Capital Adequacy Requirements for Sukuk, Securitisations and

Top 20 FREQUENT WORDS

assets 129 suk<U+016B>k 100 iifs 90 risk 89 investment 69 originator 68 estate 65 credit 63 asset 58 exposures 48 securitisation 43 issuer 42 ifsb 35 shar<U+012B> 34 holders 31 structure 31 underlying 31 funds 27 islamic 27 ownership 27

DOCUMENT KEY POINTS

• about the islamic financial services board ifsb the ifsb is an international standard setting organisation that promotes and enhances the soundness and stability of the islamic financial services industry by issuing global prudential standards and guiding principles for the industry broadly defined to include banking capital markets and insurance sectors
• the standards prepared by the ifsb follow a lengthy due process as outlined in its guidelines and procedures for the preparation of standards guidelines which includes the issuance of exposure drafts and the holding of workshops and where necessary public hearings

• sultan bin nasser al suwaidi governor central bank of united arab emirates in alphabetical order of the country the member represents i

• these aspects are the following a capital requirements for iifs that are holders of suk k that do not meet the criteria set out in paragraph of ifsb a that is they do not represent the holder s proportional ownership in an undivided part of an underlying asset or pool of assets where the holder assumes all rights and obligations attaching to such an asset or pool of assets so that the requirements of section c
• for real estate investment this standard deals primarily with the following issues a capital requirements for an iifs that invests its own funds in real estate investment activities and b the capital treatment of exposures in real estate investment activities where an iifs either commingles the funds of investment account holders iah with those of shareholders and other non profit sharing investment account holders or otherwise invests the funds of unrestricted investment account holders uiah

• the standard adapts the practices of various institutions in terms of prudential regulations and capital adequacy requirements regarding real estate exposures in both investment and financing activities that are set out by various countries including ifsb member countries and the basel committee for banking supervision
• the standard also points out the need for the authorities supervising iifs to set forth threshold limits for iifs having real estate investment activities and financing activities involving real estate exposures

• while it may initially appear that suk k structures that are not based on partnership interests mush rakah or mu rabah have real assets at their core a detailed analysis of the commercial terms and legal structure shows that in fact any one of the three following situations may exist a an asset backed suk k structure that meets the requirements for being an assetbacked structure as assessed by a recognised external credit assessment institution ecai this structure would leave the holders of suk k to bear any losses in case of the impairment of the assets

• issues arising include asset based structures in islamic finance are found in cases where given the applicable legal environment the ownership rights over the underlying asset may not reliably result in an effective right of possession in case of default and in consequence the suk k holders need to have a right of recourse to the originator in case of default

• this gives rise to the risks of a the enforceability or strength of the repurchase undertaking in the jurisdiction and b the ranking or priority of the suk k in the capital structure of the originator
• this is a structure involving asset based suk k where a separate entity may act as sponsor and issuer by purchasing the underlying assets from the originator that is a financial institution packaging them into a pool and securitising the pool by issuing the suk k

• such a securitisation may offer the iifs one or more of the following benefits i increased liquidity since a relatively illiquid asset such as an asset held as lessor in an ij rah or ij rah muntahiyah bittaml k imb is converted into cash paid by the investors in the suk k and ii reduced capital requirements insofar as the securitisation may permit the iifs to exclude the assets from the calculation of its risk weighted assets since they are derecognised subject to any securitisation exposures see sub section
• the parties in a securitisation structure include the originator the issuer and the investors in addition to which the following may be involved one or more credit rating agencies to rate the securities suk k an investment banker to act as an adviser or to place the securities with investors and in conventional securitisations an institution that acts as a provider of credit enhancement

• equal to the suk k the issuer may in this capacity the issue amount at exercise a clean originator is the maturity of the up call and the referred to as a lease term the holders of the servicer and suk k holders or suk k being despite satisfaction the spe on their cancelled may not of all the regular behalf will have a make the return securitisation right to take legal they are expecting
• table risk exposures from various perspectives originator servicer issuer spe holder risks related to service default default bankruptcy liquidity repurchase where the if the originator spe is generally the suk k holder undertaking underlying assets fails to pay the incorporated as a will be subject to binding promise are consumer coupon payments bankruptcy remote liquidity risk the originator is linked there is still the suk k holders vehicle to mitigate associated with the obligated to make a dependence on or the spe on bankruptcy risk

• thus while suk k based on financial assets are not tradable the latter may be combined in a pool with non financial assets that can act as a basis for tradable suk k provided the proportion of non financial assets neither debt nor cash in the pool is not less than a certain acceptable minimum ratio in accordance with shar ah rules and principles
• use of such a portfolio allows for a greater mobilisation of funds as mur bahah or salam assets that do not meet shar ah criteria for tradability being classed as receivables can be combined in a portfolio with ij rah assets and or with mush rakah or mu rabah instruments that are classed as non financial

