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Islamic Finance and Derivatives LSE Islamic Finance Seminar Series

Islamic Finance and Derivatives LSE Islamic Finance Seminar Series. Habib Motani, Partner. 6 November 2013. Order of the Presentation. Islamic Finance - An Introduction Islamic Hedging and Risk Management ( Ta'hawwut ) Structure charts ISDA / IIFM Ta'hawwut Master Agreement Current Trends

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Islamic Finance and Derivatives LSE Islamic Finance Seminar Series

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  1. Islamic Finance and Derivatives LSE Islamic Finance Seminar Series Habib Motani, Partner 6 November 2013

  2. Order of the Presentation • Islamic Finance - An Introduction • Islamic Hedging and Risk Management (Ta'hawwut) • Structure charts • ISDA / IIFM Ta'hawwut Master Agreement • Current Trends • Conclusion Islamic Derivatives and the ISDA/IIFM Master Agreement

  3. Islamic Finance –An Introduction Islamic Derivatives and the ISDA/IIFM Master Agreement

  4. Background • Body of institutions and commercial and financial arrangements which adhere to the core tenets of Islamic law (Shari'a) • The idea of Shari'a-compliant financing has been prevalent for over 1,400 years (at the advent of Islam), slowly evolving over the centuries • Phase of more dramatic growth can be traced back to the founding of the Islamic Development Bank (in 1974) and more recently the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the International Islamic Financial Market (IIFM). Islamic Derivatives and the ISDA/IIFM Master Agreement

  5. Growth so far….. • The industry has been growing at around 10% per annum (FSA) for the last decade with Clifford Chance helping to lead the way • Since 2000, Islamic banking assets have been growing at a rate of just under 20% p.a. (Financial Times) • Steady rise in sukuk issuance from $500m in 2002 to $140bln in 2012 (with global outstanding at $240bln) (Zawya) • Sovereign sukuks on the rise and outside the Middle East – Turkey (2012) and announcement of UK sovereign sukuk to be issued in 2014 • Estimated 350 Islamic Financial Institutions holding $1.46trln of assets under management and the industry could control $2trln of assets by 2013 (Reuters). Islamic Derivatives and the ISDA/IIFM Master Agreement

  6. A Global Rapidly Expanding Industry • Many banks have established Islamic banking operations, joint ventures and subsidiaries in the Middle East (e.g. Deutsche Bank, HSBC, Standard Chartered Saadiq etc.) • Ever increasing range of Shari'a-compliant indices produced by Dow Jones, FTSE, Standard & Poor's and MSCI (e.g. S&P/TSX 60 Shari'a recently launched in Canada) • The industry has increasingly international appeal (significant recent developments in traditionally non-core markets including the UK, Russia, Nigeria, Turkey, Egypt, Sri Lanka, Australia and Tunisia) • UK government support - (i) HM Treasury's Islamic Finance Experts Group was established in April 2007, (ii) tax amendments made in 2009 to allow for Islamic finance products and (iii) announcement of £200 million sovereign sukuk issuance in 2014. Islamic Derivatives and the ISDA/IIFM Master Agreement

  7. Shari'a Fundamentals • Shari'a carries ethical, social, political and religious dimensions that inform its structure • It is derived from a number of primary (Quran, Sunnah and Hadith) and secondary (Ijtihad, Ijma and Qiyas) sources • Not a codified body of law • There are a number of schools of jurisprudence (Madhabs) • There are a number of core tenets of Shari'a which must be considered in the context of financial transactions. Islamic Derivatives and the ISDA/IIFM Master Agreement

  8. Tenets of Islamic Economic Thought • Riba - Prohibiting the receipt and payment of interest - the return of an investment should be linked to profits actually generated • Gharar - Avoiding uncertainty - e.g. traditional insurance, indemnities, options, need to be adapted • Maisir - Discouraging speculative behavior - e.g. speculation, gambling, games of chance • Sharik - Advocating risk sharing - investors should earn returns by sharing profits and assuming the risk of any loss • Haraam/Halal - Prohibiting haraam activities - e.g. activities that are strictly forbidden under Shari'a, such as financial investments in alcohol, pork related activities, tobacco, gambling and pornography • 'Aqd - Maintaining the sanctity of contracts. Islamic Derivatives and the ISDA/IIFM Master Agreement

