Assoc. Prof. Dr. Asyraf Wajdi DusukiHead, Research Affairs

AANZFTA BUSINESS SEMINAR: Partners In Growth: Services Trade with Southeast AsiaAmora Hotel, Wellington; Friday 3 June 2011

AANAFTABusiness Seminar

Shariah-Compliant Operation1st Level of Compliant2nd Level of CompliantNominate ContractsNon-Nominate ContractsInvestment ActivitiesRectifying & PurifyingConversion ProcessHedging InstrumentsMonitoring & SupervisionSocial ResponsibilityMaqasid al-Shariah(The Objectives of Shariah)The Framework of Islamic Finance ENDS / MEANS/

Asset Classes in Islamic Finance

Free from GamblingFree fromGharar (Ambiquity)Entitlement toEqual, Adequate,Accurate Info.Free fromDharar (Detrimental)Free from Riba (Usury)Promote Public Interest (Maslahah)Free fromPrice control & ManipulationFreedom to ContractEntitlement toTransaction at Fair PriceCharacteristics of Shariah-compliant Banking and Financial SystemPromote EquityA system grounded on moral and ethics

Illustration on Sukuk Structuring

Technical Meaning Sukuk refers to securities, notes, papers or certificates, with features of liquidity and tradability (except for salam and murabahah sukuk)Literal MeaningSukuk is the plural of sak which means certificates. Other similar terms:Taskik process of dividing assets into papers (sukuk)Tawriq to render something into cash

SUKUKAAOIFIInvestment sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufructs and services (in the ownership of) the assets of particular projects or special investment activity

Income Generating ProjectSukuk InvestorsObligor/Project DeveloperIssuer/TrusteeSukuk Issue ProceedsProceeds fromSukuk SalesIncome from projectBASIC STRUCTURE OF SUKUK

Comparing SUKUK to BONDS

SukukBonds1. Holder owns assets1. Holder owns cash flow only2. Use a variety of contracts to create financial obligations between issuer and investors; e.g. Sale, lease, equity partnership, joint-venture etc.2. Simply use a loan contract to create indebtedness3. Return linked to profit elements in-built in the sale, lease or partnership3. Return linked to interest charged out of the loan contract4. Instrument may be equity or debt depending on underlying contract4. It is a Debt instrument5. Tradability of the sukuk depends on the nature of the underlying asset5. No restriction on the tradability6. Investment in Shari`ah-compliant activities6. Proceeds are invested in any business without restrictions

Hong KongAims to become Islamic finance gateway to ChinaPlans to issue sovereign sukukHang Seng Islamic China Index Fund in 2007UKGovt sets an objective to entrench London as a global gateway for Islamic finance5 FSA-approved Islamic banks and Takaful operatorsPlans to issue sovereign sukuk, amend tax law on IFUAEJapanLaw passed allowing banks to do Islamic finance

FrancePassed rules/regulations to support Islamic finance activitiesIn process of licensing Islamic banksMade fiscal & legal adjustment for IF transaction i.e. taxation guidelines on sukuk & murabaha

SingaporeEstablished first Islamic bankIntroduced tax neutrality for Islamic financeAspiring to be centre for Islamic financeLaunched Islamic ETFSouth KoreaParliament expected to pass the law related to offering of tax waiver on foreign investors interest income from sukuk issuedThailandQatarKuwaitGermanySaxony-Anhalt state issued government sukukFirst Islamic bank to operate in 2010

Emerging interest on Islamic finance as viable alternative to the global financial system Saudi ArabiaBahrainMaltaPlans to position as Islamic finance hub for the MediterraneanJordanPlans to tap sukuk market to finance its deficitTurkeyAnnounced IFC Istanbul in Sep 09 with focus includes interest-free financial businessBrunei Aim to become Islamic financial services hub for Asia Muslim-majority countries offering Islamic finance (IF)Non-muslim countries starting to offer IFCourtesy of Bank Negara MalaysiaMalaysiaIranStarting in 1971 with the first Islamic bank in Egypt, there are now more than 600 Islamic financial institutions in 75 countries

*Global developments Islamic bankingGrowth expected to continueGlobal growth rate of 15-20% per annum over the last 10 yearsMid 1990s approximately USD150b2009 approximately USD780b2010 estimated USD956b2012 USD1.6t (IFSB estimate) By 2020, estimated to reach USD4tAlmost 90% of global market share are in top 6 Islamic financial marketsCourtesy of Bank Negara Malaysia

*Global sukuk marketContinued to expand in 2009Courtesy of Bank Negara Malaysia

Chart1

54.2

13.6

12.7

7.1

6.4

2.4

1.6

1.5

0.4

0.1

Global Sukuk issued by country in 2009 (USD 24.6 billion)

