Islamic Risk Management Instruments
First Internati
Islamic Finance C
Labuan - Mal
(6-7 July 2004
Islamic Risk Man
Instrumen
Corporate
and Investment
Banking
Table of contents
SECTION 1 The FX & Debt/Deposit issues
SECTION 2 Conventional vs. Islamic hedgi
SECTION 3 The Sukuk
SECTION 4 A new perspective for Sukuk St
SECTION 5 BNP Paribas in Islamic Banking
Section 1: The FX & Debt/Deposit issues
Islamic Institution and their risks
• Contrary to common beliefs, Islamic Bank
Banks, are fully exposed to Forex and Intere
>> The following example -based on the
financials of an Islamic Institution financial
our opinion on this matter
Islamic Banks are exposed to FX flu
• The FX issue:
>> As shown below, due to geographical diversif
assets & liabilities, Islamic Banks are exposed to
fluctuations in foreign currency exchange rates o
positions and cash flows
Mismatch
Islamic Banks are exposed to Intere
• The Debt/Deposit issue:
>> Assets and Liabilities Mismatch is also a co
Banks Indeed, such a mismatch, implies 2 othe
⇀ Liquidity Risk and
⇀ Interest Rate Risk
Maturity Mismat
Islamic Financial Institutions’ risks
• Summary:
Three different kind of risks can be clearly identi
⇒ The Foreign Exchange risk
⇒ The Interest Rate risk
⇒ The Liquidity risk
⇒ Islamic Financial Institutions ne
Sharia-Compliant hedging instrum
Section 2: Conventional vs. Islamic instruments
Conventional Hedging instruments..
• Hedging tools used and proposed by conventio
following:
⇒ FX Swaps:
Combination of both a FX spot and a FX
⇒ Interest Rate Swaps:
Exchange of a Floating against a Fixed I
⇒ Bonds:
Negotiable Debt instrument (based on In
...Not applicable to Islamic Banks
• These different mechanisms and instruments are
with Sharia principles:
⇒ These instruments refer to the concept of ‘riba
⇒ The forward concept is not acceptable
⇒ Pure monetary flows (no underlying Assets) ar
⇒ Debt instruments are not tradable under Sharia
New Islamic instruments have to be
to meet Islamic banks’
Eventual Solutions
BNP Paribas has developed Sharia-compliant FX
• Double Currency Exchange Deposit (equivalent
• Murabahas Profit Exchange (equivalent IR Swa
These Instruments have been approve
BNP Paribas in-house Sharia
And are currently at the final stage
documentation
The Double Currency Exchange Dep
Mas
Contractual (Provi
Scheme 1) Client 1 deposit on a
Murabaha basis, an
amount in a specified
currency with Client 2 for
a certain period of time
2) At Maturity, Client 2
give back the deposit +
profit to Client 1 in the
currency of the deposit
Client 1 2 bis) At Maturity, Client 1
C
give back the deposit +
profit to Client 2 in the
currency of the deposit
1 bis) Client 2 deposit on
a Murabaha basis, an
amount in a specified
currency with Client 1 for
a certain period of time
(same maturity than
Time Murabaha 1)
Scheme
Client 1
deposit with
Client 2
Client 2
deposit with
Client 1
The Murabaha Profit Exchange
M
(P
Contractual Scheme
1) Client 1 deposit on a
Murabaha basis, an
amount with Client 2 for
a certain period of time
2) At Maturity, Client 2
give back the deposit +
profit to Client 1
Client 1 Cl
2 bis) On every
Intermediate maturities:
Client 1 give back the
deposit + profit to Client 1
1 bis) Client 2 deposit on a
revolving Murabaha basis
(Total maturity = maturity of
Murabaha 1, an amount with
Client 2 for a certain period of
Time Scheme time
Client 1
deposit with
Profit
Client 2 Profit
Deposit + Deposit +
Client 2
Profit Deposit Profit Deposit
deposit with
rolled over rolled over
Client 1
Challenges raised by these structure
⇒ Accounting issues:
Can these structures allow an off-balance sheet
conventional tools?
Is it compatible with the standards set up by AAI
standards?
