Allen & Overy Islamic Derivatives Seminar Richard Tredgett, Andrew Sulston & Nick Williams, Partners...

Allen & Overy Islamic Derivatives Seminar

Richard Tredgett, Andrew Sulston & Nick Williams, PartnersPriya Uberoi & Ian Carnochan, Senior Associates

28 November 2008

Order of Seminar

1. Islamic Finance – An Introduction

2. Islamic Hedging and Risk Management (Ta’hawut)

3. Sharia-compliant Funds and Hedge Funds

4. ISDA / IIFM Ta’hawut Master Agreement

5. Conclusion

Islamic Finance – An Introduction

Priya Uberoi, Senior Associate

So what is Islamic Finance?

Isn’t it just a lot of funny sounding words and over-complicated

structures?

Body of institutions and commercial and financial arrangements which adhere to the core tenets of Islamic law (Sharia)

The idea of Sharia-compliant financing has been prevalent for over 1,400 years (at the advent of Islam), slowly evolving over the centuries

Phase of more dramatic growth can be traced back to the founding of the Islamic Development Bank (some 30 years ago) and more recently the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the International Islamic Financial Market (IIFM)

Background

Growth so far……….

The industry has been growing at around 10% per annum (FSA) for the last decade with Allen & Overy helping to lead the way

Over the last five years, Islamic banking assets have been growing at a rate of just under 20% p.a. (Financial Times)

Steady rise in Sukuk issuance from $500mln in 2002 to $60bln in 2007 (Standard & Poor’s)

Balance sheets of Islamic banks grew by 40% in 2007 (Euromoney)

Estimated 300 Islamic Financial Institutions holding $700bln of assets under management and the industry could control $4trln of assets by 2010 (The Economist)

A Global Rapidly Expanding Industry

Many banks are establishing Islamic banking operations, joint ventures and subsidiaries in the Middle East (e.g. Deutsche Bank)

Ever increasing range of Sharia-compliant indices produced by Dow Jones, FTSE, Standard & Poor’s and MSCI

The industry has increasingly international appeal (significant recent developments in traditionally non-core markets including the UK, Turkey, Egypt, Pakistan, Morocco and Tunisia)

Estimated 1.2 – 1.5bln muslims globally, 20% of world’s population

UK government support - HM Treasury's Islamic Finance Experts Group was established in April 2007 to advise the government on supporting the development of Islamic finance in the UK, and cementing London as a global Islamic finance industry hub.

The Vital Statistics The Islamic finance industry is already a $1trln industry (Global

Investment House)

Industry growth estimates predict 15-25% annual growth over the next five years (Risk Magazine and The Economist)

The global Sukuk market is valued at $70bln and is expected to top the $160bln mark by the end of the decade (Standard & Poor's)

Over $1trln in projects in the Middle East already in the pipeline

Middle Eastern investors estimated $1,200bln of investment in international assets in recent years (HSBC)

Despite oil prices tumbling 56% from a record $147.27 on July 11 (Bloomberg), oil at $50 is enough to sustain growth (Saudi Arabian Monetary Agency) and the Middle East region is expected to earn $20trln of oil revenue in coming years and as much as a third of this may be invested in the Islamic finance sphere (Financial Times / KPMG)

The Sovereign Wealth Funds

The Sovereign Wealth Funds (SWFs) in GCC at present collectively manage $1.5trln assets

SWFs of the GCC states hold assets estimated at (IMF, 2008): UAE – $875bln Saudi – $289bln Kuwait – $213bln Qatar – $50bln Oman – $2bln Bahrain – $10bln (Sovereign Wealth Fund Institute)

Projections suggest that foreign assets under management of SWFs could reach $6-10trln by 2013 (IMF, 2008)

Sovereign Wealth Funds and recent market turmoils While SWFs do not want to be seen as white knights, they are not sitting on the sidelines

(Financial Times)

The Qatar Investment Authority and Abu Dhabi’s ruling family have together recently invested £5.8bln in Barclays Plc, representing a stake of over 30% (Financial Times, Reuters)

The Abu Dhabi Investment Authority, which in November 2007 bought a $7.5bln stake in Citigroup, is already eyeing attractive US assets (Reuters), KKR has appointed Lehman’s ex head of sovereign wealth to push into the Middle East (Financial Times), Prudential is in talks with two SWFs over the sale of a 20% stake in the insurer (The Independent)

“The Gulf states will have a vital role to play in agreeing the plans to get the world economy moving again…. they are increasingly important source of inward investment in the UK” (Gordon Brown)

