Shariah-Compliant Hedging Derivatives Start in Malaysia: Islamic Finance

Standard Chartered Plc and Bank Islam Malaysia Bhd. plan to offer Shariah-compliant derivatives in Malaysia that will allow investors to hedge against interest rates and commodity prices.Standard Chartered, the U.K. bank that earns most of its profit from emerging markets, will begin selling contracts in the first quarter that provide protection from fluctuations in the cost of items such as rice and oil, according to an e-mailed reply to questions yesterday. Bank Islam Malaysia, the country’s oldest Islamic lender, will offer swaps that allow two parties to exchange different forms of payments from an underlying asset.
Shariah-Compliant Hedging Derivatives Start in Malaysia

Shariah-Compliant Hedging Derivatives Start in Malaysia

The lack of such Shariah products is hindering industry growth, Badlisyah Abdul Ghani, chief executive officer of Kuala Lumpur-based CIMB Bank Islamic Bhd., said in an interview on Dec. 20. The market will be limited to hedging after derivatives contributed to the global financial crisis, which resulted in $1.8 trillion of credit losses and write downs.
“The industry has gone through a set of innovations over the past 10 years to offer Shariah-compliant solutions and today the industry can say we have Islamic derivatives,” Syed Alwi Mohd Sultan, director of origination at Standard Chartered Saadiq Bhd., the bank’s Kuala Lumpur-based Islamic banking unit, said in a telephone interview on Dec. 15. “A wide acceptance of the standards will bring greater convergence of the industry.”
Derivatives are contracts whose values are tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.
Sukuk Returns
Malaysia, the Asian hub for Shariah-compliant finance, accounts for more than 50 percent of the $144 billion of outstanding Islamic bonds, or sukuk, globally, according to data compiled by Bloomberg. Total sales of the securities, which pay asset returns to comply with the religion’s ban on interest, have dropped 24 percent to $15.3 billion this year.
Shariah-compliant bonds returned 12.4 percent in 2010, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. Debt in developing markets gained 11.7 percent, JPMorgan Chase & Co.’s EMBI Global Diversified Index shows.
The difference between the average yield for sukuk and the London interbank offered rate shrank two basis points, or 0.02 percentage point, to 305 on Dec. 21, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. The spread has narrowed 163 basis points this year.
Rising Demand
The yield on Malaysia’s 3.928 percent Islamic notes due June 2015 rose two basis points to 3.10 percent today, according to prices from Royal Bank of Scotland Group Plc. The debt has returned 5.8 percent since it was issued in June.
The difference in yield between the Dubai Department of Finance’s 6.396 percent sukuk due November 2014 and Malaysia’s Islamic note was little changed at 339 basis points today, according to data compiled by Bloomberg. The gap shrank 59 basis points this month.
Demand for services complying with Shariah law is increasing by about 15 percent a year and assets will rise to $1.6 trillion by 2012, from around $1 trillion currently, according to the Kuala Lumpur-based Islamic Financial Services Board.
Bank Islam Malaysia plans to introduce new contracts that will allow an exchange of profit or return rates between two counterparties, Hizamuddin Jamalluddin, the bank’s assistant general manager, said at a seminar for Islamic derivatives on Dec. 14 in Kuala Lumpur. These will be in addition to its existing Shariah-compliant hedging contracts, he said.
Record-low borrowing costs in the U.S. may rise in 2011, providing a “timely” opportunity for banks to issue swaps- based derivatives, Hizamuddin said.“It is very critical that holders of sukuk have access to hedging solutions that would enable them to counter the challenges in a rising interest-rate environment,” he said. “Interest rates seem to have hit rock bottom.”

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