islamic capital markets overview - tkbb 09-asa… · islamic capital markets overview iqbal asaria...

Durham Islamic Finance Autumn School in Istanbul, 2011

Iqbal Asaria, Islamic Capital Markets 1

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.



Markets

§ Definition § Liquidity § Speculation and Market

Makers § Functions

• Equity Markets • Debt Markets



Bonds & Sukuks

§  Bonds – Characteristics §  Securitisation

•  Receivables •  Assets-Backed Revenues •  Asset Based Revenues

§  Islamic Bonds in Malaysia §  Sukuk Markets

•  Primary •  Secondary



Asset Classes

§  Cash and Near Cash §  Equity

•  Long •  Long-Short •  REITS •  ETFs

§  Bonds §  Property §  Alternative Assets

•  Private Equity •  Hedge Funds •  Derivatives



Ernst & Young Islamic Funds and Investment report

§ Mass Affluent

§ Corporate (eg

takaful) § SWF’s § (U)HNWI

§ Market Segmentation

§ Largely via mutual funds, local equities § 80% equities, § 15% cash

Country dependant

§ 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

§ Shariah Sensitivity

§ 70% - 90% prefer Islamic

§ 70% - 90% prefer Islamic

§ Islamic requirement

§ Not predisposed to Islamic

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



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…

H ig h LowRisk & Return Spectrum

EquitiesReal Estate, Sukuks

C ommodity Murabaha

DIV ERS IFICA TIO NKey to successful investment strategy

Increasing Sector Focus

O ver Reliance & Low Returns,

O pportun ity – H ig h Returns 2 5 % +

> Private Equity is the natural next stage as the Islamic Finance industry develops

> Private Equity/ Venture C apita l considered “the missing link in Islamic Finance”(Source: Zawya)

Limited Islamic Universe

PO RTFO LIO MAN AG ER IN VESTMEN T DEC ISIO N



PE part of the alternative investments asset class

§ Private Equity •  (VC)

•  Growth capital •  Buy-out

•  Mezzanine capital

§ Hedge funds •  Long/short

•  Global Macro •  Event driven

•  Arbitrage

§ Real Estate •  Office •  Retail •  REITS

•  Residential

§ Alternative Investments

§ Commodities

§ Currencies

§ Interest rates

§ Natural resources

§ Source: Diagram adapted from EVCA Paper on PE

New area of development

in Islamic finance. Historical

issues with derivatives

Islamic banks are overly

exposed to, therefore

presenting significant risk

to Islamic banking (CBB

Governor)

§ Significant Growth Area – ‘The next Islamic fund

boom’?

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



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

Co.B Co.A Co.C

§ Mudaraba

§ musharika

§ 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.



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.



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.



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.



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.



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



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



Islamic Alternative Investment Funds



Derivatives

§  Role of Derivatives •  Primary •  Secondary

§  The ISDA Master Agreement §  The ISDA Tahawwut Agreement



Contact:

M Iqbal Asaria Afkar Consulting Ltd

0208 861 2012

[email protected]

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