Full Risk management and new products developme

1,702 views

Published on

Full presentation brought from IBFIM Malaysia

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
1,702
On SlideShare
0
From Embeds
0
Number of Embeds
4
Actions
Shares
0
Downloads
130
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Full Risk management and new products developme

  1. 1. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Introduction New Product Development in Islamic finance Introduction 1. Market Updates / Statistics New Product Development in Islamic 2. Recent Development Finance 3. Contemporary issues 4. New Products Development in Islamic Finance 5. Commodity Murabahah By ZAIRULNIZAD SHAHRIM 6. Islamic Exchange Traded Fund (ETF) 24th Feb 2009 Page 1 Page 2Copyright IBFIM @ 2008. All Rights Reserved
  2. 2. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Market Updates & Statistics Market Updates & Statistics Introduction Introduction REVIEW OF INDUSTRY – SUKUK MARKET INDUSTRY STATISTICS (SUKUK VS CONVENTIONAL BONDS) of total PDS Sukuk Approved by SC 140.0 121.3 120.0 100.0 RMbil 80.0 60.0 43.3 42.0 38.4 35.3 32.7 33.8 37.5 40.0 26.7 19.0 17.6 19.3 Source: SC’s ICM Quarterly Bulletin- January 2008 12.0 15.2 20.0 Sukuk captured 76% of the RM-PDS market in 2007 (55% in 2006) 0.0 2001 2002 2003 2004 2005 2006 2007 Sukuk in 2007 (RM121.3b) increased by 189% from 2006 (RM42.02b) Year 1 The Sukuk figure includes the approval of 7 combination issuances (conventional and sukuk) with a combined issue size of RM89.5 billion and 2 ABS amounting to RM3.4 billion Conventional Sukuk 2 The combination issuance of RM60 billion by Cagamas Berhad was not included for the purpose of this calculation due to uncertainty of the amount per multiple Syariah principles to be used. Page 3 Page 4Copyright IBFIM @ 2008. All Rights Reserved
  3. 3. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Market Updates & Statistics Market Updates & Statistics Introduction Introduction INDUSTRY STATISTICS (DOMESTIC VS GLOBAL) INDUSTRY STATISTICS (SUKUK VS CONVENTIONAL BONDS) DOMESTIC 140.0 121.3 120.0 100.0 80.0 189% R bil M 60.0 43.3 42.0 40.0 19.0 17.6 20.0 15.2 12.0 0.0 Source: Securities Commission 2001 2002 2003 2004 2005 2006 2007 Source: Securities Commission Page 5 Page 6Copyright IBFIM @ 2008. All Rights Reserved
  4. 4. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Market Updates & Statistics Market Updates & Statistics Introduction Introduction INDUSTRY STATISTICS (DOMESTIC VS GLOBAL) GLOBAL STATISTICS (SUKUK ISSUED BY COUNTRY) GLOBAL Full-Year 2007 60.0 47.8 50.0 40.0 76% U SD $b il 27.2 30.0 20.0 12.0 5.7 7.2 10.0 0.8 1.0 0.0 2001 2002 2003 2004 2005 2006 2007 Source: IFIS Continuous growth in both domestic and global markets Source: Dealogic Database Page 7 Page 8Copyright IBFIM @ 2008. All Rights Reserved
  5. 5. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Market Updates & Statistics Market Updates & Statistics Introduction Introduction GLOBAL STATISTICS (SUKUK ISSUED BY COUNTRY) 2007- TYPES OF SUKUK CONTRACTS LOCAL – 58% Musyarakah Musyarakah 58% Pakistan Kuwait Qatar 1.7% 0.8% BBA Saudi Arabia 2.1% Bahrain 15.7% 0.5% Indonesia 0.3% United Arab Em irates 30.2% Malaysia 48.6% 2% Istisna Malaysia captured the biggest 9% market share in 2007 at Ijarah Murabahah 11% Mudharabah 19% 48.6% 1% Source: Raw data compiled from IFIS and SC Page 9 Page 10Copyright IBFIM @ 2008. All Rights Reserved
  6. 6. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Market Updates & Statistics Market Updates & Statistics Introduction Introduction 2007- TYPES OF SUKUK CONTRACTS Global view of Islamic Finance GLOBAL – 46% Musyarakah 1. There are more than 267 Islamic financial institutions (IFIs) in the world with capitalization in excess of USD 13 billion. This includes banks, mutual Musyarakah funds, mortgage companies and takaful 46% Investment Sukuk 2. Syariah compliant financial products estimated to exceed USD 250 billion 7% with annual growth rate of 23.5% over the past 5 years Islamic Exchangeable Bond 3. The potential is huge. By 2020, there will be 2.5 billion of Muslim population 9% worldwide from the current 1.5 billion level Others Mudharabah 9% 10% 4. Islamic banks are expected to manage 40% to 50% of total savings of Ijarah Murabahah Muslim population in 8 to 10 years. Therefore, potential for Islamic services 17% 2% is estimated at USD 4 trillion by 2020. Source: Raw data compiled from IFIS and SC Source: IFIS Page 11 Page 12Copyright IBFIM @ 2008. All Rights Reserved
