic option
a) option is deemed as
earnest money
b) option is not tradable
Conventional option
a) Premium – cost to buy the
option
b) option is tradable
(international Shari`ah
Standards)
c) underlying asset must be
compliant
©Copyrights reserved Amanie 2006
c) underlying assets must not
necessarily be compliant
25
Futures Contract
• It is negotiable contract to make or take delivery at an
agreed price of a standardized amount of a commodity
or financial instruments during a specific month, under
terms and conditions established by a national/
international regulated future exchange market where
trading takes place.
• Future contracts are often used as a hedging device
against interest rate or price risk of the primary market.
• Normally, in future trading, the seller of a contract
(known as a short) will notify the exchange of his
intention to deliver contracts to a buyer (called the
long) as the contract delivery month draws near.
©Copyrights reserved Amanie 2006
26
Cont’d
• Under future contracts, buyers and sellers have the
option of exchanging an expiring contract for a new
one which is common rather than take delivery.
• Underlying assets for future contracts:
–
Share / stock
–
Commodities
–
Interest rate
–
Index
–
Currency
©Copyrights reserved Amanie 2006
27
Cont’d
• In a nutshell, futures contract is based on:
–
Deferred payment (subject to margin payment)
–
Deferred delivery (or cash settlement)
–
Marked –to –market
• From a shari’ah perspective, a number of issues are to
be considered:
–
Can both the counter-values be deferred ?
–
(Compare with Salam and Istisna’)
–
Does the practice of marked – to –market make the
contract uncertain (gharar) or similar to gambling?
©Copyrights reserved Amanie 2006
28
Cont’d
• The SC’s resolution
– “When a crude palm oil futures is offered, specification
such as quantity, type, price and delivery date are made
known to the market players. Therefore, there is no element
of gharar in the contract. All specifications are made clear
in the contract, and surveillance and regulation are
provided to ensure there is no cheating”.
• Futures Contract: The Way Forward: Binding bilateral
promise.
©Copyrights reserved Amanie 2006
29
Islamic Forward FOREX
• Forward FOREX involves essentially two dissimilar
ribawi items i.e. two different currencies. Currency is
a ribawi item.
• Under the principles governing any exchange of
two dissimilar ribawi items, the exchange of two
counter values must be spot or simultaneous (hand
to hand).
• Forward FOREX entails that the rate of exchange is
locked in today (the day of contract) but delivery
of two counter values is being deferred to a future
date where the delivery of these two counter
values will be made on spot basis.
©Copyrights reserved Amanie 2006
30
Cont’d
• There is a silent consensus amongst the jurists that this
method of exchanging a currency for another is not
compliant to the requirement of “hand to hand”.
• “Hand to hand” requires the delivery of the two countervalues be made on the day of the contract which is not
the practice in current FOREX.
©Copyrights reserved Amanie 2006
31
Islamic Solutions To FOREX
• Islamic law requires delivery to be made on the day of
the contract. However, Islamic law does not prohibit
promise to buy and sell currencies on one date and
delivery to be made on another date because the
proper contract only concludes on the day of delivery.
• This premise of argument has led to the
argument/construction of wa’d (promise) in structuring
Islamic version of FOREX.
©Copyrights reserved Amanie 2006
32
Cont’d
• Under wa’d structure, only one party (obligor / promisor)
promises to buy/sell as the case may be, where he is
bound by that promise (which is binding). The other
party / promisee / obligee is not bound to proceed with
the promise that was undertaken by the promisor.
• Binding promise from only one party is not deemed valid
under Islamic law as a contract. Therefore, this can
facilitate FOREX.
• Binding promises from both parties are deemed to be
leading to a contract conclusion and therefore is
prohibited.
©Copyrights reserved Amanie 2006
33
Are Islamic Derivatives A Need
• Some Scholars argue that Islamic Derivatives are not in
tandem with Islamic philosophy because they are,
interalia:
– Artificial products
– They are created to suit conventional products which are
based on either interest or speculation
• Some other scholars argue that “Islamic Derivatives” are
needed for protecting real businesses activities and not
just for speculation purposes / undertakings.
– Forward currency or currency swap to protect real import
and export activities involving two different currencies
©Copyrights reserved Amanie 2006
34
Cont’d
– Profit rate swap to manage real asset and liability potential
miss-match of a financial institution
• Would there be any limits to the usage of Islamic
Derivatives or Islamic Structured products?
– Investment Fund
– Synthetic Products
©Copyrights reserved Amanie 2006
35
Islamic Potential Contracts/ Principles For Islamic
Structured Products
• Earnest money or ‘Urbun
• Salam Sale
• Unilateral binding promise (wa’d)
• Istijrar – purchasing an asset the price of which is to be
determined later
• Murabahah / Tawarruq contract
• Fixed and floating contracts
• Short Sale?
©Copyrights reserved Amanie 2006
36
Shariah Issue For Deliberation
• Deferment of both counter values in the future market
• Margin account and marked to market
• Enforcement of unilateral binding promise
• Fees for guarantee / protection (CPPI)
• Third party guarantee
• Separate legal entity in Murabahah / Tawarruq and in
wa’d structure
• Unilateral binding promise
©Copyrights reserved Amanie 2006
37
Islamic Structured Products: The Way Forward
• Product innovation between the prohibition of interest
and prohibition of gharar
– Riba is a fixed formula
– Gharar is a phenomenon and risk tolerance
• Guidelines on Islamic SP
• Risk Management in Basel II and IFSB
• Research and Development
©Copyrights reserved Amanie 2006
38
THANK YOU
Services
1. Shari’ah Advisory & Consultancy
2. Structuring & Enhancing Business Products
3. Shari’ah Conversion of Entities or Business
4. Intelligent Networking & Smart Matchmaking
Amanie Business Solutions
Suite A-D, Level 14,
Bangunan Angkasa Raya
50250 Jalan Ampang
Kuala Lumpur
Tel : +603 2034 2545
Fax : +603 2034 2546
www.iiif-inc.com/ www.amanie.com.my
Amanie Business Solutions