Islamic Trade Finance

CHAPTER 1 : ISLAMIC TRADE FINANCE OVERVIEW

WHAT IS DEFINE TRADE FINANCE ?

Financing facilities granted by the bank to the merchant @ traders in the domestic business and international business, which connects on country to another. Involve import & export & foreign currency exchange commercial use of financial documents & transactions.

LIST ISLAMIC CONCEPT

- Wakalah

- Musyarakah

- Qardhul Hassan

- Ibra'a

- Kafalah

-Murabahah

-Ujrah

PROHIBITED IN ISLAMIC CONTACT

RIBA'

Literally means to increase, to grow to rise, to add, to swell. It is, however, not every increase or growth which has been prohibited by Islam. In the Shari’ah, “riba” technically refers to the premium that must be paid by the borrower to the lender along with the principal amount as a condition for the loan or for an extension in its maturity. In this sense riba has the same meaning as interest in accordance with the consensus of all jurists without any exceptionxii[12]. So the Holy Qur’an and the Hadith do not make any such difference between usury and interest. Interest and usury both are taken as synonymous for the Arabic word riba.

RIBA DUYUN

- (riba out of lending and borrowing)

· This kind of riba is the extra amount of money over and above the principal of the loan either:

· imposed by the lender upon the borrower in the contract;

· promised by the borrower in the contract.

· is sub-divided into:

1.1. Riba qardh i.e. riba is imposed from the beginning.

1.2. Riba jahiliyah i.e. there is no riba at the beginning; riba is imposed only after default.

RIBA BUYU

- This kind of riba may occur out of an exchange between two ribawi materials of the same kind where the necessary rule(s) are not observed.

· There is no riba in trading transactions where a ribawi material is exchanged with a non-ribawi material like money with a car; or a non-ribawi material is exchanged with another non-ribawi material like rubber with a refrigerator.

· 2.1. Riba fadhl i.e. the ribawi materials (of the same kind) exchanged are of different weights, measurements or numbers and they are exchanged at the same time.

2.2.Riba nasiah or riba yad i.e. the ribawi materials exchanged are of equal weights,measurements or numbers but payment of the price and delivery of the goods are made at two different time.

Islamic banking does not give out loans. Therefore riba out of lending and borrowing does not arise. To avoid involvement with riba in trading transactions, Islamic banking must pay proper attention to the requirement that the buying and selling of the following matters must be on cash terms:

(i) gold in treasury functions for liquidity,

(ii) silver in treasury functions for liquidity, and

(iii) currencies, the currency of each country being considered as a kind, for hedging and payments of imports.

DEFINED GHARAR

In general terms major gharar is:an uncertainty which is so great that it becomes unacceptable, orit is so vague that

GHARAR YASIR

i.e. minor or slight gharar

hotel charges the customer the same prices even though the criteria of the customers are different.

GHARAR FAHISH

i.e. major or serious gharar

is a great uncertainty and the product cannot be measured, so the contract is ambiguous

DEFINED MAISIR

· Gambling is betting or charging something that will be forfeited if one fails to obtain the greater gain that one hopes for.Speculation is not gambling. Some jurists say that speculation is prohibited,

· But contracts involving speculation are still valid.Gambling (al maisir) means a game of haphazard in all matters-particularly a game of chance by means of divinatory arrows. Maisir is of various categories.

Some of these types of Maisir are seeking omen or fortune by divinatory arrows, back-gammous,

PRODUCING/SELLING OF IMPROVED GOODS

- Give OR sales item not good.

Example, non good or wine including not lawful and muslim Serve

GOODS THERE ARE NO USE

- Sale item not use when no value.

Example, sell things that can cause eager music

RISK IN TRADING

INSOLVENCY RISK

FRAUD

EXCHANGE RISK

DEFAULT BY SELLER/EXPORTER

CHAPTER 2 : TERM OF PAYMENT AND DOCUMENTATION

FINANCIAL DOCUMENT

1- Bill of exchange

2- Promissory Note

3- Cheque

MODES OF PAYMENT

1- Open account Basis

2- Consignment Basis

3- Advance payment

4- Documentation Collection

5- Documentation Credit

TERM OF PAYMENT

a) Ex-work

b) Cost and Freight

c) Cost , insurance and freight

d) Carriage and insurance paid to

e) Carriage paid to

f) Free carrier

g) Free on Board

h) Free Alongside ship (FAS)

i) Delivered at Frontier

j) Delivered at ex-ship

k) Delivered ex-Quay

l) Delivered Duty paid

m) Delivered Duty Unpaid

FINANCIAL DOCUMENT

• BILL OF EXCHANGE

An unconditional orders issued by a person or business which directs the recipient to pay a fixed sum of money to either fixed or negotiable. A bill of exchange must be in writing and signed and dated. also called draft.

