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

2011

Assoc. Prof. Dr. Asyraf Wajdi Dusuki

Head, Research Affairs

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Global Outlook of Islamic Finance Growth of Islamic Financial Assets

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AANAFTA Business Seminar

The Impact Financial Crisis to Islamic Finance

Salient Features of Islamic Finance Showcase of Malaysian Islamic Financial Centre The Framework of Islamic Finance

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Characteristics of Islamic Finance

Conclusion

ENDS /

Maqasid al-Shariah (The Objectives of Shariah)

The Framework of Islamic Finance

Riba 1st Level of Compliant (Usury)

Injustices

Gharar
(Uncertainty)

MEANS/

Nominate Contracts

Islamic Contract

Non-Nominate Contracts

Investment Activities Rectifying & Purifying 2nd Level of Compliant Shariah-Compliant Operation Conversion Process

Hedging Instruments
Monitoring & Supervision Social Responsibility

Asset Classes in Islamic Finance

Sukuk
Islamic Structured Instrument Real Estates (IREITs)

Islamic Financing

Asset Classes in Islamic Finance

Islamic Private Equity

Islamic Equities (unit trust, index funds etc.)

Takaful

Islamic ETFs

Islamic Hedge Funds

Promote Public Interest (Maslahah) Free from Riba (Usury)

Entitlement to Equal, Adequate, Accurate Info.

Free from Gharar (Ambiquity)

Promote Equity

Free from Dharar (Detrimental)

A system grounded on moral and ethics

Freedom to Contract

Characteristics of Shariahcompliant Banking and Financial System

Free from Price control & Manipulation Free from Gambling

Entitlement to Transaction at Fair Price

Illustration on Sukuk Structuring

Literal Meaning
Sukuk 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

Technical Meaning
Sukuk refers to securities, notes, papers or certificates, with features of liquidity and tradability (except for salam and murabahah sukuk)

SUKUK

AAOIFI Investment 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

Malaysian Securities Commision A document or certificate which represents the value of an asset Asset may include financial asset such as receivables and debts, as well as non financial assets like tangible assets, usufructs and services.

Obligor/Project Developer

Issuer/Trustee

Proceeds from Sukuk Sales

BASIC STRUCTURE OF SUKUK

Issue Proceeds

Sukuk

Income from project

Income Generating Project

Sukuk Investors

Comparing SUKUK to BONDS

Sukuk Bonds

1. Holder owns assets

2. Use a variety of contracts to create financial obligations between issuer and investors; e.g. Sale, lease, equity partnership, joint-venture etc.

1. Holder owns cash flow only

2. Simply use a loan contract to create indebtedness

3. Return linked to profit elements in-built 3. Return linked to interest charged out of in the sale, lease or partnership the loan contract 4. Instrument may be equity or debt depending on underlying contract 4. It is a Debt instrument

5. Tradability of the sukuk depends on the 5. No restriction on the tradability nature of the underlying asset 6. Investment in Shari`ah-compliant activities 6. Proceeds are invested in any business without restrictions

Emerging interest on Islamic finance as viable alternative to the global financial system
Starting in 1971 with the first Islamic bank in Egypt, there are now more than 600 Islamic financial institutions in 75 countries
UK

Germany

Saxony-Anhalt state issued government sukuk First Islamic bank to operate in 2010

South Korea Parliament expected to pass the law related to offering of tax waiver on foreign investors interest income from sukuk issued Japan Law passed allowing banks to do Islamic finance Hong Kong Aims to become Islamic finance gateway to China Plans to issue sovereign sukuk Hang Seng Islamic China Index Fund in 2007 Brunei Aim to become Islamic financial services hub for Asia

Govt sets an objective to entrench London as a global gateway for Islamic finance 5 FSA-approved Islamic banks and Takaful operators

Turkey Announced IFC Istanbul in Sep 09 with focus includes interest-free Plans to issue sovereign sukuk, amend financial business tax law on IF Iran Bahrain Qatar Pakistan France Malta Saudi Arabia UAE Kuwait Thailand Passed rules/regulations to Plans to position Malaysia support Islamic finance as Islamic finance Sudan activities hub for the Mediterranean In process of licensing Indonesia Islamic banks Jordan Made fiscal & legal adjustment for IF Plans to tap sukuk market to transaction i.e. taxation finance its deficit Singapore guidelines on sukuk & Established first Islamic bank murabaha Introduced tax neutrality for Islamic finance

Aspiring to be centre for Islamic finance Launched Islamic ETF

Muslim-majority countries offering Islamic finance (IF) Non-muslim countries starting to offer IF

Courtesy of Bank Negara Malaysia

Global developments Islamic banking

Growth expected to continue

Almost 90% of global market share are in top 6 Islamic financial markets

By 2020, estimated to reach USD4t

Global growth rate of 15-20% per annum over the last 10 years

Mid 1990s approximately USD150b

2009 approximately USD780b

2010 estimated USD956b 2012 USD1.6t (IFSB estimate)
Courtesy of Bank Negara Malaysia

