Understanding Shariah Markets the key to profitable new
Understanding Shariah Markets: the key to profitable new product innovation - Ascertaining client needs - The growing demand for Islamic finance - Discovering transparency across the Islamic client base - Gathering momentum for product creation - Researching liquidity, market making, volumes and pricing Ranjeet Guptara Chief Operating Officer, Public Sector & Infrastructure Finance DEPFA BANK plc Geneva, 28 th May 2008
1. DEPFA’s experience of product innovation 2. Background to Islamic Finance 3. Possible avenues in Islamic Finance 2
DEPFA BANK plc is the only Bank focused on Public Sector & Infrastructure Finance DEPFA has a portfolio of over € 250 bn in Government Related Investments, an increasing portion of which is from the Middle East and in Shariah Compatible Sukuk / Murabaha format. 3
Ascertaining client needs may be serendipitous but a strategy helps $1 bn+ $50 bn+ Constantly Innovating New Products Constant diversification in response to client demand, e. g. : Programmes Deposits, Commercial Paper, Certificates of Deposit, Repo Currencies EUR, USD, CAD, GBP, CHF, JPY Durations overnight to 30 years Ratings A+ Unsecured Deposits to AAA Covered Bonds Jurisdictions Germany, Ireland, USA… 4
Ascertaining client needs may be serendipitous but a strategy helps New Clients New Product Need Identified Old Clients Old Product Client needs change due to variety of factors, for example: -Same Investor Base but new realisations - growing demand for Shariah Compliancy, e. g. Bahrain - legal constraints, e. g. issuing out of New York branch vs. Dublin - Changing Investor Base - External shifts in wealth, e. g. Middle East, BRIC, Emerging Markets - Internal shifts in policy, e. g. Credit allowing Corporate deposits - Market changes e. g. better Repo rates, CAD market closing 5
What DEPFA can add to Islamic Banking § DEPFA serve government clients and have strong existing relationships with Central Banks § Islamic investors are willing to pay a premium for such a credit quality and for a product in line with their religious beliefs § DEPFA’s AA- credit rating is in line with Islamic Banking's desire to avoid gharar, or excessive risk § DEPFA will provide diversification in the market, as there are not enough providers of Islamic products § Diversity within Islamic depositary institutions is necessary to fulfil their regulatory requirements as they cannot have more than 20% in holding with any one bank § DEPFA’s willingness to become involved in the Islamic Market adds further liquidity and transparency to the world of Islamic Finance § DEPFA has already invested around $500 m in Islamic Assets (Sukuk / Murabaha) where we see attractive pricing opportunities (all investments in Sovereigns / Infrastructure) §Hypo Real Estate, our parent company, has successfully structured >$500 m in Shariah compliant Real Estate deals for Islamic investors since 2003. 6
Obstacles encountered § Perception versus Reality § DEPFA still feels like a European bank, with predominantly Irish / German roots § Islamic Finance can be perceived as something very Alien, but “reprogramming” is possible § Lobbying at Board level before even asking for approval can create opportunities: e. g. Sarbanes-Oxley / USA example §Reality § Expectations management: not possible to launch overnight – relationship driven § Often strategically interesting but questions raised about financial viability (e. g. UK Treasury) § Specific problems: much of DEPFA’s assets deemed “usurious” as a Bank § General problems: Costs of legal, tax advice, Shariah board: $1 m? § Benefit vs. same costs involve in a US Registered 144 A issuance? § Internal operational barriers to overcome / departments to bring alongside (New Product Process): § Legal / Tax / Compliance resident)? § Shariah Advisory Board § Risk Management § Accounting, Operations & IT § Products & Sales 7 contracts? jurisdiction? new customer forms (non-Irish Necessary? Obligation on purchaser, not issuer (except retail)? Commodities Risk? Reputational Risk? Counterparty Risk? Transaction process through to settlement? Fit with product palette? Marketing material? Potential clients?