The US would welcome investment from SWFs (Deputy US Treasury Secretary – Robert Kimmitt), France’s state-owned finance house wants SWFs to become co-investors in a new investment fund used to fend off foreign predators (Reuters)

Although SWFs are expected to become more cautious and conservative about their investments, and more likely to shop around and hold out for bargains, they will be looking for opportunities (Financial Times)

Sharia Fundamentals

Sharia carries ethical, social, political and religious dimensions that informs its structure

It is derived from a number of primary (Quran, Sunnah and Hadith) and secondary sources (Ijtihad, Ijma and Qiyas)

Not a codified body of law

There are a number of schools of jurisprudence (Madhabs)

There are a number of core tenets of Sharia which must be considered in the context of financial transactions

Tenets of Islamic Economic Thought

1. Riba - Prohibiting the receipt and payment of interest - the return of an investment should be linked to profits actually generated

2. Gharar - Avoiding uncertainty - e.g., traditional insurance, indemnities, options, need to be adapted

3. Maisir - Discouraging speculative behavior - e.g., speculation, gambling, games of chance

4. Sharik - Advocating risk sharing – investors should earn returns by sharing profits and assuming the risk of any loss

5. Haraam/Halal - Prohibiting haraam activities - e.g., activities that are strictly forbidden under Sharia, such as financial investments in alcohol, pork related activities, tobacco, gambling and pornography

6. ‘Aqd - Maintaining the sanctity of contracts

For example, a conventional cross-currency swap would infringe the tenets of:

Riba

Gharar

Maisir

In the Context of Derivative Transaction

So how do we approach this as lawyers?

It is all about innovation

Using knowledge of both:

1. classical Islamic financial and commercial arrangements; and

2. conventional products,

to create new structures that replicate the returns of conventional products but in a way that does not offend the tenets of Sharia.

Sharia Scholars & Boards

The Scholars

Small number of scholars specialising in the application of Sharia who have played a significant role on the offshore structures to date

There is a wide range of views and scope for uncertainty

Notable scholars include:

Sheikh Taqi Usmani (Pakistan)

Sheikh Nizam Yaquby (Bahrain)

Sheikh Hussain Hassan (Dubai)

Dr. Mohammed Ali Elgari (Saudi Arabia)

Dr. Abus Sattar Abu Ghuddah (Syrian based in Saudi Arabia)

Dr. Muhammad Imran Ashraf Usmani (Pakistan)

Dr. Mohd Daud Bakar (Malaysia)

Sheikh Yusuf Talal De Lorenzo (USA)

Sharia Scholars & Boards Role of Scholars

Islamic institutions place reliance on their opinions (fatwas) in determining whether transactions are in compliance with Sharia

Weight is given to the identity of the scholars

Prior to launching a transaction, the scholar/board will issue a fatwa confirming that the transaction adheres to the tenets of Sharia (this fatwa may be disclosed)

Appointing and Dealing with Scholars and Sharia Boards Scholars may be employed on a transaction by transaction basis or through the establishment of a

Sharia board

Establishment of a Sharia board can provide greater comfort to Islamic investors or counterparties

Based predominantly in the Middle East and Pakistan

Typically three scholars on retainer

Typically commercially astute and have exposure to issues through acting on several Sharia boards for various banks (often with educational background in Western economics or finance)

Involved whilst settling the term sheet and in reviewing the penultimate draft of documents

Typically contact is through telephone, fax and email but meetings also usually required

Typically a renowned scholar can earn up to $250,000 on a capital markets deal

Fatwa One, some or all parties to a transaction may or may not be bound by the fatwa

Not all aspects of the transaction necessarily have to be covered by the fatwa

No precedent system for fatwas (save for public deals)

Legal documents are usually drafted to be governed by either English or New York law

Questions of enforceability of obligations are dealt with according to the applicable national law

With exceptions (Sudan, Iran and Saudi Arabia), Sharia is not the national law

As Sharia is not the governing law of the documentation, being bound by Sharia is essentially elective and seen as an extra layer of compliance

The Shamil case affirms that English courts will only ever seek to interpret English law and will not interpret Sharia

It is for each party to satisfy itself that a transaction is compliant with Sharia

Subsequent ruling by scholars that a transaction does not comply with Sharia will not affect its enforceability under the applicable national law

Documentation and Enforceability

Islamic Hedging and Risk Management (Ta’hawut)

Andrew Sulston, PartnerPriya Uberoi, Senior Associate

Ian Carnochan, Senior Associate

Islamic Hedging and Risk Management

Given the core Sharia tenets one might conclude that derivative transactions may contravene the prohibitions of gharar (uncertainty), maisir