  9. In the context of a Derivative Transaction • For example, a conventional cross-currency swap would infringe the tenets of: • Riba • Gharar • Maisir Islamic Derivatives and the ISDA/IIFM Master Agreement

  10. Shari'a Scholars and Boards • The Scholars • Small number of scholars specialising in the application of Shari'a who have played a significant role on the offshore structures to date • There is a wide range of views and scope for uncertainty • Notable scholars include: • "The credibility of institutions comes from the stature of the Shari'a boards they have" –Afaq Khan (CEO, Standard Chartered Saadiq) • Role of Scholars • Islamic institutions place reliance on their opinions (fatwas) in determining whether transactions are in compliance with Shari'a • Weight is given to the identity of the scholars • Prior to launching a transaction, the scholar/board will issue a fatwa confirming that the transaction adheres to the tenets of Shari'a (this fatwa may be disclosed) • Sheikh Taqi Usmani (Pakistan) • Sheikh Nizam Yaquby (Bahrain) • Sheikh Hussain Hassan (Dubai) • Dr. Mohammed Ali Elgari (Saudi Arabia) • Dr. Abdul Sattar Abu Ghuddah (Syrian based in Saudi Arabia) • Dr. Muhammad Imran Ashraf Usmani (Pakistan) • Dr. Mohd Daud Bakar (Malaysia) • Sheikh Yusuf Talal De Lorenzo (USA) Islamic Derivatives and the ISDA/IIFM Master Agreement

  11. Shari'a Scholars and Boards(cont/…) • Appointing and Dealing with Scholars and Shari'a Boards • Scholars may be employed on a transaction by transaction basis or through the establishment of a Shari'a board • Establishment of a Shari'a board can provide greater comfort to Islamic investors or counterparties • Based predominantly in the Middle East and Pakistan • Typically three scholars on retainer • Typically commercially astute and have exposure to issues through acting on several Shari'a boards for various banks (often with educational background in Western economics or finance) • Involved whilst settling the term sheet and in reviewing the penultimate draft of documents • Typically contact is through telephone, fax and email but meetings also usually required • Typically a renowned scholar can earn up to $250,000 on a capital markets deal • Fatwa • One, some or all parties to a transaction may or may not be bound by the fatwa • Not all aspects of the transaction necessarily have to be covered by the fatwa • No precedent system for fatwas (save for public deals). Islamic Derivatives and the ISDA/IIFM Master Agreement

  12. Documentation and Enforceability • Legal documents are usually drafted to be governed by either English or New York law • Questions of enforceability of obligations are dealt with according to the applicable national law • With exceptions (Sudan, Iran and Saudi Arabia), Shari'a is not the national law • As Shari'a is not the governing law of the documentation, being bound by Shari'a is essentially elective and seen as an extra layer of compliance • The Shamil case affirms that English courts will only ever seek to interpret English law and will not interpret Shari'a • It is for each party to satisfy itself that a transaction is compliant with Shari'a • Subsequent ruling by scholars that a transaction does not comply with Shari'a will not affect its enforceability under the applicable national law. Islamic Derivatives and the ISDA/IIFM Master Agreement