  7. 7. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Market Updates & Statistics Recent Development Introduction Introduction Islamic finance in ASIA Commitment Malaysia, S. Arabia, Business Bahrain, Dubai, innovation Kuwait, Qatar, UAE Market innovation Brunei, Indonesia, Singapore, South Competitor Africa, Morocco, matching Turkey Minimum Syiria, Lebanon, presence Germany, USA, Europe Monitor development China, India, HK, Japan, Korea, Indo- China Wait & see Exploratory Development Expansion Research Source: Internal research Page 13 Page 14Copyright IBFIM @ 2008. All Rights Reserved
  8. 8. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Recent Development Recent Development Introduction Introduction Malaysia International Islamic Financial Centre (MIFC) Malaysia International Islamic Financial Centre (MIFC) 1. 14 August 2006 marked the launch of a nationwide initiative to promote 3. It comprises a diversified range of financial institutions operating from Malaysia as an International Islamic Financial Centre - MIFC. The MIFC anywhere in Malaysia that offer Islamic financial products and services in any initiative is aimed at fortifying Malaysia’s position as a vibrant, innovative and currency to non-residents and residents. The objective of the MIFC is to competitive Islamic financial hub, with significant roles in: promote Malaysia as the centre for : Facilitating relationships between the international Islamic financial Origination, distribution as well as trading of Islamic treasury and capital markets; and market instruments Bridging and expanding investment and trade relations between the Islamic fund and wealth management services Middle Eastern, West Asian and North African regions with East Asia International currency Islamic financial services (including deposits and financing) 2. The MIFC initiative is specifically undertaken by the collective efforts of the Takaful and retakaful countrys financial and market regulators, together with the participation of Islamic finance education, training, consultancy and research the industry representing the Islamic banking, takaful and capital market in Malaysia Page 15 Page 16Copyright IBFIM @ 2008. All Rights Reserved
  9. 9. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Recent Development Introduction Contemporary Issues Introduction International Currency Business Unit (ICBU) Infrastructural support 1. An International Currency Business Unit (ICBU) of a licensed institution, 1. Syariah namely Islamic bank, commercial bank and investment bank, is permitted to conduct a wide range of Islamic banking business under the Islamic Banking • Lack of standardisation in financial contracts and can be a source of Act 1983 (IBA) or Islamic banking business under Section 124 of the Banking ambiguity, dispute and higher cost and Financial Institutions Act 1989 (BAFIA) in international currencies other • Different Syariah interpretation than Malaysian ringgit 2. The income arising from the transactions of the ICBU is eligible for full tax 2. Legal exemption accorded under the Income Tax Act 1967 for ten years from the • International acceptance of Islamic financial contract requires them to year of assessment 2007 be acceptable to the Syariah as well as enforceable under Common Law and Civil Law Page 17 Page 18Copyright IBFIM @ 2008. All Rights Reserved
  10. 10. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Contemporary Issues Introduction Contemporary Issues Introduction Infrastructural support Image of Islamic products and services 3. Human talent 1. The credibility and sustainability of Islamic products as compared to conventional • Syariah experts that have adequate knowledge of banking and finance • Resemblance to the products and services offered by conventional • Finance specialist to have adequate knowledge of the applicable rules players and principles • Whether we can integrate standard and codes of good practice developed at national level into global practices • Acceptance of standard used in Sukuk issuance, rating decision and equity and project screening at international level Page 19 Page 20Copyright IBFIM @ 2008. All Rights Reserved