· PROMISSORY NOTE

a signed document containing a written promise to pay a stated sum to a specified person or the bearer at a specified date or on demand.

· CHEQUE

cheque is a written order directing a bank to pay out money, and it's exactly the same thing as a check, but with more exciting letters.

MODES OF PAYMENT

1. Open account basis

Ø Buy now pay later”

Ø Goods will be posted in advance and payment will be made later

Ø Customer must pay on the date specified in the initial agreement.

2. Advance payment

Ø Payment must be made first before getting the goods.

3. Consignment Basis. Send items to customers without asking for payment.

2 concept :

- the goods will be returned if not sold.

- the goods will be sent in advance and payment at the end of the month.

1. Documentary collection

- Transaction whereby the exporter entrusts the collection of payments to a collecting bank (importer’s bank), along with instructions for payment.

- Is an undertaking by the issuing bank to pay the beneficiary a stipulated amount if the letter fulfils the terms and conditions of the credit.

(a) Documents against Payment (D/P)

- The exporter ships the goods, and then gives the documents to his bank, which will forward them to the importer’s collecting bank, along with instruction on how to collect the money from the importer.

(b) Documents against Acceptance (D/A)

- The exporter extends credit to the importer by using a time draft. In this case, the documents are released to the importer to receive the goods upon acceptance of time draft.

Nature of documentary credit payment
~ significantly reduce the risk involved in foreign trade transactions
~ for importer help ensure that the exporter has actually shipped the goods for which they are pays.

Forms of documentary credit

(a)Revocable Credit

~ M ay be revoked or modified for any reason , at any time by the issuing bank without notification.
~ It is rarely used in international trade

b) Irrevocable Credit

~ in this case it is not possible to revoke or amended a credit without the agreement of the issuing bank , the comfirming bank and the beneficiary .

c) Comfirmed Irrevocable Credit

~ the seller / beneficiary may also look to the creditworthiness of the additional confirming bank for payment assurance.

d) Sight and Usance Credit

-sight credit states that the payment would be made by the issuing bank at sight on demand or on presentation.

~ in case of usance credit , draft are drawn on the issuing bank or the correspondent bank at specified usance period . The credit will indicate whether the usance draft are to be drawn on the issuing bank or in the case of confirmed credit on the confirming bank.

Parties involved in documentary credit process
i) issuing bank
ii) advising bank
iii) negotiating bank
iv) reimbursing bank

Practices in documentary credit

6. Bilateral payment agreement scheme

~ bilateral trade agreement give preference to certain countries in commercial relationships ,trade and investment between the home country and the foreign country by reducing or eliminating tariffs , import quotas , export restraints and other trade barriers.

-Bill of Lading

-Air Ways

-Delivery Order

INVOICE

Non - negotiable commercial instrument issued by a seller to a buyer. It identifies both the trading parties and lists, describes, and quantifies the items sold, shows the date of shipment and mode of transport, prices and discounts (if any), and ), and delivery and payment terms

-Commercial Invoice

-Proforma Invoice

-Certificated Invoice

-Consular Invoice

-Legalised Invoice

INSURANCE

a) Cover notes

A note written by an agent notifying the insured that his or her coverage has taken effect.Comparable to a binder, but not issued by a company like a binder.

b) Inpection of certificate

Required usually for import of industrial equipment, meat products, and perishable merchandise, it certifies that the item meets the required specifications and was in good condition and correct quantity when it left the port of departure. Also called inspection certificate or inspection report.

c) Halal certificate

Recognition that the product is allowed under islamic law.

TERM OF PAYMENT (INCOTERM)

a) Ex-Work

-

Ø The seller makes the goods available at his/her premises.

Ø This term places the maximum obligation on the buyer and minimum obligations on the seller.

Ø Ex work means that a buyer incurs the risks for bringing the goods to their final destination

b) Cost & Freight (CFR)

Ø The seller deliver the goods to the ship. Full risk and responsibility pass to the buyer when the goods cross the ships rail.

The seller pays for the contract of carriage to the agreed port of destination.

c) Cost, Insurance and Freight

Ø he seller delivers the goods to the ship. All risks and responsibility in the goods pass to the buyer when the goods cross the ships rail.

Ø The seller pays for the contract of carriage to the port of destination and takes out cargo insurance at his own cost.

d) Carriage And Insurance Paid To (CIP)

e) Carriage Paid To (CPT)

Ø he seller delivers the goods into the custody of the carrier and pays for the costs of the

Ø carriage to the agreed destinations.