• for the purpose of tax accounting and or regulation the derecognition of the assets from the originator s balance sheet relies on a true sale meaning that the economic value of assets has been transferred from one party to another in a way that prevents the creditors or liquidator of the seller from claiming the assets from the buyer thus creating bankruptcy remoteness for the assets
• from the shar ah perspective subject to jurists interpretations in the jurisdiction there are four key criteria for a transaction to be considered as a true sale that transfers beneficial title a the transfer must be such that it cannot be recharacterised by a court or other body as a secured loan or otherwise be avoided in a bankruptcy or insolvency proceeding involving the originator of the assets such as pursuant to a fraudulent transfer in anticipation of bankruptcy or a preference payment

• in the case of bankruptcy remoteness subject to the legal framework in the jurisdiction the conditions include the following a if there were a bankruptcy of the issuer the assets of the issuer would be distributed in accordance with law or a court order rather than in accordance with the contractual arrangements involving the issuer
• while it is clear that the tradability of suk k is often a key issue and is of fundamental importance if an iifs is acting as a sponsor of an asset backed securitisation programme involving assets of a customer this section of the standard does not deal with the issue of whether the suk k conventional securitisations are categorised as either traditional or synthetic

• the rating of suk k must be from an eligible ecai as recognised by the iifs s supervisory authority and must take into account the entire amount of the credit exposure of the iifs with regard to all amounts owed to it
• subject to meeting such requirements the proposed risk weight for liquidity facilities having a maturity of implicit guarantees to be met out of iah funds would not be normal as iah would only consent if they would derive some shar ah compliant benefit from so doing and in general benefits for providing a guarantee would not be shar ah compliant

• rather if the income from the assets fell below a specified level the holder of the first loss position would waive its right to some or its entire percentage share for example of the income in favour of the investors
• a servicer cash advance based on qar interest free loan is an advance granted by the servicer to the spe to ensure timely payment to the investors a for instance in cases of timing differences between collection and payments

• in a shar ah compliant credit enhancement structure for example as described in paragraph the different components in the structure would be risk weighted as set out in basel ii paragraph as shown below risk weights rating aaa to aaa to abbb to bbbbb to bbb and below unrated risk weight deduction deduction
• when an iifs is required to deduct a securitisation exposure from its capital the deduction must be taken from tier and from tier

• investment in real estate refers to the iifs investing its own and or customers funds directly in real estate assets or in real estate projects or in partnerships in real estate or real estate projects for commercial purposes to achieve profits from property development or to benefit from asset price appreciation

• from a capital adequacy perspective where an iifs has a subsidiary through which it carries out real estate investment its investments in the capital of such a subsidiary should be treated in the same way as an investment in a non banking legal entity a that is by deduction of the carrying amount of the investment from its regulatory capital if the amount is greater than of its capital base
• investments in real estate a that is holding the assets a at any stage of the development process or even completed properties can be generally characterised as risky in that there is a high degree of variability or uncertainty of returns on invested funds as well as a risk of a significant loss of capital

• the former limit an aggregate limit should be a percentage of regulatory capital that is substantially lower than the aggregate limit of mentioned in a above while the latter limit would be a percentage of the uiah funds that is greater than what would be implied by the aggregate of regulatory capital mentioned in a above but low enough to limit appropriately the uiahs exposure to real estate for example of uiah funds

• when the supervisory discretion version of the car formula is applied a proportion a alpha a of the rwa financed by iah funds is included in the denominator of the car thus the risk weights apply only to the proportion alpha of the assets financed by iah funds

• ij rah muntahiyah an ij rah muntahiyah bittaml k is a form of lease contract that offers the bittaml k lessee an option to own the asset at the end of the lease period either by or ij rah wa purchase of the asset through a token consideration or payment of the iqtina market value or by means of a gift of contract

• the iifs holds the right to obtain the dissolution of the contract during a certain period otherwise it will be considered as partial payment by the customer
• salam an agreement to purchase at a predetermined price a specified kind of commodity which is to be delivered on a specified future date in a specified quantity and quality

• less recovery value of the leased asset maturity of contract term and not applicable capital charge of the the leased asset is returned to carrying value of the asset the iifs this credit rw is applicable only when iifs will have recourse to any hamish al jiddiyyah security deposit held as collateral paid by the customer and depending on the legal situation may have a right to recoup from the customer any loss on leasing or disposing of the asset to a third party after taking account of the urb n earnest money held after a contract is established as collateral to guarantee contract performance
• appendix capital requirement at various stages of the operating ij rah applicable stage of the credit rw market risk capital charge contract asset available for lease prior binding promise to lease pl non binding pl to signing a lease ij rah asset acquisition cost capital charge equivalent contract to

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DOCUMENT WORD ANALYSIS

Main Category

AlHuda Material\sukuk islamic

KeyWords

asset invest risk ici rate investor origin credit financi structur securitisation NA iif required exposure fund estate servic NA legal

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DOCUMENT REFERENCES

Number of Pages

28

Published Date

2009-02-19 21:05:52

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