Islamic Financial System (Shariah Rule)

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

o
o o o

Elimination of interest (Riba).

Ensures a profit sharing mechanism in the system. Prohibition of speculative transactions (Gharar). 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). 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

Murabahah

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 1215% 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 1215% 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:
IstinaaIts 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-salamIts 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 SYSTEM V/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 Regulatory head - MIFC 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 financial 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

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 Sharia-Permissible Investments for I-REITs

Real Estate Physical land and man-made items attached to the land. Real estate related assets Units of other I-REITs, Sharia-compliant securities of property companies and Islamic bonds securities issued by property companies. Single Purpose companies Private companies whose principal assets comprise real estate

 Liquid Assets Sharia-compliant securities of non property companies Non real estate-related assets Cash, deposits or other instruments convertible into cash within 7 days (Sharia-compliant) Asset-backed securities Islamic Bonds issued from Securitization transaction

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 Shariah 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

Size of sukuks approved in 2010

21% mushrakah istisnaa 11% ijarah murabahah

58% 10%

Sukuk programmes and issuance in 2010

Issuer Sharia principle Amount (US$ million) 17,466 Amount (RM million) 60,000+ Cagamas Bhd Multiple

Binaring GSM Sdn Bhd Telekom Malaysia Bhd & Hijrah Pertama Bhd

Musharakah Ijarah

4,473 872

15,366 2,997

Khazamah nasional Bhd MISC bhd

Musharakah Murabahah

841 728

2,890 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 Shariah Index (FBM EMAS Shariah)
-FTSE Bursa Malaysia Hijrah Shariah Index (FBM Hijrah Shariah)

Insurance

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

Malaysia is largest player. Takaful contribution in Muslim countries constitute only 1% of total global insurance premiums. Muslims account for 22% of worlds population.

Money Markets

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. Profit Sharing: Negotiable

Conclusion

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Malaysia: A Global Islamic Capital Market

By Nov 2007, 86% of Bursa Malaysia comprises of shariah compliant stocks 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
Saudi UAE Bahrain Malaysia US UK China

Size of Malaysias Equity Market

0% 20% 40% 60% 80% (Source: Bursa Malaysia, E&Y Islamic Funds and Investment Report 2007)

100%

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

Malaysia: A Global Islamic Capital Market

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. Recent experience has shown that products with more global features attract more investment from abroad vis USD denominated sukuks
As at December 2003

As at December 2007

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

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Islamic Papers have always Outperformed Conventional Papers in Malaysia

Ringgit Bonds with maturities of 1-year and above
155

Ringgit Bonds with maturities of 5-years and above

155 Islamic 145 Conventional

Islamic
145

Conventional

135

135 125 115

125

115

105

105 95

Mar-04

Mar-05

Dec-03

Dec-04

Dec-05

Mar-06

Jun-04

Jun-05

Mar-04

Mar-05

Dec-03

Dec-04

Dec-05

Mar-06

Jun-04

Jun-05

Jun-06

Sep-03

Sep-04

Sep-05

Jun-06

95
Sep-03 Sep-04 Sep-05 Sep-06

Index reading 1-year and above 5-years and above

(Source: CIMB Fixed Income Research)

Av. Annualized Returns Islamic 7.64% 7.57% Conventional 6.27% 4.39%

Average Duration Islamic 4.73 6.32 Conventional 3.98 6.11

Islamic 145.47 142.07

Conventional 138.35 125.43

Sep-06

45

Leading in Islamic Asset Management

46

Malaysia has some 134 funds at the end of 2007 and is estimated to account for 22% of Islamic funds worldwide (Securities Commission, Eurekahedge)
No. of Shariah Funds vs Conventional Funds

No. of Funds

Fund assets have been growing at a CAGR of 38% per annum between 1997 and 2007.
Shariah-based Unit Trust Funds
18 16 14 12 10 8 6 4 2 0 16.90

600 500 400 300 200 100 0

387 171 55
2003

229 71
2004

257 83
2005 Year

316 134
2007

100
2006

12

Shariah-based

Conventional

NAV (RM billion)

6.8

7.7

8.6 7.5
9.17

9.98 10
8 6 4 2 0

6.76 4.75 2003 2004

8.49

2005 Year

2006

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)

NAV

% to Total Industry

(%)

Growing Potential of Takaful

Takaful sector has been growing at an average of 17% p.a. since 2001 and by end 2007 total contributions were estimated at USD931 million. (BNM, Islamic Finance News) Growth of takaful is driven by demand for mortgage, motor, medical and education plans. In the same period total assets of Takaful are estimated to amount to USD1.7 Breakdown of Family Takaful Contributions Total Takaful Contributions 2003-2006 billion. 2001-2006

47