Ø The goods travel at the buyers risk

(f) Free carrier ( FCA)

Ø he seller delivers the goods to the ship and he is considered to have fully carried out his side of the bargain when the goods pass over the ship rail.

Ø The buyer bears full responsibility from that moment onwards

g) Free on Board (FOB)

Ø he seller hands over the goods cleared for export to a carrier named by the buyer at the place agreed by the buyer and the seller.

The buyer is responsible for the contract of carriage and all other formalities.

h)Free Alongside Ship (FAS)

Ø eans the seller fulfills its obligation to deliver when the goods have been placed alongside the vessel on the quay or in containers at the named port of shipment.

Ø The buyer has to bear all costs and risks of loss of or damage to the goods from that moment.

Ø The seller must clear the goods for export.

Ø FREE ALONGSIDE SHIP can only be used for sea or inland waterway transport.

Ø the quay or in containers at the named port of shipment.

i)Delivered at Frontier (DAF)

DELIVERED AT FRONTIER means the seller fulfils its obligation to deliver when the goods have been made available, cleared for export, at the named point and place at the frontier, but before the customs border of the adjoining country.

The term "frontier" may be any frontier, not just the country of export.

DELIVERED AT FRONTIER is intended to be used when goods are to be carried by road or rail, but it may be used for any mode of transport.

When delivery must be a destination port, aboard a ship or at a dock use one of the following terms:· DES - DELIVERED EX SHIP

j) Delivered Ex-Ship

Ø DELIVERED EX SHIP means the seller fulfills its obligation to deliver when the goods have been made available to the buyer on board the ship uncleared for import at the named port of destination.

Ø If the parties wish the seller to bear the costs and risks of discharging the goods, then use the term DEQ - DELIVERED EX QUAY.

DELIVERED EX SHIP can only be used for sea or inland waterway transport.

k) Delivered Ex-Quay

Ø fulfils its obligation to deliver when the goods are placed at the disposal of the buyer not cleared for import on the quay (wharf) at the named port of destination.

Ø The seller has to bear costs and risks involved in bringing the goods to the named port of destination and discharging the goods on the quay (wharf).

Ø The buyer clears the goods for import and pays for all formalities, duties, taxes and other charges upon import.

Ø This is the opposite of the previous version of Incoterms.

Ø If the parties wish to include in the seller’s obligations all or part of the costs payable upon import of the goods, this should be made clear by adding explicit wording to this effect in the contract of sale.

Ø If the parties wish to include in the seller’s obligations the risks and costs of the handling of the goods from the quay to another place (warehouse, terminal, etc.) in or outside the port, then one of the following terms should be used:

· DDU - DELIVERED DUTY UNPAID (... named place of destination)

· DDP - DELIVERED DUTY PAID (... named place of destination)

DELIVERED EX QUAY can only be used for:

ü Sea or inland waterway transport

ü Multimodal transport

Discharging from a vessel onto the quay (wharf) in the port of destination.

Ø DELIVERED DUTY UNPAID means the seller fulfills its obligation when the goods arrive by any means of transportation to the named place of destination.

The seller has to bear the costs and risks involved in bringing the goods thereto (excluding duties, taxes and other official charges payable upon importation) as well as the costs and risks of carrying out customs formalities.

M) Delivered Duty Paid (DDP)

Ø DELIVERED DUTY PAID means the seller fulfills its obligation when the goods arrive by any means of transportation to the named place of destination.

Ø The seller has to bear the costs and risks involved in bringing the goods thereto (including duties, taxes and other official charges payable upon importation) as well as the costs and risks of carrying out customs formalities.

Ø The seller pays the duty.

Ø DELIVERED DUTY PAID represents the seller's maximum obligation.

Ø The buyer has to pay any additional costs and to bear any risks caused by its failure to clear the goods for import in time.

DELIVERED DUTY

Ø PAID should not be used if the seller is unable to obtain an import license.

Ø If the parties wish the seller not to carry out customs formalities and bear the costs and risks, or not pay any taxes, this has to be made clear by adding words to this effect.

Ø DELIVERED DUTY PAID can be used for all modes of transport.

CHAPTER 3: TRADE FINACE FACILITIES

Documentary Credit/Letter of Credit-i

· What is Letter of Credit?