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Global sukuk market

Continued to expand in 2009

12 Courtesy of Bank Negara Malaysia

Global developments Breakdown of Islamic finance assets

The largest share of Islamic financial assets remains in Islamic banking, although growth is slowing

Sukuk and takaful continues to grow Islamic funds registers a slight decrease
13 Courtesy of Bank Negara Malaysia

Post crisis sukuk market

Impact of global financial crisis

Not spared as sukuk is seen in the same asset class as bonds
USD34b

but has since staged a recovery

USD20b in 2008 USD33b in 2009 (70%)
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USD50b ( 55%) in 2010

Courtesy of Bank Negara Malaysia

Post crisis global Islamic banking industry

Largely shielded
Study on Top 10 Conventional banks vs Top 10 Islamic banks
Between Dec 2006- May 2009 Combined market capitalisation Conventional 42.8% Declined from USD116b to USD42b loss Islamic 8.5% Increased by 9% from USD4.2b to USD4.6b 55% (USD147b) 36% From 5.8x to 6.6x

Net profits

Total assets growth Total equity growth Leverage ratio (Assets/equity)

36% (USD17.4t)
24% From 16.6x to18.2x

2008

Only 1 Islamic financial institution required government assistance 5 top conventional banks received government assistance of USD163.0b or 26% of their combined equity

2009

Not a single Islamic bank required to be rescued

Source: IFSB-IRTI-IDB Islamic Finance and Global Financial Stability Report,

15 Courtesy of Bank Negara Malaysia

6 April 2010 based on E&Y study

Global Islamic banking industry

Largely shielded: reasons why

Surrounding factors Market deregulation followed by unprecedented levels of leverage, relaxed lending standards Rapid issuance of mortgage-backed securities Tremendous growth of CDS market Growth of complex securities and derivatives
US Commercial Papers Outstanding

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Courtesy of Bank Negara Malaysia

Global Islamic finance industry

Largely shielded: reasons why

Avoidance of unethical activities Avoidance of maisir (gambling) & riba (interest) & nonpermissible goods & services Screening investment Forbearance for customers in difficulties

Direct link to real economy Certainty supported by underlying activities (prohibition of gharar - uncertainty) Prohibits excessive leveraging Money is not commodity

Ethical
Real Activities

Real Activities

Greater transparency & disclosure

Shariah values Ethical consistent with universal value

additional Shariah governance unique risks

Governance

Partnership
Governance

Different contractual relationship Equity-based & risk-sharing transactions Clearly defined risk & profit-sharing characteristics serve as additional built-in mechanisms 17
Courtesy of Bank Negara Malaysia

Greater fiduciary duties & accountability Emphasis on clear documentation & contract add to soundness & stability

Context setting

The Malaysian Financial Landscape

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Malaysia: the worlds most comprehensive Islamic financial system

Governance
Legal & Regulatory Islamic Banking Act Takaful Act Government Funding Act Capital Market Services Act Shariah Advisory Council Islamic Banks & Takaful Companies Islamic Money Market Islamic Capital Market

Diversified Players
Banking 17 Islamic banks 10 Islamic windows 3 International Islamic Banks 14 International Currency Business Units (ICBU)

Labuan IBFC Money market

Malaysian Financial System

Capital market

Takaful 8 takaful operators 4 retakaful operators 7 ICBUs Fund Management 9 Islamic fund managers 35 Islamic fund management windows

Central Banking Act

Dispute Resolution Judicial system: dedicated high court KL Regional Centre for Arbitration Financial Mediation Bureau

Conventional Banks & Insurance Companies

Professional Service
Legal firm Accounting Financial Intermediaries Financial Advisors Consultancy Service

Financial Markets
Capital Market Money Market Foreign Exchange Market Commodity Market Bursa Suq Al-Sila

Infrastructure
Payment, clearing and settlement, custodian Principal Dealers Listing on Bursa with authorise exchange status

More than 30 years of experiences in developing Islamic Courtesy of Bank Negara Malaysia finance

Malaysia has a well-developed sukuk market

Source: Malaysian ICM Bulletin, June09, SC

58% of outstanding corporate bond are sukuk Malaysias outstanding sukuk (public & private) = USD66 billion @ end June 2009

62% of total outstanding sukuk globally

Malaysia as centre for innovative sukuk Active secondary sukuk market

More than 80% of the sukuk are private sectors sukuk

Courtesy of Bank Negara Malaysia

ISRA @ INCEIF 2nd Floor, Annexe Block Menara Tun Razak Jalan Raja Laut 50350 Kuala Lumpur MALAYSIA General Line : +603-2781 4000 Fax : +603-2691 1940 Email Website : asyraf@isra.my : www.isra.my