(speculation) and riba (interest)

Islamic Hedging and Risk Management However, market witnessing embryonic stage of an OTC Islamic derivatives

market

In November 2006 Bank Islam Berhad and Bank Mumalat Malaysia Berhad agreed to execute a pro-forma derivative Master Agreement for documentation of Islamic derivative transactions

ISDA/IIFM joint initiative to develop a Sharia-compliant Master Agreement. ISDA (International Swaps and Derivatives Association) IIFM (International Islamic Financial Market)

Most common forms of derivative transactions used by Islamic banks and corporations are cross-currency swaps, profit rate swaps, total return swaps and fund index-linked derivatives

In recent years, some Sharia scholars have gradually accepted the use of hedging as a tool of prudence and risk management

“There are a few instruments which have been ‘tamed’ and designed to be alternatives (to) conventional derivatives. These are relatively new and we have to look into them” (Sheikh Nizam Yaquby)

Given current market volatility, producers, consumers, counterparties and scholars are more aware of the need of hedging market risk and demand for such products is growing accordingly

Through innovative structuring of traditional Islamic products (e.g. Murabaha, Wa’ad, Arbun and Salam) we can replicate conventional derivative cash flows in order

to generate a similar economic profile in a Sharia-compliant manner and actually increase the range of asset classes traditionally not available to the Islamic

investor

Islamic Hedging and Risk Management

Murabaha – cost-plus financing

Ass

ets

Assets

STEP 3

Buyer settles price at end of an agreed period in

one lump-sum or in instalments

BUYER

(COUNTERPARTY)

SELLER

Price $(x+y)

STEP 1

Financier buys Assets

from Seller for $x

STEP 2

Financier sells Assets

to Buyer for $(x + y)

(where y is the pre-agreed

profit element)

Pri

ce $

x

FINANCIER

(BANK)

* Islamic finance is based on real assets

Conventional Cross-Currency Swap (IDR / USD)

Islamic Counterparty = Paying IDR and Receiving USD Bank = Paying USD and Receiving IDR

BANK ISLAMIC COUNTERPARTY

1 Initial ExchangeIDR 350 at inception

USD 100 at inceptionInitial Exchange

2

IDR interest quarterly (Interim Amount)

IDR 350 at maturity (Final Amount)

USD 100 at maturity(Final Amount)

USD interest quarterly (Interim Amount)

Islamic Cross-Currency Swap (IDR / USD)

To cash account of the Islamic Counterparty

with Bank

Seller

Buyer

immediately Sells Metals at IDR 350

3

CASH ACCOUNT

ISLAMIC COUNTERPARTY

SUPPLIER

BANK

Seller

Deferred Payment at IDR 665 in 40 instalments

Buyer

COMMODITY BROKER

Re-sells

Metals at IDR

350

9

An amount from the Islamic Counterparty’s own funds in USD/IDR

to be used to fund Reverse Murabaha + an amount in IDR as

collateral

5

Proceeds in USD for Islamic Counterparty’s own

use4

Deferred Payment at USD 190 in 40 instalments

After instructions to Bank to act as

Collateral Manager for the Islamic

Counterparty under the Reverse Murabaha

Immediately following

Sharia-compliant

Separation between Murabahas Islamic Counterparty = Paying IDR and Receiving USD

Bank = Paying USD and Receiving IDR

Sells Metals at cost price (IDR 350)

1

2 Term Murabaha

On-Sells Metals at IDR 350

8

On-Sells Metals at USD 100

Reverse Murabaha

Buys Metalsat Cost Price from own

funds

6

Sells Metals at Relevant Amount

7

Conventional Interest Rate Swap

FLOATING RATE PAYER

FIXED RATE PAYER

Series of fixed rate payments

Each of the fixed and floating rate payments is made by reference to a preagreed notional amount

Series of corresponding floating rate payments

Islamic Profit Rate Swap

BANK

SUPPLIER

COLLATERAL ACCOUNT

Cashflow = Aggregate Deferred Sale Price = Cost price + Fixed Profit portion

Sells Comm

odities

Term Murabaha

Del

iver

s C

omm

oditi

es

Cos

t Pri

ce

Security for taking credit risk on the

Counterparty

$

FIXED RATE PAYER

Sells Commodities

Sells Commodities

FLOATING RATE PAYER

Revolving Murabahas to match the periodic payment dates under the

Term Murabaha

(NB. The full commodity value payable should mirror the corresponding Cost Price payment under the Primary Murabaha)