ü Written undertaking by a bank

ü Given to a seller(beneficiary)

ü At the request and instruction of the buyer(applicant)

ü To pay at sight or at a determinable future date

ü A stated sum of money

ü Within a prescribed time limit against stipulated/complying documents

ISLAMIC IMPORT FACILITIES

v INWARD BILLS FOR COLLECTION-i (IBC-i)

Inward Bills for Collection-i (IBC-i) is the handling of inward documents (domestic and foreign) received from the remitting Bank and / or seller for

· presentation to buyer for payment at sight or acceptance of usance Bills of Exchange for payment at a future date.

Features:

§ Documents are sent on collection basis

§ Financing for Sight Bill (D/P) and Usance Bill (D/A)

Benefits:

§ Immediate fund

§ Improve company’s cash flow pending payment buyer

§ Financing for full amount of the bill

v LETTER OF CREDIT/ DC WAKALAH

· This occurs when a person appoints a representative to undertake transactions on his/their behalf, similar to a power of attorney.

· Literally Wakalah means protection or remedying on behalf of others. Legally Wakalah refers to a contract where a person authorizes another to do a certain well-defined legal action on his behalf.

· Refers to an agency relationship where a Bank acts as an agent on behalf of a company or individual

· Tenets of Wakalah:

• Principle

• Agent

• Object to be transacted

• Offer and acceptance

· Features:

§ Undertaking by the Bank to pay

§ Customer MAY require to place a deposit for the full value of the DC where the bank accepts under the concept of wadiah yad dhamanah

§ Does not involve bank’s financing

§ Bank charges commission under the principle of Al-Ujr(fee)

v LETTER OF CREDIT/ DC MUSYARAKAH

· Refers to a partnership or joint venture profit sharing between a bank and a customer whereby the customer has to contribute part of the capital in a joint venture project

· The distribution of profits will be based on agreed portion at a point of contracting

· Tenets:

§ Shareholders

§ Capital

§ Project

§ Offer and acceptance

· Features:

§ Customer places with the bank a deposit for its share of the cost of the goods as agreed in the Musyarakah agreement

§ Undertaking to pay the negotiating bank upon receipt of complied documents by utilising the customer’s deposit as well as its own share of financing

§ The customer takes possession of the goods and disposes these off in the manner agreed in the agreement

§ The bank and customer share in the profit from the venture as provided in the agreement

§ Refers to the selling of merchandise at a price based on cost plus profit margin agreed by both parties

· Facility granted to customer to finance his short term working capital requirement to purchase (foreign and local) stock & inventories,spares and replacement, semi finished goods, finished goods and raw material

· Features:

§ The cost must be revealed

§ The price and tenor of the lump sum deferred payment must be agreed by upon by bank and the customer

§ Customer is appointed as the purchasing agent for the bank to purchase the merchandise

§ Bank will effect payment using its own funds to the supplier directly or through its correspondence agent

§ Bank subsequently sells the merchandise to the buyer at a price which includes the bank’s profit

§ Customer is allowed to pay on deferred term depending on the trade cycle of the business concern

COMPARISON BETWEEN TR-i AND TR

TR-i:

ü Based on the concept of buy and sell on deferred payment thus creating a debt

ü Financing is for full invoice value

ü The bank buys the goods and sells it at bank’s selling price comprising the cost and the bank’s profit margin

ü The profit rate is fixed throughout the financing period

ü Rebate is given for early settlement

TR :

ü Base on lending concept

ü Financing is for full invoice value

ü Interest is charged on current rate at a fixed margin above the current base lending rate

Base lending rate fluctuates. The rate may change during the financing tenor

ISLAMIC EXPORT FACILITIES

v OUTWARD BILLS OF COLLECTION-i (OBC-i)

· Outward Bills for Collection-i (OBC-i) is the handling of domestic sales and export documents, which are presented to the Bank by the seller to collect payment from the buyer through the buyer’s bank.

· Facility granted to the seller to finance their trade debt, which arises from sale contract of goods (halal), presented under Documentary Credit under the principle of 'Bai Al-Dayn'.

· Features:

§ Sale contracts of goods drawn under documentary credit

§ Financing for Sight Bill and Usance Bill

§ Documents presented that comply with the Documentary Credit terms

· Benefits:

§ Customers get immediate fund

§ Improve company’s cash flow pending payment from buyer

§ Financing for full amount of the bill

v BILL OF EXCHANGE PURCHASED-i

· It is a facility granted to the customer to finance sales/export by discounting/purchasing sales/export documents drawn under documentary collection

· To finance exporters/sellers who need funds immediately in exchange for export documents.

