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First Internati

Islamic Finance C

Labuan - Mal

(6-7 July 2004

Islamic Risk Man

Instrumen

Corporate

and Investment

Banking

Table of contents

SECTION 1 The FX & Debt/Deposit issues

SECTION 2 Conventional vs. Islamic hedgi

SECTION 3 The Sukuk

SECTION 4 A new perspective for Sukuk St

SECTION 5 BNP Paribas in Islamic Banking

Section 1: The FX & Debt/Deposit issues
Islamic Institution and their risks

• Contrary to common beliefs, Islamic Bank

Banks, are fully exposed to Forex and Intere

>> The following example -based on the

financials of an Islamic Institution financial

our opinion on this matter

Islamic Banks are exposed to FX flu

• The FX issue:

>> As shown below, due to geographical diversif

assets & liabilities, Islamic Banks are exposed to

fluctuations in foreign currency exchange rates o

positions and cash flows

Mismatch

Islamic Banks are exposed to Intere

• The Debt/Deposit issue:

>> Assets and Liabilities Mismatch is also a co

Banks Indeed, such a mismatch, implies 2 othe

⇀ Liquidity Risk and

⇀ Interest Rate Risk

Maturity Mismat

Islamic Financial Institutions’ risks

• Summary:

Three different kind of risks can be clearly identi

⇒ The Foreign Exchange risk

⇒ The Interest Rate risk

⇒ The Liquidity risk

⇒ Islamic Financial Institutions ne

Sharia-Compliant hedging instrum

Section 2: Conventional vs. Islamic instruments
Conventional Hedging instruments..

• Hedging tools used and proposed by conventio

following:

⇒ FX Swaps:

Combination of both a FX spot and a FX

⇒ Interest Rate Swaps:

Exchange of a Floating against a Fixed I

⇒ Bonds:

Negotiable Debt instrument (based on In

...Not applicable to Islamic Banks

• These different mechanisms and instruments are

with Sharia principles:

⇒ These instruments refer to the concept of ‘riba

⇒ The forward concept is not acceptable

⇒ Pure monetary flows (no underlying Assets) ar

⇒ Debt instruments are not tradable under Sharia

New Islamic instruments have to be

to meet Islamic banks’

Eventual Solutions

BNP Paribas has developed Sharia-compliant FX

• Double Currency Exchange Deposit (equivalent

• Murabahas Profit Exchange (equivalent IR Swa

These Instruments have been approve

BNP Paribas in-house Sharia

And are currently at the final stage

documentation

The Double Currency Exchange Dep

Mas

Contractual (Provi

Scheme 1) Client 1 deposit on a

Murabaha basis, an

amount in a specified

currency with Client 2 for

a certain period of time

2) At Maturity, Client 2

give back the deposit +

profit to Client 1 in the

currency of the deposit

Client 1 2 bis) At Maturity, Client 1

C

give back the deposit +

profit to Client 2 in the

currency of the deposit

1 bis) Client 2 deposit on

a Murabaha basis, an

amount in a specified

currency with Client 1 for

a certain period of time

(same maturity than

Time Murabaha 1)

Scheme

Client 1

deposit with

Client 2

Client 2

deposit with

Client 1

The Murabaha Profit Exchange

M

(P

Contractual Scheme

1) Client 1 deposit on a

Murabaha basis, an

amount with Client 2 for

a certain period of time

2) At Maturity, Client 2

give back the deposit +

profit to Client 1

Client 1 Cl

2 bis) On every

Intermediate maturities:

Client 1 give back the

deposit + profit to Client 1

1 bis) Client 2 deposit on a

revolving Murabaha basis

(Total maturity = maturity of

Murabaha 1, an amount with

Client 2 for a certain period of

Time Scheme time

Client 1

deposit with

Profit

Client 2 Profit

Deposit + Deposit +

Client 2

Profit Deposit Profit Deposit

deposit with

rolled over rolled over

Client 1

Challenges raised by these structure

⇒ Accounting issues:

Can these structures allow an off-balance sheet

conventional tools?

Is it compatible with the standards set up by AAI

standards?

⇒ Legal issues:

Can the agreement be equivalent and as secured

one? (ISDA agreement)

⇒ Other issues:

Should we allow early settlement / unwinding of

Can we consider an endorsement by the IIFM?

