Islamic finance

1. Durham Islamic Finance Autumn School
in Istanbul, 2011
Islamic Capital Markets
Overview
Iqbal Asaria
Afkar Consullting
Presented at the
Durham Islamic Finance Autumn School 2011
jointly organised by
Durham Centre for Islamic Economics and Finance and
ISAR-Istanbul Foundation for Research and Education
Istanbul Commerce University, Istanbul
19th-22nd September 2011
Captial Markets
A ‘capital market’ is a market for issuance and sale of
bonds, stocks or similar securities to raise long-term
capital. The maturity of securities distinguishes debt
capital markets from ‘money market’, where trading is in
short term debt instruments with a tenor of less than one
year or so. Capital markets are divided into debt capital
markets and equity capital markets. The Sukuk market
falls into falls into the debt capital market arena because
contemporary Sukuk are structures to produce a fixed-income
return for Sukuk holders. Capital markets are also
classified into primary markets and secondary markets. In
the primary market an investor buys securities which are
issued for the first time. Existing securities are purchased
and sold in the secondary market. Primary capital markets
are important for capital development of an economy.
Iqbal Asaria, Islamic Capital Markets 1

2. Durham Islamic Finance Autumn School
in Istanbul, 2011
Markets
§ Definition
§ Liquidity
§ Speculation and Market
Makers
§ Functions
• Equity Markets
• Debt Markets
Iqbal Asaria, Islamic Capital Markets 2

3. Durham Islamic Finance Autumn School
in Istanbul, 2011
Bonds & Sukuks
§ Bonds – Characteristics
§ Securitisation
• Receivables
• Assets-Backed Revenues
• Asset Based Revenues
§ Islamic Bonds in Malaysia
§ Sukuk Markets
• Primary
• Secondary
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4. Durham Islamic Finance Autumn School
in Istanbul, 2011
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5. Durham Islamic Finance Autumn School
in Istanbul, 2011
Asset Classes
§ Cash and Near Cash
§ Equity
• Long
• Long-Short
• REITS
• ETFs
§ Bonds
§ Property
§ Alternative Assets
• Private Equity
• Hedge Funds
• Derivatives
Iqbal Asaria, Islamic Capital Markets 5

6. Durham Islamic Finance Autumn School
in Istanbul, 2011
Iqbal Asaria, Islamic Capital Markets 6

7. Durham Islamic Finance Autumn School
in Istanbul, 2011
Ernst & Young Islamic Funds and Investment report
Country dependant
§ 70% - 90%
prefer Islamic
§ Mass
Affluent
§ Islamic
requirement
§ Corporate
§ 70% - 90%
prefer Islamic
§ Not
predisposed
to Islamic
(eg
takaful) § (U)HNW § SWF’s
I
§ Shariah
Sensitivity
§ Market
Segmentation
§ Largely via
mutual funds,
local equities
§ 80% equities,
§ 15% cash
§ Typical Asset
Allocation
§ Cross asset
class
allocation
§ 20%
alternatives
§ 15% RE
§ Solvency
requirement
§ 60% equities
10% RE
§ Pension funds
50% in cash
deposits
§ 20% RE
5 %
Alternatives
with focus
international
§ 55% equities
2009 Report - key highlights:
► Islamic fund management sector has not been immune
► All key Islamic asset classes (equity, fixed income, commodity, RE) have performed poorly in 2008, leading to a
change in investor risk appetite
► The industry remains fragmented and a shakeout appears to be taking place
► Managers seeking to survive the downturn must manage their key business risks and adapt
§ Source : Ernst & Young
Iqbal Asaria, Islamic Capital Markets 7

8. Durham Islamic Finance Autumn School
in Istanbul, 2011
Alternative Asset Classes
§ Private Equity
§ REITS
§ Hedge Funds
§ Derivatives
• The ISDA / Tahawwut Agreement
Islamic Market Backdrop and Risk profile
§ Increasing demand for alternative Islamic products such as private equity…
PO RTFO LIO
MAN AG ER
IN VESTMEN T
DEC ISIO N
DIVERSIFICATIO N
Key
to
successful
investment
strategy
H ig h Risk
&
Return
Spectrum Low
Equities
Real
Estate,
Sukuks
C ommodity
Murabaha
Increasing
Sector
Focus
O ver
Reliance
&
Low
Returns,
Limited
Islamic
Universe
O pportunity
– H ig h
Returns
2 5% +
>
Private
Equity
is
the
natural
next
stage
as
the
Islamic
Finance
industry
develops
>
Private
Equity/ Venture
C apital
considered
“the
missing
link
in
Islamic
Finance”
(Source:
Zawya)
Iqbal Asaria, Islamic Capital Markets 8