· Features:

§ Ability to obtain immediate funds upon presentation of necessary documents

§ As a means of financing for working capital requirements

§ Margin of financing is up to 100% of the bill amount/invoice value

§ Simple document preparation as document is presented under a collection basis

· Types of BEP-i

§ Domestic Bills of Exchange Purchased-i (DBEP-i)
Bills drawn in RM purchased by the bank and forwarded to its own branches or other banks in Malaysia under collection basis

§ Foreign Bills of Exchange Purchased-i (FBEP-i)
Bills drawn in RM or in foreign currencies purchased by the bank and forwarded to its own branches, agents or other banks outside Malaysia under collection basis

v BANKERS ACCEPTANCE- i(BA-i)

· BA-i (purchases) is a facility granted to buyer to finance his purchases under the contract of Al Murabahah

· BA-i (sale) is a facility granted to seller to finance his sale on credit terms under the contract of Bai’ al Dayn

The BA-i is similar to Bankers Acceptance, formulated on the Islamic contracts/principles

· Bai’al dayn (sales)

§ The customer prepares the sale document as required under the sales contract which is to be sent to the purchaser’s bank

§ The customer draws on the bank a new bills of exchange as a substitution bill that represent the BA-i

§ The bank will purchase the BA-i at a mutual agreed price (using the concept of bai’ al dayn or debt trading)

§ The proceeds will be credited to the customer’s account

v ISLAMIC EXPORT CREDIT REFINANCING-i (PRE & POST SHIPMENT) – ECR-

i (PRE & POST)

· A scheme whereby Exim Bank (EB) provide short-term export financing to direct and indirect exporter, via commercial banks prior to or upon shipment of the products

· EB refinances the commercial banks which had extended short-term financing to eligible direct/indirect exporters at the prevailing ECR-i rate determined by EB.

· PRE-SHIPMENT ECR-i

§ Pre-shipment ECR-i facility is an advanced by EB to facilitate the production of eligible goods for export prior to shipment and

§ to promote backward linkages in industrial development

§ Pre-shipment ECR-i is available to a direct and indirect exporter to finance their:

ü purchased of domestic input in relation to the production of eligibility goods

· POST-SHIPMENT IECR

§ Post-shipment IECR facility is an advance made by EB to exporters to finance the export of eligible goods after shipments.

§ Is available to a direct exporter who export eligible products on sight/usance terms

§ Can obtain immediate funds upon presentation of export documents after shipment of goods

· Syariah Principles Applicable:

§ Pre-shipment ECR

ü Al Murabahah

ü Bai’ al Dayn

§ Post-shipment IECR

ü Bai’ al Dayn

§ Period of financing

ü For sight terms is from the date when the export documents are presented to ECR-i Bank up to a maximum of two months (60 days)

ü For usance terms it is from the date when the export documents are presented to ECR-i Bank until the maturity of date of the export bill plus standard en-route period subject to minimum of 7 days, maximum 6 months (183 days)

ü Amount of financing is up to 100% of the export bill value

§ Pre-shipment ECR

ü Al Murabahah

ü Bai’ al Dayn

§ Post-shipment IECR

ü Bai’ al Dayn

§ Period of financing

ü For sight terms is from the date when the export documents are presented to ECR-i Bank up to a maximum of two months (60 days)

ü For usance terms it is from the date when the export documents are presented to ECR-i Bank until the maturity of date of the export bill plus standard enroute period subject to minimum of 7 days, maximum 6 months (183 days)

ü Amount of financing is up to 100% of the export bill value

MURABAHAH WORKING CAPITAL FINANCING

Murabahah Working Capital Financing is an application of Murabaha, which is a form of a cost plus financing. It is also called markup sale. The cost must be made known to the purchaser. Through this concept, the bank or financier may finance a client who wishes to acquire given Goods but to defer the payment for the asset for a specific period or pay by monthly payments

BAI AL-DAYN SALES

To be specific , it can be defined as the sales of debt according to fuqaha as a type of a sales contract in which the creditor sells his Payable right upon the debtor either to the debtor himself or third party.

Example; NIDC

ISLAMIC ACCEPTANCE BILLS

- Accepted Bill (Purchase) <import>

- Accepted Bill (sales) <export>

Define Islamic Acceptance Bills: Islamic Accepted Bills (IAB) is bill of exchange drawn to finance domestic and foreign trade transaction and payable on a specified future date. In line with the Bank Negara Malaysia’s (BNM) circular in respect of the standardization of the generic name for Islamic banking products, the IAB is now to be known as Accepted Bills-I (AB-i). This financing facility were introduced in 1991 and have their guidelines for its establishment known as Guidelines on Accepted Bills-I issued by BNM.

Characteristics

Ø Minimum for financing RM50,000

Ø Maturity minimum financing 21 days.

Ø Based on buy and sell debt.