Example Corporate Structure / Organisation Relationship / sales DEPFA BANK plc ACS Central Banks + PFB Banks / Institutions Places assets If necessary Autonomous SPV sets up Public Shariah Funding Trust services monitors appoints when necessary Shariah Board Murabaha Product monitors 8
Shariah Funding Programme: Overview DEPFA could profit from this rapidly growing market “Total Sukkuk issuance in 2007 reached $40 bn. In 2006, $26. 8 bn was issued. Seven years ago, issuance was just $336 m. “ *(Gulf Times / Financial Times) § DEPFA could take a “three step” approach to this market: § § § A. $1 bn+ Money Market 90 day “Murabaha” (deferred sale) program – mid 2008? B. Securitisation of $400 m+ existing Islamic assets on the Balance Sheet – late 2008? C. Eventual Sukuk issue (backed by IFU assets) by 2009? § Clients visited to ascertain interest for Shariah products since ‘ 07 § HRE already has a track record with several smaller Shariah-compliant Real Estate products § The suitability of IFU Assets are being considered to collateralise potential DEPFA Sukuk issuance, perhaps dedicated “water sukuk”. § Depend on client feedback to show where demand is greatest, for what amount, at what price 9 * Financial Times, quoting Islamic Finance Information Service, 3 rd September 2007
Infrastructure Finance Asset quality: portfolio analysis Parking 1. 5% Ports 4. 2% Waste Mgmt 0. 4% Sovereign 0. 2% BB 1 9% Telecommunications 4. 2% Accommodation 4. 3% Schools 6. 6% BBB 2 6% Bridges / Tunnels AAA 56% BBB 1 7% 7. 7% A 3 3% Roads 14. 5% Airports 8. 3% Healthcare 9. 5% A 2 2% Power 11. 0% Total Commitments: € 16. 4 bn 10 D 0% BBB 3 13% Water 22. 9% Rail / Metro 4. 6% B 0% BB 2 0% A 1 2% 90%+ in OECD countries AA 3 1% AA 2 1% Average rating: A 1 Investment Grade: 95%+
Treasury: Capital Markets: DEPFA ACS Secondary Market Levels Source: Dresdner 25 th October, 2007 | 11 |
Treasury: Capital Markets DEPFA ACS USD 1. 25 bn 5. 125% due 16 March 2037 Transaction Details Issuer: Rating: Bookrunners: Size: Coupon: Settlement: Maturity: Pricing: Format: Listing: | 12 | DEPFA ACS BANK Aaa/AAA Goldman Sachs, Merrill Lynch, Morgan Stanley USD 1. 25 billion 5. 125%, annual 15 March 2007 16 March 2037 US Treasury +57. 25 bps, Mid Swaps +2 bps Euro/144 A Dublin Transaction Highlights I This landmark transaction is DEPFA’s first ultra-long ACS issue and the first ever 30 yr USD covered bond I US accounts bought 88% of the deal, the rest being sold in Europe I 79% of bonds were allocated to accounts that had not participated in any of the last 3 DEPFA USD transactions I The largest amount went to Funds (73%), followed by Insurance (16%), Pension Funds (7%) and Central Banks (4%) I The total order book reached USD 1. 8 bn, the largest order book that DEPFA has had on a USD deal, and included 30 orders ranging from USD 0. 5 mn to USD 290 mn I This transaction priced at UST +57. 25 bps which corresponds to m/s +2 bps I The decision to price at +2 was based on two factors: DEPFA's standard approach in terms of fair pricing to recognize in the Treasury spread if there has been a material move in swap spreads during the process and to bring in brand new accounts to the Covered Bond market who felt more comfortable at +2
Meeting with Lawyers regarding Shariah Funding Clifford Chance Dubai | 13 |
Project Organisation Sharia Products Steering Committee | 14 | Brian Farrell (Chair) Kieran Walsh Des Moran (Legal) Ranjeet Guptara (Project Leader) Money Markets Sales Legal Counsel Sarah Lea (Project Office)
1. DEPFA’s experience of Product Innovation 2. Background to Islamic Finance 3. Possible Avenues in Islamic Finance 16
Introduction to Islam § Islam is the religion founded by Muhammad (Peace be upon him). § Muslims are the followers of the religion of Islam § “Islam” means “Surrender”(to the will of Allah) § Muslims believe Muhammed (PBUH) was the final prophet of Islam § § § 17 Muslims claim Adam, Abraham, and Moses as previous prophets of Islam. While Muslims recognise Jesus as a virgin-born prophet, who will judge the earth, they do not revere him as God. Muhammad takes the title “paraclete” which is reserved for the Holy Spirit in the Bible. Muhammad’s life is documented in the Qur’an, Sunna and Hadith, but some question historicity § Muhammad was born in c. 570 AD in the city of Mecca in Arabia and died in 632 AD in Medina § He was a merchant by trade, and started preaching around the age of 43 § Following persecution he became a warrior, leaving Mecca in 622 AD There are “ 5 pillars of Islam”: § Shahadah ~ Profession of faith § Salah ~ Prayer § Zakah ~ Almsgiving (2%) § Sawm ~ Fasting during Ramadan § Hajj ~ Pilgrimage to Mecca