  11. 11. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Contemporary Issues Introduction Contemporary Issues Introduction Market liquidity Rating and statistical reporting 1. Market 1. Rating is done using conventional methodology • Short term liquidity management and asset liability management • Many Sukuk appear to have assets at their core, detailed analyzes of their commercial terms and legal structures shows that performance, • Financial risk management and hedging for issuer as well as investor for some is not governed by their assets, indeed, the credit risk is really that of the sponsor or originator - Moody’s 2. Products and services • No substantial distinction from traditional rating criteria – Fitch • There is a gaps between Syariah compliant products and conventional • No significant difference in the methods to rate conventional and Islamic debt securities. Has own Syariah board and will validate • Lack of hedging and derivatives products to be used as risk Syariah compliance structure – MARC management tools • No significant difference in methodology – Standard and Poor’s • Money market instruments to manage market liquidity and set benchmark rate of return • No significant difference in methodology - RAM 2. Different contractual relationships require different type of reporting Page 21 Page 22Copyright IBFIM @ 2008. All Rights Reserved
  12. 12. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM New Product Development in Islamic finance New Product Development in Islamic finance Introduction Introduction Preamble Issues 1. Width (increasing issuance of new products) and depth (introducing more derivatives) of product range is one of the essential components of an efficient 1. Too few products in the market market 2. Products are not competitive enough 2. Sell what the market want, and not what can be produced 3. Products are not compatible with the present infrastructure 3. Essential product characteristics: a. Risk tolerance (high, medium and low risk) 4. Products are not flexible enough b. Meeting the return expectation c. Meeting the liquidity expectation 5. Most currently available products are based on Uqud al-Muawadah (contract d. Meeting the unique needs (Syariah compliance and other needs) of exchange) rather than Uqud al-Isthirak (contract of participation) 4. Efficient market structure Page 23 Page 24Copyright IBFIM @ 2008. All Rights Reserved
  13. 13. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM New Product Development in Islamic finance New Product Development in Islamic finance Introduction Introduction Issues Product Development Process 6. All Islamic capital market products need to have endorsement from Syariah 1. It’s a dynamic management processes adviser – Attract additional cost and time consuming 2. Market research – Identify the market needs 7. Pricing mechanism – How do we price Islamic capital market products? 3. Analysis and product design 8. Products are not well understood 4. Pricing and profitability consideration 9. Islamic capital market products are not/less liquid – difficult to exit 5. Promotion – selling aspect of the product development Page 25 Page 26Copyright IBFIM @ 2008. All Rights Reserved
  14. 14. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM New Product Development in Islamic finance New Product Development in Islamic finance Introduction Introduction Five key elements Product Development - The way forward Return from Islamic instruments vs 1. Develop, enhance and coordinate Islamic finance / Islamic capital market conventional infrastructure products serv ture & Dev rketing 2. Interaction between Syariah and Finance Prod ent & ma ices elop struc uct m Infra ISLAMIC 3. Sound and establish regulatory framework INSTRUMENTS 4. A large and diverse number of companies, investors and intermediaries s Co tor & mpe fac te Pe tit g ntia nt in e rfo ive rm ne tify fer me an ss en if ru er 5. Strong support from the Government ce Id at d inst oth th ne r an o ve o Source: Failaka International Page 27 Page 28Copyright IBFIM @ 2008. All Rights Reserved
  15. 15. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Commodity Murabahah & Tawarruq Introduction Commodity Murabahah & Tawarruq Introduction 1. What is Tawarruq? 3. Is it permissible? 3 opinions: • Comes from the word al-wariq, meaning silver, because the one who buys the product is only buying for the sake of Dirham’s (originally, silver and coins) Opinion 1 • Majority of scholars say YES! Because Allah says (interpretation -” whereas Allah has permitted trading and prohibited riba”) 2. Tawarruq – In practice • Buying a commodity from a supplier on deferred payment basis, then the purchaser sells such commodity to a third party in cash • The purchaser is buying the commodity either to benefit from the commodity itself or to benefit from its price • This transaction involves three parties: a. The Trader (owner of the commodity) • Meets the needs of people for cash as compared to Qard Hassan. b. The purchaser (or the Mustawriq – the person who s engaging in this transaction of tawarruq to obtain cash) c. The second Purchaser ( who buys the said commodity from the Mustawriq) Page 29 Page 30Copyright IBFIM @ 2008. All Rights Reserved
