RepoRepo AlternativeAlternativeRepoRepo AlternativeAlternativeCollateralizedCollateralizedCollateralized Collateralized 

FinancingFinancing SolutionSolutionFinancingFinancing SolutionSolutionIsmail Dadabhoy

Oman May 2102

GenericGenericC ti l RC ti l RConventional RepoConventional Repo

TRI PARTY

BUYSELLCLASSIC SELLCLASSIC

Repo Pumps Liquidity Repo Pumps Liquidity I t th M k tI t th M k tInto the MarketInto the Market

Great Tool for Cash Management 

Frees up Blank Credit lines with relationship Bankswith relationship Banks

Develops Liquidity in theDevelops Liquidity in the Fixed Income Market leading to tighter Bid offer Spread

Value PropositionValue Proposition‐‐ ConventionalConventionalValue PropositionValue Proposition ConventionalConventional

Leveraging Portfolio forYield EnhancementYield Enhancement

Carry Trade

Revenue Generation

Increased take up in the Primary market

Greater Liquidity in the secondary market

Hedging & Financing of Derivatives

Islamic SolutionIslamic SolutionIslamic SolutionIslamic Solution

• Financing Transaction with the benefit of Collateral

Collateralized Product Benefits Collateralized Product Benefits  Alternative to Clean Lending: Collateralized financing offers a structure that

requires some extra operational task but does provide credit enhancement as well as providing an effective liquidity management tool for use with the C ll l Collateral Management Agent.

Credit Risk Management: as long as the collateralization, is followed, Counterparty exposure is reduced to the margin threshold plus Sukuk Cou e pa y e posu e s educed o e a g es o d p us Su u execution risk, rather than a full clean exposure. It can allow for positive capital treatment.

IFSB to provide guidance and standard Liquidity Management: Having the comfort of collateral allows the institutions Liquidity Management: Having the comfort of collateral allows the institutions

to finance for a longer duration and or larger quantum as the credit risk is reduced.

Multi Currency Capabilities – Allows financial institution under Repo document to support multicurrency activities that are netted to a pre agreed base currency for easy monitoring of overall exposures and margin calls.

Development for Sukuk: Allowing Financial institutions to maintain less cash and allocate more in income generating Sukuk. Giving rise to greater take up of Sukuk by Islamic investors

Collateralization Overall Transaction FlowCollateralization Overall Transaction Flow5‐ Party A delivers acceptable pool of S k k h i k l i f h

Single or

Pool of Sukuk From Party A

Collateral5

Sukuk having market value in excess of the Deferred Cash as collateral 

66 – Party A transfers the  Party BFrom Party A

PARTY A 1

yDeferred payment at maturity and receives  its Sukuk back5

yProvides Funding

7Requires Funding

1 P t B i t P t A

7

Acting    as Agent

Acting as Principal 2

3

1‐ Party B appoints Party A     as Agent to purchase Commodity and transfers Cash to  Agent  to forward the funds for the purchase of  the commodity

CommoditySeller

Commodity Buyer

4 3‐ Party A NOW acting as Principal Purchases the same commodity from     

2‐ Party A buys commodity for Spot Payment and Spot Deliver from the market as Agent  for Party B

yParty B for Spot Deliver But with deferred Payment 

4‐ Party A sells commodity to the market for spot deliver & spot payment and raises Cash for its funding needs

Types of CollateralTypes of CollateralTypes of Collateral Types of Collateral International SukukInternational Sukuk

Equity Linked Sukuk  ‐‐ Convertible / Exchangeable

Domestic SukukSharia Compliant Structured Notes

Sharia Compliant Commodities

Sharia Compliant Funds

Sharia Compliant EquitiesSharia Compliant Equities

Margin & Credit ControlMargin & Credit ControlggRisk Mitigation via Documentation

Mark to market of collateral margin maintenance

Netting of Credit Exposure  greater volumeg p g

Default  Counterparty credit risk managed via haircuts                                    and the daily margin process

Haircuts are imposed in line with agreement by the two parties– these represent a discount on the amount of cash funding provided or taken

Daily margin process operated by Operations or Collateral Management deptLooks at an individual client’s portfolio and aggregates mark‐to‐market of each trade to an overall  portfolio threshold

The ability to price securities financed is vital for the risk management process to succeed and therefore, Banks will only take Collateral that it feels comfortable in being able to price

Collateral Sharia RequirementCollateral Sharia Requirementqq

Shariah requires that any form of collateral taken should be kept in a segregated clientkept in a segregated client account and not comingled with the bank’s own inventories.