  13. Islamic Hedging and Risk Management (Ta'hawwut) Islamic Derivatives and the ISDA/IIFM Master Agreement

  14. Islamic Hedging and Risk Management • New OTC Islamic derivatives market • In November 2006 Bank Islam Berhad and Bank Mumalat Malaysia Berhad agreed to execute a pro-forma derivative Master Agreement for documentation of Islamic derivative transactions • Each house has over the past few years been developing its own template documentation • ISDA/IIFM Shari'a-compliant Ta'hawwut Master Agreement ("TMA") published on 1st March 2010 • Profit Rate Swaps (Mubdalatul Arbaah) template documentation to be used with published on 27th March 2012 • Most common forms of derivative transactions used by Islamic banks and corporations are cross-currency swaps, profit rate swaps, total return swaps and fund index-linked derivatives • In recent years, some Shari'a scholars have gradually accepted the use of hedging as a tool of prudence and risk management • Given current market volatility, producers, consumers, counterparties and scholars are more aware of the need for hedging market risk (to minimise systemic risk) and demand for such products is growing accordingly. Islamic Derivatives and the ISDA/IIFM Master Agreement

  15. Building Blocks Islamic Derivatives and the ISDA/IIFM Master Agreement

  16. Wa'ad Structure • Literally means "promise" • Can be regarded as a unilateral undertaking by one party to do or not to do certain actions in the future • Does not bind anyone but the promisor (i.e. the party giving the undertaking) • Contrast this with a bilateral contract (aqd') which binds both parties to the contract • English law, draft under deed poll: lack of consideration • Qualified analogy with Promissory Estoppel. Islamic Derivatives and the ISDA/IIFM Master Agreement

  17. Wa'ad Structure(cont/…) • Binding nature and enforceability is a subject of debate amongst scholars • Sample of views: Islamic Derivatives and the ISDA/IIFM Master Agreement

  18. Double Wa'ad Structure (Total Return Swap) £ to purchase the assets (Purchase Price) Markets 3 4 Shari'a-compliant Assets Wa'ad (1) – Issuer promises to sell the Assets at Wa'ad Sale Price 5 1 Issue Price Bank Issuer Certificate Holder 2 6 Certificates Wa'ad (2) – Bank promises to buy the Assets at Wa'ad Sale Price 7 Wa'ad Sale Price Shari'a-compliant Assets Only Wa'ad (1) or Wa'ad (2) shall ever be exercised, never both. Islamic Derivatives and the ISDA/IIFM Master Agreement

  19. The Wa’ad and Murabaha • Islamic risk managements products are now often structured using the combination of a promise (the wa’ad), in the form of a purchase undertakings, together with the traditional murabaha sale agreement • The purchase undertakings act as a promise to buy on certain conditions:certain assets (i.e. commodities) on a certain date for a certain price and to enter into a murabaha sale agreement • At the onset, each party gives the other a purchase undertaking setting out the conditions of a trade, for example a profit rate swap: FIXED RATE Less Than FLOATING RATE BANK (PROMISSOR) BORROWER (PROMISSEE) PURCHASE UNDERTAKING FLOATING RATE Less Than FIXED RATE BORROWER (PROMISSOR) BANK (PROMISSEE) PURCHASE UNDERTAKING Islamic Derivatives and the ISDA/IIFM Master Agreement

  20. Murabaha – Cost Plus Financing Step 2 Financier sells Assets to Buyer for $(x+y) (where y is the pre-agreed profit element) Assets FINANCIER (BANK) BUYER (COUNTERPARTY) Price $(x+y) Step 1 Financier buys Assets from Seller for $x Step 3 Buyer settles price at end of an agreed period in one lump-sum or in instalments Price $x Assets SELLER * Islamic finance is based on real assets Islamic Derivatives and the ISDA/IIFM Master Agreement

  21. FLOATINGRATE(5%) FIXEDRATE (4%) HIGHER HIGHERTHANFIXED THANFLOATINGRATE(3%) RATE (4%) Walking through a Wa’ad-Murabaha Trade TRADEDATE COUNTERPARTY BANKEXERCISES EXERCISEBANK COUNTERPARTY UNDERTAKING UNDERTAKING Commodities Commodities COUNTERPARTY BANK BROKER (1) BROKER(1) (Seller) (Seller) Cost Price Cost price Cost Price +Profit Cost Price +Profit Commodities Commodities FIXED-FLOATING FLOATING - FIXED Cost Price Cost Price BANK COUNTERPARTY BROKER (2) BROKER(2) (Purchaser) (Purchaser) Commodities Commodities Key: Asset / Commodities Cashflow Islamic Derivatives and the ISDA/IIFM Master Agreement

