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IIBR: The Trilogy in De-Linking from Conventional Finance

RUSHDI SIDDIQUI GLOBAL HEAD ISLAMIC FINANCE & OIC COUNTRIES RAFIZA GHAZALI HEAD OF ISLAMIC FINANCE,ASIA ABDULAZIZ GONI ISLAMIC FINANCE TEAM, ASIA 9th March, 2012

NOTE: The information herewith is provided for the purpose of general discussion and should not be used as a reference for research and republished and redistributed without the consent of the author

Decoupling Why Important? Authenticity


Decoupling or Delinking
Conventional finance

Law of Necessity
Indigenous development

Dow Jones Islamic Market Index (1999)

DJ-CitiGroup Sukuk index (2006)


DJ Islamic Sustainability Index (2006) SAMI Halal Food Index (2011) Islamic Interbank Benchmark Rate (IIBR 2011)

Pre-IIBR Comments
Same as LIBOR
Islamic Finance getting out of its Comfort Zone Arbitrage Banking and Islamic can't go together unless it is zero percent rate or the return is not fixed but arbitrary Resistance to change Over reliance on usage of LIBOR rates.

Indicators in/of Islamic finance


SC Equity Indexes Sukuk Index Launch of Banks (windows/subs), Takaful, Funds, etc Consolidation, default and bankruptcies Shariah Scholars Launch of innovative products Stock Price or credit rating of publicly listed IFIs CDS of IFI? Deposits/Loans NPLs & Provisioning Islamic finance conferences Newsletters/Magazines Academic Papers Global? Regional? National? State?

DIB scenario
Institution Name : Dubai Islamic Bank (DIB) Average Daily Volume 5 days Index Credit Deposit Rating (M AED) Loans (M AED) As Nov at 2011 64,771.32 As at Nov 2011 65,944.47 Emirates NBD saves troubled Dubai Islamic Bank % Change YTD News Stock Price

5,641,024.60 S & P GCC A Islamic Fitch Composite Index BBB/ A-3 S&P
Source: Thomson Reuters

+11.86

Lagging & Leading Indicators


Performance benchmarks
Lagging indicators

Pricing Benchmarks
Leading indicators

Attempts for creating Islamic LIBOR


SC equity indexes, CPI, Inflation, real estate, etc. Issues:
Volatile, weekly/monthly/quarterly, How will western/conventional markets react?

Lagging & Leading Indicators


Leading indicator Lagging indicator

An economic indicator that changes An economic indicator that changes before the economy has changed. after the economy has changed. Is LIBOR a leading or lagging indicator? Why? Is stock performance a lagging indicator? Are Bond yields a leading or lagging indicator? Is the unemployment rate a leading or lagging indicator? Is the Consumer Pricing Index (CPI) a leading or lagging indicator? Is the value of commercial and industrial outstanding loans a leading or lagging indicator?

Reference Rate
LIBOR and country interbank rates:
Short term treasury investments Retail finance
Property, vehicle, etc

Corp/Sovereign finance
Sukuk iSyndicated Loans

History of LIBOR
The London Interbank Offered Rate otherwise known as LIBOR is An interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers' Association (BBA).
LIBOR is calculated and published by Thomson Reuters. Controversy with LIBOR include the fear of manipulation of rates by BBA members when first

Whether LIBOR could give an accurate picture of the British financial market.

Growth of Islamic Finance Stages (Abilities)


Crisis (l &ll) GFH/TID Sukuk Default NPL/Provisioning UK Sov Sukuk?

IIBR?

Scalability Sustainability

Durability Windows/Subs Acct/Law Non-OIC IF Hubs


Viability Alternative Catch up to Halal? Faith & Finance Merger Credibility

40 Years $1T $150B Sukuk $87B iLoans $37-52B iFunds G20 over OIC Presence

A.I.R. Abilities?

De-Coupling From Conventional A.I.R.


