Bahraini body endorses Malaysian derivatives

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.” 

Malaysia’s CIMB Islamic, RHB Islamic Bank Bhd and Bank Islam Malaysia Bhd are already offering profit-rate swaps in the Southeast Asian nation to their own specifications, which are approved by the central bank. The fragmented market makes it difficult for investors and lenders to decide on which contracts to adopt, Hang Tuah Amin Tajudin, vice-president of Kuala Lumpur-based OCBC Al-Amin Bank Bhd, said in an interview yesterday. 

“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
 
http://www.btimes.com.my

Global Islamic hedging agreement is launched

MANAMA: The International Islamic Financial Market (IIFM) and the International Swaps and Derivatives Association, (ISDA) yesterday launched the ISDA/IIFM Tahawwut (Hedging) Master Agreement at a meeting in Bahrain.

The development is a breakthrough in Islamic finance and risk management, and marks the introduction of the first globally standardised documentation for privately negotiated Islamic hedging products.

The agreement is the first financial industry framework document that is applicable across all jurisdictions where Islamic finance is practised.

The launch of the agreement was officially announced at an event in Bahrain hosted by IIFM and ISDA under the patronage of Central bank of Bahrain Governor Rasheed Al Maraj.

"Given the growing nature of the Islamic finance industry, the institutions operating on Sharia principles can no longer afford to leave their positions un-hedged," said IIFM chairman and CBB executive director of banking supervision Khalid Hamad.

"Hence, some key hedging products are now becoming common across jurisdictions to mitigate risk.

"The ISDA/IIFM Tahawwut Master Agreement gives the industry access to a truly global framework document which is neutral in terms of treatment to both the transacting parties and at the same time strictly conforms to Sharia principles.

"IIFM is honoured to have achieved this milestone in collaboration with ISDA and I am confident that such joint efforts will continue in the future," he added.

"Demand for customised, privately negotiated hedging tools that conform to the principles of Islamic finance has increased in momentum," said ISDA chairman and managing director and head of fixed income for the EMEA region for Credit Suisse Eraj Shirvani.

The agreement provides the structure under which institutions can undertake Islamic hedging transactions such as profit-rate and currency swaps, which are estimated to represent most of today's Islamic hedging transactions.

It is designed to be used between two principal counterparties as a master agreement. Parties understand that no interest shall be payable or receivable and no settlement based on valuation or without tangible assets is allowed.

Moreover, the counterparties to the agreement make representations as to the fact that they enter into Sharia-compliant transactions only.

Link: http://www.gulf-daily-news.com/NewsDetails.aspx?storyid=271971

‘Hedging permissible in Islamic finance’

Hedging is permissible in Islamic finance and the industry should not look at banning derivatives, says a Shariah scholar. Dr Mohammed Daud Bakar said that Islamic finance cannot depart from risk management for both pre and post transactions.

"We can have Islamic hedges, but we cannot allow Islamic speculators. Hedges are permissible," he said at the 5th International Islamic Finance Forum Asia 2009 in Kuala Lumpur last week. Mohd Daud, who runs Amanie Business Solution Sdn Bhd and chairs the Shariah Advisory Council (SAC) of Bank Negara Malaysia (BNM), was one of the panelists at the two-day conference organised by Informa Finance. He said that hedging is important as institutions need to hedge against the real risk faced in day-to-day transactions.

"We cannot ban Islamic derivatives. They are required. Some speakers tend to give extreme examples of CDS — (as) one of the reasons that brought down some large financial institutions in the US (in arguing against allowing hedging in Islamic finance). "But CDS is a remote example. It is not reflective of derivatives on the whole," he told the conference. Credit default swaps, or CDS, became a buzzword in the financial market following the spectacular collapse of a number of big names in the US during the financial crisis. Hedging risk is one of the typical concerns at a bank, including Islamic financial institutions. They go hand in hand with the management of risks concerning liquidity and also that of asset and liabilities management.

Treasury risks include risks arising from the management of the financial resources of financial institutions in terms of cash management, equity management, shortterm liquidity management as well as asset and liabilities management. In an earlier paper at another event, Mohd Daud touched on the Shariah perspective of the economics of hedging. He noted that the principles of capital protection, risk management and risk hedging are essentially acceptable to the general principles of Islamic law as long as they are free from (a) taking and paying interest, (b) uncertainty in pricing, subject matter and other relevant aspects in a contract (gharar); and, (c) any element/clause/practice which contradicts the very purpose of an underlying contract (e.g. capital guarantee in investment contract).