  22. Features of the Wa’ad-Murabaha • Two purchase agreements are entered into on day 1. Thereafter, only one commodity trade has to be effected on each subsequent trade date depending on the conditions of the purchase undertaking. • Reduced costs • Reduced ownership risk • No execution risk – as the obligation to purchase assets and pay sale price arises under the purchase undertaking once exercised. A murabaha sale agreement is signed to evidence the trade rather than effect it. • As the sale price is effectively the netted price, this can also avoid issues of netting in certain jurisdictions. Islamic Derivatives and the ISDA/IIFM Master Agreement

  23. US$ @ LIBOR FOREURO @ EURIBOR EURO @ EURIBOR FORUS$ @ LIBOR Wa’ad-Murabaha Flexibility – Cross Currency TRADEDATE COUNTERPARTY BANKEXERCISES EXERCISEBANK COUNTERPARTY UNDERTAKING UNDERTAKING Commodities Commodities COUNTERPARTY BANK BROKER (1) BROKER(1) (Seller) (Seller) Cost Price (EUR) Cost price (US$) Commodities COST PRICE (US$) Commodities COST PRICE (EUR) Cost Price (EUR) Cost Price (US$) BANK COUNTERPARTY BROKER (2) BROKER(2) (Purchaser) (Purchaser) Commodities Commodities Key: Asset / Commodities Cashflow Islamic Derivatives and the ISDA/IIFM Master Agreement

  24. US$ @ LIBOR FOREURO @ EURIBOR Wa’ad-Murabaha Flexibility – FX Forward / Option TRADEDATE COUNTERPARTY EXERCISEBANK UNDERTAKING Commodities COUNTERPARTY BROKER (1) (Seller) Cost Price (EUR) COST PRICE (US$) Commodities Cost Price (US$) BANK BROKER (2) (Purchaser) Commodities Key: Asset / Commodities Cashflow Islamic Derivatives and the ISDA/IIFM Master Agreement

  25. ISDA / IIFM TA'HAWWUT MASTER AGREEMENT Islamic Derivatives and the ISDA/IIFM Master Agreement

  26. The Need for Standardisation • Lack of standardisation means a proliferation of bespoke documentation • Cost of evaluating and negotiating documentation • Documentation not likely to be balanced • Basis risk • Constrains the growth of the market • Standardisation contributes to efficiency, liquidity and certainty • Provides a benchmark in the market (as did the development of the original ISDA Master Agreement in the 1980s) • Help reduce price divergence between Islamic derivatives and their conventional counterparts Islamic Derivatives and the ISDA/IIFM Master Agreement

  27. ISDA/IIFM Ta'hawwut Master Agreement • Joint initiative between ISDA/IIFM to produce a Master Agreement under which Shari'a-compliant hedging transactions can be documented • Published on 1 March 2010 • Based on ISDA's 2002 Master Agreement with necessary amendments made for Shari'a compliance • Multiproducted – PRS launched, Cross Currency Swap is in development • To be used by all participants, in all geographical regions • CC is the law firm responsible for drafting the ISDA/IIFM Ta'hawwut Master Agreement and product documentation Islamic Derivatives and the ISDA/IIFM Master Agreement