Ø Financing for full value

Type of guarantee offered by bank

Al-Kafalah Bank Guarantee ( BG-I)

his is a surety given by the Bank (made under the concept of Al-Kafalah of Al-Dhamanah) whereby agrees to guarantee a liability of a customer/applicant in case of the latter defaults in fulfilling his obligation.

AL-KAFALAH SHIPPING GUARANTEE (SG-I)

This is a guarantee provided by a person (the Bank) to the owner of a goods, who had placed or deposited his goods with a third party, made under the concept of Al-Kafalah or Al-Dhamanah whereby any subsequent claim by the owner for his goods must be met by the guarantor and the third party.

SG- is a facility granted by the Bank to importers for clearance of goods at the port without producing original Bill of Lading. It should only be issued for documents drawn under the Bank's LC or customers with approved SG-i facilities for collections documents.

Benefits

•Importer can take delivery of goods immediately;

•Importer will not have to incur excessive storage charges;

•Enables the importer to sell

Features

•It is a Letter of Indemnity to the shipping company signed by the customer and countersigned by the bank authorizing the release of goods to the importer;

•Release of goods without

CHAPTER 4: SECURITIZATION

SECURITIZATON

· Process of transferring of liquid asset into liquid one

· Process of packaging financial promises and transferring them into another form whereby they can be freely transferred among a multitude of investors

· Securitization is a conversion of asset into marketable securities. Asset comprise of;

· Physical asset: Sukuk

· Financial asset: Asset back-securities (ABS)

SUKUK

Sukuk are defined by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) as:

‘certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity’.

Often referred to as an ‘Islamic bond’, Sukuk are asset-backed trust certificates evidencing ownership of an asset or its usufruct (earnings or fruits). However, Sukuk securities comply with Islamic commercial jurisprudence and its investment principles which prohibit the charging or paying of interest.

IFSB :

“Sukuk (plural of sakk), frequently referred to as ‘Islamic bonds’, are certificates with each sakk representing a proportional undivided ownership right in tangible assets, or a pool of predominantly tangible assets, or a business venture. These assets may be in a specific project or investment activity in accordance with Shariah rules and principles.

What is sukuk?

· Certificates of equal value representing proportionate ownership of tangible assets or usufructs or services or (of) the assets of a project or in an investment activity.

· This ownership comes in effect after the completion of subscription and with the investment of received funds.

Different Kinds Of Sukuk

Ø Sukuk representing ownership in tangible assets (mostly based on Sale and Lease back or direct lease).

Ø Sukuk representing Usufructs or Services (based on sub lease or sale of services).

Ø Sukuk representing equity share in a particular business or investment portfolio (based on Musharakah/ Mudarabah).

Ø Sukuk representing receivable or future goods (based on Murabaha or Salam or Istisna’).

Tradable Sukuk

Sukuk representing tangible assets or proportionate ownership of a business or investment portfolio are tradable. For e.g. Sukuk of Ijarah or Musharakah /Mudarabah

Non-Tradable Sukuk

Sukuk representing receivables of cash or goods are nontradable. For e.g. Sukuk of Salam or Murabaha.

The Relation Between Involved Parties

ü The issuer and the subscribers are the main parties to the underlying contract.

ü The SPV is a legal entity for a common representation of the subscribers.

ü The underlying contract defines who is who.

ü The relation between the issuer and the subscriber is governed by the rules of the original contract.

Basic Shariah Rules

§ All the rules of original contract on the basis of which Sukuk are created should be applied.

§ The issuer cannot guarantee the face value of the certificate for the holder except in case of negligence/misconduct.

§ In Sukuk based on sale and lease back, the issuer can unilaterally undertake that he will purchase the asset after one year for a certain price.

§ Different types of reserves (e.g. profit equalization reserve) or takaful pool can be created.

§ Only those Sukuk can be traded that represent proportionate ownership of tangible assets, usufructs or services.

§ Trading or redemption of Sukuk is allowed after closing subscription, allotment of Sukuk and commencement of activity.

§ Sukuk of usufructs can be traded before the assets are sub-leased.

§ Sukuk of services can be traded prior to passing the services to the user.

§ In Sukuk of Musharakah/Mudarabah, the issuer can redeem the certificates on the market price or the mutually agreed price.

Hybrids – Convertible and Exchangeable Sukuk

Both convertible and exchangeable Sukuk have been accepted. A convertible Sukuk will give the holder the right (but not the obligation) to exchange his paper into a pre-determined number of equity in the issuer at a pre-determined price. An exchangeable Sukuk will give the holder the right to do so in a third party company.

