An Introduction To Islamic Capital Markets - REDmoney Events
An Introduction to Islamic capital marketsMarch 2017Dalia Nammari
ObjectivesWhat do we want to achieve in this session? What are the capital markets? What are the Islamic capital markets? Understand sukuk and how they differ toconventional bonds. Identify the main sukuk structures and understandthe ijara Understand current market trends for sukuk1
What are the capital markets? Common ways a company raises funds:- issue shares- borrow money Common ways a company borrows money:- bank market (loan)- issue debt securities Capital markets are markets for buying and selling equity securities (i.e.shares) and debt securities (i.e. bonds). Capital markets include primary markets, where new stock and bondissues are sold to investors, and secondary markets, where existingsecurities are traded Key participants: buyers, sellers and financial intermediaries Purpose of capital markets is to match demand for funds with supply offunds – fuels economic growth2
What are bonds?A bond is conventional debt security – an instrument issued by a borrowerunder which the borrower promises to pay to the holder the amount borrowedplus interest at the end of a given periodTrusteeAgentsU.S. U.S. agers3
What are the Islamic capital markets? Any market in which Sharia’a compliant securities are traded. Includes Sharia’a compliant stock and/or sukuk markets. Companies and governments use the Islamic Capital markets to raisefunds for their operations or expand ongoing activities e.g. a company may undertake an IPO a government may issue Sharia’a compliant securities or Sukuk to raisefunding for public projects Role of Investors - purchase Sharia’a compliant securities in order toextract a return and earn profit on the securities. Markets in Muslim States - such as Bursa Malaysia (leading market byvolume) and Saudi Arabia (Tadawul) and UAE (Dubai, Abu Dhabi andNasdaq Dubai) becoming increasingly important and will increase as theydevelop Major international primary markets - IPOs and Sukuk may be placed withinvestors through underwriters, and secondary markets, where allsubsequent trading takes place, such as the London Stock Exchange, Irish& Luxembourg stock exchanges – not just a Muslim world phenomena4
Islamic capital market: a component of theIslamic financial marketThe Islamic financial marketIslamic Banking &TakafulIslamic CapitalMarketEquityIslamic bankingFinancial Products Sharia'a deposit investment productsMoney market productsFinancing productsOther Investment productsTakaful InvestmentProducts Takaful productsTakaful linked investment productsIslamic InterbankMoney Market Sharia’a compliant securitiesIslamic indexesIslamic Unit TrustIslamic venture capital / PEIslamic ETF Islamic Fund ManagementIslamic REITsIslamic Structured ProductsIslamic stock brokingSukuk ijaraistisna’amusharaka murabahawakalamudarabaSharia’a-compliant derivativesExchange traded Futures Single Stock Futures(provided the underlyingshares are Sharia'a-compliant)OTC Islamic profit rate swap Foreign Exchange swap Cross Currency Swap5
What are Sukuk? “Islamic bond”: Sharia-compliant equivalent of a conventional bond equity investment vs. debt instrument certificates of equal value representing undivided shares inownership of an underlying asset (including tangible assets,usufructs, services and/or other contractual rights). Origins of sukuk not simply a claim to cash flow but an ownership claim in a pool ofassets differentiates sukuk from conventional bonds as the latterrepresents a debt due under an interest-bearing security Sukuk mirror the economic effect of conventional bonds can be issued in tradeable form and listed on usual stock exchanges6
Sukuk in a nutshell Basic structure: Issuer issues Sukuk and collects proceeds from SukukInvestors and uses those proceeds to acquire the Islamic asset(s) onbehalf of Sukuk Investors. The Issuer then declares a trust over theseproceeds and assets. Underlying asset: the underlying asset is another Islamic contract e.g.ijara or mudaraba hence the reference to sukuk al-ijara etc Basis of entitlement: The commercial exploitation of underlying assetsgenerates return for Sukuk Investors. Sukukholders are entitled to receivetheir share of profits generated by the asset and the proceeds of disposalof the asset at the end of the term. Redemption mechanisms: Typically most Sukuk are redeemed by theeventual sale of the underlying asset to the Originator. In a default, SukukInvestors have the right to enforce a buy back agreement with theoriginator. (Legal documentation does not typically give Sukuk Investorspowers to take over the underlying asset and dispose them).7