  28. Conventional ISDA Agreement Structure • Credit Support Documents to reduce credit risk • 2001 Margin Supplement (incorporating 2001 Margin Provisions) • 1995 Credit Support Annex (Transfer English law) • 1994 Credit Support Annex (New York law) • Annexes • North American Power Annex • North American Gas Annex • GTMA Annex (UK Power) • European Gas Annex • Bridges • 2002 Energy Agreement Bridge • 2001 Cross-Agreement Bridge • 1996 FRABBA Bridge • 1996 BBAIRS Bridge • Definitions for use in documenting Transactions • 2007 Property Index Derivatives Definitions • 2006 Definitions • 2006 Inflation Derivatives Definitions • 2005 Commodity Definitions • 2003 Credit Derivatives Definitions • 2002 Equity Derivatives Definitions • 1998 Euro Definitions • 1998 FX and Currency Option Definitions • 1997 Government Bond Option Definitions 2002 MASTER AGREEMENT • 1995 Credit Support Deed (Security Interest - English law) • Confirmations • Long form confirmations • 1995 Credit Support Deed (Japanese law) • Confirmations • Short form confirmations • Master confirmation agreements • 2002 Master Agreement Protocol Islamic Derivatives and the ISDA/IIFM Master Agreement

  29. ISDA/IIFM Ta'hawwut Master Agreement Structure ISDA/IIFM Ta'hawwut Master Agreement • Confirmations • Confirmations documenting existing Transactions • Confirmations documenting Designated Future Transactions Islamic Derivatives and the ISDA/IIFM Master Agreement

  30. ISDA/IIFM Tahawwut Master Agreement Architecture Architecture • Multiproduct Agreement (all murabaha , musawamaand wa’ad based products but also potentially salam and arbun) • Available for use by all market participants, in all geographical regions (madhabs) • Not part of ISDA modular library • New concept hard-wired throughout the Agreement • Transactions: live transactions (concluded transactions) – “Confirmation” • transactions: Designated Future transactions (non- concluded transactions) – “DFT Terms Agreement”, “DFT Terms confirmation” Islamic Derivatives and the ISDA/IIFM Master Agreement

  31. ISDA/IIFM Tahawwut Master Agreement Architecture • Both Transactions and DFT Terms Agreements fall within the scope of: • “Single Agreement” (Section (1)(c)) • Flawed asset provision (Section 2(a)(iii)) • Representations (Section 3) • Undertakings (Section 4) • Relevant Events of Default and Termination Events (Section 5) Explanatory Memorandum Guidelines regarding the sorts of transaction that may be entered into under the ISDA/IIFM Tahawwut Master Agreement. For the purposes of Shari'ah compliance: • Transactions entered into under the ISDA/IIFM Tahawwut Master Agreement should only be for the purpose of hedging actual risks of the relevant party • Transactions should not be entered into under the ISDA/IIFM Tahawwut Master Agreement which are for the purposes of speculation • Transactions must be real transactions, involving the actual transfer of ownership of real assets, actual risk and real settlement • The asset itself must be halal • Interest must not be chargeable under the transaction Islamic Derivatives and the ISDA/IIFM Master Agreement

  32. Preliminaries The IIFM Shari’ah Advisory Panel has given Shari’ah Approval on the Agreement only • Disclaimer on front of Agreement re Transactions, DFT Terms Agreements and amendments or additions • Footnotes do not form part of Agreement • Although it is intended that Shari’ah-compliant derivatives be documented under the Agreement, the onus is on each of the parties to the Agreement to confirm with its own Shari’ah advisers or panel the Shari’ah compliance of the Agreement itself and each transaction traded under it Islamic Derivatives and the ISDA/IIFM Master Agreement

  33. Analysis between 2002 Master Agreement & ISDA-IIFM Ta’hawwut Agreement The Master Agreement is a new market document and in preparing it, we have sought, where practical, to be consistent with other market standard documentation. • ISDA architecture (confirmations, single agreement, flawed assets concept) • No compensation or interest on defaulted or deferred payments and deliveries • No interest payable • Additional Representations as to Shari'a compliance • Governing law and dispute resolution • Early Termination • Dual Close-out mechanism • Set-off and netting mechanics Islamic Derivatives and the ISDA/IIFM Master Agreement

  34. 3 Pillars of the ISDA Master Agreement SINGLEAGREEMENT FLAWED ASSET/CONDITIONALITY CLOSE-OUT NETTING

