The International Islamic Financial Market (IIFM) and the International Swaps and Derivatives Association (ISDA) announced their newest master agreement for a profit rate swap (mubadalatul arbaah). This is a good development in my opinion because it provides a lower cost way for Islamic financial participants to hedge against fluctuations in the interest rates that are used to determine the cost of Islamic financial products.
The idea of Islamic derivatives have been controversial because they are often viewed as instruments for speculation, which is viewed as not being in the spirit of Islamic finance. Speculation financed by Islamic financial products (e.g. in the Dubai real estate market before the crisis) somehow escapes the same level of scrutiny as derivatives. Other objections have focused on the synthetic nature of Islamic derivatives as being just copies of conventional products done in a way that is Shari'ah-compliant, and is somewhat condescendingly described as not being used to finance 'real economic activity'.
However, profit rate swaps are quite easily used for legitimate hedging transactions that doesn't necessarily shift risk from one party to another at least entirely (a criticism that could be more aptly pointed at talk of developing Islamic credit default swaps). Hedging is viewed as permissible, where speculation is viewed in a negative light (again with a somewhat double standard).
Take, for example, a situation where an Islamic bank financing a widget factory through a murabaha. The bank only offers the company a floating rate loan. However, the managers of the widget factory don't want to be exposed to the risk that the financing costs increase over the term of the murabaha because it could lead to additional cost that complicates their planning for the business.
The manager of the company may then approach an investment company to lock in the financing costs, to make its finance costs predictable over the life of the murabaha. A fund approaches the company with the offer of a profit-rate swap that locks in the financing costs for the widget company through a profit-rate swap. The fund receives a stream of fixed rate payments in exchange for paying a floating rate, which it expects to benefit its investors.
The master agreement facilitates this process by lowering the costs compared to the participants having to custom build a profit-rate swap. Without the master agreement, there would be fewer transactions, which would make an impact on the 'real economy' because fewer companies would have the opportunity to fix their financing, and effectively shift the management of interest rate fluctuations to institutions that have a focus on managing those changes.
The one criticism I have of the profit rate swap is that it is an over the counter (OTC) swap. The benefits of the profit-rate swap come with the cost of counterparty risk by adding a third party into the original murabaha, which exposes the widget to the company that it will lose its fixed rate protection if the counterparty in the swap cannot fulfill the terms of the contract. However, creating an exchange for swaps is a whole different challenge that can (and probably will) wait for another day (likely well into the future).
Showing posts with label Swaps. Show all posts
Showing posts with label Swaps. Show all posts
Tuesday, March 27, 2012
Thursday, June 24, 2010
Dar al-Arkan swap, sukuk fund diversification
Dar al-Arkan, which issued a 10.5% sukuk in February to refinance its debts, has entered into a Shari'ah-compliant swap agreement to lower its financing costs. The arrangement swaps the current financing cost of 10.75% with a floating rate of 7.95% over 3-month SAIBOR (I would appreciate if someone could email me a source of SAIBOR rate data) for half of the sukuk, $225 million. The article discusses that the swap lowers the cost of financing, however, it should be remembered that if Dar Al Arkan is now exposed to interest-rate risk on this portion of the sukuk. If interest rates rise, the costs of the floating rate side of the swap to which Dar al-Arkan is exposed will rise. The sukuk matures in 2015 (the length of the swap was not included in the article) and interest rates are currently very low so if the swap covers the entire period of the sukuk, it could expose Dar al-Arkan to substantial additional financing costs.
European Finance House, an affiliate of Qatar Islamic Bank, released the performance of its EFH Global Sukuk Plus Fund. The performance was higher than its benchmark (3m USD LIBOR + 2%) by 780 basis points and the fund says it has experienced lower volatility than the sukuk markets as a whole in its first year. The article describes the diversification the fund was able to achieve across 13 sukuk in nine jurisdictions. This is not surprising, but it is also not very diversified. This is not a problem specific to this one fund; there are far too few sukuk that are available for sukuk funds. Until the growth in sukuk issuance increases--and it has rebounded this year--it will be difficult for sukuk funds to achieve diversification anywhere comparable to conventional bond funds. For comparison, one of the world's largest bond funds, the PIMCO Total Return Fund, has 11,619 holdings according to Morningstar.
Other News
European Finance House, an affiliate of Qatar Islamic Bank, released the performance of its EFH Global Sukuk Plus Fund. The performance was higher than its benchmark (3m USD LIBOR + 2%) by 780 basis points and the fund says it has experienced lower volatility than the sukuk markets as a whole in its first year. The article describes the diversification the fund was able to achieve across 13 sukuk in nine jurisdictions. This is not surprising, but it is also not very diversified. This is not a problem specific to this one fund; there are far too few sukuk that are available for sukuk funds. Until the growth in sukuk issuance increases--and it has rebounded this year--it will be difficult for sukuk funds to achieve diversification anywhere comparable to conventional bond funds. For comparison, one of the world's largest bond funds, the PIMCO Total Return Fund, has 11,619 holdings according to Morningstar.
Other News
- The Dubai bailout has increased demand in secondary markets for GCC-based sukuk.
