Bahraini regulators are for the first time endorsing a derivatives market started in Malaysia to hedge movements in Islamic borrowing costs, removing an obstacle to growth in the US$1 trillion industry.
The International Islamic Financial Market in Manama will issue a global standard on so-called profit-rate swaps in the first quarter, backing an effort by some Malaysian lenders who introduced the product as early as 2004. The contracts, the syariah-compliant equivalent of an interest-rate swap, will make the market more efficient, Ijlal Alvi, chief executive officer of the standardisation body, said yesterday in an interview.
While some Islamic scholars have argued that the swaps may conflict with syariah law, which prohibits the payment and receipt of interest, the lack of tools for investors to hedge risk is raising costs and leaving businesses exposed to market swings, according to Kuala Lumpur-based CIMB Islamic Bank Bhd.
“It’s scary to think that the Islamic financial market is not effectively managing risk,” Badlisyah Abdul Ghani, the chief executive officer of CIMB Islamic, a unit of CIMB Group Holdings Bhd, said in a November 9 interview. “This means that players are having open positions that may have a negative impact on their business and the industry as a whole.”
The International Islamic Financial Market in Manama will issue a global standard on so-called profit-rate swaps in the first quarter, backing an effort by some Malaysian lenders who introduced the product as early as 2004. The contracts, the syariah-compliant equivalent of an interest-rate swap, will make the market more efficient, Ijlal Alvi, chief executive officer of the standardisation body, said yesterday in an interview.
While some Islamic scholars have argued that the swaps may conflict with syariah law, which prohibits the payment and receipt of interest, the lack of tools for investors to hedge risk is raising costs and leaving businesses exposed to market swings, according to Kuala Lumpur-based CIMB Islamic Bank Bhd.
“It’s scary to think that the Islamic financial market is not effectively managing risk,” Badlisyah Abdul Ghani, the chief executive officer of CIMB Islamic, a unit of CIMB Group Holdings Bhd, said in a November 9 interview. “This means that players are having open positions that may have a negative impact on their business and the industry as a whole.”
“An internationally recognised agreement will be of great help as the lack of such a document has been a drag on the Islamic derivatives market,” said Hang Tuah. “It will make it easier for banks to manage counterparty risk.”
The swaps provide protection from fluctuations in prices of assets that back Islamic bonds, or sukuk, which pay a profit rate rather than interest. The contracts are only for hedging and cannot be used for speculative investment, which is forbidden under syariah law. Derivatives are products whose value is derived from stocks, bonds, loans, commodities and currencies, or linked to specific events such as changes in weather or interest rates.
“In Islamic finance, the risk isn’t detached and traded separately as is the case in conventional derivatives,” said the International Financial Market’s Alvi.
Some scholars say it’s difficult to ensure the swaps aren’t used for speculation, Asyraf Wajdi Dusuki, head of research affairs at the Kuala Lumpur-based International Syariah Research Academy, said in an interview yesterday. The agency was set up by Bank Negara Malaysia in 2008 to promote growth in finance that complies with Islam’s ban on interest.
The Kuala Lumpur-based Islamic Financial Services Board, a global standards-setting body, estimates that the syariah- compliant industry has grown 20 per cent annually since 2000 and will reach US$2.8 trillion by 2015.
Global sales of sukuk climbed 44 per cent to US$20.6 billion this year, compared with US$14.3 billion in the same period of 2010, according to data compiled by Bloomberg. The bonds have returned 6.8 per cent in 2011, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index, while debt in developing markets gained 8.3 percent, JPMorgan Chase & Co’s EMBI Global Diversified Index shows.
Average yields on Islamic bonds were little changed at 3.79 per cent yesterday, 41 basis points off a six-year low reached on August 4, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index.
Indonesia sold US$1 billion of Islamic bonds yesterday at half the rate of its 2009 debut. The 2018 dollar securities were sold at 4 per cent, data compiled by Bloomberg show. The nation issued US$650 million of five-year sukuk in April 2009 at 8.8 per cent.
The yield on the 8.8 per cent notes due April 2014 rose four basis points to 3.40 per cent today, according to Royal Bank of Scotland Group Plc prices.
The Bloomberg Malaysian Sukuk Ex-MYR Index, which tracks government and corporate foreign-currency bonds listed in Malaysia, the world’s biggest market for sukuk, dropped to 104.3680 yesterday. The gauge has gained 5.9 per cent this year.
Demand for profit-rate swaps is growing, especially in the more advanced Islamic markets such as those in the Middle East, said Abdul Kadir Hussain, chief executive officer at Mashreq Capital DIFC Ltd in Dubai.
“It is still a very nascent sort of idea,” Hussain said in an interview yesterday. “As you get more and more of these fixed-rate securities come out, it makes sense for both issuers and investors to potentially look at swapping into floating rates or vice-versa. It is just an outgrowth of the fact that the underlying basic issuance market is increasing.”
The Asia-Pacific region was the biggest market for derivatives in the first half of this year and accounted for 40 per cent of the global total, according to data from the Washington-based Futures Industry Association published in September. That compares with North America’s 33 per cent market share. The instruments contributed to the global financial crisis, which resulted in US$1.6 trillion of credit losses and write downs.
London-based Standard Chartered plc started offering Islamic swaps based on commodities in the Persian Gulf in March 2010, Azrulnizam Abd Aziz, chief executive officer of the lender’s unit in Kuala Lumpur, said by e-mail yesterday. The bank introduced the instruments in Malaysia in April.
The new standard for Islamic swaps from the International Islamic Financial Market will encourage the development of more Shariah-compliant derivatives such as cross-currency swaps, according to Suzaizi Mohd Morshid, head of treasury at RHB Islamic Bank in Kuala Lumpur.
“They are a natural requirement for hedging and it’s more relevant when Islamic assets and liabilities grow,” Suzaizi said in an interview yesterday.
CIMB’s Badlisyah said documentation isn’t the main hurdle to growth in Islamic hedging instruments.
“Misconceptions of hedging and the lack of an internal framework to facilitate hedging transactions are the main deterrents,” he said. “There’s still a barrier to acceptance.” -- Bloomberg
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