Islamic Financial System (Shariah Rule)

• A financial system which is based on Islamic principles and values (shariah).

• Characterised by –

o Elimination of interest (Riba).

o Ensures a profit sharing mechanism in the system.

o Prohibition of speculative transactions (Gharar).

o Prohibits investing in businesses that are considered unlawful (haraam) (such as businesses that sell alcohol or pork, or businesses that produce media such as gossip columns or pornography, which are contrary to Islamic values).

o Shariah prohibits what is called "Maysir”, i.e. being involved in contracts where the ownership of a good depends on the occurrence of a predetermined, uncertain event in the future

Islamic laws on trading

• The Qur'an prohibits gambling (games of chance involving money).

• The hadith, in addition to prohibiting gambling (games of chance), also prohibits bayu al-gharar (trading in risk, where the Arabic word gharar is taken to mean "risk" or excessive uncertainty).

• There are a number of hadith that forbid trading in gharar, often giving specific examples of gharhar transactions (e.g., selling the birds in the sky or the fish in the water, the catch of the diver, an unborn calf in its mother's womb etc.)

• Jurists have sought many complete definitions of the term.

• They also came up with the concept of yasir (minor risk); a financial transaction with a minor risk is deemed to be halal (permissible)

• While trading in bayu al-ghasar (non-minor risk) is deemed to be haram

Types Of funds

Murabaha

• They are similar to development funds, also referred to as ‘cost-plus’ financing, where a fund will buy goods and resell them to a third party at a given price.

• The price is made of the cost of goods plus a profit margin.

• Cost and margin are agreed in advance.

Ijara

• Funds that acquire and keep ownership of an asset (real estate, machinery, vehicles or equipment) and then makes profits by leasing it out in return of a rental payment.

• The fund is responsible for the management of the asset and will normally receive a management fee.

• The leased item must be used in a Halal manner.

Islamic equity funds• Islamic equity funds invest in common shares in companies engaged in halal

business.

• Companies are also screened in order to check for Shariah compliant accounting principles.

• Because of the limited pool of companies the funds can invest into, equity funds can have higher volatility compared to similar funds in the same space.

• Islamic investment equity funds market is one of the fastest-growing sectors within the Islamic financial system.

• Currently, there are approximately 100 Islamic equity funds worldwide.

• The total assets managed through these funds currently exceed US$5 billion and is growing by 12–15% per annum

Islamic equity funds• Islamic investment equity funds market is one of the fastest-growing sectors within

the Islamic financial system.

• Currently, there are approximately 100 Islamic equity funds worldwide.

• The total assets managed through these funds currently exceed US$5 billion and is growing by 12–15% per annum.

• With the continuous interest in the Islamic financial system, there are positive signs that more funds will be launched.

• Some Western majors have just joined the fray or are thinking of launching similar Islamic equity products.

Islamic equity funds• Despite these successes, this market has seen a record of poor marketing as

emphasis is on products and not on addressing the needs of investors.

• Since the launch of Islamic equity funds in the early 1990s, there has been the establishment of credible equity benchmarks by Dow Jones Islamic market index (Dow Jones Indexes pioneered Islamic investment indexing in 1999) and the FTSE Global Islamic Index Series.

• The Web site failaka.com monitors the performance of Islamic equity funds and provide a comprehensive list of the Islamic funds worldwide

Commodities

• Commodities funds generate profits by buying and reselling Halal commodities.

• Because of the restrictions on the use of derivatives, commodities fund make use of two types of Shariah approved contracts:

• Istina’a- It’s a contract where the buyer of an item funds upfront the production of the

item. A detailed specification of the item has to be agreed before production starts and the cost of production has to be paid in full when the contract is agreed.

• Bay al-salam- It’s similar to a forward contract where the buyer pays in advance for the delivery

of raw materials or fungible goods at a given date. The delivery price of the contract is calculated at spot price minus a discount to compensate the buyer of the credit risk for the upfront payment.

CONVENTIONAL FINANCIAL SYSTEMV/S

ISLAMIC FINANCIAL SYSTEM

Malaysia at a glance

• Population – 28.3 m

Muslim – 16.4 m (58%)

• Strong GDP growth

3rd quarter 2011 5.4%

• Low inflation

Malaysian Islamic financial systems• Comprehensive Islamic financial system covering all financial sectors

– operating in parallel with conventional financial system

• Diversities of players

– 12 full-fledged Islamic banking institutions

– 2 domestic Islamic banks

– 3 full-fledged foreign owned Islamic banks

– 7 Islamic banking subsidiaries

– 9 takaful operators

Classification of Financial Market of Malaysia

Debt Market• Sukuk

Money Market• Islamic Interbank Money Market

Equity Market• i-ETF• i-REIT• Bursa Suq al Sila

Malaysian Equity market

• Bursa Malaysia (previously known as Kuala Lumpur stock exchange) is the stock exchange of Malaysia.

