Standardization in Islamic Financial Services Industry (IFSI) Inter-linkages with global financial system and challenges in integration

given that standards are voluntary

AAOIFI versus IFRS IFSB versus Basel II & III IIFM versus ISDA, ICMA etc.,

Expectations, industry support & role of Islamic banks (IILM, Mega Bank)

Role of regulators in the implementation of Standards at jurisdictional, regional and global level

Market immediate need versus long term benefits

Risk Mitigation in Islamic Finance

Significance of Treasury – Risk & Balance Sheet Management

Key Risk Mitigation Functions Asset & Liability Management

Liquidity mismatches Cash Flow mismatches

Foreign Exchange Open position Cross Currency mismatches

Why Hedging Solutions are Needed

Islamic Banks retail portfolio mostly consist of fixed profit rate assets on a Murabaha basis while liabilities to corporate customers are on floating rate benchmarks

Rate of Return mismatch in Assets & Liabilities require protection against steep rise or fall in reference rates of return

Islamic Banks’ foreign currency exposures such as deposits, import & export L/C’s, Sukuk etc.,

The foreign currency exposures need to be managed to avoid loss due to volatility in the international currency markets

ISDA/IIFM Tahawwut (Hedging) Master Agreement Jointly Published on 1st March 2010

Tahawwut Master Agreement (TMA) TMA is a framework risk mitigating document for hedging transactions and is developed for the entire Islamic finance industry

TMA Explanatory Memorandum In order to provide information on key features of TMA and how these can be applied, a detailed Explanatory Memorandum is also part of the publication

Tahawwut Master Agreement – Documentation

2) TMA Explanatory Memorandum Guidelines regarding the sorts of transaction that may be entered into under

the Tahawwut Master Agreement. For the purposes of Shari’ah compliance:

Transactions entered into under the Tahawwut Master Agreement should only be for the purpose of hedging actual risks of the relevant parts

Transactions should not be entered into under the Tahawwut Master Agreement which are for the purposes of Speculation

Transactions must be real transactions, involving the actual transfer of ownership or real assets, actual risk and real settlement

The Asset itself must be Halal

Interest must not be chargeable under the transaction

Tahawwut Master Agreement – Shari’ah Principles

1) Murabaha Treatment is defined based on use of Murabaha under the institution’s

product structure No discounting and claim for full amount Fully delivered terminated transactions treatment (Murabaha) Non-fully delivered terminated transactions treatment [Designated

Future Transaction (DFT)]

2) Wa’ad Both parties will exchange Wa’ad at the time of entering into the

transactions e.g. Currency Swap

Mubadalatul Arbaah (Profit Rate Swap) Product Definition

Mubadalatul Arbaah (Profit Rate Swap) An agreement to exchange profit rates between a Mu’addal Ribh Thabit

(fixed rate) party and Mu’addal Ribh Mutaghayyar (floating rate) party, or vice versa

Utilization of Wa’ad

It is a binding unilateral promise and is binding one way only. It is being used or utilized in this transaction in order to ensure that the Mubadalah (swap) reaches its maturity

Use of PRS – Cash Flow Management

Source: IIFM Sukuk Issuance Database

Issue Date Obligor Issue Currency

Amount in Millions (USD or USD Equivalent)

Issuer Status Profit Rate

7-Feb-12 Majid Al Futtaim Properties LLC USD 400.0 Corporate 5.850% 18-Jan-12 First Gulf Bank P.J.S.C USD 500.0 Corporate 4.046% 18-Jan-12 Emirates Islamic bank P.J.S.C USD 500.0 Corporate 4.718% 18-Jan-12 Saudi Arabian Civil Aviation Authority SAR 4,000.0 Sovereign 2.500% 16-Nov-11 Abu Dhabi Commercial Bank USD 500.0 Corporate 4.071% 21-Nov-11 Government of Indonesia USD 1,000.0 Sovereign 4.000% 22-Nov-11 Government of Bahrain USD 750.0 Sovereign 6.273% 30-Nov-11 Abu Dhabi Islamic Bank USD 500.0 Corporate 3.780% 6-Jul-11 Government of Malaysia USD 800.0 Sovereign 4.646% 6-Jul-11 Government of Malaysia USD 1,200.0 Sovereign 2.991% 3-Feb-11 Emaar Properties P.J.S.C USD 500.0 Corporate 8.500% 17-Jan-11 Qatar Central Bank QAR 9,067.0 Sovereign 5.000% 31-Oct-10 Abu Dhabi Islamic Bank, UAE USD 750.0 Corporate 3.750% 25-Oct-10 Islamic Development Bank USD 500.0 Quasi-Sovereign 3.550% 5-Oct-10 Qatar Islamic Bank USD 750.0 Corporate 3.860% 1-Sep-10 Celcom Transmission Berhad, Malaysia RM 572.0 Corporate 5.500% 10-Feb-10 Government of Indonesia IDR 862.0 Sovereign 8.700% 7-Jan-10 Dar Al Arkan, Saudi Arabia USD 450.0 Corporate 10.750% 27-Nov-09 General Electric US USD 500.0 Corporate 3.400% 24-Sep-09 Government of Bahrain BHD 437.8 Sovereign 3.750% 9-Jun-09 Government of Bahrain USD 750.0 Sovereign 6.250% 14-May-09 Government of Malaysia RM 1,420.8 Sovereign 5.000% 23-Apr-09 Government of Indonesia USD 650.0 Sovereign 8.800% 16-Mar-09 Panerbangan Malaysia Berhad, Malaysia RM 405.8 Quasi-Sovereign 3.850% 25-Feb-09 Government of Indonesia IDR 464.5 Sovereign 12.000% 13-Sep-07 Government of Malaysia RM 1,060.6 Sovereign 3.580% 5-Jun-07 Silterra Malaysia Sdn. Berhad, Malaysia RM 529.0 Corporate 3.900% 12-Mar-07 Rantau Abang Capital Berhad, Malaysia RM 606.1 Corporate 4.100% 29-Sep-06 Khazanah Nasional Berhad, Malaysia USD 750.0 Corporate 5.070% 2-Jun-06 Aaber Petroleum Investment Company, UAE USD 460.0 Corporate 6.890% 11-Jun-05 Islamic Development Bank USD 500.0 Quasi-Sovereign 3.740%

