IIBR Presentation2012 03 9

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IIBR: The Trilogy in De-Linking fromConventional FinanceRUSHDI SIDDIQUI GLOBAL HEAD ISLAMIC FINANCE & OIC COUNTRIES

RAFIZA GHAZALI HEAD OF ISLAMIC FINANCE,ASIAABDULAZIZ GONI ISLAMIC FINANCE TEAM, ASIA

9th March, 2012


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NOTE:

The information herewith is provided forthe purpose of general discussion andshould not be used as a reference forresearch and republished and

redistributed without the consent of theauthor


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DecouplingWhy Important? Authenticity

Decoupling or Delinking

Conventional finance

Law of Necessity

Indigenous development

Dow Jones Islamic Market Index (1999)

DJ-CitiGroup Sukuk index (2006)

DJ Islamic Sustainability Index (2006)

SAMI Halal Food Index (2011)

Islamic Interbank Benchmark Rate (IIBR 2011)


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Pre-IIBR Comments

Same as LIBOR

Islamic Finance getting out of its Comfort Zone

ArbitrageBanking and Islamic can't go together

unless it is zero percent rate or the return is notfixed but arbitrary

Resistance to change Over reliance on usage ofLIBOR rates.


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Indicators in/of Islamic finance

SC Equity Indexes

Sukuk Index

Launch of Banks (windows/subs), Takaful, Funds, etc

Consolidation, default and bankruptcies

Shariah Scholars

Launch of innovative products

Stock Price or credit rating of publicly listed IFIs

CDS of IFI?

Deposits/Loans

NPLs & Provisioning

Islamic finance conferences

Newsletters/Magazines

Academic Papers

Global?

Regional?National?State?


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DIB scenario

AverageDailyVolume

5 days

Index CreditRating

Deposit(M AED)

As Nov at2011

Loans

(M AED)

As at Nov2011

News StockPrice

%

ChangeYTD

5,641,024.60 S & P GCCIslamicComposite

Index

A

Fitch

BBB/

A-3S & P

64,771.32 65,944.47 EmiratesNBDsaves

troubledDubaiIslamicBank

+11.86

Institution Name : Dubai Islamic Bank (DIB)

Source: Thomson Reuters


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Lagging & Leading Indicators

Performance benchmarks Lagging indicators

Pricing Benchmarks

Leading indicators

Attempts for creating Islamic LIBOR

SC equity indexes, CPI, Inflation, real estate, etc.

Issues:

Volatile, weekly/monthly/quarterly, How will western/conventional markets react?


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Lagging & Leading Indicators

Leading indicator

An economic indicator that changesbefore the economy has changed.

Is LIBOR a leading or laggingindicator? Why?

Is stock performance a laggingindicator?

Are Bond yields a leading or

lagging indicator?

Lagging indicator

An economic indicator that changesafter the economy has changed.

Is the unemployment rate a leadingor lagging indicator?

Is the Consumer Pricing Index(CPI) a leading or laggingindicator?

Is the value of commercial andindustrial outstanding loans aleading or lagging indicator?


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Reference Rate

LIBOR and country interbank rates: Short term treasury investments

Retail finance

Property, vehicle, etc

Corp/Sovereign finance Sukuk

iSyndicated Loans


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History of LIBOR

The London Interbank Offered Rate otherwiseknown as LIBOR is An interest rate at which bankscan borrow funds, in marketable size, from otherbanks in the London interbank market.

The LIBOR is fixed on a daily basis by the BritishBankers' Association (BBA).

LIBOR is calculated and published by ThomsonReuters.

Controversy with LIBOR include the fear ofmanipulation of rates by BBA members when first

Whether LIBOR could give an accurate picture of

the British financial market.


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Growth of Islamic Finance Stages (Abilities)

Viability

Credibility

Durability

Sustainability

Scalability

40 Years $1T$150B Sukuk$87B iLoans$37-52B iFundsG20 over OIC Presence

Crisis (l &ll)GFH/TIDSukuk DefaultNPL/ProvisioningUK Sov Sukuk?

Windows/SubsAcct/LawNon-OIC IF Hubs

AlternativeCatch up to Halal?Faith & Finance Merger

A.I.R. Abilities?

IIBR?


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De-Coupling From ConventionalA.I.R.

Islamic EquityIndexes

ConventionalEquity

Indexes

SAMI Halal

Food Index

Parallel Alternative Convergence

Regulations(ters)Stock ExchangesDerivativesListed ProductsDeposit Insurance

Lender of Last resortIFRS/GAAP

Islamic Stock Exchange?AAOIFIIFSBIIRA

IIFM

Customers

$1T$100T+

Customer led?

Regulatory led?Bank led?