9. Durham Islamic Finance Autumn School
in Istanbul, 2011
PE part of the alternative investments asset
class
§ Private Equity
• (VC)
• Growth capital
• Buy-out
• Mezzanine capital
§ Alternative Investments
§ Hedge funds
• Long/short
• Global Macro
• Event driven
• Arbitrage
§ Real Estate
• Office
• Retail
• REITS
• Residential
§ Commodities
§ Currencies
§ Interest rates
§ Natural resources
New area of
development
in Islamic
finance.
Historical
issues with
derivatives
§ Significant
Growth Area
– ‘The next
Islamic fund
boom’?
§ Source: Diagram adapted from EVCA Paper on PE
Islamic banks
are overly
exposed to,
therefore
presenting
significant risk
to Islamic
banking (CBB
Governor)
Definition of Private Equity
• The term Private Equity represents a diverse set of investors who take an equity
stake in a private company. The success of PE has meant that there are a
number of new players in the space (eg., Hedge Funds)
• Private equity is medium to long-term finance (usually 3-7 years), provided in
return for an equity stake in potentially high growth unquoted companies
• In Europe the term “private equity” is synonymous with “venture capital” and is
used to cover funding at all stages of a businesses life cycle
• In the USA “venture capital” refers only to investments in early stage and
expanding companies whilst “private equity” covers more mature businesses; ie,
management buy-outs and buy-ins
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10. Durham Islamic Finance Autumn School
in Istanbul, 2011
Key issues in Islamic private equity
► Prohibited industries - gambling, pork, FS, etc
► Expect to use Islamic funding throughout where
possible. Short term concessions maybe given
► Middle man theory/approach – validity?
► Leverage parameters applying to listed stocks:
– Conventional debt (all types and
quasi-debt) to market cap (or total
assets) not to exceed 30%
– Ratio of Non-operating gross interest
income (plus any incidental income
from non-permissible means) to
revenue must be below 5%
– Ratio of cash plus interest bearing
securities to total assets not to
exceed 30%
– Ratio of liquid assets (cash + trade
receivables) to total assets not
exceed 45%
§ Instrument types (convertibles, preferred shares) –
limited market precedence, however increasing
innovation in this area. Recent Mezz fund (Qatar MIP
II)
§ Purification – all income from non-permissible sources
to be donated quarterly
§ PE structure
§ Limited
Partner
§ General
Partner
§ Mudaraba
§ musharika
Co.A Co.B Co.C
§ Portfolio companies
Exchange Traded Funds
§ ETF’s are: tradable securities tracking a
predefined basket of securities which are
constituents of an index.
§ ETF’s derive their value and volatility from the
market movements of the underlying stocks
which comprises the portfolio.
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11. Durham Islamic Finance Autumn School
in Istanbul, 2011
Definition of ETF
§ Simply understood as index fund which is traded
like stock.
§ An open-ended investment fund that tracks a
particular index.
§ It combines the characteristics of a closed-end
fund and that of a share, i.e. it is structured as a
unit trust fund with the units listed and traded on
the exchange similar to shares.
§ However, it differs from share and unit trust fund
in many ways.
ETF’s Attractions [1]
§ They provide investors with the benefits of
diversification through one investment product.
§ They are lower in expenses compared to an
actively managed fund.
§ High degree of transparency in identifying the
constituents.
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12. Durham Islamic Finance Autumn School
in Istanbul, 2011
ETF’s Attractions [2]
4. They have the advantage of intraday valuation.
5. Small investors can buy into ETF’s as the price
is much smaller than mutual funds minimum.
The NASDAQ 100 index ETF average price is
only $ 35.00
6. Speedy trade.
7. In certain countries (such as the USA) ETF’s
are tax efficient.
Many Types of ETFs
— There are ETF’s for company shares,
bonds, commodities, currency, real estate
and gold and silver.
— The basic principle is the same, the
structure may differ.