Cashflow = Full commodity value + floating rate profit

portion (linked to LIBOR) payable at the

end of each revolving Murabaha

SUPPLIER

UK Tax - Introduction

UK government’s aim for Sharia-compliant products to be taxed in the same way as equivalent financial products

UK tax legislation "Alternative Finance Arrangements" Description of certain types of structures (Murabaha,

Diminishing Musharaka, Sukuk, Mudaraba, Wakala) Other requirements

UK tax consequences Loan Interest

UK Tax – Profit Rate Swap

Purchase and Resale (Murabaha) One of parties has to be a financial institution Difference between sale price and purchase price =

return on an investment of money at interest UK tax consequences if an alternative finance

arrangement within the UK tax rules? Taxed as loan relationship Interest - withholding tax

If not treated as an alternative finance arrangement? General UK tax principles Non-UK parties with UK agent?

Conventional Credit Default Swaps

Recent excitement in market to produce a Sharia-compliant credit default swap (CDS)

Attempts have been made to create this product What is a conventional CDS?

CDS is contract whereby a Credit Protection Buyer purchases credit protection from a Credit Protection Seller on a third party Reference Entity / Reference Obligation

CDS can be either cash / physically settled The Credit Protection Buyer pays a premium to the

Credit Protection Seller in return for a payment that is triggered on the occurrence of a set of pre-defined Credit Events

First Method Capped indemnity structure Whereby an Islamic institution sold credit protection to a bank on

Reference Obligations under a capped indemnity

Problems

a. Credit Protection Buyer has to suffer an actual loss, whereas in a conventional CDS no loss is necessary to trigger a payment

b. The amount of the credit protection has to be “capped” to ensure compliance with Sharia, as cannot have an unlimited Indemnity, principal of gharar – avoiding uncertainty

c. Insurance re-characterisation concerns

Second Method Cash settled CDS based on a bespoke A&O Sharia-compliant Master

Agreement Working with clients to come up with alternatives as to how to produce

an Islamic CDS

Islamic Credit Default Swaps

Reverse Convertible Structure

Bank Investors/CertificateHolders

SUPPLIER

Markets

Sells into the market

SPV uses £ to purchase Shares in e.g. BA

3

Shares4

Sells Commodities

Reverse Murabaha7

Receive £ for Commodities on a deferred basis

8

Commodities6 Murabaha

SPV uses £ from dividends to purchase Commodities at spot market rate

5

Trust Certificates

1

£2

Coupon payments (converting conventional cash flows into Sharia-compliant cash flows - matches deferred basis income stream from the Reverse Murabaha)

9

SPVSPV receives dividends on

shares

What are Sharia-compliant (Halal) Shares?

Easy answer - Shares listed on the DJIMI (Dow Jones Islamic Markets Index)

One example of how the DJIMI categorises a share as being “non haraam” employs specific screens

a. Industry Screen (Sin Screen) - excludes shares in companies that deal in haraam activities e.g. gambling, insurance, casinos and pornography

b. Debt Equity Screen - excludes shares in companies whose total debt comprises 33% or more of its balance sheet

Many other types of screens that organisations use to categorise whether shares are haraam or halal

Wa’ad Structure

Literally means “promise”

Can be regarded as a unilateral undertaking by one party to do or not to do certain actions in the future

Does not bind anyone but the promisor (i.e. the party giving the undertaking)

Contrast this with a bilateral contract (aqd’) which binds both parties to the contract

English law, draft under deed poll: lack of consideration

Wa’ad Structure

Binding nature and enforceability is a subject of debate amongst scholars

Sample of views:

Group A Imam Abu Hanifah, Imam Al-Shafai’, Imam Ahmad and some of the Maliki Jurists

Fulfilling a promise is noble but it is neither mandatory nor enforceable through a court of law

Group B Samurah b. Jundub, Umar b. Abdul Aziz, Hasan Al-Basri, Said b. al-Ashwa’, Ishaq b. Rahwaih, Imam Al-Bukhari and some Maliki Jurists

Fulfilling a promise is mandatory and the promisor is under a moral as well as a legal obligation to honour his promise

Group C Some Maliki Jurists, Islamic Fiqh Academy (IFA) A promise is not binding under normal circumstances but becomes binding where the

promisor has caused the promisee (i.e. the party having the benefit of the undertaking) to incur certain expenses or undertake work or any form of liability

Single Wa’ad (FX Put Option)

Bank(Seller)

Customer(Buyer)

Purchase price in currency 2(Payable on Settlement Date)

Specified amount of currency 1(Payable on Settlement Date)

Non-refundable fee (Payable on Trade Date)