• Islmaic Products offered by Bursa Malaysia

– REITS

– i-ETFs– Bursa suq al sila.

Real Estate Investment Trusts (REITs)

• REITs are a liquid asset that can be sold fairly quickly to raise cash or take advantage of other investment opportunities.

• Tax benefits in taxable jurisdictions, attracting foreign investors.

• High cash dividends relative to the market

Investing in Islamic REITs - Issues

• High distributions of annual profit and lower reinvestment leads to a slower growth rate.

• Although the business tends to be a fairly stable one, REITs are not without risk.

• Sharia restrictions might restrict investment universe.

Malaysian Shari’a-Permissible Investments for I-REITs

• Real Estate

• Real estate related assets

• Single Purpose companies

• Liquid Assets

• Non real estate-related assets

• Asset-backed securities

Islamic ETFs

• Similar to conventional ETFs

• Main point of difference: Benchmark Index

• Islamic Benchmark Index comprises of Co.’s which are Shariah compliant.

• Appointment of Shariah Adviser/ Committee

Structure of Islamic ETF

Advantages for Investing in i-ETFs

• Diversification

• Lower expense ratio

• Lower transaction cost

• Transparency

• Shariah-compliant investment

Bursa suq al sila

• Bursa Suq Al-Sila' is a commodity trading platform specifically dedicated to facilitate Islamic liquidity management and financing by Islamic banks.

• Initiated by:

– Malaysia International Islamic Financial Centre (MIFC)

– Bank Negara Malaysia (BNM),

– the Securities Commission Malaysia (SC),

– Bursa Malaysia Berhad (Bursa Malaysia).

• Fully electronic web based platform providing industry players with an avenue to undertake multi commodity and multi currency trades from all around the world.

• In the initial stage, crude palm oil was used as the launch commodity. Eventually, this will expand to other Shari’ah approved commodities covering both soft and hard commodities.

• The first day of trade saw transactions worth RM200 million being exchanged on 20 july 2009.

Debt Markets

Sukuks

• Sukuks are Islamic bonds which have similar characteristics with conventional bonds.

• Asset backed and free from usury (interest).

• Linked to the returns and cash flows of the financing to the assets purchased or returns from the assets purchased.

• Sukuk based concepts in malaysia

– Mushrakah (normal partnership agreement)

– Murabaha (contract of cost plus margin)

– Ijarah (leasing)

– Istisnaa (pre delivery and leasing)

Sukuk structure

58%

10%

11%

21%

Size of sukuks approved in 2010

mushrakahistisnaaijarahmurabahah

Sukuk programmes and issuance in 2010

Issuer Sharia principle Amount (US$ million)

Amount(RM million)

Cagamas Bhd Multiple 17,466 60,000+

Binaring GSM Sdn Bhd Musharakah 4,473 15,366

Telekom Malaysia Bhd & Hijrah Pertama Bhd

Ijarah 872 2,997

Khazamah nasional Bhd Musharakah 841 2,890

MISC bhd Murabahah 728 2,500

Equity Markets

Bursa Malaysia

• Shari'ah Compliant Listed Equities• Guidelines for Sharia compliant Companies• 825 Shariah complaint securities• 89% of Bursa Malaysia• Market capitalisation as at 31 March 2011: USD 429 billion• Islamic Equity Indices –• FTSE Bursa Malaysia EMAS Shari’ah Index (FBM EMAS

Shari’ah)• FTSE Bursa Malaysia Hijrah Shari’ah Index (FBM Hijrah

Shari’ah)

Non Depository Market

Takaful

• Meaning• Concept of Tabarru• Profit Sharing

Types of Takaful Business

Family Takaful Business General Takaful Business

Family Takaful Business

• Islamic Life Insurance• Combination of long-term investment and

mutual financial assistance scheme• Objectives:

» to save regularly over a fixed period of time;» to earn investment returns in accordance with Islamic

principles; and» to obtain coverage in the event of death prior to

maturity from a mutual aid scheme.

• Examples: Individual family takaful plans;Takaful mortgage plans; Takaful plans for

education; Group takaful plans; and Health/Medical takaful.

General Takaful Business

• Short term• Surplus Sharing: On the basis of principle of

al-Mudharabah• Examples: Fire Takaful Scheme; Motor Takaful

Scheme; Accident/Miscellaneous Takaful Scheme;

Marine Takaful Scheme; and Engineering Takaful Scheme.