⇒ Legal issues:
Can the agreement be equivalent and as secured
one? (ISDA agreement)
⇒ Other issues:
Should we allow early settlement / unwinding of
Can we consider an endorsement by the IIFM?
Section 3: The Sukuk
Overview of the Sukuk market
• The Sukuk are another solution to resolve the l
Maturity Mismatch.
•As of 03/09/2004 The Sukuk market is as follows
• The world stock of sovereign Islamic bond
US$ 3 billion
• In comparison, in Malaysia, the value of ou
corporate bonds stands at nearly US$ 16 bil
⇒ Given the growing demand on these inst
international Islamic debt capital market still
developed (new issues needed)
The structures
⇒ So far, three structures have been d
International Islamic Capital market:
⇒ The Ijara Sukuk
⇒ The Mixed Assets Sukuk
⇒ The Sukuk Al-Salam
The existing structures (1): The Ijara
From a Sharia perspective, the Ijara Sukuk is a
format of Islamic Bond among Scholars
Indeed, the following Sharia constraints are ob
• It is Asset-Backed,
• It complies with the principles of Risk-Shari
(through an Ijara) as opposed to the princip
money,
• The Return on the notes have the form of R
payments.
Examples of Ijara Sukuk issues:
⎯ Bahrain Local & International Sukuk
⎯ Malaysia Global Sukuk (July 2002)
⎯ Qatar Global Sukuk (2003)
The Ijara Sukuk: The Structure
6) Buys Back the Assets
at maturity
1) Sells the Assets
Islamic
Issuer
S.P.V. 2
o
P
(
3) Lease Agreement
7) Re
issue
4) Rental Payments
Direct Recourse
The existing structures: Mixed asset
In terms of structure, the Mixed Assets Sukuk i
version
From a Sharia perspective, it is also a widely ac
Sukuk among Scholars
Example of Mixed Assets Sukuk issues:
⎯ Islamic Development Bank Global Suku
The Mixed Asset Sukuk: The Structu
Balanc
- 51% of
- 49% of
1) Transfer of Murabahas
deals
Islamic S.P.V.
Ultimate (Issuer)
Borrower 3) Purchase of the
2 Bis
Assets (1 & 1 Bis)
of p
1 Bis) Transfer of Leased Assets or 4) Fixed P
Assets to be Leased back to Issuer
Direct Recourse
The existing structures (3): The Suk
Al Salam is a transaction where two parties a
sale and the purchase of an underlying Asset
future date but at a price determined and fully
contract is entered into
The Sukuk Al Salam structure is a well-accep
short-term money market instruments (the Ba
Agency issues 3-months maturity Sukuk Al S
basis)
On a longer term, this structure still has to be
Tradability of such instrument is also a conce
The Sukuk Al Salam: The Structure
2) Payment against future delivery
of the Assets
Islamic S.P.V.
Ultimate (Issuer) 1 Bis
Borrower of Pa
(Suk
3) at maturity, Delivery of the goods
4) Undertaking agreement
(instantly executed)
5) payment o
Off-Takers
The challenges and problems of the
⇒ Assets issues:
How to structure such type of Sukuk in case t
Borrower have no assets or if available asset
negative pledges?
⇒ Legal issues:
Some jurisdictions do not allow foreigners (in
own locally domiciled assets
⇒ Tax issues:
The purchase, the lease and/or the buy back
important fiscal implications on the transacti
Section 4: A new perspective for Sukuk Structur
Need for new structures
Given the problems encountered in Structuring
Sukuk, new structures have to be developed an
respond to the following criteria:
⇒ Compliance with Sharia principles & supp
⇒ Acceptable to Islamic investors (same feat
⇒ Structurally enhanced to appeal to crosso
⇒ Tradable
⇒ Easily documented and that could facilitat
In this perspective, BNP Paribas has deve
tends to comply with these
The Sukuk Al Murabah
Sukuk al Murabaha - The Structure
Direct Obligation
Islamic Principal 1) Fun
Mudaraba
Borrower Profit (Issuer)
(& Principal @ maturity) 2) Suku
4) Profit
(& Principal @ mat
3) Revolving International Commodity
Murabaha Facility
No-withdrawal ag
(special exit cond
(Manager/ Mudarib)
Sukuk al Murabaha - The Structure
Initial Steps in Setting up the Transactio
Step 1: A Special Purpose Vehicle (Mudara
the first step in the proposed issue of secur
will be the issuing entity.
