Presentation during GNEXID workshop Geneva – Switzerland March 28/2014

1. Saudi Export Program 2014 Presentation during GNEXID workshop Geneva – SwitzerlandMarch 28/2014

2. Outline of the Presentation 2 SEP’sObjectives. Basic Requirements of SEP Operations. Beneficiaries. SEP Tools in supporting Saudi Exports. SEP Financial Instruments. SEPExport Credit Insurance Facilities. SEPAchievements.

3. 3 I. SEPProgram

4. SEP’s Objectives 4 Established in 1999 to develop and diversify Saudi non-oil exports, Provide competitive insurance and credit facilities to Saudi Exporters and foreign buyers. Motivate Saudi exporters to explore and enter new markets by mitigating risks associated with International trade transactions. Maximize technical cooperation, joint financing and reinsurance arrangements with most international and regional banks/Institution involved in Trade Financing.

5. Basic Requirements of SEP Operations 5 SEP’sfinancing my reach up to 100% of the transaction value. Transaction amount minimum SR 100,000 (Equivalent to about 27.000 US Dollars ). Exports should be of Saudi origin. Local value added should be more than 25%. SEPdoes not Finance exports of crude oil. SEPoffers financing in Saudi Riyals or United States Dollars. SEPcomplements commercial banks and not competing them.

6. Beneficiaries 6 Saudi exporters (Saudi companies and establishments), Local buyers (Saudi companies and establishments) exporting Saudi products, Foreign exporters (Companies Exporting from Saudi Arabia), Foreign Buyers (private or public) of Saudi goods and services, Local and Foreign Banks that provide financing facilities for eligible Saudi exports.

7. Security / Collateral 7 Depending on the nature of transaction and types of risks involved,SEPwould seek payment security that may deem necessary.

8. SEP Tools in Supporting Saudi Exports 8 Financial Instruments. Insurance Instruments.

9. Financial Instruments of SEP 9 A ) Direct Financing: 1- Supplier Credits. Supplier Credit assists Saudi exporters to provide the required credit to the foreign importers. 2- Local Buyer Credits. SEPoffers such credit facilities to Saudi businessmen (local buyers) and investors who execute projects outside the KSA and need financing fromSEPto export Saudi goods and services to use them in the project implementation. 3- Foreign Buyer Credits. These credit facilities assist importers (buyers) from outside the KSA to obtain the required financing directly fromSEP.

10. 10 B ) Indirect Financing: 1 -Lines of Credit for Banks, financial institutions, large Firms. Provided to Banks and Financial institutions (acting as agents forSEP) in theimporter’s country. Focus on SME’s.

11. Repayment periods 11

12. SEP'sAchievements 12

13. 13 II. Islamic Finance and Trade

14. 14 Islamic Finance: • Refers to a system of banking or banking activity that is compliant with the principles of Islamic–Shariah-low. • Islamic treats money as a unit of account and a means of exchange not a commodity. • There is a lack of complete uniformity in Fiqh view points, The different view points can be a source of counterparty risks as a result of the atmosphere of an ineffective litigation.

15. 15 Continue… • With the establishment of the Auditing and Accounting organization for Islamic Financial Institution (AAOIFI) in early 1990 in Manama, Bahrain, the process for bringing scholarly attentions to focus on particular issues was streamlined, with the result that consensus could be brought about through one institution, and then regular standards for a wide spectrum of Shari’ah-related issues could be approved and implemented.

16. 16 Continue… • The Islamic Financial Services Board (IFSB) was lunched in 2002 in Kuala Lumpur, Malaysia, by a consortium of central banks and with support of the IMF with the mandate including the provision of prudential standards and guidelines for international application by banking supervisors in the supervision of Islamic bank.

17. 17 Fundamental Principles that guide Islamic Finance These are that transactions Must : • Be interest free. • Usury “Riba” any increase, however great or small, above the original lent or exchanged amount. • Have risk sharing . • “Alghurm bil ghurm”. • “There is no return without risk”. • Ensures that real assets and inventories are created “real economy”.

18. 18 Continue… • Have contractual certainty. • Absent of basic prerequisite, such as. • The existence of the subject matter . • The fixing of a delivery date . • The agreement on a price. • So, • Conventional insurance, interest, Futures, and options all contain an element of contractual un certainty (Gharar) and are thus prohibited. • And that all the element of transaction Must in and of them selves be ethical . • Means that there is no buying, selling, or trading in conventional banking and insurance, alcohol, and tobacco.

19. 19 Continue… • Speculation. • Contracts which involve speculation (Maysir) are not permissible (not lawful) and are considered void, however, Islamic law doesn't prohibit general commercial speculation, but it does prohibit speculation which is similar to gambling, i.e. gaining something by chance rather than productive effort.

