SEMINAR ON DERIVATIVES IN ISLAMIC FINANCE ISLAMIC PROFIT

SEMINAR ON DERIVATIVES IN ISLAMIC FINANCE “ISLAMIC PROFIT RATE SWAP – ITS MECHANICS AND OBJECTIVES” by Badlisyah Abdul Ghani June 24, 2004

CONTENT What is Interest Rate Swap 1 Islamic Profit Rate Swap (IPRS) – Definition 2 Objective of IPRS 3 The Dynamics of IPRS 4 How IPRS Works 5 IPRS Documentation 6 Status of Development 7 2

WHAT IS AN INTEREST RATE SWAP 4 An Interest Rate Swap is an agreement to exchange interest rate cash flows, calculated on a notional principal amount, at specified intervals (payment dates) during the life of the agreement. 4 Each party’s payment obligation is computed using a different interest rate. In an interest rate swap, the notional principal is never exchanged. Swap typically refers to a generic interest rate swap in which one party pays a fixed rate and another pays a floating rate. 3

ISLAMIC PROFIT RATE SWAP (IPRS) - DEFINITION 4 An Islamic Profit Rate Swap is an agreement to exchange profit rates between a Fixed Rate Party and a Floating Rate Party or vice versa implemented through the execution of a series of underlying contracts to trade certain assets under the Shariah principles of Bai’ and Bai’ Bithaman Ajil. 4 Each party’s payment obligation is computed using a different pricing formulae. In an Islamic profit rate swap, the notional principal is never exchanged as it is netted off. Swap typically refers to the difference in the price over and above the notional principal in which one party pays a fixed rate and another pays a floating rate. 4

OBJECTIVES OF IPRS 4 to match funding rates with return rates (from investment); 4 to achieve lower cost of funding; 4 to restructure existing debt profile without raising new finance, or altering the structure of the balance sheet; 4 to manage exposure to interest rate movement as Islamic financial institutions still compete with conventional banks for market space; 4 to deepen Islamic Financial Market. 5

THE DYNAMICS OF IPRS Islamic Swap Counter Party Pays fixed profit rate Financial Liabilities Receives floating profit rate Financial Assets CIMB Pays floating obligations Receives fixed returns 6

HOW IPRS WORKS STAGE 1: Fixed Profit Rate Islamic Swap Counter Party STEP 1 CIMB sells Asset to Islamic Swap counter Party at notional principal of RM 500 k. STEP 3 Notional principal amount of RM 500 k owed by both CIMB and Islamic Swap party to each other is set off ASSET CIMB STEP 2 Islamic Swap Counter Party sells Asset to CIMB at notional principal RM 500 k + mark-up based on fixed profit rate STEP 4 The net difference i. e. the fixed profit rate in Step 2 is paid to Islamic Swap counter Party by CIMB at the agreed interval payment date of say 6 month 7

HOW IPRS WORKS STAGE 2: Floating Profit Rate Islamic Swap Counter Party STEP 1 CIMB sells Asset to Islamic Swap counter Party at notional principal RM 500 k + floating profit rate. STEP 3 Notional principal amount of RM 500 k owed by both CIMB and Islamic Swap party to each other is set off ASSET CIMB STEP 2 Islamic Swap counter Party sells Asset to CIMB at notional principal of RM 500 k. STEP 4 The net difference i. e. the floating rate profit in Step 1 is paid to CIMB by Islamic Swap counter Party at the agreed interval payment date of say 6 month 8

HOW IPRS WORKS STAGE 3 – Determination of Subsequent Floating Rate Islamic Swap Counter Party ASSET CIMB 6 MONTHS MATURITY Floating Profit Rate (Stage 2) is repeated every 6 months until maturity. 9

IPRS DOCUMENTATION 4 Islamic Swap Master Agreement 4 Asset Purchase Agreement (fixed) 4 Asset Sale Agreement (fixed) 4 Asset Purchase Agreement (floating) 4 Asset Sale Agreement (floating) 10

STATUS OF DEVELOPMENT 4 Secured approval from the National Shariah Advisory Council (NSAC) of BNM on structure subject to documentation 4 On-going discussion with the International Swap and Derivatives Association for regional/global standardisation 4 Finalising Malaysian documentation for submission to NSAC targeted in July/August 2005 4 To be launched in Malaysia as industry wide Islamic product in 4 th quarter 2005 11

Contact Details CIMB Islamic Commerce International Merchant Bankers Berhad 10 th Floor, Bangunan CIMB Jalan Semantan, Damansara Heights 50490 Kuala Lumpur, MALAYSIA Tel : +603 2084 8888/+603 2084 9666 Fax : +603 2093 0685 www. cimb. com. my 12