Islamic Equity Islamic Stock Exchange? Indexes

AAOIFI IFSB IIRA IIFM

Conventional Equity Indexes

SAMI Halal Food Index

Regulations(ters) Stock Exchanges Derivatives Listed Products Deposit Insurance Lender of Last resort IFRS/GAAP

Customer led? Regulatory led? Bank led? Customers $1T $100T+

Parallel Alternative Convergence

Daily USD LIBOR ,QBHIBOR1Y=, QAEIBOR1Y=, QUSDLIBOR1Y=, QKIBOR1Y= Price


2.8 2.6 2.4 2.2 2 1.8 1.6 1.4 1.2 1 0.8 J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A 2009 2010 2011 2012

Price 1.04 1.02 1

AEIBOR

BHIBOR

0.98 0.96 0.94

KIBOR

0.92 0.9 0.88

USD LIBOR

0.86

De-linking begins

Oman Crude v Brent/US Crude


The DME is pushing the Oman contract as a benchmark for markets east of Egypt's Suez canal, arguing that much of the world's crude comes from the region and should be priced in the Middle East. Its target is for the Oman contract to eventually challenge established global benchmarks, Brent <LCOc1> and U.S. crude futures <CLc1>. "We strongly believe the Omani crude contract is an outstanding proxy for the Middle Eastern crude. It make lot of sense. It has good correlations," Gary Morsches, managing director, energy for CME Group said in a conference call to reporters.

IIBR v LIBOR
Is IIBR a proxy for ME cost of Islamic funds?

20

Islamic Interbank Benchmark Rate


Whats the difference?

IIBR measures expected profit while conventional benchmarks measures interest rates
The IIBR question for contributors explicitly refers to the cost of raising Shariah compliant funding The IIBR contributors benchmark based on return generated by Islamic assets, hence a reference to an Islamic asset risk profile

Although invariably some connection/correlation to global markets, the IIBR is linked to the economies of the Islamic world and not to the events and risks of Europe and the US

Participating Institutions

A MARKET FROM WORLD INVOLVES THE THE A LARGEST ISLAMIC PARADIGM FIRST FOR THE MARKET BANKS SHIFT

Pulse of the Islamic Capital Markets


The profit rate that an individual Contributor Panel bank would perceive to be reasonable for Shariah compliant funding were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11.00 am Makkah local time (GMT + 3).

What
Interbank profit rate fixing by 16 contributor banks Calculated and distributed by Thomson Reuters Governed by the Islamic Benchmark Committee Certified by the Shariah committee comprised of AAOIFI scholars Calculated daily SundayThursday

Why
Certainty, Reliability & Transparency To Agree settlement and marked-to-market procedures Increase trade through transparent and trusted pricing De-link from conventional benchmarks Establish local currency benchmarks Be rate linked to Islamic banks real financing and investment activities
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The myriad uses of the Islamic Benchmark


Pricing of common overnight to short term investment and financing instruments such as Murabaha, Wakala and Mudaraba Pricing of longer term investment and financing of yielding assets (Ijarah assets) Pricing of sukuk and other Shariah compliant fixed income instruments Official incorporation possible for pricing onto confirmations/annexes related to the IIFM-ISDA Tahawwut Master Agreement (TMA).

EVOLUTIONARY OBJECTIVE INDIGENOUS ISLAMIC PRICING


Indigenous pricing is eventually achieved as Islamic banks increase
Banks provide estimate contributions

Interbank transaction
Benchmark securities issuances to the Islamic rate eventually less reliant on the conventional banking system and its pricing
Rates incorporated in TR Dealing

TR Dealing captures dealt rates

Overall Structure and Governance


Islamic Benchmark Committee
Panel Association (Thomson Reuters, Islamic Development Bank, AAOIFI,AIBIM, SESRIC, Hawkamah Institute for Corporate Governance, Bahrain Association of Banks, and representatives of Contributing Banks)

Selected Contributing Banks

Rates Data
By 10.45am Makkah time

Top & Bottom Quartile Excluded

IIBR
By 11.00 am Makkah time

Fixing
Arithmetic Mean (Average) Taken

Thomson Reuters Terminals

Audit Committee

Shariah Committee
Sh. Yusuf Talal Delorenzo (Chairman); Dr. Abdulrahim Sultan Al Olama; Dr. Mohammad Daud Bakar; Sheikh Muddassir Siddiqui

Timing of Fix publication


OFFICIAL REFERENCE TIME: MAKKAH (GMT +3)
9.00 AM 10.44 AM 10.45 AM 10.45-10.59 AM 11.00 AM

Rates are contributed based on a pre-set question asked to contributor banks

Rates are snapped by Thomson Reuters

Automated and Manual Audit and Review Procedures (Errors / Tolerance / Std. Dev / Call)

Publication on Thomson Reuters Terminals

TENORS: ON, 1 W, 1 M, 2M, 3M, 6M, 9M, 1Y

PUBLICATION FREQUENCY Every business day (Sun Thurs) except


New Years Day Eid Al Adha (1st Shawwal)* Eid Al Fitr (10th Dhul Hijjah)*
*As determined by the authorities in Saudi Arabia