In the event the customer delivers a cancellation notice to the bank in respect of a Wa'ad, the cashflows will be as follows:

Bank(Seller)

Customer(Buyer)

Non-refundable fee (Payable on Trade Date)

In the event the customer does not deliver a cancellation notice in respect of a Wa'ad, the cashflows will be as follows:

Double Wa’ad Structure (Total Return Swap)

Bank Issuer Certificate Holder

Markets

Sharia-compliant Assets

Issue Price1

Certificates

2

Sharia-compliant Assets

4

5Wa’ad (1) – Issuer promises to sell the Assets at Wa’ad Sale Price

Wa’ad (2) – Bank promises to buy the Assets at Wa’ad Sale Price

6

7

Wa’ad Sale Price

£ to purchase the Assets(Purchase Price)

3

Sharia-compliant Funds and Hedge Funds

Nick Williams, PartnerPriya Uberoi, Senior Associate

28 November 2008

Current State of the Sharia Funds Market

Despite the latest market turmoils, financial institutions are still pressing ahead with Sharia-compliant funds:

BNP Paribas has just launched its first Sharia-compliant fund, the Global Equity Optimizer (The National, UAE Newspaper);

Currently $21bln invested in Sharia equity funds (Faliaka Advisors)

Funds - What’s happening in the Sharia funds market?

Strategies – participating in and sharing the risks of a joint venture About two thirds:

Index tracker funds – Sharia indices e.g. Dow Jones/FTSE Long equity funds

Sukuk/income funds Balanced managed funds Real estate/private equity/infrastructure Hedge funds Fund of funds Structures: Retail or institutional investors/HNWI Regulated Funds Alternative investments:

Closed ended structures: Private Equity/Infrastructure/Opportunistic Real Estate Funds

Open ended structures: Listed equity Core Real Estate Funds Hedge Funds

Umbrella structures

Types of Funds – varying with liquidity of assets

Liquidity of Underlying Investment

MispricingRisk

Low High

Low

High Hedge FundsHedge Funds

UCITS/ Regulated

Funds

UCITS/ Regulated

Funds

Private Equity Funds

Private Equity Funds

Infrastructure Funds

Infrastructure Funds

Opportunistic RE FundsOpportunistic RE Funds

Core RE Funds

Core RE Funds

Fixed Income Funds

Fixed Income Funds

Structure diagram - closed ended Limited Partnerships

Fund LP (limited

partnership)

LP Feeder

Manager -usually

regulated

GP -usually

SPV

Possiblysub-advisor

Carried Interest Partner

Investors

[Carry structure]

Management Agreement

Advisory Agreement

Executives/Sponsor

100%

LP

LPs

GP

[Investments, usually through holding structure]

Structure diagram - Hedge Funds

On-ShoreFeederFund

(Partnership)

Off-Shore FeederFund

(Cayman OEIC)

MasterFund

(Cayman OEIC)

Investments

US Tax-Payer Investors

Non-US and US Tax-Exempt Investors

Fees Fees

BK:10165333

Structure diagram – “Umbrella” fund

Sub-fund 1 Sub-fund 2 Sub-fund 3 Sub-fund 4

Protected/Incorp. Cell Company/Segregated PortfolioLuxembourg / Cayman / Guernsey / Jersey

Investment Manager

Investors Investors Investors Investors

Service providers

Holdcos / Investments

Investment Manager




Investment Manager

Investment Manager

Funds - What do I have to do to make my fund Sharia-compliant?

Strategy: Investment criteria and structuring Sharia board

On establishment Ongoing role – depends on the strategy

Annual review Specific investments

Fund of funds Structure

Usual drivers – liquidity of investments; location of investments and investors; tax and regulatory issues

Meeting the requirements of Sharia in arrangements between investors, managers and service providers

Relationship between manager and investors – agent/steward – duties of trust and confidence

Information disclosure – investment risk/fee arrangements Fund mechanics – Riba – equalisation mechanics; defaulting investors

Hedge funds and Sharia concerns

What is a hedge fund?

