Sharia Compliant Treasury

Transcription

1 IIFM Industry Seminar on Islamic Capital & Money Market th May 2014, Tower Level,Bank Indonesia, Indonesia Ismail E Dadabhoy Advisor IIFM Sharia Compliant Treasury Liquidity Management Tools Murabaha Wakala Sukuk Salam Fx Forward Deposit Swaps Mudaraba Etc Credit Liquidity Tenor Diversification Quantum 2 1

2 Enhancing Liquidity Management Financing Transaction with the benefit of Collateral Conventional Collateral Market Eurex Repo on the up and up Frankfurt 04 April 2014 Eurex Repo, which operates Swiss Franc, Euro Repo and GC Pooling markets, recorded in all markets in March 2014 an average outstanding volume of 217. billion, increasing from the 215. billion seen last year. The secured money market GC Pooling recorded an average outstanding volume of billion, decreasing from the billion seen year-on-year. The Euro Repo market grew by 2 percent and reached an average outstanding volume of 40.1 billion euros (March 201: 0.4 billion euros).the Swiss Franc Repo market achieved 27.1 billion euros. 22 April ISDA Collateralisation has a fundamentally important role to play in risk mitigation, said Robert Pickel, CEO of ISDA. Over the past 14 years, ISDA s Margin Survey has provided a consistent set of benchmarks for collateral use and is part of a broader set of the association s initiatives in the area of collateral, including documentation, best practices and practitioner guidelines. 4 2

3 IIFM Consultative Process Collateralization Consultative Meeting Collateralization Working Group IIFM, organized an industry consultative meeting in Dubai. It was well attended by all the stake holders, including Islamic Banks, Islamic windows, Sharia Scholars, Lawyers, Accountants, and Global Custodians. The participant supported this initiative A core working group comprising representatives from IIFM member banks reviewed the 2nd draft of the agreement with the aim to produce Standard Collateralization product structure, documentation. Currently being presented to the IIFM Sharia Executive Committee 5 Collateralized Product Benefits Alternative to Clean Lending Credit Risk Management Liquidity Management Central Bank Market Intervention Development for Sukuk Collateralized financing offers a structure that requires some extra operational task but does provide credit enhancement as well as providing an effective liquidity management tool for use with the Collateral Management Agent. as long as the extra collateral is followed, Counterparty exposure is reduced to the margin threshold plus Sukuk execution risk, rather than a full clean exposure. It can allow for positive capital treatment. Having the comfort of collateral allows the institutions to finance for a longer duration and or larger quantum as the credit risk is reduced. CB can include Islamic Banks as part of its market liquidity actions ( Add or Remove Cash from the system. Also, Islamic Financial Institutions can use this liquidity instrument to raise funds from the CB Allowing Financial institutions to maintain less cash and allocate more in income generating Sukuk. Giving rise to greater take up of Sukuk by Islamic investors

4 Murabaha Collateralised by Sukuk Murabaha Cash Rich Party Sukuk Requires Liquidity 7 Collateralisation How does it Work? IIFM Workshop on Collateralisation & Tri-Party 201, 2nd June, Singapore 9 4

5 Collateralization Overall Transaction Flow Bi- Lateral Transaction Single or Pool of Sukuk From Party A - Party A delivers acceptable pool of Sukuk having market value in excess of the Deferred Cash as collateral Collateral PARTY A Requires Funding Cash Rich PARTY B Provides Funding 1 4 Commodity Buyer 4- Party A sells commodity to the market for spot deliver & spot payment and raises Cash for its funding needs Acting as Principal - Party A NOW acting as Principal Purchases the same commodity from Party B for Spot Deliver But with deferred Payment Acting as Agent 2 1- Party B appoints Party A as Agent to purchase Commodity and transfers Cash to Party A s account to purchase the commodity Commodity Seller 2- Party A buys commodity for Spot Payment and Spot Deliver from the market as Agent for Party B 8 KEY to CREDIT Enhancement Documentation & Margin Maintenance A (1) Assuming the Collateral Value Decreases Below the Threshold Variance Bank to provide more (same or other) acceptable Sukuk Provide other acceptable Collateral as previously agreed Or Provide acceptable Letter of Credit To bring the collateral level back up to 110% If none of the above agreed instrument is delivered then the Party A will be in Default A (2) Assuming the Collateral Value Increases Above the Threshold Variance Party B will Return part of the Sukuk in order to bring it back down to 110% of the Finance Amount Or Party A may consider not to request this extra amount from Party B and may wish to leave extra buffer and save on operational cost 9 5