Sheet1

Malaysia54.2

UAE13.6

Saudi Arabia12.7

Indonesia7.1

Bahrain6.4

US2.4

Brunei1.6

Pakistan1.5

Singapore0.4

Gambia0.1

Chart1

36.9

35.6

11.2

4.6

4.5

3.2

2

1.3

0.6

0.1

Global Sukuk issued by country in 2008 (USD15.5 billion)

Sheet1

Malaysia36.9

UAE35.6

Saudi Arabia11.2

Bahrain4.6

Indonesia4.5

Pakistan3.2

Qatar2

Kuwait1.3

Brunei0.6

Gambia0.1

*Global developmentsBreakdown of Islamic finance assetsThe largest share of Islamic financial assets remains in Islamic banking, although growth is slowingSukuk and takaful continues to grow Islamic funds registers a slight decreaseCourtesy of Bank Negara Malaysia

*Post crisis sukuk marketImpact of global financial crisisNot spared as sukuk is seen in the same asset class as bondsbut has since staged a recovery USD20b in 2008USD33b in 2009 (70%)USD50b ( 55%) in 2010USD34bCourtesy of Bank Negara Malaysia

*Post crisis global Islamic banking industry Largely shieldedOnly 1 Islamic financial institution required government assistance5 top conventional banks received government assistance of USD163.0b or 26% of their combined equity

Not a single Islamic bank required to be rescuedSource: IFSB-IRTI-IDB Islamic Finance and Global Financial Stability Report, 6 April 2010 based on E&Y study 20082009Study on Top 10 Conventional banks vs Top 10 Islamic banksCourtesy of Bank Negara Malaysia

Between Dec 2006- May 2009Conventional IslamicCombined market capitalisation42.8% 8.5% Net profitsDeclined from USD116b to USD42b lossIncreased by 9% from USD4.2b to USD4.6bTotal assets growth36% (USD17.4t)55% (USD147b)Total equity growth24%36%Leverage ratio (Assets/equity)From 16.6x to18.2xFrom 5.8x to 6.6x

Global Islamic banking industryLargely shielded: reasons why *US Commercial Papers OutstandingCourtesy of Bank Negara Malaysia

Surrounding factorsMarket deregulation followed by unprecedented levels of leverage, relaxed lending standardsRapid issuance of mortgage-backed securitiesTremendous growth of CDS marketGrowth of complex securities and derivatives

Greater transparency & disclosure- additional Shariah governanceunique risksGreater fiduciary duties & accountabilityEmphasis on clear documentation & contract add to soundness & stability *Real ActivitiesEthicalGovernanceGlobal Islamic finance industryLargely shielded: reasons whyDirect link to real economyCertainty supported by underlying activities (prohibition of gharar - uncertainty) Prohibits excessive leveragingMoney is not commodityAvoidance of unethical activities Avoidance of maisir (gambling) & riba (interest) & non-permissible goods & servicesScreening investmentForbearance for customers in difficultiesDifferent contractual relationshipEquity-based & risk-sharing transactionsClearly defined risk & profit-sharing characteristics serve as additional built-in mechanismsCourtesy of Bank Negara Malaysia

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Legal & RegulatoryIslamic Banking Act Takaful Act Government Funding Act Capital Market Services Act

Shariah Advisory CouncilCentral Banking Act

Dispute ResolutionJudicial system: dedicated high courtKL Regional Centre for ArbitrationFinancial Mediation Bureau Banking17 Islamic banks10 Islamic windows3 International Islamic Banks14 International Currency Business Units (ICBU)

Takaful8 takaful operators4 retakaful operators7 ICBUs Fund Management9 Islamic fund managers35 Islamic fund management windowsLegal firmAccountingFinancial Intermediaries Financial AdvisorsConsultancy Service

Payment, clearing and settlement, custodianPrincipal DealersListing on Bursa with authorise exchange statusProfessional ServiceDiversified PlayersGovernanceInfrastructureFinancial MarketsCapital MarketMoney MarketForeign Exchange MarketCommodity MarketBursa Suq Al-SilaMore than 30 years of experiences in developing Islamic finance Malaysia: the worlds most comprehensive Islamic financial systemIslamicBanks & Takaful CompaniesIslamicCapital MarketIslamicMoney MarketMoney marketConventional Banks & Insurance CompaniesCapital marketMalaysian Financial SystemLabuan IBFCCourtesy of Bank Negara Malaysia

58% of outstanding corporate bond are sukukMalaysias outstanding sukuk (public & private) = USD66 billion @ end June 200962% of total outstanding sukuk globallyMalaysia as centre for innovative sukukActive secondary sukuk marketSource: Malaysian ICM Bulletin, June09, SCMalaysia has a well-developed sukuk marketMore than 80% of the sukuk are private sectors sukukCourtesy of Bank Negara Malaysia

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