Thursday, November 11, 2010

UAE Islamic CDs

The UAE Central Bank released more details about its Islamic CDs that it will offer "soon" according to Zawya Dow Jones. The sukuk will be murabaha, issued in UAE dirhams, US dollars and Euros, with maturities of between one week and five years. It will be likely limited to banks in the UAE as they are being issued as "a monetary policy tool for the Central Bank of the UAE" and "as a liquidity management tool for the Islamic banks".

The circular (PDF) from the UAE Central Bank describes in more detail the product. It will be a commodity murabaha where the banks (through the central bank as agent) purchase commodities in the spot market and then resell them to the central bank with deferred repayment but immediate delivery. The central bank will then resell the commodity in the spot market.

The one year and less maturity will be auctioned to banks daily with T+1 settlement and early redemption at the option of the banks. The method of the early redemption is that the bank requests early redemption and the central bank replies with an offer for "full proceed for the redemption through Reuters Dealing System". The reason this is done likely is for Shari'ah-compliance because a murabaha represents a receivable and therefore there is no early redemption discount permissible (accounting for just principal and accrued interest). This has been an issue in Malaysia where many Islamic mortgages are done via murabaha and in cases of prepayment, banks typically offer a rebate (ibra) representing the portion of the markup that has not accrued (based on an equivalent conventional mortgage) to equalize the outcome. Bank Negara Malaysia earlier this year issued a Shari'ah resolution that mandated ibra in murabaha financing.

As expected based on prior Shari'ah rulings, the sukuk will be non-tradable except at par ("due to Shariah limitations"). There will be no use of these securities at the central bank's repo facility "at the moment", which indicates a potential in the future for creating a repo facility based on the Islamic CDs.

The daily auctions of under 1 year maturity bills will be done for AED denominated bills and USD and EUR only "based on demand". Issuance of longer-term notes will be done "on bilateral arrangement".

In general, I think the new issuance is positive and it adds another country in the GCC (to Bahrain) whose central bank offers liquidity management tools for Islamic banks. Bahrain has offered limited issuance of salam and ijara sukuk with 3 and 6 month maturities, respectively. The CBB issues its sukuk monthly (compared to the UAE issuing daily) and the CBB sukuk are all denominated in Bahraini dinars, so the UAE Islamic CDs will offer the option of currency diversification for banks that have assets and liabilities with exchange rate exposure. In addition, the UAE Islamic CDs will have greater maturity diversification with 1 week and 1, 2, 3, 6, 9 and 12 month bills in addition to the 2, 3, 4, and 5 year sukuk. Both the CBB sukuk, which have been issued for several years, and the new UAE Islamic CDs are precursors to the International Islamic Liquidity Management Corporation (my thoughts on the ILMC) short-term sukuk, which will be issued in US dollars and Euros.

What will interest me is whether the ILMC sukuk will follow the murabaha model (used in the UAE) or salam (in Bahrain), both of which are not tradable in the secondary market except at par. The CBB sukuk al-ijara sukuk are tradable, although I don't know whether there is a market for them. The non-tradability of murabaha sukuk is a limitation in terms of establishing a pricing benchmark (my thoughts on an Islamic pricing benchmark) as an alternative for LIBOR, but if the ILMC were issued daily like the UAE Islamic CDs will be, it would reduce significantly the drawbacks of the murabaha model. The next 6 months should be interesting as information is released on the ILMC's methodology.

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