Islamic Geography § § Islam spreads across around 20%1 of the worlds population, or 1. 2 bn people 2 Muslims are also increasingly prevalent in the west: USA: 3 m, Germany: 3 m, UK: 2 m, Ireland: 30 k The majority of estimated $400 bn+ of Muslim institutional wealth is in the Gulf, where Islamic Finance is requested by around 75%3 of the population, but has only c. 20% penetration in banking products There are three axes of strictness – Malaysia and the Far East (lax), Gulf/Subcontinent (strict), Cairo (sidelined) Kuwait Riyadh Bahrain Dubai 1: Todd Johnson, "Religious Projections for the Next 200 Years , " World Network of Religious Futurists, at: http: //www. wnrf. org/articles/next 200. htm 18 2: Samuel Huntington, "The Clash of Civilizations and the remaking of world order, " Touchstone Books, (1998), Pages 65 to 66. 3: Abdulkader Thomas: “Structuring Islamic Finance Transactions”, Euromoney (1995) 4: Map Source: University of Texas
Moses’ Finance • • 19 The Old Testament has several reminders not to lend money with usury. “If you lend money to any of my people, even to the poor with you, you shall not be to him as a creditor; neither should you lay upon him interest. (Exodus, 22: 24)” “And if your brother become poor…; then you should uphold him: as a stranger and a settler he should live with you. Take no interest from him, but fear God. You shall not give him money for interest, nor give him food at your profit. ” (Leviticus, 25: 35 -37) “You shall not lend on interest to your brother: interest of money, interest of food, interest of any thing that is lent upon interest. To a foreigner you may lend on interest; but to thy brother you shall not lend upon interest; that the LORD your God may bless you in all that you put your hand to, in the land where you go in to possess it. ” (Deuteronomy, 23: 20 -21)
Jesus’ Finance • • • 20 Jesus gave us two parables in the New Testament that refer to concepts of "usury" or "interest" both approving of the concept in principle. In the parable of the gifts or talents, Jesus gives the story of a rich owner (representing God the Father) who says to the lazy servant “Why didn’t you put my money into the bank, that I would have been able to get usury on my money? ” (Gospel of Luke, 19: 23). Many people have thought that this meant Jesus didn’t mind usury. However, this was an amusing absurdity to a Jewish audience; and shows that even the great sin of usury was considered less than wasting the opportunities and talents God has given.
Christian Finance • Already from the earliest church councils (Council of Nicea, AD 325) Usury was considered a crime. The poet Dante ranked usury as a crime for the 7 th circle, the lowest pit of hell! • Previously, even the Greek philosopher Aristotle said that "to live by usury is exceedingly unnatural". • St. Thomas Aquinas, the leading 12 th Century theologian of the Catholic Church, argued charging of interest is wrong because it amounts to "double charging", charging for both the thing and the use of the thing. • Aquinas said this would be morally wrong in the same way as if one sold a bottle of wine, charged for the bottle of wine, and then charged for the person using the wine to actually drink it. • In the 13 th Century, Cardinal Hostiensis argued that the principle of lucrum cessans (profits given up) allowed for the lender to charge interest "to compensate him for profit foregone in investing the money himself. " • In the Fifth Lateran Council, (AD 1512 – 1517) Pope Leo X made the first concessions to usury in the Catholic Church (the Medici Family as the foremost bankers in Europe had already made Usury widespread). 21
Islamic Finance • • • 22 Those who charge usury are in the same position as those controlled by the devil's influence. This is because they claim that usury is the same as commerce. However, God permits commerce, and prohibits usury. Thus, whoever heeds this commandment from his Lord, and refrains from usury, he may keep his past earnings, and his judgment rests with God. As for those who persist in usury, they incur Hell, wherein they abide forever (Al-Baqarah 2: 275) God condemns usury, and blesses charities… O you who believe, you shall observe God and refrain from all kinds of usury, if you are believers. If you do not, then expect a war from God and His messenger. But if you repent, you may keep your capitals, without inflicting injustice, or incurring injustice. If the debtor is unable to pay, wait for a better time. If you give up the loan as a charity, it would be better for you, if you only knew. (Al-Baqarah 2: 276 -280) O you who believe, you shall not take usury, compounded over and over. Observe God, that you may succeed. (Al-'Imran 3: 130)