Important to stress that any income received from the underlying productImportant to stress that any income received from the underlying product held in a segregated accounts belongs to the Collateral giver. The Bank receiving or being credited income in its custody account has to pass the fund to original ownerpass the fund to original owner

Regulatory & Legal ChallengesRegulatory & Legal Challenges

In case of conventional market repo documentation the collateral is effected through netting i.e. the ability to close out and set-off in an insolvency where the value of the collateral securities can be determined value of the collateral securities can be determined and applied in set off against the repurchase price. However, the legal framework in most of the OIC countries does not recognize this techniquecountries does not recognize this technique.

The Islamic Industry need to assess and tackle this The Islamic Industry need to assess and tackle this requirement or find a workable solution

IIFM and ISDA are working towards obtaining opinion in the UK, Singapore, & Malaysia as a starter

L ki F dL ki F dLooking ForwardLooking Forward

TRI – PARTYI A Y

BUY – SELL St tStructure

Operational Solution for Collateral ManagementOperational Solution for Collateral Management

• A frequently used product in U.S. domestic and international bond repo markets to invest or raise funds

• Uses third party to Monitor Collateral Threshold and request to move cash and allocate securities

• Benefits:Benefits:Auto allocation of bonds within pre-agreed

criteria/schedulesMark-to-market pricing and margin maintenance p g gReduced operational burdenOptimisation of collateralMinimal infrastructure

Funds & Collateral (Sukuk) FlowFunds & Collateral (Sukuk) Flow –– Tri PartyTri PartyFunds & Collateral (Sukuk) Flow Funds & Collateral (Sukuk) Flow  Tri PartyTri Party

Tri Party Agent

IslamicBank A

(Against Payment)Sukuk

Fundsg

IslamicBank B

Sukuk

Bank B

Islamic Bank B

Islamic Bank A

Funds

(as principal) (as principal)

Initiation of Collateralized Transaction  Initiation of Collateralized Transaction  ––

Tri PartyTri Party

Tri Party Agent

Upon receipt of FundsParty B undertakes 

TransactionFor & with Party  A

Agent

Bank A and Bank B informs the Tri-party Agent on trade of Collateralized Transaction (could be Murabaha or other arrangement)

Financing Amount + CurrencyPartyA

PartyB

Financing Amount + Currency Profit Rate/AmountStart Date & End Date

Collateral Parameters

Margin Maintenance Threshold AmountBase Currency for Portfolio Valuation and Margining

Initiation of Collateralized Transaction Initiation of Collateralized Transaction ––

Tri PartyTri Party

Tri Party i a yAgent

Start  – Value Date

PartyB

PartyA

Monitoring of Collateralized Transaction Monitoring of Collateralized Transaction ––

Tri Party Tri Party 

Tri Party i a yAgent

PartyPartyB

PartyAPeriod of monitoring from Start 

Date to Termination Date

Termination of Collateralized Transaction Termination of Collateralized Transaction ––

Tri Party Tri Party Tri Party Agent Transfers

T i P t

Tri Party Agent Transfers Sukuk back to Party A upon receipt of Funds

Tri Party Agent

Termination  –D f d V l D t

PartyB

PartyA

Deferred Value Date

Agent to receive a fee gfor its services

Collateralized FinancingCollateralized FinancingCollateralized  Financing Collateralized  Financing SolutionSolution

P i i al & T i Pa tyP i i al & T i Pa tyPrincipal & Tri PartyPrincipal & Tri PartyTHANK YOU• THANK YOU

Ismail .E.Dadabhoyy