Section 3: The Sukuk
Overview of the Sukuk market

• The Sukuk are another solution to resolve the l

Maturity Mismatch.

•As of 03/09/2004 The Sukuk market is as follows

• The world stock of sovereign Islamic bond

US$ 3 billion

• In comparison, in Malaysia, the value of ou

corporate bonds stands at nearly US$ 16 bil

⇒ Given the growing demand on these inst

international Islamic debt capital market still

developed (new issues needed)

The structures

⇒ So far, three structures have been d

International Islamic Capital market:

⇒ The Ijara Sukuk

⇒ The Mixed Assets Sukuk

⇒ The Sukuk Al-Salam

The existing structures (1): The Ijara

From a Sharia perspective, the Ijara Sukuk is a

format of Islamic Bond among Scholars

Indeed, the following Sharia constraints are ob

• It is Asset-Backed,

• It complies with the principles of Risk-Shari

(through an Ijara) as opposed to the princip

money,

• The Return on the notes have the form of R

payments.

Examples of Ijara Sukuk issues:

⎯ Bahrain Local & International Sukuk

⎯ Malaysia Global Sukuk (July 2002)

⎯ Qatar Global Sukuk (2003)

The Ijara Sukuk: The Structure

6) Buys Back the Assets

at maturity

1) Sells the Assets

Islamic

Issuer

S.P.V. 2

o

P

(

3) Lease Agreement

7) Re

issue

4) Rental Payments

Direct Recourse

The existing structures: Mixed asset

In terms of structure, the Mixed Assets Sukuk i

version

From a Sharia perspective, it is also a widely ac

Sukuk among Scholars

Example of Mixed Assets Sukuk issues:

⎯ Islamic Development Bank Global Suku

The Mixed Asset Sukuk: The Structu

Balanc

- 51% of

- 49% of

1) Transfer of Murabahas

deals

Islamic S.P.V.

Ultimate (Issuer)

Borrower 3) Purchase of the

2 Bis

Assets (1 & 1 Bis)

of p

1 Bis) Transfer of Leased Assets or 4) Fixed P

Assets to be Leased back to Issuer

Direct Recourse

The existing structures (3): The Suk

Al Salam is a transaction where two parties a

sale and the purchase of an underlying Asset

future date but at a price determined and fully

contract is entered into

The Sukuk Al Salam structure is a well-accep

short-term money market instruments (the Ba

Agency issues 3-months maturity Sukuk Al S

basis)

On a longer term, this structure still has to be

Tradability of such instrument is also a conce

The Sukuk Al Salam: The Structure

2) Payment against future delivery

of the Assets

Islamic S.P.V.

Ultimate (Issuer) 1 Bis

Borrower of Pa

(Suk

3) at maturity, Delivery of the goods

4) Undertaking agreement

(instantly executed)

5) payment o

Off-Takers

The challenges and problems of the

⇒ Assets issues:

How to structure such type of Sukuk in case t

Borrower have no assets or if available asset

negative pledges?

⇒ Legal issues:

Some jurisdictions do not allow foreigners (in

own locally domiciled assets

⇒ Tax issues:

The purchase, the lease and/or the buy back

important fiscal implications on the transacti

Section 4: A new perspective for Sukuk Structur
Need for new structures

Given the problems encountered in Structuring

Sukuk, new structures have to be developed an

respond to the following criteria:

⇒ Compliance with Sharia principles & supp

⇒ Acceptable to Islamic investors (same feat

⇒ Structurally enhanced to appeal to crosso

⇒ Tradable

⇒ Easily documented and that could facilitat

In this perspective, BNP Paribas has deve

tends to comply with these

The Sukuk Al Murabah

Sukuk al Murabaha - The Structure

Direct Obligation

Islamic Principal 1) Fun

Mudaraba

Borrower Profit (Issuer)

(& Principal @ maturity) 2) Suku

4) Profit

(& Principal @ mat

3) Revolving International Commodity

Murabaha Facility

No-withdrawal ag

(special exit cond

(Manager/ Mudarib)

Sukuk al Murabaha - The Structure

Initial Steps in Setting up the Transactio

Step 1: A Special Purpose Vehicle (Mudara

the first step in the proposed issue of secur

will be the issuing entity.