  35. No Compensation or Interest • Section 9(h) - No Compensation or Interest on Defaulted or Deferred Payments and Deliveries • There is no equivalent of Section 9(h) of the 2002 ISDA Master Agreement contained in the ISDA/IIFM Tahawwut Master Agreement. • The Scholars requested removal of this provision in its entirety and thus the related concepts of “fair market value”, “Applicable Deferral Rate” and “Default Rate” have also been removed • Subsequently parties cannot recover amounts for any cost of funding they incur as a result of any late payment or delivery; however the possibility of this leading to an EOD under the Agreement is in itself a deterrent Islamic Derivatives and the ISDA/IIFM Master Agreement

  36. No Interest Payable • Section 9(h) - No Interest Payable • All references to "interest" have been deleted due to interest / riba being haraam and thus forbidden under Shari'ah principles • Section 9(h) of the ISDA/IIFM Tahawwut Master Agreement is essentially a waiver of the right to interest arising as a result of any arbitral or judicial award or by operation of law • In the event that interest is "payable or receivable under or in connection with the Agreement" ................. then such interest will be donated by the recipient to an officially recognised or registered charity • Similarly there is no interest element on the calculation of Unpaid Amounts (the Applicable Close-out Rate which is usually different for the Defaulting and Non-defaulting Party) Islamic Derivatives and the ISDA/IIFM Master Agreement

  37. Representations New Representations Satisfaction as to compliance with Shari’ah – Section 3(h) Each party represents it has satisfied itself as to the Shari’ah-compliance of the Agreement, each Transaction, each DFT Terms Agreement (and each Designated Future Transaction under it) Note: “Insofar as it wishes or is required for any reason to enter ....” Non-reliance – Section 3(i) Each Party represents that it has not relied on the other party or on any documents (including a pronouncement/fatwa) prepared by or on behalf of the other party for the purposes of determining whether the Agreement, each Transaction, each DFT Terms Agreement (and each Designated Future transactions under it) is Shari’ah-compliant Islamic Derivatives and the ISDA/IIFM Master Agreement

  38. Representations Amended Representations • Capacity as Principal (Section 3(g)): An extra limb has been introduced to the standard “No Agency” representation to clarify that where a party enters into the Agreement, a Transaction or a DFT Terms Agreement through an agent (common in Islamic Financing), such party represents that the obligations that arise are obligations of the party itself and not the agent • Consents (Section 3(a)(iv)): Additional wording has been added to ensure that any “declaration, pronouncement, opinion or other attestation” required to satisfy Section 3(h) has been obtained and is in full force and effect Islamic Derivatives and the ISDA/IIFM Master Agreement

  39. Governing Law and Dispute Resolution • No reference to Shari'ah in the governing law clause • Parties may elect either English law or the laws of the State of New York as the governing law of the Agreement and each Transaction and Designated Future transaction made thereunder • The term "law", does not include principles of Shari'ah • In line with the 2002 ISDA Master Agreement no wording incorporated into the Agreement to accommodate Regulation (EC) No 864/2007 on the "Law Applicable to Non-Contractual Obligations (the Rome II Regulation)" which came into effect on the 11 January 2009 • Both parties at the outset have the flexibility to elect whether dispute resolution should take place through the courts or through arbitration • Common practice for parties who currently enter into transactions with Middle Eastern counterparties to amend forum provision under a 1992/2002 ISDA Master Agreement by providing for arbitration Islamic Derivatives and the ISDA/IIFM Master Agreement

  40. Governing Law and Dispute Resolution • Arbitration tends to be more enforceable as most countries are signatories to the 1958 Convention on the "Recognition and Enforcement of Foreign Arbitral Awards, the NY convention" and, thus, arbitral awards are perceived to be more easily enforceable than a judgement from English or New York courts Common Questions • What are the repercussions if Shari’ah thinking evolves? • Is Agreement enforceable if it ceases to be Shari’ah-compliant? Islamic Derivatives and the ISDA/IIFM Master Agreement