A hedge fund is a private investment fund open to a limited range of investors which undertakes a wider range of activities in liquid investments

There are a very wide range of different strategies followed by hedge funds – it is hard to generalise

This talk is focusing on those that pursue absolute return strategies of a certain basis points above a chosen benchmark

Hedge funds and Sharia concerns

Hedge funds often seek to use the following three techniques:

1. Leverage - to amplify profits and investments;

2. Short selling - selling borrowed securities which are expected to decrease in value; and

3. Derivatives - to hedge their exposure to various underlying assets and instruments.

The concept of hedging and a hedge fund was initially misconstrued by many Sharia scholars as relating to a "complete elimination of risk" and it was seen to go against the principle of returns being proportionate to risk

Richard Phillipson, a principal at London-based consultants Investit was quoted in the Financial News: “If you can make a Sharia hedge fund then anything is possible”

Conventional Short Selling

Short selling is the practice of selling borrowed securities in the hope that the price of such securities subsequently falls so that they can then be bought back at a lower price

On 19 September 2008, the UK Financial Services Authority (the FSA) introduced temporary measures prohibiting the creation or increase of net short position in UK financial sector companies and requiring disclosure of all net short positions in excess of 0.25% or more of the share capital of those companies

Only market makers (entities dealing as principal in equities, options or derivatives as part of their business of receiving orders from clients) are exempt from the prohibition and requirement of disclosure

The equivalent of the FSA in various EU jurisdictions, Australia, the US and Russia have implemented similar bans aimed at curbing the short selling of financial stocks

Short Selling under Sharia

The Hadith prohibits one from selling something one does not own: This would prohibit the borrowing of shares for sale at a gain (i.e. short selling)

However Islamic hedge funds are being set up and running successfully

Barclays Capital (in conjunction with Shariah Capital) launched a prime brokerage platform (Al Safi Trust) in June 2008, based its short selling mechanism on Arbun structure

Newedge Group (a brokerage jointly owned by Calyon and Société Générale) launched its Sharia-compliant offering in October 2005, based its short selling mechanism on Salam structure

Sharia-compliant hedge funds are estimated to be worth $5bln (Oracle Investment Management)

Short selling using Salam

Hedge Fund(HF)

Buys ‘S’ from the market on Day 10 (5)

Prime Broker(PB)

Advises to sell (overvalued) ‘S’

to Buyer (1)Sells ‘S’ in

the market on Day 1 (2)

Price: $100 on Day 1 (3)

Delivers ‘S’ on Day 10 (7)


BuyerSeller

$98 ($100 less $2 Spread) on Day 1 (4)

‘S’ = Sharia-compliant share

Short selling using Arbun

SellerHedge Fund

(HF)

Buys ‘S’ from the market on Day 10 (6)

Advises to sell to Buyer an option

to purchase ‘S’ (1)

Sells option to Buyer to purchase ‘S’ (2)


Delivers ‘S’ on Day 10 if option is exercised (8)


Pays the remaining price of $30 on Day 10(if option is exercised) (5)

BuyerPrime Broker(PB)

$68 ($70 less $2 Spread) on Day 1 (4)

‘S’ = Sharia-compliant share

Current State of Sharia Hedge Funds Market

Despite the latest market turmoils, financial institutions are still pressing ahead with Sharia-compliant hedge funds:

Amiri Capital plans to launch an Islamic fund of funds next year using the concept of Wa’ad to enable short selling (The Guardian)

The Dubai Government is investing $200mln seed capital in four different funds (Blackrock Global Resources and Mining Fund, Tocqueville Asset Management, Zweig DiMenna International Managers and Lucas Capital Management) as part of its initiative to expand Sharia investing options on the Al Salfi Trust Platform (Dow Jones International News)

Four funds will trade in Sharia-compliant commodity equities and will trade off a new platform, DSAM Kauthar Global Resources & Mining Fund (an exclusive feeder fund) (Dow Jones International News)

The Dubai Government also plans to launch a Sharia-compliant exchange-traded fund to allow investment in physical gold (Dow Jones International News)

ISDA/IIFM TA’HAWUT MASTER AGREEMENT

Richard Tredgett, Partner


These structures use bespoke Master Agreements that we at A&O draft to ensure that these structures are Sharia-compliant

However…..


Joint initiative between ISDA/IIFM to produce a Master Agreement under which Sharia-compliant hedging transactions can be documented

Based on ISDA’s 2002 Master Agreement with necessary amendments made for Sharia compliance

Version 1 will be a Master Agreement under which Murabaha transactions can be documented. As the market develops, the document may evolve to cover other types of Sharia-compliant products

To be used by all participants, in all geographical regions

A revised draft was circulated to the Working Group on 20 August 2008 and Working Group met on 9 October 2008

A&O is commenting as a member of the Working Group and has provided detailed input on this project

Credit Support Documents to reduce credit risk

• 2001 Margin Supplement (incorporating 2001 Margin Provisions)

• 1995 Credit Support Annex (Transfer English law)

• 1994 Credit Support Annex (New York law)

• 1995 Credit Support Deed (Security Interest – English law)

• 1995 Credit Support Deed (Japanese law)