Step 2: The Manager (Mudarib) will, on behalf

(Sukuk holders), enter into a revolving internat

Murabaha with the Issuer. The funds raised via

applied towards this Murabaha scheme.

Periodic Profit Distribution

Profit earned on the revolving Murabahas and

Mudaraba will be passed on to the Sukuk holde

At Maturity

At the maturity of the Murabaha, the Issue

principal initially invested back to the Mudara

turn will redeem the Sukuk.

Advantages of the Structure

Easy to Structure:

The Sukuk al Murabaha is easier and faster to st

Ijara (Documentation ready for each step of the t

No transfer of Tangible Assets:

Under the recommended structure the Issuer is

any tangible asset transfers to a private entity, e

No due diligence on assets:

The assets backing the Sukuk al Murabaha struc

priced on the LME which obviates the need for a

assets

Same rating as the Issuer:

The international rating of the Sukuk will reflect t

exposure on the Issuer by the Mudaraba and the

would give investors a greater level of comfort

No return volatility:

The return (fixed or floating) on the Sukuk is set

subject to any change

Replicable Structure:

The Sukuk al Murabaha structure is elegant and

Compliance with Shariah Principles

Reason 1: Sign off by scholars

The Sukuk al Murabaha structure has already

prominent Sharia Scholars and large Middle

This format of Sukuk has already been issued

Investment Bank, a Bahrain-based Islamic Inv

mio, dual tranche: 3 & 5 yrs)

The Sukuk al Murabaha is a combination of v

widely used instruments in the market compr

Reason 2: Based on well established Islamic

⎯ A Restricted Mudaraba in order to use and

⎯ Sukuk representing a share in the Mudara

⎯ A Revolving International Commodities M

Compliance with Shariah Principles

Reason 3: New, Shariah Compliant Tradabilit

From a Shariah perspective, the structure

trading at specific dates:

⎯ Tradability allowed once the underlying

matured and before it revolves (usually

Typically, Sukuk trading during the life of

Murabaha would be considered from a Sh

debt trading (forbidden)

To assure tradability, BNP Paribas have d

accepted additional structure in order to t

time and price, giving this Sukuk the same

other accepted types of Sukuk

Section 5: BNP Paribas in Islamic Banking
BNP Paribas: 19 years in Islamic Ban

• Islamic Investment Department within BNP

dedicated multi-product capabilities:

⎯ Large short term Murabaha deposits bas

⎯ Co-arranger in Project Finance Islamic tr

⎯ First Islamic capital protected fund struct

⎯ One of the first Islamic Equity fund

1985

1985 1996

1996 1999

1999

CaravanFund:

Caravan Fund: FaysalShield

Faysal ShieldFund

Fund

11ststMurabaha

Murabaha

Deposits

Deposits Oneof

One thefirst

ofthe firstUS

US 11ststIslamic

IslamicEquity

Equity

Islamic Equity

Islamic Equity LinkedCapital

Linked Capital

Fund

Fund GuaranteedFund

Guaranteed Fund

BNP Paribas’ Islamic Banking Unit Or

Selected Panel Of Clients

Origination &

Marketing

Islamic Banking Unit:

Head: J-M Riegel

Dty. Head: A. Raad

Structurin

Execution

Asset Structured

Treasury Equities

Management Finance

The Sharia Board of BNP Paribas

BNP Paribas SSC is composed of well-know

commended scholars and is the first Interna

include in its Sharia Board scholars from bo

and Asia (Malaysia):

• Dr. Nizam Yaquby - Bahrain (Chairman of

• Dr. Abdul Sattar Abu Ghuddah – Syria (ba

• Dr. Mohamed Daud Bakar - Malaysia

Your contacts at BNP Pa

Jean-Marc Riegel

Head Of Islamic Banking

Regional Manager - Financial Instituti

Tel. +973 17 52 50 29

Fax +973 17 53 12 37

email: jean-marc.riegel@mideast.bnpp

Alain-Amin Raad

Deputy Head of Islamic Banki

Deputy Regional Manager Financial Insti

Tel. +973 17 52 06 96

Fax +973 17 53 12 37

email: alain.raad@mideast.bnppari

Islamic Risk Management Instruments - Revision history

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