The Mubadalatul Arbaah (PRS) Documentation

• Party A and Party B have already entered into a Tahawwut Master Agreement

• To enter into the PRS, Party A and Party B enter into two separate DFT Term Agreements (each of which is documented in a separate DFT Terms confirmation: one in respect of the fixed rate leg of the PRS and one in respect of the floating rate leg of the PRS)

• Each DFT Terms confirmation contains a wa'ad (undertaking) to enter into one or more Designated Future transactions (if the wa'ad is exercised)

10

PRS Templates - Process

• Schedule • Fixed Rate Leg DFT Terms confirmation (Wa’ad) • Floating Rate Leg DFT Terms confirmation (Wa’ad) • Exercise leads to

– entry into Murahaba (Transaction Confirmation) – Delivery of asset – Payment (deferred or spot basis)

11

Two Sales Structure documentation architecture

12

DFT Terms confirmation (wa’ad) – Fixed Profit

Rate/FPR Leg

Profit Rate Swap (Two Sales Structure):

Exercise Notice

Schedule

DFT Terms confirmation (wa’ad) – Floating Profit

Rate /FLPR Leg

Murabaha Sale Murabaha Sale

Tahawwut Master Agreement

(Master Terms)

Exercise Notice

Single Sale Structure documentation architecture

13

DFT Terms confirmation (wa’ad) – Fixed Profit

Rate/FPR Leg

Profit Rate Swap (Single Sale Structure):

DFT Terms confirmation (wa’ad) – Floating Profit

Rate /FLPR Leg

Exercise Notice in relation to undertaking where Exercise Condition is met

Murabaha Sale

Tahawwut Master Agreement

(including Schedule)

(Master Terms)

Wa’ad Based - 2 Sales

• Day 1: Fixed Profit Rate Payer (A) grants B multiple exercise Wa’ad – if exercised A will purchase commodity from B at cost

plus Fixed Profit Rate amount • Day 1: Floating Profit Rate Payer (B) grants A

multiple exercise Wa’ad – if exercised, B will purchase commodity from A at cost

plus Floating Profit Rate amount • Exercise Dates for Wa’ad are Day 1 and, say, every

6 months

14

Wa’ad Based 2 Sales (Cont’d)

– when exercised, there will be immediate entry into Murabaha and immediate delivery of commodity; purchase price payment can be deferred for 6 months) or spot

– if purchase price payable under both on same day in same currency, the payments can be set off so that only net amount is paid (NB Section 2(c)(ii))

15

Two Sales Structure: Exercise of wa'ad

• In the Two Sales Structure, each party may exercise the wa'ad granted to it by the Undertaking Party on an Exercise Date

• On any Exercise Date, both wa'ads may be exercised in respect of the PRS

• The wa'ad contained in the DFT Terms Agreement for the fixed rate leg is exercisable and the wa’ad contained in the DFT Terms Agreement for the floating rate leg is also exercisable

• If a wa'ad is exercised, the Undertaking Party must buy Assets from the Exercising Party and execute a Murabaha Sale Confirmation evidencing the Murabaha Sale between the parties: there are two Murabaha Sales in respect of each Exercise Date in respect of a PRS with a Two Sales Structure

Two Sales Structure: Exercise of wa'ad

• Party A and Party B have now entered into a PRS • The Calculation Agent determines Profit in relation to each leg of the PRS in respect

of the first Calculation Period

Party A FPR Assets (Copper) sold by Party B

Party B

Party A FLPR Assets (Zinc) sold by Party A

Payment (Cost plus Profit (i.e. FLPR Amount))

Party B

Payment (Cost plus Profit (i.e. FPR Amount))

If Party A exercises Party B’s FLPR wa’ad, the cash and asset flows will be as follows:

If Party B exercises Party A’s FPR wa’ad, the cash and asset flows will be as follows:

Wa’ad Based – Single Sale • Day 1: Fixed Profit Rate Payer (A) grants B

multiple exercise Wa’ad exercisable where Fixed Profit Rate exceeds Floating Profit Rate – if exercised, A will purchase commodity from B at cost

plus amount by which Fixed Profit Rate exceeds Floating Profit Rate

• Day 1: Floating Profit Rate Payer (B) grants A multiple exercise Wa’ad exercisable where Floating Profit Rate exceeds Fixed Profit Rate – if exercised, B will purchase commodity from A at cost

plus amount by which Floating Profit Rate exceeds Fixed Profit Rate

Single Sale Structure: Exercise of wa'ad

• In the Single Sale Structure, a party may only exercise the wa'ad granted to it by the Undertaking Party on an Exercise Date if the Exercise Condition has been met

• It is possible for the Exercise Condition to be met only in relation to one of the two wa'ads on any Exercise Date: only one wa'ad may be exercised in respect of the PRS

• If the Exercise Condition is met in the fixed rate leg of the PRS (which means that it will not be met in the floating rate leg), the wa'ad contained in the DFT Terms Agreement for the fixed rate leg is exercisable (and the wa’ad contained in the floating rate leg will not be exercisable)

Single Sale Structure: Exercise of wa'ad

• If the Exercise Condition is met in the floating rate leg of the PRS (which means that it will not be met in the fixed rate leg), the wa'ad contained in the DFT Terms Agreement for the floating rate leg is exercisable (and the wa’ad contained in the fixed rate leg will not be exercisable).

• If a wa'ad is exercised, the Undertaking Party must buy Assets from the Exercising Party and execute a Murabaha Sale Confirmation evidencing the Murabaha Sale between the parties: there is only one Murabaha Sale in respect of each Exercise Date in respect of a PRS with a Single Sale Structure.

Single Sale Structure: Exercise of wa'ad: What is the Exercise

Condition? • “The "Exercise Condition" is satisfied in respect of a Calculation Period if the Profit,

as determined by the Calculation Agent in accordance with Paragraph 7, is greater than zero for that Calculation Period.”

• In other words, Profit in respect of that leg of the PRS for a Calculation Period must be greater than zero in order to be exercisable

Party A FPR Assets (Copper) sold by Party B

Party B

Party A FLPR Assets (Zinc) sold by Party A

Payment (Cost plus FLPR amount less FPR amount)

Party B

Payment (Cost plus FPR amount less FLPR amount)

If FLPR (floating rate) amount exceeds FPR (fixed rate) amount, Party A can exercise Party B’s wa’ad :

If FPR (fixed rate) amount exceeds FLPR (floating rate) amount, Party B can exercise Party A’s FPR wa’ad :

Example Timeline of entry into Murabaha Sale at the start of each Calculation Period

• This diagram illustrates an example of entry into Murabaha Sale at the start of each Calculation Period: Purchase Date at start of Calculation Period Payment Date at end of Calculation Period

Trade Date: entry into DFT Terms Agreement

Effective Date: DFT Terms Agreement becomes "live"

End of First Calculation Period

Payment Date: payment of Cost + Profit by Buyer

End of Second Calculation Period

Payment Date: payment of Cost + Profit by Buyer

End of Third Calculation Period

Payment Date: payment of Cost + Profit by Buyer

Start of Second Calculation Period

Time

Conditions precedent satisfied

Start of First Calculation Period

Entry into Murabaha Sale

Purchase Date: Delivery of Assets by Seller

Exercise Date Start of Fourth Calculation Period

Entry into Murabaha Sale

Exercise Date

Purchase Date: Delivery of Assets by Seller

Start of Third Calculation Period

Entry into Murabaha Sale

Exercise Date

Purchase Date: Delivery of Assets by Seller

Third Calculation Period Second Calculation Period First Calculation Period

February March April

This diagram illustrates an example of entry into Murabaha Sale at the end of each Calculation Period: Purchase Date at end of Calculation Period Payment Date at end of Calculation Period

Trade Date: entry into DFT Terms Agreement

Effective Date: DFT Terms Agreement becomes "live"

End of First Calculation Period

Purchase Date: Delivery of Assets by Seller

End of Second Calculation Period

Payment Date: payment of Cost + Profit by Buyer

End of Third Calculation Period

Payment Date: payment of Cost + Profit by Buyer

Start of Second Calculation Period

Time

Conditions precedent satisfied

Start of First Calculation Period

Start of Fourth Calculation Period

Start of Third Calculation Period

Entry into Murabaha Sale

Payment Date: payment of Cost + Profit by Buyer

Purchase Date: Delivery of Assets by Seller

Entry into Murabaha Sale

Purchase Date: Delivery of Assets by Seller

Entry into Murabaha Sale

Exercise Date Exercise Date Exercise Date

Third Calculation Period Second Calculation Period First Calculation Period

February March April

Example Timeline of entry into Murabaha Sale at the start of each Calculation Period

PRS Templates – Points to Note

Agency arrangements

Broker arrangements

Tax, especially VAT

Exclusion of Vienna Sales Convention

Calculation Agent duty Deed

Thank You

info@iifm.net www.iifm.net