  16. 16. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Commodity Murabahah & Tawarruq Introduction Commodity Murabahah & Tawarruq Introduction Opinion 2 Opinion 3 • Not permissible because: • Permissible subject to certain conditions: i. The aim is to take money for money and the commodity comes i. That the person be in need of money in between as a means of making the transaction permissible (hilah) ii. That he should not be able to obtain money in any other permissible manner ii. It leads to creation of huge debts in the Muslim society which is undesirable by Syariah and which cause instability in the economy iii. That he does not sell the purchased commodity to the same seller whom he bought it from for less price iv. There should not be any pre-arrangement or fictional device (hilah) in this transaction that might lead to riba Page 31 Page 32Copyright IBFIM @ 2008. All Rights Reserved
  17. 17. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Commodity Murabahah & Tawarruq Introduction Commodity Murabahah & Tawarruq Introduction Tawarruq via the Banks Tawarruq via the Banks 4. It involves an additional party (the Bank) so we have four parties: 1. Is the mode through which some Banks are facilitating the supply of cash to their clients i. The Trader (the original owner of the commodity and the first seller) ii. The Bank (the first Purchaser of the commodity and the second Seller of the said commodity) 2. It involves buying a commodity by the Bank (upon the request of the client) from a supplier, then selling the said commodity to the client on deferred iii. The Mustawriq, who is in need of cash (the second Purchaser of the payment basis, then the client resells such as commodity to a third party in Commodity and the third Seller) cash iv. The Third Purchaser (who buys the said commodity from the Mustawriq) 3. Is different than the original Tawarruq known to earlier scholars 5. It might involves authorizing the Bank to sell the commodity on behalf of the customer 6. It involves the Banks in a new business without full practice Page 33 Page 34Copyright IBFIM @ 2008. All Rights Reserved
  18. 18. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Commodity Murabahah & Tawarruq Introduction Commodity Murabahah & Tawarruq Introduction Tawarruq via the Banks 1. Murabahah: Definition 7. Banking Tawarruq is permissible subject to certain conditions: • Sale of goods at cost plus mark-up on a deferred basis i. The commodity is existed ii. The Bank has full ownership over the commodity with its rights and liabilities 2. Commodity Murabahah iii. The Bank acquires the commodity • A sale of certain specified commodity, on a cost plus profit basis iv. Upon the conclusion of sale with the customer, the customer has a full • Murabahah transaction is nested in Tawarruq concept ownership over the commodity with it rights and liabilities • Tawarruq – Purchase of commodity on deferred payment followed by v. The customer has the right to keep or sell the commodity selling of the commodity to a 3rd party vi. The customer is not allowed to sell the commodity back to the Bank Page 35 Page 36Copyright IBFIM @ 2008. All Rights Reserved
  19. 19. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Commodity Murabahah & Tawarruq Introduction Commodity Introduction liquidity management Islamic tools for Murabahah Islamic Treasury Operation 3. The users Bank A buys commodity from • Financial institutions providing Islamic services globally Broker A spot USD10 mil • Islamic Financial Institutions – full fledged Islamic banks and other banks with Islamic banking windows Bank A Broker A (excess) 4. What is it used for? Bank A sells commodity to Bank B deferred USD10 mil + profit • To facilitate liquidity management and risk management in the Islamic financial market Broker B Bank B (deficit) Bank B sells the commodity to Broker B spot USD10 mil Page 37 Page 38Copyright IBFIM @ 2008. All Rights Reserved