6 Benefits of Collateralisation by Sukuk Great Tool for Cash Management A Tool that Pumps Liquidity Into the Cash & Sukuk Market 10 What Does Tri Party Offer? Credit Enhancement Tri- Party plays and important role by providing independent operational facility while holding underlying collateral Operation Out Sourcing Credit Management Expands Client Base Allows entities to participate in Collateralised Financing even when their operation and IT capabilities cannot support due to limitation Its function is to ensure the Collateral Value are maintained by daily mark to market the Collateral, Call for additional Margin if required, ensure the Collateral is of the type and quality as per the agreement and to process Corporate actions Central Banks, Pension Funds, Asset Managers, Leasing Co and Corporate entities can provide extra cash liquidity to the market. Knowing the exposures are monitored by an independent entity 11

7 Murabaha Collateralised by Sukuk TRI PARTY Cash Rich Party Margin Calls Sukuk Margin Calls Custodian Requires Liquidity 12 Regulatory & Legal Challenges In case of conventional market repo documentation, the collateral is effected through netting i.e. the ability to close out and set-off in an insolvency where the value of the collateral securities can be determined and applied in set off against the repurchase price. However, the legal framework in most of the OIC countries does not recognize this technique. The Islamic Industry need to assess and tackle this requirement or find a workable solution 1 7

8 IIFM Collateralization Initiatives IIFM initiative is to develop Liquidity Management using International and Domestic Sukuk as Collateral for Murabaha transactions IIFM initiative to introduce Tri- Party Liquidity Management Tool to ease Operational deficiencies by Out-Sourcing to a Domestic or International Custodians IIFM initiative on Tri-Party will expand cash rich and Sukuk investors, likes of Central Banks, Banks, Corporate, Pension Funds, Asset Mangers to provide extra liquidity to the market IIFM Future initiative is to expand the universe of acceptable collateral from SUKUK to include Sharia compliant Equities and possible other Sharia Products IIFM Future initiative is to explore other Sharia structures for Liquidity Management Using alternative structures eg. Salam, Separate Buy & Sell etc) 14 Thank you

9 Appendix Step By Step & Flow Charts Collateralised Mubaraha 1 Murabaha Collateralisation Product Macro Steps Step 1 Step 2 Both parties agrees on Term of the murabaha transaction, the mark up, type of Sukuk, and Margin call parameters (Top-up or extra collateral, Threshold & Base Currency) Party B invest $100 million Cash for say1 Month via a Murabaha transaction with a local bank Step Party B receives acceptable Sukuk as agreed by both parties to a value of $ 110 million to collateralize the exposure and allow 10% variance on both side. Reason to provide 10 million extra coverage is to allow for price fluctuation and to reduce the movement of Collateral back and forth Step 4 Assuming Collateral fluctuation remains within the band then on the deferred maturity date the Party B receives its $ 100 million Cash + the profit and the Party B returns all of the Sukuk Collateral to the Islamic bank 17 9