Islamic Economics § Islamic Finance is based upon two principles: § No “riba” (“usury”, or interest from money) § No “gharar” (excessive risk) / equitable approach to risk sharing § Islamic Finance was overtaken by colonialism around the 17 th century § The resurgence of Shariah-compliant finance began in Egypt in the 1960 s as a micro-finance experiment in the Nile Delta town of Mit Ghamr by Dr. Ahmad Elnaggar. § Islamic economics is economics in accordance with Islamic law. There are two paradigms: § one assuming the political framework is Islamic (i. e. , Khilafah) § the other assuming the political framework is non-Islamic, resulting in a paradigm that seeks to integrate some prominent Islamic tenets into a secular economic framework 23
Debt Arrangement § Most Islamic economic institutions advise participatory arrangements between capital and labor. § The latter rule reflects the Islamic norm that the borrower must not bear all the cost of a failure, as "it is God who determines that failure, and intends that it fall on all those involved. “ § Conventional debt arrangements are thus usually unacceptable - but conventional venture investment structures are applied even on very small scales. § However, not every debt arrangement can be seen in terms of venture investment structures. § For example, when a family buys a home it is not investing in a business venture - a person's shelter is not a business venture. § Similarly, purchasing other commodities for personal use, such as cars, furniture, and so on, cannot realistically be considered as a venture investment in which the Islamic bank shares risks and profits for the profits of the venture. 24
Problems with Islamic Finance § There is a lack of census on Shariah compatibility § Shariah scholars opine on what is allowed (negative constraints: do not invest in pork, gambling, pornography, idolotrous industries) § This is different from Ethical Investing as promolgated by e. g. Sustainable Asset Management (www. sam-group. com) or the FTSE 4 Good index. § Venture Philanthropy / Social Entrepreneurship may be a way to combine these issues of conscientious investing 25
1. DEPFA’s experience of Product Innovation 2. Background to Islamic Finance 3. Possible Avenues in Islamic Finance 26
Dow Jones Citigroup Sukuk Index (since March 2006) Increasing Volatility But still somewhat of a hedge to mainstream bond classes 27
Proponents of Shariah Products Many Investment and Corporate Banks appreciate the liquidity in the Middle East and South-East Asia Sukuk underwriting League table 2008 ytd: Total $6 bn, 93 Issues, 28 underwriters, fees ~0. 5% 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 28 Calyon HSBC Aseambankers Malysia Berhad Morgan Stanley Dubai Islamic Bank Emirates NBD JP Morgan Standard Chartered CIMB Affin Investment Bank Bhd Deutsche Bank UBS AM Investment Bank Bhd Gulf International Bank OSK Investment Bank Islam Malaysia Berhad Kuwait Finance House Commercial Bank of Qatar Islamic Bank Qatar National Bank Source: Bloomberg, May 2008
New Issues Monitor: Signs of increasing activity and recovery Many Investment and Corporate Banks May 2008: Islamic Bond Market 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 29 Malaysia 3. 4% Bahrain Leasing 2. 4% Bank Negara 0% SABIC FRN RAK Capital FRN SBI Syariah 8. 24% Horizon Hills 4. 1% Jimah Energy 9. 85% Almana FRN HBFC FRN Aras Sejagat 4. 85% Hong Leong Industry 4. 8% Nakheel Development FRN Tabreed 7. 5% Total Mobile 6. 5% Austrian Volksbank FRN Source: Bloomberg, May 2008 100 m MYR 5 m BHD 600 m MYR 5, 000 m SAR ($~1. 3 bn) 1, 000 m AED 544 bn IDR 30 m MYR 240 m MYR (12 to 16 year maturity) 600 m AED 1. 5 bn PKR 420 MYR 50 m MYR 3. 6 bn AED ($1 bn) 1. 7 bn AED 10 m MYR 10 m EUR
Market Size § Islamic finance has been gaining momentum on a global scale for the last 30 years, and offers profitable opportunities for institutions and individual investors of all sizes. § The Industry size is currently estimated at more than $400 billion § The projected growth is at least 15% per annum. 30