- Gas pipeline company Trans Thai Malaysia, a joint venture of Petronas and PTT pcl, is likely to issue a sukuk.
- Bank Negara Malaysia, on behalf of the government, issued MYR2.4 billion ($743 million) of three-year Sukuk 1Malaysia notes with a 5% coupon. The transaction was facilitated through Bursa Suq Al-Sila', the commodity murabaha platform.
- Pakistan's government plans to issue $410 million in short-term (1-, 2- and 3-year) sukuk shortly once it receives government approval from the Sindh government and the Ministry of Defense. The sukuk will be based on land at a terminal at the Karachi airport.
- An article in a Turkish newspaper describes sukuk. The description included: "Sukuk are not debts of the issuer". This is technically correct because even asset-based sukuk involve the transfer of beneficial ownership, however, they are structured to be treated pari passu with the unsecured debts of the issuer and often provide recourse to the issuer through a purchase undertaking.
Friday, September 11, 2009
Malaysia leading in sukuk, CBK appoints monitor for TID, Nakheel sukuk rises on comments, derivatives framework by year end, Islamic finance in France
Malaysia remains the largest issuer of sukuk representing 45% of total issues followed by Saudi Arabia with 22% in the first 7 months of 2009 according to a report by Standard & Poor's. The largest issuer was Saudi Electric Company which issued a $1.8 billion sukuk. 20% of the sukuk issued were denominated in US$, up from 10% in 2008. 3/4 of all new issues were from sovereign issuers. In another report, the Securities Comission of Malaysia reported that through August 2009, more sukuk had been issued than all of 2008 which amonted to 58.2% of the total issuance of sukuk & bonds in the country through July (p from 57% in 2008).
The Investment Dar, whose sukuk is in default, has not filed its 2008 financial statements yet and will be monitored by a temporary monitor appointed by the Central Bank of Kuwait.
Troubled property firm Nakheel saw its sukuk rise over par in secondary market trading after Shaikh Mohammed bin Rashid Al Maktoum, ruler of Dubai, said he was not worried about either the $1 billion in maturity debt for the Emirate or the $3.52 billion maturing Nakheel sukuk. Speculation has been rising that Dubai will bail out Nakheel using the $20 billion it raised recently with half coming from the UAE Central Bank. I wrote a summary of this sukuk earlier this year when it was trading at a substantial discount to par.
The International Islamic Financial Market (IIFM) will finalize a master agreement for Islamic derivatives by the end of the year. The agreement, called Ta'Hawwut may be based on Arbun, which has been used to replicate call options in a Shari'ah-compliant way. Derivatives like options and swaps have have attracted some significant criticism for simply replicating conventional products. I recently wrote a blog post on whether all innovation is necessarily beneficial within the Islamic financial industry.
France wants to attract Islamic finance, but concerns remain about how well Islamic retail institutions would fit in with the country's strict separation between religion and state. The author of the article in Reuters has a blog post at the website providing additional insight behind the article.
An Australian newspaper has an article on the MCCA co-operative that recently offered a retail Shari'ah-compliant mortgage interest fund. It's an interesting article about a product that is not available in much of the world in Shari'ah-compliant fashion. However, it is available to some extent in the U.S. and Canada also in the co-operative model. However, one of the significant limitations of the co-operative model is that it often faces a shortage of capital to fund the home purchases for the members because it cannot access capital markets by securitizing the mortgages or, in the U.S., by using funding provided by Freddie Mac.
Other News
The Investment Dar, whose sukuk is in default, has not filed its 2008 financial statements yet and will be monitored by a temporary monitor appointed by the Central Bank of Kuwait.
Troubled property firm Nakheel saw its sukuk rise over par in secondary market trading after Shaikh Mohammed bin Rashid Al Maktoum, ruler of Dubai, said he was not worried about either the $1 billion in maturity debt for the Emirate or the $3.52 billion maturing Nakheel sukuk. Speculation has been rising that Dubai will bail out Nakheel using the $20 billion it raised recently with half coming from the UAE Central Bank. I wrote a summary of this sukuk earlier this year when it was trading at a substantial discount to par.
The International Islamic Financial Market (IIFM) will finalize a master agreement for Islamic derivatives by the end of the year. The agreement, called Ta'Hawwut may be based on Arbun, which has been used to replicate call options in a Shari'ah-compliant way. Derivatives like options and swaps have have attracted some significant criticism for simply replicating conventional products. I recently wrote a blog post on whether all innovation is necessarily beneficial within the Islamic financial industry.
France wants to attract Islamic finance, but concerns remain about how well Islamic retail institutions would fit in with the country's strict separation between religion and state. The author of the article in Reuters has a blog post at the website providing additional insight behind the article.
An Australian newspaper has an article on the MCCA co-operative that recently offered a retail Shari'ah-compliant mortgage interest fund. It's an interesting article about a product that is not available in much of the world in Shari'ah-compliant fashion. However, it is available to some extent in the U.S. and Canada also in the co-operative model. However, one of the significant limitations of the co-operative model is that it often faces a shortage of capital to fund the home purchases for the members because it cannot access capital markets by securitizing the mortgages or, in the U.S., by using funding provided by Freddie Mac.