Although these economic objectives may be acceptable under Shariah law, the mechanism to achieve the desired objective must be equally compliant, he added. Mohd Daud was one of the panelists examining the risk return potential of derivatives and hedge funds in the Islamic finance market. The session was moderated by head for product development of Bursa Malaysia Bhd's Islamic capital market Norfadelizan Abdul Rahman. Other panelists were Singapore-based AFG Capital Management managing director Kevin Ho and Thomson Reuters global head of Islamic finance Rushdi Siddiqui.

In another panel session entitled "Positioning Islamic finance to tap into new non-Islamic markets" moderated by The Malaysian Reserve's associate editor Habhajan Singh, the panelists were Rushdi, Kuwaitbased Rasameel Structured Finance vice chairman and CEO Issam Al-Tawari and Citi head for regional Islamic structuring at fixed income, currencies and commodities Ahmad Shariman Mohd Shariff. The conference was officiated by Accounting and Auditing Organisation for Islamic Financial Institution's (AAOIFI) secretary general Dr Mohamad Nedal Achaar. Among top local Islamic bankers attending the two-days conference were Kuwait Finance House Malaysia acting CEO Ab Jabbar Ab Rahman, Unicorn International Islamic Bank Malaysia Bhd (Unicorn Malaysia) CEOKhalid Mahmood Bhaimia and CIMB Islamic Bank Bhd CEO Badlisyah Abdul Ghani.

Link: http://islamicfinanceasia.blogspot.com/2009/07/hedging-permissible-in-islamic-finance.html

Experts push alternative asset classes

Islamic finance experts on Tuesday advocated the development of alternative asset classes in the sector, including Islamic exchange-traded funds (ETFs), hedge funds and the securitisation of gold.

Speaking at the International Islamic Finance Forum (IIFF) in Dubai, Muhammad Daud Bakar, one of the world's eminent Sharia-supervisory board members, said that assets classes had become more sophisticated in line with the development of the Islamic finance sector.

"Investors are always looking for more diversification, be it in real estate, equities, gold and silver," said Bakar.

"[In the sector] we started off with Sharia-compliant stocks, then set up mutual funds, then private equity funds, and we have now moved to the products of ETF which have been launched in Bahrain and Malaysia."

Islamic ETFs, Sharia-compliant unit trusts or mutual finds that are listed and traded on an exchange, have been launched over the past year. ETFs in general have gained popularity in recent years, in part thanks to the low fees.

Eric Mayer, Shariah Capital chief executive, said that in order for ETFs to be recognised in the global markets, size of forthcoming ETFS must be at least $500 million.

"If you're going to try and build a best-of-breed hedge fund or ETF, you need leading Sharia scholars," said Meyer. 

"You have to get hold of prime brokers, work in offshore jurisdictions, need to get the leading fund-managers, and finally you need an anchor tenant - like sponsorship from a leading financial institution."

Both Mayer and Bakar both spoke about the development of Islamic hedge funds, and about misconceptions within the industry about their Sharia compliance.

"I think hedging has been misunderstood by many people who are dealing with this instrument - but in my opinion, it can be a good way of locking into price," said Bakar.

"A short sale took place 1,400 years ago, where both partners were selling something they did not own, but both of them were in agreement about taking the risk. The price could go up or could go down."

Mayer also said that Islamic hedge funds, despite the various Sharia restrictions, do have a place in the market and are being developed.

"Hedge names have a terrible name on the street, on the high street and on Wall Street," said Mayer. "I feel hedge funds are no different than an old Islamic merchant guild - it is all in the rules."

Though some Islamic hedge funds have been launched in recent years, they have failed due to their relatively small size and cost, Mayer said.

"Previous Islamic hedge funds have failed because they don’t have a prime broker based in New York - that's where the biggest players are in hedge funds," said Mayer, of the US-based firm. "If you can't get the cost comparable to a Western fund, you'll have problem."

The Islamic finance sector should also take further notice in gold as an investment asset class, said Ian C. MacDonald, executive director of gold and precious metals at the Dubai Multi Commodities Centre (DMCC).

"Gold has become the third reserve currency of the world again having been asleep in the 80s and 90s," said MacDonald, who also called the commodity an alternative to the US dollar. 

"Gold production is declining in the world. It does protect against inflation and particularly gold will perform well in financial crises that is going around the world."

MacDonald said that the DMCC, owned by the Dubai Government, has introduced Sharia-investment products which securitise commodities like gold, and said that more sophisticated products were in development.

Link: http://www.arabianbusiness.com/516664-experts-urge-creation-of-alternative-asset-classes