• 2002 Master Agreement Protocol

Annexes

• North American Power Annex

• North American Gas Annex

• GTMA Annex (UK Power)

• European Gas Annex

Bridges

• 2002 Energy Agreement Bridge

• 2001 Cross-Agreement Bridge

• 1996 FRABBA Bridge

• 1996 BBAIRS Bridge

2002 MASTER AGREEMENT

Confirmations

• Long form confirmations

Confirmations

• Short form confirmations

• Master confirmation agreements

Definitions for use in documenting Transactions• 2007 Property Index Derivatives Definitions

• 2006 Definitions

• 2006 Inflation Derivatives Definitions

• 2005 Commodity Definitions

• 2003 Credit Derivatives Definitions

• 2002 Equity Derivatives Definitions

• 1998 Euro Definitions

• 1998 FX and Currency Option Definitions

• 1997 Government Bond Option Definitions

Conventional ISDA Agreement Structure

ISDA/IIFM Ta’hawut Master Agreement Structure

ISDA/IIFMTa’hawut Master Agreement

Confirmations Confirmations documenting existing Transactions

Confirmations documenting Designated Future Transactions


Main differences from 2002 ISDA Master Agreement: Unlike the Confirmations for existing Transactions, the Confirmations

documenting Designated Future Transactions (“DFTs”) will not fall within “single agreement” concept under the Master Agreement, and such DFTs will not constitute “Transactions” for the purposes of the Master Agreement

Close-out netting (Early Termination)

No compensation on defaulted or deferred payments and deliveries

No interest payable

Representations as to Sharia compliance

Arbitration Clause

Next Steps

Once the Agreement is published, the next step will be to develop template Confirmations

In addition to commenting extensively on the Agreement as an active member of the Working Group, A&O has also developed bespoke Master Agreements and other documents for clients wishing to document Sharia-compliant hedging transactions

Joint initiative under way between the International Capital Markets Association (ICMA) and IIFM to produce a Master Agreement under which Sharia-compliant repos can be documented

Market consensus is that standardisation of documents should help Islamic finance to flourish even further

Conclusion

Priya Uberoi, Senior Associate

Turmoil in the Market and the future…

WTI Crude oil prices have tumbled from a record $147.27 on July 11 2008 to $52.19 at 17:00 on 26 November 2008

So long as the Brent Crude oil remains above $50, government spending will remain expansionary (Saudi Arabian Monetary Agency)

Long term (4 – 5 years) oil price forecasts from $130 (Economist Intelligence Unit) up to $200 (Jeff Rubin, Chief Economist, CIBC)

“Prediction of a soft landing for the Middle East” (Financial News)

GCC states have intervened and injected liquidity into the markets

IMF (2nd October 2008) expects growth in GCC region to be 5.9% (from 6.4% in 2000)

Gulf Bank – Kuwait’s fourth-largest lender by market value, rescued in October by Kuwait’s central bank after suffering currency derivative losses, announced a $1.4bln emergency rights issue. A new board will be appointed. This is the biggest emergency recapitalisation in the Gulf since the start of the global credit crisis. The Kuwait Investment Authority, the country’s top sovereign wealth fund will buy any shares from the issue left unsubscribed by shareholders

Turmoil in the Market and the future…

According to Financial News the Islamic finance industry will not only weather the credit crisis but may also benefit from it

Why involved in Islamic Finance Derivatives?

All encompassing, inclusive not exclusive, no centre of gravity

Islamic finance is fundamentally a different approach to finance, potentially applicable to every office, every practice area and every product – think of it as a “wrapper”

Islamic financiers believe that the global trend towards greater transparency and regulatory concerns will result in a shift towards their mode of operation (Financial News)

Our Derivatives Practice

Allen & Overy’s derivatives experts make up one of the largest teams in the

industry and are renowned in the market for being innovative and

commercially aware of clients needs.

More than 100 London-based lawyers work within our broader London

Derivatives Group, including 14 ICM partners and over 60 ICM-qualified

associates specialising in pure derivatives work, providing a responsive and

focused service for OTC derivatives across all asset classes, derivative

securities and structured products.

International transactions are commonplace with specialists in the majority

of our international offices including Bratislava, Budapest, Frankfurt, Hong

Kong, Madrid, New York, Paris, Prague, Rome, Tokyo and Warsaw.

The team regularly works alongside securitisation, structured finance,

banking, corporate, tax, regulatory, corporate trustee and litigation lawyers

to ensure transaction needs are met and complex structures are

successfully completed.

The team is global external counsel to ISDA.