20. 20 Comparison of Islamic and Conventional Finance

21. 21 Islamic Financing Products • Equity based: • Mudarabah is profit sharing and loss-bearing contract. Under a Mudarabah contract, the capital provider agrees to share the profits with the entrepreneur (Mudarib) at an a greed percentage. • Musharakah is profit-and loss-sharing partnership contract, the Islamic bank may enter into a Musharakah with a customer for the purpose of providing a Shari’ah-compliant financing facility to the a customer on a profit and loss-sharing basis. • Sukuk is an Islamic bond, structured in such away to generate returns to investors without infringing Islamic law. Sukuk represents undivided shares in the ownership of tangible assets relating to particular projects or special investment activity. A Sukuk investor has a common share in the ownership of the assets. Linked to the investment although this doesn't represent a debt owed to the issuer of the bond.

22. 22 Continue… • Trade based • Murabaha is a cost plus mark-up arrangement. • Salam is an advance payment commodity sale contract where the delivery of the commodity is deferred. • Istisna’a is a “manufacture to order” contract for yet to be manufacture of good on payment of on advance price either in full or in installments.

23. 23 Continue… • Lease based • Ijarah contract is an operating lease contract refers to hiring or renting any asset commodity to benefit from its usufruct. • Ijarah Muntahia Biatamleek is a lease-to-purchase . “ashari’ah-compliant alternative to a finance lease”

24. 24 Islamic Risk Mitigation Tool • Takaful is a co-operative system of reimbursement in case of loss, paid to people and companies concerned about hazards, compensated out of fund to which they agree to donate small regular contributions managed on behalf of them by a Takaful operator .

25. 25 Murabaha Trade Finance in Practice

26. 26 Operational Risk in Islamic Finance • Operational risk as per the IFSB is defined as “the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events, which includes but is not limited to, legal risk and shari’ah-non-compliance risk. • This definition excludes strategic and reputational risk. • Such risks are likely to be significant in Islamic finance, due to specific contractual features and the general legal environment.

27. 27 Continue… • Specific aspects that could raise operational risks in Islamic finance include the following: • The cancellation risks in non binding Murabahah and Istisna’a contracts. • Problems in internal control systems to detect and manage potential problems in operational processes and back-office functions. • The potential difficulties in enforcing Islamic finance contracts in a broader legal environment.

28. 28 Continue… • The risk of non-compliance with shari’ah requirements that may impact on permissible income. • The risk of misconduct and negligence which would result in Murabahah-based becoming a liability of Islamic bank, with consequent capital adequacy and solvency implications. • The need to maintain and manage commodity inventories, often in non-liquid markets. • The potential cost and risks in monitoring equity-based contracts and the associated legal risks.

29. 29 Risk Management in Islamic Finance • The specific risks associated with each of Islamic Finance products:- • Risks in Murabha. • Credit risk . • client backs out from purchasing the goods. • Market risk • exposure to the fluctuating market price of goods. • Supplier risk. • supplier is unknown to the bank which may cause a delay in delivery time goods and non-conformity specifications. • Operational / Ownership risk. • Client as agent gains possession of goods from the supplier without informing the bank. • Transit period risk. • The risk associated with goods after the bank purchases them from the supplier and before the client purchases them from the bank. • Documentation Risk. • The risk that the counterparty does not provide sufficient documentation.

30. 30 Continue… • Risks in Salam • Holding Risk. • The risk of holding goods until the time of delivery. • Shariah non-compliance Risk. • Arises if goods are sold before receiving their physical or constructive possession. • Settlement and delivery Risk. • Arises in the event goods are not delivered on time and do not conform to specifications. • Rate of Return and Price Risk. • The risk that a decrease in the commodity’s price after contract maturity will result in a lower rate of return.

31. 31 Continue… • Risk in Istisna. • Risk of hidden defects. • Risk of defects inherent in the manufactured products. • Shariah non-compliance Risk. • Arises as a result of not specifying the characteristics of goods, the time or place of delivery or lack of information about the supplier. • Settlement and Credit Risk. • Arises when the customer is unable to honour deferred payments. • Price Risk • Bank’s exposure to the risk of selling goods to a third party for a lesser price as a result of contract cancellation. • Delivery Risk. • The risk of not being able to make a scheduled delivery of manufactured goods a Parallel Istisna. • Legal Risk. • Litigation costs for claims against Istisna requestor that terminates the contract.

32. 32 Continue… • Risk in Ijarah. • Risk associated with security that sells for a lower price in the market as a result of which the bank cannot cover its loss. • Asset Risk. • Asset is stolen, damaged. • Price Risk. • Bank’s exposure to changes in the cost during the Ijarah’sterm. The longer the term the greater the bank’s exposure to price fluctuations. • Risk that the customer will back out form his promise to lease, the bank may have to sell the asset at a price lower than market price. • Legal Risk. • Litigation costs against the client who refuse to compensate the bank for losses resulting from unfulfilled promises.

33. 33 Continue… • Risk in Musharakah and Mudarabah. • Shariah non-compliance Risk. • Debt cannot be used as a substitute for equity. • One partner cannot guarantee the other partner’s principal or profit. • Risk of the funds being from a prohibited source. • Credit Risk. • Managing partner manipulates to show lower returns. • Prohibition of any collateral to secure the bank’s investment poses additional risk.

34. Thank You For Your Attention

35. The Saudi Fund for Development Saudi Export Program SEP www.sep.gov.sa +966 11 4659399- 4658117 Fax +966 11 4659699 P.O. Box 50483 Riyadh 11523