  20. 20. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Commodity Murabahah Islamic tools for liquidity management Introduction The way forward: Commodity Murabahah House Islamic tools for liquidity management Introduction Interbank Placement (CMH) Commodity Commodity Broker A Broker A Broker B 1 CPO Producer A 1 Bank A Bank A sells the Islamic Bank A 5 purchases commodities on commodities behalf of BNM CPO Producer B from Broker 2 Bank A 3 CPO Producer C Broker B CMH 3 2 4 (Trading & Commodity Bank A sells BNM pays to BNM 6 Bank A Islamic Bank B/ Clearing) commodities to Bank A on appoints credits the Client Payment BNM (at cost deferred Bank A as proceeds to (spot) 4 plus) basis (at an Agent to BNM Payment mark up sell the (placement) (deferred) price) commodity (net off) 1. CPO Producer sells commodity straight to Islamic Bank via Broker A 2. CMH guarantees the performance of CPO Producer BNM 3. Islamic Bank A sells commodity to its clients or another Islamic Bank B 4. The Client or Islamic Bank B appoints Islamic Bank A to sell commodity to CMH via Broker B Source: Bursa Malaysia Page 39 Page 40Copyright IBFIM @ 2008. All Rights Reserved
  21. 21. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Exchange Traded Fund (ETF) Introduction Exchange Introduction Fund (ETF) Traded ETFs Stocks Unit Trust Definition: Nature Units that represent Shares Units that represent underlying basket of stocks underlying basket of stocks 1. Simply understood as index fund which is traded like stock Traded on exchange YES YES YES Redemption Purchases and Sales of the Purchases and Sales of the Redemption with the fund 2. An open-ended investment fund that tracks a particular index funds’ shares only take shares take place in the place in the secondary secondary market market Diversification YES NO YES 3. It combines the characteristics of a closed-end fund and that of a share, i.e it is structured as a unit trust fund with the units listed and traded on the Price Transparency YES YES NO exchange similar to shares YES YES NO Traded through broker Management fees <1% 0 1-2% for index fund 4. However, it differs from share and unit trust fund in many ways Brokerage 0.6% 0.6% 0 Sales charge 0 0 3-5% Cash settlement T+3 T+3 Upfront Source: Bursa Malaysia Page 41 Page 42Copyright IBFIM @ 2008. All Rights Reserved
  22. 22. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Exchange Traded Fund (ETF) Introduction Exchange Traded Fund (ETF) Introduction Main Parties in an ETF Structure In-kind Creation and Redemption 1. Fund Manager • Managers and administers the ETF 1. In-kind Creation • Delivery of shares of underlying stocks in the ‘basket’ by Participating Dealer (PD) in exchange for new ETF units 2. Trustee • There is minimum creation size in terms of number of ETF units, or • Acts as custodian of ETF assets creation unit block • Safeguards interests of unit holders • Number of ETF units in circulation will increase 3. Participating Dealer (PD) / Liquidity Provider • Facilitates in-kind creation and redemption • Provides trading liquidity for listed ETF units Page 43 Page 44Copyright IBFIM @ 2008. All Rights Reserved
  23. 23. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Exchange Traded Fund (ETF) Introduction Exchange Traded Fund (ETF) Introduction In-kind Creation and Redemption Benefits of Investing in an ETF 2. Redemption 1. Convenience / Accessibility • Delivery of ETF units by Participating Dealer (PD) in exchage for • Multiple investments in a single transaction shares of underlying stocks in the ‘basket’ • Immediate effective ownership in basket of securities • There is a minimum redemption siza in terms of number of ETF units, usually the same as creation unit block 2. Risk Management / Diversification • Number of ETF units in circulation will decrease • Simultaneous exposure to basket of securities 3. Transparency • Constituent stocks, indicative NAV, unit price readily available Page 45 Page 46Copyright IBFIM @ 2008. All Rights Reserved
  24. 24. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Exchange Traded Fund (ETF) Introduction Exchange Traded Fund (ETF) Introduction Benefits of Investing in an ETF Risks of Investing in an ETF 3. Tradability / Liquidity 1. Market Risk • Units traded anytime during trading hours of the exchage • Performance of ETF or its underlying securities may be adversely affected by economic, political or other issues 4. Low transaction cost 2. Tracking error • Brokerage for single purchase/sale transaction • ETF performance may not closely track performance of underlying benchmark/index 6. Low Expense Ratio • Less frequent transactions • Lower fee for passive management Page 47 Page 48Copyright IBFIM @ 2008. All Rights Reserved