Islamic Finance Tier 1 team (Legal 500 UK, 2008): the firm has the ability “

as a leading capital markets/derivatives firm, to apply its deep experience

and technical skill to innovative Islamic finance structures “.

“the best derivatives

practice is at Allen &

Overy, without a doubt”

Chambers UK, 2009

“the team’s technical

skill and sector

knowledge are almost

without peer”

Legal 500 UK, 2008


Richard Tredgett, Partner - Derivatives & Structured Finance. Partner since 2002.

Richard is a Partner in the Derivatives and Structured Finance Group in Allen & Overy LLP. He advises on various forms of structured finance and derivatives transactions. He has worked on many documentation projects for the International Swaps and Derivatives Association, including ISDA's EMU Protocol, ISDA's 2002 Master Agreement and various commodity and energy-related documentation initiatives. He is a frequent speaker on derivatives documentation and collateral.

Richard is advising a number of major investment banks on OTC Sharia-compliant derivative transactions.

Tel: +44 20 3088 2467 [email protected]


Andrew Sulston, Partner - Derivatives & Structured Finance. Partner since 2005.

Andrew is a partner in the Derivatives & Structured Finance Group in Allen & Overy LLP.

Andrew trained at Allen & Overy and was admitted as a solicitor in England and Wales in 1997. He spent 2½ years in the Tokyo office following qualification and returned to London in 2000.

Andrew specialises in derivative securities and other derivative products linked to a wide range of underlying asset classes. Working primarily with a number of major financial institutions, he works in the areas of equity-linked, fund-linked, credit-linked, FX products and emerging markets transactions. He is also increasingly involved in products for the retail markets and Sharia-compliant securities products, including Wa'ad based products under structured securities programmes



Priya Uberoi, Senior Associate - Derivatives & Structured Finance. Qualified in 1999.

Priya is a senior associate in the Derivatives and Structured Finance Group in Allen & Overy LLP. Over the past nine years Priya has advised on a number of complex structured finance transactions mainly in Emerging Markets (Middle East, Russia, Kazakhstan and North Africa) that blend conventional debt and derivative instruments with local law particularities.

Priya focuses heavily in developing OTC derivatives technology in the world of Islamic Finance e.g. converting conventional cash flows into Sharia-compliant cash flows and using halal Islamic products to mimic the cash flows under a conventional swap. She works alongside a number of partners in London and our international offices particularly in the Middle East. In addition Priya advises on both the English law and Sharia elements of the hedging requirements in large scale projects, loans and retail note programmes.

Priya is a principal driver in developing the Islamic derivatives practice in London.


Our Funds Practice

Nick Williams, Partner - Investment Funds Group.

Nick is a partner in the international Investment Funds Group in Allen & Overy LLP. He trained at Allen & Overy, qualified in 1995 and became a partner in 2002. Nick advises on a wide variety of asset management matters including fund establishment and regulatory issues. He has a broad experience of various financial instruments and various regulated industries. He has particular experience of infrastructure, debt and real estate funds and cross border structures. He is increasingly involved in funds that are being structured so as to be Sharia-compliant.

Nick is part of a team of lawyers in various jurisdictions (including London, Luxembourg, Amsterdam and our Middle East offices) working on various Sharia-compliant funds.


Our Tax Practice

Ian Carnochan, Senior Associate - Taxation. Qualified in 2001.

Ian is a senior associate in the Taxation Department in Allen & Overy LLP.

He advises on the UK taxation aspects of banking, corporate finance, and tax-related financing transactions. He has a wide range of experience on the taxation aspects of financing structures, ranging from syndicated lending to capital market issuances, and including securitisations, tax structured financing arrangements and derivatives. He also advises on corporate transactions, including mergers and acquisitions, reconstructions, joint ventures and business sales, and has experience of tax litigation.

Ian has also advised a number of financial institutions on the UK taxation aspects of Sharia-compliant structures, including, in particular, Murabaha based products.


Questions?

These are presentation slides only. The information within these slides does not constitute definitive advice and should not be used as the basis for giving definitive advice without checking the primary sources.

Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications or an individual with equivalent status in one of Allen & Overy LLP's affiliated undertakings.

Allen & Overy Islamic Derivatives Seminar

Richard Tredgett, Andrew Sulston & Nick Williams, PartnersPriya Uberoi & Ian Carnochan, Senior Associates

28 November 2008

Allen & Overy Islamic Derivatives Seminar Richard Tredgett, Andrew Sulston & Nick Williams, Partners...

Documents

Transcript of Allen & Overy Islamic Derivatives Seminar Richard Tredgett, Andrew Sulston & Nick Williams, Partners...