The Market is growing: Grow with it! Morgan Stanley said the $40 bn sukuk issued by the GCC companies in 2007 could have exceeded $50 bn, had it not been for the liquidity crunch in the second half of 2007. Despite current constrained liquidity, we expect growth in new sukuk issues to remain high in double-digit in 2008 and 2009? though the cost of debt was not likely to retract significantly? from the current levels, it said. It said the GCC companies cannot afford to postpone their expansion for much longer and added we expect Gulf-based banks, particularly the Islamic banks, to emerge as sukuk issuers. ? The reasons for the Gulf banks to emerge as sukuk issuers were due to the fact that growth in customer deposits has been lagging growth in assets, particularly at the UAE banks, and also competition for deposits had intensified in a negative real interest rate environment. Moreover, we forecast a high teens CAGR (compounded annual growth rate) in assets in the next few years, which should push banks to raise more sizeable medium-to-long-term funding, it said. Highlighting that sukuk was one of the fastest growing financial instruments globally; Morgan Stanley said it expected them to be largest contributor to sustained double-digit growth in Islamic finance. It said total outstanding issued sukuk were more than $90 bn, of which 40% were international issues. Between 2003 and 2007, sukuk registered a CAGR of 60%. Islamic bonds have been issued in 14 countries and in more than 10 currencies, it said, adding, Malaysia has issued 55% of sukuk to data and the UAE 20%. Sukuk has also been issued by corporate houses and sovereigns/quasi sovereigns including Malaysia, Pakistan, Qatar, Bahrain, Brunei and the UAE, it said. 31
UK Government considers issuing Sukuk before 2009 § London, April, 23, IRNA § § Britain is seeking to become the first country in west to issue Islamic bonds, it was reported Monday. Shariah-compliant bonds have previously been issued by the governments of Pakistan and Malaysia and also by corporate issuers around the world but never by a western nation. But according to the Financial Times, Treasury Secretary Ed Balls was set to announce Monday that Britain was paving the way for the launch of such bonds no later than next year in a bid to bolster London's claim as a centre for Islamic finance. Britain will conduct a feasibility study into issuing Islamic bonds in a bid to bolster London's standing as a centre for Islamic finance, Balls will say in a speech on Monday. "Balls also believes that today's move will send a powerful message to the Muslim community both in Britain and around the world that the UK authorities are intent on engaging with them in innovative ways, " the daily said. The UK's aim was said to be not only to issue the new bonds on wholesale financial markets but also to use them as vehicles to allow Muslims in Britain to invest in National Savings products through banks and post offices. Britain's Treasury, which hosted a summit last week with leading members of the Muslim community, has estimated that total Islamic finance assets worldwide, including private equity and bonds exceed dlrs 250 billion. The Financial Times said that although it has not yet worked out what the underlying structure of UK-issued Islamic bonds will be, Balls was "confident that the technical details can be worked out by the Debt Management Office and Treasury officials. " The move comes after Chancellor of the Exchequer Gordon Brown announced in his annual budget last month that new measures will be introduced for sukuk, a Shariah-compliant trust certificate, so they can be issued, held and traded in the same way as corporate bonds. Issuing sukuk, or Islamic bonds that make regular payments to investors, is usually considered to be slightly more expensive than raising funds with western-style bonds, because they require extensive, costly legal and religious advice. But Balls last week reiterated the British government's determination to create a level playing field for Islamic finance products, with UK banks already declaring a range of Shariah- compliant services. § § § § 32 http: //www 2. irna. ir/en/news/view/menu-237/0704233373152608. htm
33 Sarah Lea Project Management DEPFA BANK plc Ranjeet Guptara Public Sector Finance DEPFA BANK plc 1 Commons Street Dublin 1, Ireland 105 Wigmore Street London W 1 U 1 QY, UK Tel. : +353 1 792 2222 Fax: +353 1 792 2211 www. depfa. com Tel. : +44 2072908482 Fax: +353 1 792 2211 www. depfa. com
Thank You! 34
Thank You! 35
- Slides: 35