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BHIBOR

KIBOR

USD LIBOR

Daily USD LIBOR ,QBHIBOR1Y=, QAEIBOR1Y=, QUSDLIBOR1Y=, QKIBOR1Y=

Price

0.86

0.88

0.9

0.92

0.94

0.96

0.98

1

1.02

1.04

Price

0.8

1

1.2

1.4

1.6

1.8

2

2.2

2.4

2.6

2.8

J J A S O N D J F M A M J J A S O ND J F M A M J J A S O ND J F M A2009 2010 2011 2012

AEIBOR


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De-linking begins

Oman Crude v Brent/USCrude

The DME is pushing the Oman contractas a benchmark for markets east ofEgypt's Suez canal, arguing that muchof the world's crude comes from the

region and should be priced in theMiddle East. Its target is for the Omancontract to eventually challengeestablished global benchmarks, Brent and U.S. crude futures.

"We strongly believe the Omani crudecontract is an outstanding proxy for theMiddle Eastern crude. It make lot ofsense. It has good correlations," GaryMorsches, managing director, energyfor CME Group said in a conference callto reporters.

IIBR v LIBOR Is IIBR a proxy for ME cost of

Islamic funds?

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Islamic Interbank Benchmark RateWhats the difference?

IIBR measures expected profit while conventionalbenchmarks measures interest rates

The IIBR question for contributors explicitly refersto the cost of raising Shariah compliant funding

The IIBR contributors benchmark based on returngenerated by Islamic assets, hence a reference toan Islamic asset risk profile

Although invariably some connection/correlation toglobal markets, the IIBR is linked to theeconomies of the Islamic world and not to the

events and risks of Europe and the US


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A WORLDFIRST

A

PARADIGM

SHIFT

FROM THE MARKET

FOR THE MARKET

INVOLVES THE

LARGEST ISLAMIC

BANKS

Participating Institutions


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Pulse of the Islamic Capital Markets

Interbank profit rate fixing by16 contributor banks

Calculated and distributed byThomson Reuters

Governed by the IslamicBenchmark Committee

Certified by the Shariahcommittee comprised ofAAOIFI scholars

Calculated daily Sunday-Thursday

What Why

Certainty, Reliability &Transparency

To Agree settlement andmarked-to-market procedures

Increase trade throughtransparent and trusted pricing

De-link from conventionalbenchmarks

Establish local currencybenchmarks

Be rate linked to Islamic banks

real financing and investmentactivities

The profit rate that an individual Contributor Panel bank would perceive to bereasonable for Shariah compliant funding were it to do so by asking for andthen accepting inter-bank offers in reasonable market size, just prior to 11.00 amMakkah local time (GMT + 3).

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The myriad uses of the Islamic Benchmark

Pricing of common overnight to short term investment and financinginstruments such as Murabaha, Wakala and Mudaraba

Pricing of longer term investment and financing of yielding assets (Ijarahassets)

Pricing of sukuk and other Shariah compliant fixed income instruments

Official incorporation possible for pricing onto confirmations/annexes relatedto the IIFM-ISDA Tahawwut Master Agreement (TMA).

Indigenous pricing is eventuallyachieved as Islamic banksincrease

Interbank transaction

Benchmark securitiesissuances to the Islamic rate

eventually less reliant on theconventional banking systemand its pricing

Banks provideestimate

contributions

Ratesincorporatedin TR DealingTR Dealing

capturesdealt rates

EVOLUTIONARY OBJECTIVE INDIGENOUS ISLAMIC PRICING

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Overall Structure and Governance

Audit Committee

ThomsonReuters

Terminals

Rates Data

By 10.45amMakkah time

Islamic Benchmark CommitteePanel Association (Thomson Reuters, Islamic Development Bank, AAOIFI,AIBIM, SESRIC,

Hawkamah Institute for Corporate Governance, Bahrain Association of Banks, andrepresentatives of Contributing Banks)

Fixing

Top & Bottom QuartileExcluded

Arithmetic Mean(Average) Taken

IIBR

By 11.00 amMakkah time

Shariah CommitteeSh. Yusuf Talal Delorenzo (Chairman); Dr. Abdulrahim Sultan Al Olama;

Dr. Mohammad Daud Bakar; Sheikh Muddassir Siddiqui

SelectedContributing

Banks

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TENORS: ON, 1 W, 1 M, 2M, 3M, 6M, 9M, 1Y

PUBLICATION FREQUENCY

Every business day (Sun Thurs) except New Years Day

Eid Al Adha (1st Shawwal)*

Eid Al Fitr (10th Dhul Hijjah)*

*As determined by the authorities in Saudi Arabia

Timing of Fix publication

Rates arecontributed based

on a pre-setquestion asked tocontributor banks

Rates are snappedby Thomson

Reuters

9.00 AM 10.44 AM 10.45 AM 10.45-10.59 AM 11.00 AM

OFFICIAL REFERENCE TIME: MAKKAH (GMT +3)