Other News
- The government of the Indian state of Kerala plans to set up an Islamic bank according to the region's finance minister.
- Two Bahrain-based Islamic investment firms, Inovest and Tharawat, are investing $32 million in a water filter production company.
- An article on the recovery includes what I think is an important reminder that "'Islamic Finance's immunity is a myth which is brought up persistently', says Fares Mourad, Managing Director and Head of Islamic Finance at Swiss private bank Sarasin."
- Does Islamic finance need more supervision?
- Malaysia's state-owned body which owns transit assets priced RM2 billion ($573m) in 15- and 20-year sukuk.
- Kuwait Turkish Participation Bank, majority owned by Kuwaiti firm Kuwait Finance House, received approval to conert its commercial office in Mannheim into an Islamic banking institution by the end of 2009 or early in 2010.
- Abu Dhabi's Tourism Development & Investment Company may raise $1 billion in sukuk.
- A $125 million syndicated secured ijara facility from a Kuwaiti issuer may have helped the market for other syndicated ijara facilities.
- Qatari Diar is raising $962 million through a syndicated Islamic facility to fund investments in Europe.
Friday, January 16, 2009
Al Mi'yar
As I mentioned in my last blog post, I have posted a more detailed look at the newest structured product from Deutsche Bank, billed as a platform to issue "tradable Islamic security certificates, which represent ownership in Islamic assets."
Tuesday, January 30, 2007
Deutsche Bank white paper, Ed Balls speaks on Islamic finance & other news
Deutsche Bank produces white paper on the structure of Shari'ah-compliant "swaps"
Deutsche Bank and the consultancy it partly owns, Dar Al Istithmar, produced a white paper on structuring a Shari'ah-compliant "swap". While the paper acknowledges that "the technique DB uses has the same economic result as a total return swap but is structured differently" to ensure Shari'ah-compliance, the move towards transparency demonstrated by the white paper being publicly available is a positive move in the Islamic financial industry and I hope that other IFIs begin to demonstrate commitment to a similar level of transparency. [Press Release] [White Paper - PDF]
Ed Balls speaks on the British gov't role in Islamic financial industry
UK Economic Secretary Ed Balls MP, spoke at the 6th Euromoney Annual Islamic Finance summit in London, where he described the steps already taken, as well as those under development, to attract Shari'ah-compliant funds into the British market. While he addressed the Shari'ah-compliant mortgage market as well as other products designed to assuage funding problems for Muslim-owned businesses, his primary focus was on sukuk issue and secondary market trading in the UK. To date, most sukuk are held until maturity because there is no secondary market, in part because a lack of common standards creates uncertainty about individual sukuk. "The lack of standardisation is hindering liquidity," Ed Balls notes in the prepared text for his speech. "It prevents investors from knowing what risk they are assuming when they invest and increases the costs associated with sukuk". [Press Release] [Text of Speech]
Other News
A conference on various investment topics in the Middle East & North Africa (MENA) region will be held February 20-21, 2007 in Dubai, UAE. There is a website for the Broader MENA Investment Summit and it will be added shortly to the IHI's Conference list.
Merrill Lynch is opening an office at the Dubai International Financial Centre, in part to capture a share of the growing market for Islamic finance.
The government of Kuwait announced the formation of the Jaber Islamic Bank, which will be 24 percent owned by the state and the remaining shares will be privately held.
Deutsche Bank and the consultancy it partly owns, Dar Al Istithmar, produced a white paper on structuring a Shari'ah-compliant "swap". While the paper acknowledges that "the technique DB uses has the same economic result as a total return swap but is structured differently" to ensure Shari'ah-compliance, the move towards transparency demonstrated by the white paper being publicly available is a positive move in the Islamic financial industry and I hope that other IFIs begin to demonstrate commitment to a similar level of transparency. [Press Release] [White Paper - PDF]
Ed Balls speaks on the British gov't role in Islamic financial industry
UK Economic Secretary Ed Balls MP, spoke at the 6th Euromoney Annual Islamic Finance summit in London, where he described the steps already taken, as well as those under development, to attract Shari'ah-compliant funds into the British market. While he addressed the Shari'ah-compliant mortgage market as well as other products designed to assuage funding problems for Muslim-owned businesses, his primary focus was on sukuk issue and secondary market trading in the UK. To date, most sukuk are held until maturity because there is no secondary market, in part because a lack of common standards creates uncertainty about individual sukuk. "The lack of standardisation is hindering liquidity," Ed Balls notes in the prepared text for his speech. "It prevents investors from knowing what risk they are assuming when they invest and increases the costs associated with sukuk". [Press Release] [Text of Speech]
Other News
A conference on various investment topics in the Middle East & North Africa (MENA) region will be held February 20-21, 2007 in Dubai, UAE. There is a website for the Broader MENA Investment Summit and it will be added shortly to the IHI's Conference list.
Merrill Lynch is opening an office at the Dubai International Financial Centre, in part to capture a share of the growing market for Islamic finance.
The government of Kuwait announced the formation of the Jaber Islamic Bank, which will be 24 percent owned by the state and the remaining shares will be privately held.
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