Standard Chartered Plans `Big Push' on Shariah Contracts: Islamic Finance

Standard Chartered Plc, the U.K. bank that earns most of its profit from emerging markets, plans to introduce Shariah-compliant contracts in Asia to hedge against changes in commodity prices.

The products, which the London-based bank made available in the Persian Gulf in March, will allow buyers and sellers to agree on fixed or floating prices and make it easier for companies to protect themselves from volatility in goods such as sugar, rice, wheat and crude oil, Afaq Khan, chief executive officer of Standard Chartered’s Islamic banking unit in Dubai, said in an interview on Aug. 9.

Afaq Khan, chief executive officer of Standard Chartered Plc's Islamic banking unit.

“This year the big push is on commodity derivatives,” he said. “We will certainly be offering them in countries like Malaysia and Indonesia in due course. When there is sufficient demand we will go to the central banks to seek approval.”

Asia accounted for 68 percent of the total $7.8 billion of sukuk, or Islamic bonds, sold worldwide this year, according to data compiled by Bloomberg. Economic growth in developing Asia, including Malaysia and Indonesia, will accelerate to 9.2 percent in 2010 from 6.9 percent in 2009, according to estimates by the International Monetary Fund on July 7. Expansion in the Middle East was forecast at 4.5 percent, compared with 2.4 percent last year.

Malaysia is the world’s biggest market for Islamic bonds, while Indonesia has the largest Muslim population. Global sales of the securities have dropped 28 percent so far this year, Bloomberg data show.

Risk Management

Islamic commodity derivatives differ from conventional contracts because they can’t be traded or used as a speculative investment and the underlying goods must be present, not supplied for future delivery. Derivatives are financial instruments linked to stocks, bonds, loans, currencies and commodities, or to events like changes in the weather. Islamic investors tend to avoid the contracts because Shariah law prohibits speculation and payment or receipt of interest.

“You’re trying to take risk away from the market, you’re not using it as an instrument to trade and make money,” Khan said. “It’s a risk-management tool, not a speculative or trading tool.”

Demand for services complying with Shariah law is increasing about 15 percent annually, with Islamic financial assets totaling $1 trillion, according to the Kuala Lumpur-based Islamic Financial Services Board. Holdings may almost triple to $2.8 trillion by 2015, the IFSB estimates.

“As fund managers, we need hedging tools to manage currency and rate risks,” Sajjad Anwar, who helps manage the equivalent of $160 million at National Fullerton, a unit of National Bank of Pakistan, said in an interview in Karachi yesterday. “Those who deal in commodities will welcome a product that helps them mitigate risks in a volatile market.”

Malaysia Sukuk

The difference between the average yield for emerging- market sukuk and the London interbank offered rate was little changed at 389 basis points on Aug. 9, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. The spread has narrowed 78 points, or 0.78 percentage point, so far this year.

Shariah-compliant bonds returned 9.3 percent this year, according to the HSBC/NASDAQ Dubai US Dollar Index, while debt in developing markets gained 11.4 percent, JPMorgan Chase & Co.’s EMBI Global Diversified Index shows.

The yield on Malaysia’s 3.928 percent Islamic notes due June 2015 dropped two basis points to 2.85 percent today, the lowest level since the debt was sold in May, according to prices from Royal Bank of Scotland Group Plc. The notes have returned 5.5 percent since they were issued.

Creating A Market

The yield gap between the Dubai Department of Finance’s 6.396 percent sukuk maturing in November 2014 and Malaysia’s Islamic note due June 2015 has widened 13 basis points to 418 basis points this week and is up 61 points from the year’s low of 357 on June 10, according to data compiled by Bloomberg.

Standard Chartered, which earned more than 90 percent of its pretax income in 2009 from India, Africa, the Middle East and Asia, will hold the hedging contracts, which it can back with its own commodities’ inventories or source from outside, Khan said.

“Islamic financial institutions have had limited access to counterparties who could offer this kind of hedging instrument,” Harris Irfan, the Dubai-based head of Islamic finance products at Barclays Capital, said yesterday. “We are at the beginning of a very large project for the industry.”

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