  41. Early Termination (General) • Defined Terms: • Transactions – documented in a Confirmation • DFT Terms Agreements – documented in a DFT Terms confirmation • Designated Future transaction – becomes a Transaction when entered into and to be documented in a Confirmation at that time • the parties may “from time to time agree (the document and other confirming evidence exchanged between the parties or otherwise effective for the purpose of confirming or evidencing any such agreement being a “DFT Terms confirmation” and each such agreement being a “DFT Terms Agreement”) the terms of further transactions in each case being either (i) a transaction which, by such DFT Terms Agreement, the parties agree to enter into between them in the future under this Master Agreement or (ii) a transaction which, by such DFT Terms Agreement, one party (the first party) undertakes to the other (the second party) to enter into under this Master Agreement at the election of the second party at a future date (all of such further transactions being “Designated Future transactions). ” Islamic Derivatives and the ISDA/IIFM Master Agreement

  42. Early Termination (General) • Event of Default: • All Transactions • All DFT Terms Agreements • Termination Event • All Affected Transactions • All Affected DFT Terms Agreements • Except where Illegality or Force Majeure, in which case less than all can be terminated Islamic Derivatives and the ISDA/IIFM Master Agreement

  43. Early Termination Example • Party A grants wa’ad (DFT Terms Agreement) exercisable annually for 3 years by Party B. On exercise Party A must purchase under a murabaha (Designated Future transaction) commodity for immediate delivery at a deferred purchase price • Wa’ad exercised after one year; murabaha entered into (becomes a Transaction), commodity delivered, purchase price deferred and payable at end of year 2 • Early Termination after 15 months leaves outstanding: • deferred purchase price payable at end of year 2 under murabaha (Transaction) • Wa’ad potentially exercisable at end of year 2 and end of year 3 (DFT Terms Agreement) Islamic Derivatives and the ISDA/IIFM Master Agreement

  44. Early Termination – Terminated Transactions • Fully Delivered Terminated Transaction means, with respect to any Early Termination Date, any Terminated Transaction under which all goods or assets falling to be delivered have been delivered, irrespective of whether any payments fall to be made (Section 14) • (section 6(d)): accelerate all payments due after the Early Termination Date (Close-out Amount) • (Section 6(e)): add unpaid amounts • Non-Fully Delivered Terminated Transaction means, with respect to any Early Termination Date, any Terminated Transaction which is not a Fully Delivered Terminated Transaction (Section 14) • (section 6(e)): add unpaid amounts to Fully Delivered Transactions amount • (section 6(f)): treat not made deliveries and future payments like a DFT Terms Agreement • Early Termination Amount means (Section 6(e)) the sum of: • aggregated (and currency converted) accelerated future amounts under Fully Delivered Terminated Transactions • aggregated (and currency converted) unpaid amounts under all Terminated Transactions (both Fully Delivered and Non-Fully Delivered) • Payable on day on which notice of amount payable is effective if Event of Default or 2 Local Business days after notice if Termination Event Islamic Derivatives and the ISDA/IIFM Master Agreement

  45. Early Termination – DFT Terms Agreements • For terminated DFT Terms Agreements, calculate Market Quotation (or Loss) (section 6(h)) • Do the same for not made deliveries and future payments under Non-Fully Delivered Terminated Transactions • Result may be positive or negative • Becomes value of Relevant Index • Section 6(f)(v): if Relevant Index is positive (Determining Party is in the money), Determining Party can exercise the section 2(e) wa’ad of counterparty requiring counterparty to enter into musawamaand purchase asset from Determining Party at the Positive Indexed Value • Section 6(f)(v): if Relevant Index is negative (Determining Party is out of the money) other party can exercise the section 2(e) wa’ad of the Determining Party requiring the Determining Party to purchase asset from the other party at the Negative Indexed Value • Need for real transaction with real assets • Supported by set off (section6(h)) • The musawama price is expressed as a single number (actually calculated by adding cost of asset to Relevant Index Value plus applicable VAT or similar taxes) • The type and quantity of the asset to be the subject of the musawama will be fixed and specified in the Schedule at the outset (minimises gharar) Islamic Derivatives and the ISDA/IIFM Master Agreement