Step 2: The Manager (Mudarib) will, on behalf
(Sukuk holders), enter into a revolving internat
Murabaha with the Issuer. The funds raised via
applied towards this Murabaha scheme.
Periodic Profit Distribution
Profit earned on the revolving Murabahas and
Mudaraba will be passed on to the Sukuk holde
At Maturity
At the maturity of the Murabaha, the Issue
principal initially invested back to the Mudara
turn will redeem the Sukuk.
Advantages of the Structure
Easy to Structure:
The Sukuk al Murabaha is easier and faster to st
Ijara (Documentation ready for each step of the t
No transfer of Tangible Assets:
Under the recommended structure the Issuer is
any tangible asset transfers to a private entity, e
No due diligence on assets:
The assets backing the Sukuk al Murabaha struc
priced on the LME which obviates the need for a
assets
Same rating as the Issuer:
The international rating of the Sukuk will reflect t
exposure on the Issuer by the Mudaraba and the
would give investors a greater level of comfort
No return volatility:
The return (fixed or floating) on the Sukuk is set
subject to any change
Replicable Structure:
The Sukuk al Murabaha structure is elegant and
Compliance with Shariah Principles
Reason 1: Sign off by scholars
The Sukuk al Murabaha structure has already
prominent Sharia Scholars and large Middle
This format of Sukuk has already been issued
Investment Bank, a Bahrain-based Islamic Inv
mio, dual tranche: 3 & 5 yrs)
The Sukuk al Murabaha is a combination of v
widely used instruments in the market compr
Reason 2: Based on well established Islamic
⎯ A Restricted Mudaraba in order to use and
⎯ Sukuk representing a share in the Mudara
⎯ A Revolving International Commodities M
Compliance with Shariah Principles
Reason 3: New, Shariah Compliant Tradabilit
From a Shariah perspective, the structure
trading at specific dates:
⎯ Tradability allowed once the underlying
matured and before it revolves (usually
Typically, Sukuk trading during the life of
Murabaha would be considered from a Sh
debt trading (forbidden)
To assure tradability, BNP Paribas have d
accepted additional structure in order to t
time and price, giving this Sukuk the same
other accepted types of Sukuk
Section 5: BNP Paribas in Islamic Banking
BNP Paribas: 19 years in Islamic Ban
• Islamic Investment Department within BNP
dedicated multi-product capabilities:
⎯ Large short term Murabaha deposits bas
⎯ Co-arranger in Project Finance Islamic tr
⎯ First Islamic capital protected fund struct
⎯ One of the first Islamic Equity fund
1985
1985 1996
1996 1999
1999
CaravanFund:
Caravan Fund: FaysalShield
Faysal ShieldFund
Fund
11ststMurabaha
Murabaha
Deposits
Deposits Oneof
One thefirst
ofthe firstUS
US 11ststIslamic
IslamicEquity
Equity
Islamic Equity
Islamic Equity LinkedCapital
Linked Capital
Fund
Fund GuaranteedFund
Guaranteed Fund
BNP Paribas’ Islamic Banking Unit Or
Selected Panel Of Clients
Origination &
Marketing
Islamic Banking Unit:
Head: J-M Riegel
Dty. Head: A. Raad
Structurin
Execution
Asset Structured
Treasury Equities
Management Finance
The Sharia Board of BNP Paribas
BNP Paribas SSC is composed of well-know
commended scholars and is the first Interna
include in its Sharia Board scholars from bo
and Asia (Malaysia):
• Dr. Nizam Yaquby - Bahrain (Chairman of
• Dr. Abdul Sattar Abu Ghuddah – Syria (ba
• Dr. Mohamed Daud Bakar - Malaysia
Your contacts at BNP Pa
Jean-Marc Riegel
Head Of Islamic Banking
Regional Manager - Financial Instituti
Tel. +973 17 52 50 29
Fax +973 17 53 12 37
email: [email protected]
Alain-Amin Raad
Deputy Head of Islamic Banki
Deputy Regional Manager Financial Insti
Tel. +973 17 52 06 96
Fax +973 17 53 12 37
email: [email protected]