Growing Takaful Market• Takaful sector has been growing

at an average of 17% p.a. since 2001

• Malaysia is largest player.• Takaful contribution in Muslim

countries constitute only 1% of total global insurance premiums.

• Muslims account for 22% of worlds population

• Driven by demand for mortgage, motor, medical and education plans.

Money Markets

Islamic inter-Bank Money Markets (IBMM))

• Short term itermediary based on Sharia principles

• Used to match the funding requirements• Covers 2 aspects:

» Interbank trading of Islamic financial instruments; and» Mudharabah Interbank Investments ("MII")

Interbank Trading

• Trade in Islamic financial instruments• GIC are non-tradable but the players may

exchange the papers among themselves

Mudharabah Interbank Investments

• Based on Mudharabah (profit-sharing)• Period: Overnight to 12 months

Malaysia – A Global Hub for Islamic Markets

(Source: Bursa Malaysia, Securities Commission)* 2007 figures Number of Companies as at Nov 07, Market Cap as at end Dec 07

•Market capitalisation of shariah compliant stocks accounted for RM705.05 billion or 63.74% of total domestic market capitalisation as at December 2007

•Compared to the developing GCC & MENA stock markets, Bursa Malaysia provides more choice in terms of sectoral opportunities thereby providing better risk diversification

Top 10 Companies % of Total Market Capitalization

China

UK

US

Malaysia

Bahrain

UAE

Saudi

0% 20% 40% 60% 80% 100%

(Source: Bursa Malaysia, E&Y Islamic Funds and Investment Report 2007)

544585

636677 699

778

855886

853

0

100

200

300

400

500

600

700

800

900

1000

1999 2000 2001 2002 2003 2004 2005 2006 2007*

0

100

200

300

400

500

600

700

800

Bill

ion

s

Total Listed Companies Market Valuation

Size of Malaysia’s Equity Market

A Global Islamic Capital Market

(Source: The Islamic Capital Market Task Force (IOSCO) Report, ISI Emerging Markets, Bloomberg)

Malaysia 90%

Qatar3%

Indonesia0%

Others1%

Saudi Arabia2%

Bahrain4%

As at December 2003 As at December 2007

UAE8.54%Caymans

7.67%

Jersey5.97%Others

3.84%

Saudi Arabia8.18%

Malaysia 65.80%

•As of December 2007, approximately 66% of new Islamic fixed income securities globally were issued in Malaysia. The remaining global issues are from the Middle East / GCC and offshore jurisdictions.

A Global Islamic Capital Market

95

105

115

125

135

145

155

Sep

-03

Dec

-03

Mar

-04

Jun-

04

Sep

-04

Dec

-04

Mar

-05

Jun-

05

Sep

-05

Dec

-05

Mar

-06

Jun-

06

Sep

-06

Islamic Conventional

Ringgit Bonds with maturities of 1-year and above

95

105

115

125

135

145

155

Sep

-03

Dec

-03

Mar

-04

Jun-

04

Sep

-04

Dec

-04

Mar

-05

Jun-

05

Sep

-05

Dec

-05

Mar

-06

Jun-

06

Sep

-06

Islamic Conventional

Ringgit Bonds with maturities of 5-years and above

Index reading Av. Annualized Returns Average Duration

Islamic Conventional Islamic Conventional Islamic Conventional

1-year and above 145.47 138.35 7.64% 6.27% 4.73 3.98

5-years and above 142.07 125.43 7.57% 4.39% 6.32 6.11(Source: CIMB Fixed Income Research)

Islamic Papers have always Outperformed Conventional Papers in Malaysia

Leading in Islamic Asset Management

No. of Shariah Funds vs Conventional Funds

55 71 83 100 134171

229 257316

387

0

100

200

300

400

500

600

2003 2004 2005 2006 2007

Year

No

. of

Fu

nd

s

Shariah-based Conventional

Shariah-based Unit Trust Funds

16.90

4.756.76

8.49

9.177.5

9.988.67.76.8

02468

1012141618

2003 2004 2005 2006 2007

Year

NA

V (

RM

bill

ion

)

0

2

4

6

8

10

12

(%)

NAV % to Total Industry

Malaysia has some 134 funds at the end of 2007 and is estimated to account for 22% of Islamic funds worldwide (Securities Commission, Eurekahedge)

Fund assets have been growing at a CAGR of 38% per annum between 1997 and 2007.

The total NAV of Islamic unit trusts in Malaysia by end 2007 stood at some USD5.12 billion or 9.97% of total outstanding unit trusts net asset value (Securities Commission)

Thank You