  46. Set-Off • In the Master Agreement, following the occurrence of an Early Termination Date, the Agreement provides for two separate payment amounts: • (a) Early Termination Amount • (b) Positive Indexed Value/Negative Indexed Value • Once determined and payable, these two amounts (Early Termination Amount and Positive/Negative Indexed Value) can be set-off against one another pursuant to Section 6(h) of the Agreement • To avoid Non-defaulting Party having to pay Early Termination Amount before any reciprocal claim to payment of the Positive/Negative Indexed value has become payable, Non-defaulting Party can defer payment of relevant proportion of Early Termination Amount until reciprocal claim becomes payable Islamic Derivatives and the ISDA/IIFM Master Agreement

  47. Profit Rate Swap – Mubadalatul Arbaah • Two sets of PRS templates (four documents in total) have been published, as follows: • one set of PRS templates that are Wa'ad-based (or undertaking-based) and involve a Two Sales structure ("Two Sales Structure") • another set of PRS templates that are Wa'ad-based (or undertaking-based) and involve a Single Sale structure ("Single Sale Structure") • Each set of templates comprises two DFT Terms confirmations, one relating to the Fixed Profit Rate leg of a PRS; the other relating to the Floating Profit Rate leg of a PRS. A form of Confirmation is provided in Annex 2 to document the Transaction that will be entered into pursuant to the terms of each DFT Terms Agreement. Islamic Derivatives and the ISDA/IIFM Master Agreement

  48. Profit Rate Swap – Mubadalatul Arbaah Features of the DFT Terms confirmations: • Each template DFT Terms confirmation contains line items for specific agreed terms to be completed on the Trade Date (e.g. Effective Date, Business Day, Purchase Dates, Payment Dates, Buyer, Seller, etc.), as agreed between the parties upon entry into the relevant DFT Terms Agreement. • For the purposes of enabling payment netting (i.e. the set off of sums due on the same day and in the same currency) between the two legs of the PRS, the DFT Terms confirmation for one leg of a PRS should identify the DFT Terms confirmation for the other leg as being related to it, as a "Related DFT Terms confirmation“. • A form of Exercise Notice is included in each DFT Terms confirmation at Annex 1. The form of Exercise Notice is intended to be extracted, completed and used by the Seller when it wishes to exercise the Buyer's Wa'ad (or undertaking) on an Exercise Date. This form may be used multiple times over the term of the PRS and is not to be completed upon entry into the DFT Terms Agreement. • A form of Murabaha Asset Sale Confirmation (i.e. a "Confirmation” for the purposes of the TMA) is included in Annex 2 of each DFT Terms confirmation. This form is intended to be extracted, completed and used to document entry into each Murabaha Sale (i.e. a "Transaction”) for the purposes of the TMA). This form may also be used multiple times over the term of the PRS and is not to be completed upon entry into the DFT Terms Agreement. Once completed and executed, the Murabaha Asset Sale Confirmation will constitute a Confirmation for the purposes of the TMA and the Murabaha Sale that it confirms will constitute a Transaction under the TMA. Islamic Derivatives and the ISDA/IIFM Master Agreement

  49. Current Trends and Future Developments • Central Bank of Bahrain and Saudi SAMA Committee approve TMA as standard • ISDA/IIFM – Product Development for TMA • Cross Currency Swap product template to be launched in 2014 • Collateralised Murabaha (Islamic CSA) to be launched 2014/5 • Legislative changes required for recognition of enforceability under the insolvency laws / tax laws of some key jurisdictions • Development of Islamic Repo using blend of Wa’ad, Murabahah and Title Transfer or a Mudarabah Profit Share Structure • Sovereign Sukuk issuances Islamic Derivatives and the ISDA/IIFM Master Agreement

  50. CONCLUSION Islamic Derivatives and the ISDA/IIFM Master Agreement

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