Hybrid Sukuk (IDB) – Shariah Requirements

1. Shariah Board of IDB viewed that IDB can sell a mixed portfolio of tangible assets (Ijarah properties) and receivables (murabahah and istisna’) given that the Ijarah properties are at least 51%.

2. IDB undertook that the Ijarah contract proportion in the sukuk asset will not fall below 25%.

3. Based on the above, the sukuk can be freely tradable in the secondary market.

TRADABILITY OF SUKUK

Shariah scholars unanimously agree that sukuk can be sold and purchased except some differences regarding Sukuk al-Murabahah and Salam Sukuk.

ISLAMIC ASSET-BACKED SECURITY

· Islamic Bonds in Malaysia

· BBA Islamic Debt Securities (BAIDS)

· Murabahah Notes Issurance Facility (MuNIf)

· Islamic Asset-backed Securities (IABS)

Asset Securitization:

§ A security is a legal document that shows an ownership interest if financial assets such as stocks and bonds.

§ Securitization is the process of converting an assets or collection of assets into marketable securities.

Securitisation brings much benefit to both issuers and investors. For issuers, it potentially offers cheaper and more efficient funding for operations combined with greater balance sheet flexibility. For investors, securitisation provides a broad selection of fixed income alternatives. In order to facilitate the issuance of asset-backed securities in the Malaysian capital market, the Guidelines on the Offering of Asset-Backed Securities sets out clear and transparent criteria for securitisation transactions as required by the SC pursuant to section 32 of the Securities Commission Act 1993 (SCA).

Asset-Backed Securities or ABS

§ means private debt securities or Islamic securities that are issued pursuant to a securitisation transaction. Such securities shall exclude all debt securities or Islamic securities that are capable of being converted into equity how so ever and whether redeemable or otherwise.

§ Examples of such excluded securities include exchangeable bonds and private debt securities or Islamic securities with attached warrants.

§ Financial institutions that originate loans—including banks, credit card providers, auto finance companies and consumer finance companies—turn their loans into marketable securities through a process known as securitization. The loan originators are commonly referred to as the issuers of ABS, but in fact they are the sponsors, not the direct issuers, of these securities.

§ These financial institutions sell pools of loans to a special-purpose vehicle (SPV), whose sole function is to buy such assets in order to securitize them.2 The SPV, which is usually a corporation, then sells them to a trust. The trust repackages the loans as interest-bearing securities and actually issues them. The “true sale” of the loans by the sponsor to the SPV provides “bankruptcy remoteness,” insulating the trust from the sponsor. The securities, which are sold to investors by the investment banks that underwrite them, are “credit-enhanced” with one or more forms of extra protection—whether internal, external or both.

What is:

Assets:

§ refers to such assets which are the subject matter of a securitisation transaction and which satisfy all criteria as stipulated in these guidelines.

Originator:

§ refers to any entity that is seeking to transfer or dispose of its assets to a special purpose vehicle in a securitisation transaction.

Credit Enhancement:

§ refers to one or more arrangements within a securitisation transaction to enhance the credit rating of the ABS issue by, for example, the provision of a cash collateral, profit retention, third party guarantee, over collateralisation etc.

Special Purpose Vehicle (SPV):

§ means any entity which issues asset-backed securities and which satisfies all criteria stipulated under these guidelines.

§ Or known as special purpose entity (SPE)

§ Body corporate (usually a limited company of some type, or sometimes, limited partnership) created to fulfil narrow, specific or temporary objectives

§ Primarily to isolate financial risk, usually bankruptcy but sometimes a specific taxation or regulatory risk

Securitisation Transaction:

§ means an arrangement which involves the transfer of assets or risks to a third party where such transfer is funded by the issuance of debt securities or Islamic securities to investors. Payments to investors in respect of such debt securities or Islamic securities are principally derived, directly or indirectly, from the cash flows of the assets.

Servicer:

§ refers to any entity that is undertaking to administer the assets or perform such other services on behalf of the special purpose vehicle as may be required in a securitisation transaction.

Purpose of Securitisation

i. Reduce Funding Cost

§ Through securitization, a company rated BB but with AAA worthy cash flow would be able to borrow at possibly AAA rates

§ This is a number one reason to securitize a cash flow and can have tremendous impacts on borrowing costs.