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13. Durham Islamic Finance Autumn School
in Istanbul, 2011
ETF – Short History
§ The first ETF was launched in Toronto Stock Exchange
in 1989.
§ Now, ETF’s in the NYSE and American Stock Exchange
alone are over 150 in number and they are in hundreds
of billion in value worldwide.
§ The first Islamic ETF may be that of Saudi NCB and
Deutsche bank launched in 2001 called Islamic Equity
Builder.
Shariah Aspects of ETFs
4. ETF’s can be bought at cash or on deferred
payment basis, except for gold and silver
ETF’s where a deferred price sale will not be
acceptable.
5. For this kind of ETF’s (gold and silver) it is
further required that redemption must be
affected in kind if so demanded by the investor.
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14. Durham Islamic Finance Autumn School
in Istanbul, 2011
Treatment of Dividend
§ One difference between ETF’s and mutual funds is the fact that
dividend received from constituent companies is not reinvested as
this deviate ETF’s from tracking the index.
§ It remains, nevertheless, that dividend is the entitlement of the
investors. It should not be confiscated by the manager, even as a
management fees.
§ In Islamic ETF’s dividend should periodically be distributed to ETF
securities holders. Only actual dividend received should be
distributed. If there is any interest earning in the dividend account it
must be disposed off.
Purification
§ The Islamic equity investment criteria require
purification of the portfolio from impure income
earned by constituent companies in the
underlying index.
§ It is always recommended that such purification
is done by the manager. However, this makes it
difficult for the ETF’s to track the index. Many
Shari’ah boards have permitted that manager
only inform investors of the amount they need to
dispose off to purify their investment.
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15. Durham Islamic Finance Autumn School
in Istanbul, 2011
Issuer
§ The issuer is merely a manager (agent) receiving
fees.
§ It is difficult for issuer to be a Mudarib since
definition of profit is not clear.
§ Issuer must not guarantee the performance of
ETF’s, but may occasionally provide liquidity
facility to smooth the periodical payments,
redemption or purchase of new assets.
§ Fees can be fixed or based on formula based. In
all cases must be known or knowable.
REITS
§ REITS - Real Estate Investment Trusts
§ Offers Retail Investors Opportunity to
Invest in Property
§ Savings Vehicle with Market Liquidity
§ Tax Advantages if Structured Properly
§ Occupancy may Present Shariah Issues
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16. Durham Islamic Finance Autumn School
in Istanbul, 2011
Hedge Funds as Alternative Asset
Class
§ Alternative Assets
– Hedge Funds
– Commodity & Managed Funds
– Private Equity
– Credit Derivatives
– Corporate Governance
What is a Hedge Fund?
w Categories of Hedge Funds
w Market Directional
w Equity Long-Short
w Equity Market Timing
w Short Selling
w Corporate Restructuring
w Distressed Securities
w Merger Arbitrage
w Even Driven
w Convergence Trading
w Fixed Income Arbitrage
w Convertible Bond Arbitrage
w Equity Market Neutral
w Statistical Arbitrage
w Relative Value Arbitrage
w Opportunistic
w Global Macro
w Fund of Funds
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17. Durham Islamic Finance Autumn School
in Istanbul, 2011
Iqbal Asaria, Islamic Capital Markets 17

18. Durham Islamic Finance Autumn School
in Istanbul, 2011
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19. Durham Islamic Finance Autumn School
in Istanbul, 2011
Islamic Alternative Investment Funds
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20. Durham Islamic Finance Autumn School
in Istanbul, 2011
Derivatives
§ Role of Derivatives
• Primary
• Secondary
§ The ISDA Master Agreement
§ The ISDA Tahawwut Agreement
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21. Durham Islamic Finance Autumn School
in Istanbul, 2011
Contact:
M Iqbal Asaria
Afkar Consulting Ltd
0208 861 2012
mia@afkar.com
Iqbal Asaria, Islamic Capital Markets 21