Automated andManual Audit and

Review Procedures(Errors / Tolerance /

Std. Dev / Call)

Publication onThomson Reuters

Terminals

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Calculation Process

2nd StepOrdering of Rates

1st StepCollation of Rates

3rd StepDiscard Top/Bottom Quartiles

4th StepCalculateMoving Average

16ContributorBanks

5th StepPublish IIBR

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Error

Checking

Central Fixing Support @ Exeter, UK notified of alltypes of errors per bank contribution

Tolerance

Difference between the rate and the correspondingmoving average within acceptable confidence

levels

StandardDeviation

Anything above the upper and lower limit based ona pre-defined confidence levels will be flagged

OutlierVerification

Call up contributor and verify the rate. If notavailable, discretion on Thomson Reuters toaccept or reject the rate based on a number offactors

Quality Review and Audit procedures

TenorMax

Spread

ON 0.05SW 0.051M 0.102M 0.103M 0.106M 0.159M 0.151Y 0.15

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Governance Framework and Roles

IslamicInterbank

BenchmarkRate

ContributorPanel

ShariahCommittee

FixingsInfrastructure

Provider

IslamicBenchmarkCommittee

Islamic Benchmark Committee Self governing body that determines

selection, admission and exclusion ofcontributors

Oversees rules, process and proceduresfor fixing

Review of discrepancies in rate

contributions/ periodic review of contributorrate quality

Establishes disciplinary sub-committeewhen necessary

Contributor Panel Contributors as chosen by the Islamic

Benchmark Committee Regulated by the Standard Fixings

Agreement between Thomson Reutersand Contributor

Fixings Infrastructure Provider Provides the necessary infrastructure in

order to absorb, calculate and distributethe rates contributed by the ContributorPanel

Reports on the quality of contributions tothe Islamic benchmark committee

Shariah Committee Self governing body that determines

the Shariah compliance of the fixingdefinition, question, process andprocedures

Voluntary attendance of IslamicBenchmark Committee meetings

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Governance Committees

*as at 22nd November 2011

Islamic BenchmarkCommittee

INDEPENDENTMEMBERS*

AAOIFI (Secretariat) Association of Islamic

Banking Institutions

Malaysia (AIBIM) Bahrain Association of

Banks Hawkamah Institute for

Corporate Governance Islamic Development Bank Statistical, Economic and

Social Research Center for

Islamic Countries(SESRIC)

Thomson Reuters

Islamic BenchmarkCommittee

REPRESENTATIVE BANKMEMBERS*

Abu Dhabi Islamic Bank Ahli United Bank Al Baraka Bank Al Hilal Bank Alinma Bank Al Salam Bank Bahrain Islamic Bank Barwa Bank Dubai Islamic Bank Ithmaar Bank

Kuwait Finance House Masraf Al Rayan Noor Islamic Bank National Commercial Bank Qatar Islamic Bank Sharjah Islamic Bank

Shariah Committee

Yusuf Talal DeLorenzo(Chairman)

Mohammed Daud Bakar

Mohammad Abdul RahimAl Olama

Muddassir Siddiqui

Note: The Shariah Committeeworks independently from theIslamic Benchmark Committee

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Selection of Contributor Banks

SELECTING ANDADMITTING

Selection Criteria

1. Primary Preference: Highly Rated

Islamic Banks / Windows2. Secondary Preference: Include active

Islamic Banks as nominated / approvedby quorum

Admitting

Each bank must sign the Standard

Fixings Agreement and acknowledge Fixing calculation method and timing of

fix Their responsibility to contribute on

every business day

EXCLUDING

Thomson Reuters Discretion To protect the quality and integrity of the

IIBR, which is of paramount importance

Quality of Contributions Rate investigation based on outlier status Certain explanations valid Inform the Islamic Benchmark Committee

and recommend exclusion Where objections received or

recommended by at least 4 members, formDisciplinary Sub Committee

Delay in Contribution or MissingContributions

Banks that are consistently missingcontributions may be removed inconsultation with the Islamic benchmarkcommittee.

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IIBR vs. LIBOR

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IIBR vs. LIBOR

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

IIBR ON

IIBR 1M

IIBR 3M

IIBR 6M

IIBR 1Y

LIBOR ON

LIBOR 1M

LIBOR 3M

LIBOR 6M

LIBOR 1Y

Long term IIBRRates

Short term IIBR


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Conclusion

Decoupling (authentic v cosmetic)

IIBR published before LIBOR Implications?

Traction

Legal documents Wider use

Consumer reference

Looking Ahead

More banks, but limitations- geographic representation

Local currency

Wakala

Dealt rates

Documents

IIBR Presentation2012 03 9