Differences between sukuk andconventional bondsParameterSukukConventional interest bearinginstrumentIssuerA Sukuk issuer has to be engaged inSharia’a compliant business activitiesAn issuer of conventional bonds isnot limited in its business activitiesInvestor baseEnjoys a wider investor base from bothIslamic and conventional investorsConventional bonds can mainly tapconventional investorsOwnershipInvestors take ownership of an underlyingasset or pool of assetsA conventional bond represents thefinancial obligation (debt) of theissuerAdministrative costsMay incur additional legal fees and Sharia’aadvisory feesNo additional administrative costsassociated with a conventional issueFinancing costsThe increased investor pool can createlarger demand and help achieve morecompetitive pricingA comparatively smaller pool ofconventional bond investors mayimply less demand for theinstrument8
Bond vs Sukuk StructureA. “Conventional” BondB. SukukTransfer ofIslamic AssetIssuerCovenant to Pay(in Trust Deed)TrusteeObligorIslamic Doc.Issuer &e.g. IjaraPowers ofattorney aregranted e to Pay(in the Bond)BondholdersCovenant to Payis held on trustfor theBondholders (inTrust Deed)Islamic AssetIslamic Asset,IslamicDocumentspurchaseundertaking areheld on trust fortheCertificateholders(in Declaration ofTrust)Certificateholders9
Basic Sukuk StructureCAPITAL MARKETS INSTRUMENTUNDERLYING SUKUK STRUCTURE10
Why use sukuk?For Islamic Financial Institutions (IFI)and CorporatesInvestors Liquidity management Sharia’a compliant asset class Fundraising Tradability Securitisation Balance sheet managementThe resulting benefits of Sukuk: represents a new source of funds, increasingly at attractive rates are vital to developing deeper and more liquid Islamic capital market provide scope for wealth to be unlocked there is a great deal ofsurplus cash sitting in IFIs waiting to be tapped by new Shariahcompliant financial instruments11
Sukuk Structure Building Blocks Ijara (lease) Mudaraba (investment manager/profit-sharing arrangement) widely used pre-GFC, now only for perpetual issues Wakala (agency arrangement)- favoured by IFIs but finding morecommercial applications Murabaha (deferred payment sale) only feasible in the primary market trading in the secondary market is not generally permitted byShariah as the certificate represents a debt owed by the obligorto pay the deferred sale price popular in Malaysian market where the sale of debt (bay aldayn) at a negotiated price is permitted Istisna’a (construction contract – common in project financings) Musharaka (joint venture) Hybrid/pooled sukuk – used to create “asset-lite” structures12
Sukuk al-ijara structure3. Sale of landCompanyas Seller4. Purchase proceeds10. Payment of Dissolution AmountCompany asLessee5. Lease of landSPVIssuer /Trustee7. Payment of Periodic Distribution2. Issue proceedsCertificateHolders1. Issuance of Sukuk6. Rental payments8. Sale of landCompanyas Obligor/Purchaser9. Repurchase proceeds13
Market and trends Global market size 2016: U.S 40.3 bn (deal value), 135 issues Significant increase in global sukuk issues since mid-2011 Sukuk pricing has become cheaper as demand has increased Move towards hybrid structures Changing nature of assets underpinning sukuk, capacity-based sukuk –airtime, ATKMs, concession rights Sukuk more widely used by broader range of issuers: sovereigns,telecoms companies, airlines Sovereign issuers (Oman, Qatar, Hong Kong, Pakistan, Bahrain, Dubai,UK, Luxembourg) 59% of sukuk issued in 2016 was by governmental institutions Dominance of Malaysia and Malaysia Ringgit Significant innovation in last 10 years- market has seen: project financesukuk, amortising sukuk, export-credit agency based sukuk, regulatorycapital sukuk14
Trends – Global Sukuk Issues 2016 by sector(Bloomberg)9.9717.744.538.5858.74Financial InstitutionsGovernmentIndustrialsUtilitiesOther15
Trends – Global Sukuk Issues 2016 by 5315.86MalaysiaIndonesiaTurkeyCayman IslandsQatarBahrainPakistanJerseyOther16
Trends – Global Sukuk Issues 2016 by currency(Bloomberg)2.113.172.4 5.0632.839.1345.3Malaysian RinggitUS DollarIndonesian RupiahTurkish LiraQatari RiyalSaudi RiyalOther17
Any Questions?18
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