Calculation Process
1st Step
Collation of Rates

2nd Step
Ordering of Rates

3rd Step

4th Step

5th Step
Publish IIBR

Discard Top/ Calculate Bottom Quartiles Moving Average

16 Contributor Banks

Quality Review and Audit procedures


Central Fixing Support @ Exeter, UK notified of all types of errors per bank contribution

Error Checking

Tolerance

Difference between the rate and the corresponding moving average within acceptable confidence levels

Tenor ON SW 1M 2M 3M 6M 9M 1Y

Standard Deviation

Anything above the upper and lower limit based on a pre-defined confidence levels will be flagged

Call up contributor and verify the rate. If not available, discretion on Thomson Reuters to accept or reject the rate based on a number of Outlier factors Verification

Max Spread 0.05 0.05 0.10 0.10 0.10 0.15 0.15 0.15

Governance Framework and Roles


Islamic Benchmark Committee Self governing body that determines selection, admission and exclusion of contributors Oversees rules, process and procedures for fixing Review of discrepancies in rate contributions/ periodic review of contributor rate quality Establishes disciplinary sub-committee when necessary
Islamic Benchmark Committee

Contributor Panel

Contributor Panel Contributors as chosen by the Islamic Benchmark Committee Regulated by the Standard Fixings Agreement between Thomson Reuters and Contributor

Islamic Interbank Benchmark Rate

Shariah Committee

Fixings Infrastructure Provider Provides the necessary infrastructure in order to absorb, calculate and distribute the rates contributed by the Contributor Panel Reports on the quality of contributions to the Islamic benchmark committee

Fixings Infrastructure Provider

Shariah Committee Self governing body that determines the Shariah compliance of the fixing definition, question, process and procedures Voluntary attendance of Islamic Benchmark Committee meetings
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Governance Committees
Islamic Benchmark Committee
INDEPENDENT MEMBERS* AAOIFI (Secretariat) Association of Islamic Banking Institutions Malaysia (AIBIM) Bahrain Association of Banks Hawkamah Institute for Corporate Governance Islamic Development Bank Statistical, Economic and Social Research Center for Islamic Countries (SESRIC) Thomson Reuters

Islamic Benchmark Committee


REPRESENTATIVE BANK MEMBERS* Abu Dhabi Islamic Bank Ahli United Bank Al Baraka Bank Al Hilal Bank Alinma Bank Al Salam Bank Bahrain Islamic Bank Barwa Bank Dubai Islamic Bank Ithmaar Bank Kuwait Finance House Masraf Al Rayan Noor Islamic Bank National Commercial Bank Qatar Islamic Bank Sharjah Islamic Bank

Shariah Committee
Yusuf Talal DeLorenzo (Chairman) Mohammed Daud Bakar Mohammad Abdul Rahim Al Olama Muddassir Siddiqui

Note: The Shariah Committee works independently from the Islamic Benchmark Committee

*as at 22nd November 2011

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Selection of Contributor Banks


SELECTING AND ADMITTING
Selection Criteria 1. Primary Preference: Highly Rated Islamic Banks / Windows 2. Secondary Preference: Include active Islamic Banks as nominated / approved by quorum Admitting

EXCLUDING
Thomson Reuters Discretion To protect the quality and integrity of the IIBR, which is of paramount importance

Each bank must sign the Standard Fixings Agreement and acknowledge
Fixing calculation method and timing of fix Their responsibility to contribute on every business day

Quality of Contributions Rate investigation based on outlier status Certain explanations valid Inform the Islamic Benchmark Committee and recommend exclusion Where objections received or recommended by at least 4 members, form Disciplinary Sub Committee
Delay in Contribution or Missing Contributions Banks that are consistently missing contributions may be removed in consultation with the Islamic benchmark committee.
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IIBR vs. LIBOR

32

IIBR vs. LIBOR


1.40

Long term IIBR Rates

1.20

1.00

IIBR ON IIBR 1M

0.80

IIBR 3M IIBR 6M

0.60

IIBR 1Y
LIBOR ON LIBOR 1M

0.40

LIBOR 3M LIBOR 6M

0.20

LIBOR 1Y

0.00

Short term IIBR

Conclusion
Decoupling (authentic v cosmetic)
IIBR published before LIBOR Implications? Traction
Legal documents
Wider use Consumer reference

Looking Ahead
More banks, but limitations- geographic representation Local currency Wakala

Dealt rates

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