The Pakistan Credit Rating Agency PACRA Credit Ratings For Islamic Instruments May 07’12

1. The Pakistan Credit Rating Agency PACRA Credit Ratings For Islamic InstrumentsMay 07’12 ADNAN AFAQ MD PACRA

2. About PACRA 1. PACRA, Pakistan’s first rating agency – 1994 Banks AMC Insurance Refineries IPPs Corporate Sukuks 2. JV : IFC + Fitch Ratings + Lahore Stock Exchange 3. To date + 1,500 rating opinions Rated 85% of debt instruments in Pakistan 4. Recognized by Apex Regulators – Pakistan & Bangladesh 5. Development work for World Bank: Bond Market - NBFI sector 6. We do: Risk Advisory, Specialized Training on Risk Management Corporate Governance Assessment (IFC model)

3. Development of Credit Ratings Coverage of rating agencies (~ 90% of World GDP)

4. Why Credit Rating? • Bank Deposits • Tax Payers’ money • Listed Companies • Insurance • Real Estate Projects • Mutual Funds Whenever Public Money is invested Disclosure of Risk & Return is imperative Risk & Return Correlation Transparency: Independent view of risk

5. Why Credit Rating • Greater Access to Capital • Timely Action • Transparency • Relative Position Management Regulators Investor Identify Risk Factors Systemic Risk Enterprise Risk level • Not possible to • capture without • quantification • Market condition • Market action/inaction • Matching of • Risk & return

6. Crux of Islamic Finance • Transaction must have real economic purpose • No undue speculation allowed [Gharar] • No exploitation or • sinful activities permitted • Underlying concept: Sharing of risks & rewards • Riba:Interest & other Unlawful gain are prohibited

7. World Sukuk Markets • Total Sukuk Size: $215 b outstanding

8. World Sukuk Markets • Main Players: • Malaysia (60-70% of new issuances globally) • Saudi Arabia • UAE • Pakistan • Latest happenings • Malaysia- Largest Islamic bond Plus highway $10bbn • Saudi Arabia- rise in activity: Civil Aviation, Saudi bin Ladin SATORP • South Africa- Treasury Sukuk proposition • Thailand- Tax Incentive • Oman- Infrastructure Sukuk proportion • Japan- Changes in tax & stamp duties • Ireland- Finance Bill 2010 facilitate Islamic Finances Preparing Launch • Azerbaijan • Kazakhstan • Australia • India • Japan • Singapore • Nigeria • Ireland

9. Introduction to Sukuks • Plural of Sak – meaning ‘certificates’ in Arabic • Beneficial ownership interest in a tangible asset &/or resulting cash flows • Resembles a conventional lease agreement • Late payment charges paid to charity • Financier commissions the construction/manufacture of asset • Simultaneous forward Ijara agreement • Sale of agreed asset at cost plus agreed profit margin • Provides liquidity to the customer • Funds entrusted with a corporate for use in pre-agreed business • Profit & loss sharing • Similar to Mudaraba but this is an equity stake • Profit & loss sharing Risks associated with structure type

10. Sukuk Ratings • Rating looks through the structure of the Sukuk at the originator of the transaction. Step 1; Base rating = originator’s Rating Step 2; Notching [Up –Down ] dependent on: • Type of claim or underlying contract • Ijara ensures predictable returns due to fixed rentals while • Musharaka is equity-based and hence less predictable • Quality of assets underlying the transaction • Mechanisms like reserves can further enhance credit Sukuk rating will be IDR plus one or multiple notches depending on strength of afore-mentioned factors

11. Credit Risk Assessment Pyramid Long-term Sustainability Relative Positioning Macro-Economic Environment Business Life-cycle Short-term Sustainability 11

12. Credit Ratings – An Introduction Rating Scale – To measure relative credit risk Investment Grade Speculative

13. Default… Failure to perform an obligations laid down in the agreement • Failure to pay amounts due; Very strict adherence to covenants (promise) BringsMarket Discipline Creates Credit History

14. Limitations of Sukuk • Enforcementnot ensured (lack of legal precedent) Interpretation may differences between Shariah and local courts 2. Register able asset not always transferred to SPV: • Due to Foreign ownership • Cumbersome • Expensive

15. Iranian Sukuk Market

16. AnyQ & A ??? Thank You!