  25. 25. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Exchange Traded Fund (ETF) Introduction Exchange Traded Fund (ETF) Introduction Risks of Investing in an ETF ETFs in Malaysia 3. Discount or Premium 1. 3 ETFs currently listed on Bursa Malaysia Securities • ETF unit price on the exchange may be at discount or premium to its • 2 Equity ETFs, 1 Bond ETF NAV • Most recent launch is MyETF Dow Jones Islamic Market Malaysia Titans 25 – 1st Syariah ETF listed in Asia & currently largest Syariah ETF in the world 4. Manager skills • Manager may not manage in line with ETF objectives 2. Challenges • Investors’ understanding of products • Performance expectations • Competition from unit trust funds Page 49 Page 50Copyright IBFIM @ 2008. All Rights Reserved
  26. 26. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Exchange Traded Fund (ETF) Introduction Exchange Introduction Fund (ETF) Traded ETFs in Malaysia Global ETF Industry Number Share AUM (USD bn) Share 3. Moving forward US 601 51.3% 580.7 72.9% • Continuous investor education Europe 423 36.1% 128.4 16.1% Others 147 12.6% 87.5 11.0% • Additional participants (i.e. PDs, market makers) Total 1,171 100.0% 796.6 100% Growth rate 64% 41% Source: Morgan Stanley Investment Strategies, Bloomberg 1. Global average daily trading volume +143% in 2007 to USD 59.8 billion • S&P 500, the largest ETF at USD 99.2 billion, accounts for about 40% of average daily volume 2. ETF assets under management (AUM) forecast to exceed USD 2 trillion in 2011, implying CAGR of almost 26% over next 4 years Page 51 Page 52Copyright IBFIM @ 2008. All Rights Reserved
  27. 27. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Introduction Introduction Islamic Exchange Traded Fund (ETF) Islamic Exchange Traded Fund (ETF) 1. The first Islamic ETF may be that of Saudi NCB and Deutsche Bank iii. ETF securities can be traded if the assets they represent are tradable. launched in 2001 called Islamic Equity Builder The fact that the market value of an ETF may be higher or lower than the NAV of the underlying asset creates no Syariah problem 2. The ETF would be Syariah compatible if: i. The underlying asset is Syariah permissible. In the case of company iv. ETF’s can be bought at cash or on deferred payment basis, except for sharesthey have to be based on an Islamically acceptable index. The gold and silver ETF’s where a deferred price sale will not be purpose is to screen the sharesso as to select only the ones that acceptable satisfy the Islamic equity criteria v. For this kind of ETF’s (gold and silver) it is further required that ii. These shares must be held in a portfolio which is legally owned by the redemption must be affected in kind if so demanded by the investor investors Page 53 Page 54Copyright IBFIM @ 2008. All Rights Reserved
  28. 28. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Introduction Introduction Islamic Exchange Traded Fund (ETF) Islamic Exchange Traded Fund (ETF) Treatment of dividend Issuer • The Issuer is merely a manager or rather as an agent receiving fees 1. One difference between ETF’s and mutual funds is the fact that dividend received from constituent companies is not reinvested as this deviate • It is difficult for issuer to be Mudarib since definition of profit is not clear ETF’s from tracking the index. • Issuer must not guarantee the performance of ETF’s, but may occasionally 2. It remains nevertheless, that dividend is the entitlement of the investors. It provide liquidity facility to smooth the periodically payments, redemption or should not be confiscated by the manager even as a management fees purchase of new assets 3. In Islamic ETF’s dividend should periodically be distributed to ETF • Fees can be fixed or based on formula based. In all cases must be known securities holders. Only actual dividend received should be distributed. If or knowable. there is any interest earning in the dividend account it must be disposed off Page 55 Page 56Copyright IBFIM @ 2008. All Rights Reserved
  29. 29. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Introduction Key Takeaways… Introduction Islamic Exchange Traded Fund (ETF) 1. Investment climate has evolved from a very simple structure to a more Purification complex and problematic • The Islamic equity investment criteria require purification of the portfolio 2. From Islamic perspective any investment can be Syariah compliant if all the from impure income earned by constituent companies in the underlying requirements of Syariah are fulfilled index 3. Malaysia is distinct: • It always recommended that such purification is done by the manager. • Clear national strategy However, this makes it difficult for the ETF’s to track the index. Many Syariah boards have permitted that manager only inform investors of the • Clear integrated regulatory and Syariah framework – Syariah amount they need to dispose off to purify their investment. harmonisation is reality • Mandate for legal clarity – common law provides supportive legal environment • Deepening support infrastructure • Defined means for global outreach Page 57 Page 58Copyright IBFIM @ 2008. All Rights Reserved
