Tahawwut derivative contract, Islamic finance and Nakheel, BBA, Publications on Sukuk

The Tahawwut master agreement that establishes a Shari'ah-compliant derivative framework was released today. An article in Risk magazine does the best job of describing the process in detail. One of the sticking points that delayed the release was the inclusion of the murabaha contract in the agreement as well as the procedures for close-out netting of derivatives exposure. This allows parties to close out derivatives positions with offsetting contracts between counterparties. The result is that the close-out netting is allowed in jurisdictions where national law allows it, which excludes many Muslim-majority countries that do not have laws governing this. There was also probably a discussion among Shari'ah scholars about the permissibility of offsetting debts (like murabaha). In general, there are restrictions on this because it is viewed as trading in debt (bai' al-dayn), which is restricted outside of Malaysia. However, it is generally allowed where the debts are equal (i.e. exchanged at par). The standard was backed by other banks including Standard Chartered, which recently announced its own Shari'ah-compliant derivatives products. In an earlier post, I wondered whether Standard Chartered's product would be able to be competitive with an ISDA-IIFM tahawwut product based on a master agreement that could spread costs across many financial institutions.

Westlaw Business has a few quotes from a roundtable discussion they held of Islamic finance recently that mostly focus on the Dubai World/Nakheel situation. It highlights that the investor base was sophisticated and should have (and probably did) know that the sukuk were not legally backed by the government. One omission I see in the discussion (and the quotes are just selective, so it may have been raised in the discussion) is the inclusion of fully perfected mortgages over the properties backing the sukuk. While the structure was a transfer of beneficial interests in a long-term lease to the SPV, there were also mortgages granted to the SPV over the underlying properties. This should have provided investors with recourse to the land if the sukuk was not redeemed using funds provided by the government of Abu Dhabi and two government-owned banks in Abu Dhabi. There are all kinds of potential problems investors would have faced to turn those mortgages into actual ownership in the underlying lands (in part because the land was in Dubai and the sukuk used a trust structure based on English law and the concept of a trust is not recognized in the local jurisdiction). In discussing sukuk generally, this point is not necessarily relevant because most ijara sukuk do not contain mortgages on the underlying asset and the investors are generally provided with just an unsubordinated, unsecured claim against the issuer if the issuer can not or does not repurchase the asset in case of a default. An article summarizing a discussion at the recent Reuters Summit on Islamic finance looks at the Dubai World/Nakheel situation in a different light, with participants suggesting that the problems with the Nakheel sukuk highlight the need for greater product diversification in Islamic finance to allow portfolio managers to have greater opportunity for diversification.

Affin Islamic Bank, a Malaysian Islamic subsidiary of Affin Bank, says it will continue to use the bai bithamin ajil (BBA) contract, despite criticism. RHB Islamic said earlier it stopped using the BBA contract to adopt global Shari'ah standards reflecting the more stringent requirements, particularly in the Gulf. The primary difference between a BBA and murabaha contract is that in a BBA, the client makes a deposit to the seller and then transfers the rights to acquire the property to the bank which then sells it back to the client on a cost-plus basis in installments. In a murabaha, the bank buys the property and then sells it to the client on a cost-plus basis with repayment in installments. The criticism of BBA is its reliance on bai' al-inah (sale and buy-back). In contrast to the murabaha contract the transaction is executed between only two parties and therefore is viewed as a hidden (conventional) loan. The murabaha, in contrast, separates the purchase (from the third-party seller) from the sale (to the client) and is more widely viewed as legitimate.

Islamic Finance Resources has four links to recent reports on sukuk. The links are to the Zawya Collaborative Sukuk Report, the Guide to Issuing Sukuk in the DIFC, a guide to issuing sukuk from Bank Negara Malaysia and the Malaysian Securities Commission, and the description of several types of sukuk from the Malaysia International Islamic Financial Centre.


Other News

• Deutsche Bank received an international Islamic banking license from the Malaysian central bank, Bank Negara, that allows it to provide services in foreign currencies.
  
• The Central Bank of Bahrain's Sukuk al-Salam sukuk was oversubscribed with a bid-to-cover of more than 4 times with BD56.8 million in subscriptions for the BD12 million issue.
  
• An experiment in Islamic microfinance in Pakistan described in brief.
  
• Israeli fund managers are offering investment products that comply with the prohibition of interest (ribbit) as well as other prohibitions, which shows how the prohibition of riba in Islam is mirrored in other Abrahamic faiths.