10 Collateralization Transaction Macro Flow To show how the structure will work, the following commodity Murabaha based structure is presented for illustrative purposes only. Moreover, International & Domestic Sukuk is considered as collateral: (i) Overview of Structure Step 1 Party B transfers cash to Collateral Management Agent (CMA) as Tri-Party Agent for onward transfer to Party A and receives Collateral. CMA receives a fee for its services Step 2 Party A (as agent to B) Purchase of commodities for Cost Price Pays Purchase price Broker 1 Step Party B Sells commodities for Deferred Purchase price Party A to pay deferred Price at maturity date Party A Step 4 Party B Party A grants transfers Sukuk to Domestic Agent to secure obligation to pay deferred purchase price Party A Step 5 Party A Sells Commodities for Cost price Pays Purchase Price Broker 2 Step Party B Party A pays Deferred Purchase Price (being Cost plus Profit) Security released against payment Party A 18 Collateralization Overall Transaction Flow Bi- Lateral Transaction Single or Pool of Sukuk From Party A - Party A delivers acceptable pool of Sukuk having market value in excess of the Deferred Cash as collateral Collateral Party B Provides Funding 4 Commodity Buyer 4- Party A sells commodity to the market for spot deliver & spot payment and raises Cash for its funding needs Acting as Principal PARTY A -requires Funding - Party A NOW acting as Principal Purchases the same commodity from Party B for Spot Deliver But with deferred Payment Acting as Agent 2 1- Party B appoints Party A as Agent to purchase Commodity and transfers Cash to Party A s account to purchase the commodity Commodity Seller 2- Party A buys commodity for Spot Payment and Spot Deliver from the market as Agent for Party B

11 Collateralized Product Margin Maintenance A (1) Assuming the Collateral Value Decreases Below the Threshold Variance Bank to provide more (same or other) acceptable Sukuk Provide other acceptable Collateral as previously agreed Or Provide acceptable Letter of Credit To bring the collateral level back up to 110% If none of the above agreed instrument is delivered then the Party A will be in Default A (2) Assuming the Collateral Value Increases Above the Threshold Variance Party B will Return part of the Sukuk in order to bring it back down to 110% of the Finance Amount Or Party A may consider not to request this extra amount from Party B and may wish to leave extra buffer and save on operational cost 20 Collateralized Product Margin Maintenance & Foot Note b) Commitment of Both Parties * At all times during the 1 Month Transaction a 100% to 110 % collateral cover will be maintained against its Deferred payment exposure Any Increase above the 115%, Party A has the right to call collateral back Any Decrease below 105%, Party B has the right to ask for Top up Notes The counter parties would be Banks or any Financial Institution International Sukuk & Domestic Sukuk considered by relevant clearing service provider Rating Parameters of Sukuk can be considered subject to agreement by both parties Other securities which could be used as collateral are not considered at this time Use of underlying collateral by receiving bank requires further Shariah guidance as reuse is an issue for consideration Governing Law seems English law needs to be used ** * The ratio of excess margin and the variance band is subject to negotiation between the 2 parties and will vary depending on the credit quality of the parties and the collateral offered. The percentages shown are for illustration purposes. ** Other governing law can be considered subject to agreement by both parties and also presence of relevant insolvency and collateral taking law 21 11

12 OIC Jurisdiction Regulator Contribution & Industry Support Will support the Islamic Inter-bank market by making the transacting banks more comfortable to deal with each other Collateralized regime will be established which will improve the capital ratios of the Islamic banks - IFSB to provide guidance AAOIFI Standard 9 - Mortgage of Financial Papers and Sukook 4/1 it is permissible to mortgage the financial papers and sukook which can be issued and transacted according to Shari s, such as Islamic sukook and shares of Islamic financial institutions. The shares of the companies whose original activities are permissible can also be added to this category (see Shari a Standard No.21, on Financial Papers: Shares and Bonds, item AAOIFI to provide guidance on accounting 22 Documentation & Product Requirements The standard product & documentation likely to include 1. Product Structuring & related material 2. Product Guidelines. Collateralized Murabaha Agreement 4. Pledge Agreement 5. Global Master Agreement. Collateral Management Document & Client Service Documents (review only from Shari ah perspective) 2 12

13 US Triparty Breakdown Fitch Rating analysis of newly released data from the Federal Reserve Bank of New York (FRBNY) showed that, as of 9 April, almost $00 billion in non-government securities were financed through the US triparty repo market The roughly $00 billion of repo collateral is split across: $109 billion in equities, $8 billion in corporate bonds, and $7 billion in structured finance $44 billion in collateralised debt obligations, municipals, and whole loans, among other securities). $ billion Government papers 24 Thank You Once Again Contact: Ismail.dadabhoy@iifm.net 25 1