  30. 30. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Key Takeaways… Introduction 4. Scholars and bankers require more interactive dialogue on a deeper level 5. “ Do not permit an error of opinion to be come a tradition for the community” Thank you Page 59Copyright IBFIM @ 2008. All Rights Reserved
  31. 31. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Introduction DerivativesIntroduction overview - An What is derivatives? Hedging Mechanism for Islamic Capital 1. A derivative security is a financial asset whose value is dependent on the value of underlying asset. Market Products & service 2. The underlying asset could be a basic financial asset such as commodity, currency, common stocks, bonds, index or the combination of such assets. By ZAIRULNIZAD SHAHRIM 3. Common forms – Forwards, Futures, Options, Swaps 29th April 2008 and also some exotics such as Swaptions 4. Derivatives enable the avoidance of unnecessary risks Page 1 Page 2Copyright IBFIM @ 2008. All Rights Reserved 1
  32. 32. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM DefinitionsIntroduction DefinitionsIntroduction 1. Hedging – Reducing a firm’s exposure to price or 4. Futures contract – A forward contract with the rate fluctuations. Also known as immunization feature that gains and losses are realised each day rather than only on the settlement date 2. Derivative – A financial asset that represents a claim to another financial asset 5. Option contract – A contract that gives the buyer/owner the right to buy/sell some asset at a 3. Forward contract – A legally binding agreement fixed price on or before a given date between two parties calling for the sale of an asset/product in the future at a price agreed upon today Page 3 Page 4Copyright IBFIM @ 2008. All Rights Reserved 2
  33. 33. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM DefinitionsIntroduction Benefits of Introduction derivatives 6. Strike price – The fixed price specified in an option 1. Hedging purposes contract at which the holder/owner can buy/sell the • Risk management tool underlying asset. Also known as the exercise price 2. Profit from both bull and bear markets 3. Leverage / Gearing 7. Swaps – Agreement to exchange two securities/currencies/commodities Agreement to • The use of leverage will magnify the effect of a given exchange two securities/currencies/commodities price change • Small investment (premium) to own the right to purchase stocks. • The potential loss is capped at premium paid 4. Transaction cost savings e.g SSF Page 5 Page 6Copyright IBFIM @ 2008. All Rights Reserved 3
  34. 34. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Risk management for Islamic instruments Introduction Risk management for Islamic instruments Introduction 1. Risk management is more critical in Islamic finance Some of Islamic risk management tools are as follows: simply because: 1. Option in equities • The nature of contracts • Generally acceptable based on ‘urbun’ however • Real economic transaction the trading part is still questionable by some Shariah scholars 2. It is important to ensure the risk management tools also must be equally Shariah compliant 2. Profit rate swap 3. Types of risk • Permissible using murabahah transaction for both • Market risk • Rate of return risk fixed and floating mark-up • Operational risk • Equity investment risk 3. Forward sale • Permissible under the principle of salam. Page 7 Page 8Copyright IBFIM @ 2008. All Rights Reserved 4
  35. 35. Risk Management and New Products Development in Islamic Finance 29 April 2008 IBFIM Risk management for Islamic instruments Introduction Hedging Products Introduction 4. Short-sale Syariah Compliant Hedging Instruments: • Using salam contract is permissible, however the usage of salam to replicate short-sale function in an 1. Futures contracts Islamic hedge fund using both long and short sale is disputable 2. Forward contracts 5. Futures contract 3. Swap Agreements • Uncertainty is removed through standard contract and clearing house to ensure delivery 4. Structured Products Page 9 Page 10Copyright IBFIM @ 2008. All Rights Reserved 5

×