§ The difference between BB debt can be multiple hundreds of basis point

ii. Reduce Asset Liability Mismatch

§ Depending on the structure chosen, securitization can offer perfect matched funding by eliminating funding exposure in terms of both duration and pricing basis

§ Securitization allows such banks and finance companies to create a self-funded asset book

iii. Lower Capital Requirement

§ Some firms, due to legal regulatory or other reasons have a limit or a range that their leverage is allowed to be

§ By securitizing some of their assets which qualifies as a sale for accounting purpose

§ These firm will be able to lessen the equity on their balance sheets while maintaining the “earning power” of the asset

iv. Locking in Profits

§ For a given block of business the total profits have not yet emerged and thus remain uncertain

§ Once the block has been securitized the level of profit has now been locked in for that company, thus the risk of profit not emerging or the benefit or super-profit has now been passed on

v. Transfer Risk

§ (Credit, liquidity, prepayment reinvestment, asset concentration): securitization makes it possible to transfer risks from an entity that does not want to bear it, to one that does

§ Two good example of this are catastrophe bonds are entertainment securitization. Similarly by securitizing a block of business (thereby locking in a degree)

vi. Off Balance Sheet

§ Derivatives of many types have in the past been referred to as “off-balance-sheet”. This term implies that the use of derivatives has no balance sheet impact

§ While there are differences among the various accounting standards internationally, there is a general trend towards the requirement to record derivatives at fair value on the balance sheet

vii. Earnings

§ Securitization makes it possible to record an earnings bounce without any real addition to the firm

§ When the securitization takes place, there often is a “true sales” that takes places between the originator and the SPE

viii. Admissibility

§ Future cash flows may not get full credit in a company’s accounts (life insurance companies, for example, may not always get full credit for future surpluses in their regulatory balance sheet)

ix. Liquidity

§ Future cash flows may simply be balance sheet items which currently are not available for spending, whereas once the book has been securitized the cash would be available for immediate spending or investment. This also create a reinvestment book which may well be at better rates

To protect investors from possible bankruptcy of the corporation, there are three legal safeguards:

§ Transfer of assets from the corporation is a non-recourse, true sale.

§ Investors receive a perfected interest in the assets’ cash flows.

§ A non-consolidation legal opinion is obtained certifying that assets of the trust or special purpose vehicle cannot be consolidated with the corporation’s assets in the event of bankruptcy.

Benefits of Securitisation

ü New funding sources

ü Increased liquidity of bank loans

ü Enhanced ability to manage the duration gap

ü If off balance sheet, the issuer on reserve requirement deposit insurance premiums and capital adequacy requirement

CHAPTER 5: FOREIGN EXCHANGE IN TRADE FINANCE

DEFINITION:

v The exchange of one currency for another, or the conversion of one currency into another currency. Foreign exchange also refers to the global market where currencies are traded virtually around-the-clock. The term foreign exchange is usually abbreviated as "forex" and occasionally as "FX."

v The market where individual / firm / bank buying, selling, and foreign exchange currency

v The market are often used by banks, trading companies, BNM, investment firms, brokers, investors and commercial banks

v Involving in Foreign exchange activities

v Considered the largest financial market in the world

IMPORTANCE OF FOREX

1. Company (corporation)

· Used forex in trading

· Involve large companies

2. Individual

· For investment and personal use

· Individuals who interested and carry out of forex transactions will be rich

3. Commercial Bank

· Provide services to companies & individuals to conduct forex transactions

· Profit & loss incurred by the bank to help individuals who want to conduct transactions

4. Central Bank

· BNM will make arrangements with other banks and use the savings money to pay off the debt

5. Broker

· The agent between bank with the participants in the forex which helps to convert foreign currency

· An individual or firm which acts as an intermediary between a buyer and seller, usually charging a commission. For securities and most other products, a license is required.

PARTICIPANT IN FOREX

1) Speculators

a. Assumptions that will occur in the future

b. Speculation and also buy / sell foreign exchange market

c. Earn profit from currency rate fluctuations in forex trading

d. Have a strategy in the management of the foreign currency

2) The Hedges

a. Market protection involving with foreign exchange

b. Involve with multiple international financial transactions with various vendors (lender)- import export

c. Dealing with different foreign currencies in which the value is changed every day

d. Minimizes the risk of losing money compared with an increases

3) Interbank Market

a. Involve commercial banks and financial institutions either domestically or internationally

b. Operate forex trading transactions with each other throughout the world through electronic brokerage systems

c. As the foreign exchange market participants in the main trading platform of the largest banks & financial firms

d. The function: fix the exchange rate price in buying the currency price & sell per day

4) Central Bank (federal & foreign government)

a. Working behind the scenes & tend to work with the government about monetary policy

b. A great influence upon entry in the exchange of foreign currency

c. Function:

i. monitors and helps to fix the nation's financial monetary policy

ii. help generate the money supply, interest rates could affect the country's economic growth including inflation & deflation