Repo alternative ismail dadabhoy
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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