Developing Government Sukuk for Investment Purposes Susi Crawford Senior Associate 6 th May 2014 Key hedging products relating to sukuk Sukuk Risk Management and Hedging 6th May 2014 2 1
Sukuk: Risk management What Risk? Risk of non-payment by the Issuer Types of risk management: Guarantees Security Reserve Accounts / Subordinated Loans Hedging products 6th May 2014 3 Sukuk: Hedging Products Profit Rate Swap: To give certainty of payments profit payments in respect of the sukuk certificates To hedge against the possible variance between profit rates due on income payable to Issuer and profit rate payments in respect of the sukuk certificates 6th May 2014 4 2
Example: Profit Rate Swap for Sukuk Floating Rate ISSUER Fixed Rate Floating Rate HEDGING BANK SUKUK CERTIFICATE HOLDERS 6th May 2014 5 Example: Profit Rate Swap for Sukuk Income Stream Income Stream Income Stream Floating Rate ISSUER Variable Rate Floating Rate HEDGING BANK SUKUK CERTIFICATE HOLDERS 6th May 2014 6 3
Sukuk: Hedging Products Cross Currency Swap: To hedge against currency fluctuations where sukuk certificates are issued in difference currency from income To hedge profit/cost of funding rates in difference currencies 6th May 2014 7 Example: Cross Currency Swap for Sukuk ISSUER USD HEDGING BANK EUR EUR SUKUK CERTIFICATE HOLDERS 6th May 2014 8 4
Example: Cross Currency Swap for Sukuk EUR@ 3M EURIBOR ISSUER USD@ 3M USD LIBOR EUR@ 3M EURIBOR HEDGING BANK SUKUK CERTIFICATE HOLDERS 6th May 2014 9 Tahawwut Master Agreement: Hedging Products for Sukuk 6th May 2014 10 5
Tahawwut Master Agreement: Product Documentation Profit Rate Swap (Mubadalatul Arbaah) Islamic Cross Currency Swap (Himaayah Min Taqallub) 6th May 2014 11 The Mubadalatul Arbaah (PRS) Documentation Party A and Party B have already entered into a Tahawwut Master Agreement To enter into the PRS, Party A and Party B enter into two separate DFT Term Agreements (each of which is documented in a separate DFT Terms confirmation: one in respect of the fixed rate leg of the PRS and one in respect of the floating rate leg of the PRS) Each DFT Terms confirmation contains a wa'ad (undertaking) to enter into one or more Designated Future transactions (if the wa'ad is exercised) One Sale or Two Sale Structure 6th May 2014 12 6
PRS Templates - Process Schedule Fixed Rate Leg DFT Terms confirmation (Wa ad) Floating Rate Leg DFT Terms confirmation (Wa ad) Exercise leads to entry into Murahaba (Transaction Confirmation) Delivery of asset Payment (deferred or spot basis) 6th May 2014 13 The Himaayah Min Taqallub As aar (ICRCS) Documentation Party A and Party B have already entered into a Tahawwut Master Agreement To enter into the ICRCS, Party A and Party B enter into two separate DFT Term Agreements (each of which is documented in a separate DFT Terms confirmation: one in respect of currency one of the ICRCS and one in respect of the currency two of the ICRCS) Each DFT Terms confirmation contains a wa'ad (undertaking) to enter into one or more Designated Future transactions (if the wa'ad is exercised) Two Sale Structure 6th May 2014 14 7
ICRCS Templates - Process Schedule Currency One DFT Terms confirmation (Wa ad) Currency Two Leg DFT Terms confirmation (Wa ad) Exercise leads to entry into Murahaba (Transaction Confirmation) Delivery of asset Payment (deferred or spot basis) 6th May 2014 15 Single Sale Structure documentation architecture: PRS example Tahawwut Master Agreement (including Schedule) (Master Terms) Profit Rate Swap (Single Sale Structure): DFT Terms confirmation (wa ad) Fixed Profit Rate/FPR Leg DFT Terms confirmation (wa ad) Floating Profit Rate /FLPR Leg Exercise Notice in relation to undertaking where Exercise Condition is met Murabaha Sale 6th May 2014 16 8
Single Sale Structure: Exercise of wa'ad In the Single Sale Structure, a party may only exercise the wa'ad granted to it by the Undertaking Party on an Exercise Date if the Exercise Condition has been met It is possible for the Exercise Condition to be met only in relation to one of the two wa'ads on any Exercise Date: only one wa'ad may be exercised in respect of the PRS If the Exercise Condition is met in the fixed rate leg of the PRS (which means that it will not be met in the floating rate leg), the wa'ad contained in the DFT Terms Agreement for the fixed rate leg is exercisable (and the wa ad contained in the floating rate leg will not be exercisable) 6th May 2014 17 Single Sale Structure: Exercise of wa'ad: What is the Exercise Condition? The "Exercise Condition" is satisfied in respect of a Calculation Period if the Profit, as determined by the Calculation Agent in accordance with Paragraph 7, is greater than zero for that Calculation Period. In other words, Profit in respect of that leg of the PRS for a Calculation Period must be greater than zero in order to be exercisable If FPR (fixed rate) amount exceeds FLPR (floating rate) amount, Party B can exercise Party A s FPR wa ad : Party A Payment (Cost plus FPR amount less FLPR amount) FPR Assets (Copper) sold by Party B Party B If FLPR (floating rate) amount exceeds FPR (fixed rate) amount, Party A can exercise Party B s wa ad : Party A FLPR Assets (Zinc) sold by Party A Payment (Cost plus FLPR amount less FPR amount) Party B 6th May 2014 18 9
Two Sales Structure documentation architecture: ICRSC example Tahawwut Master Agreement (Master Terms) Schedule Islamic Cross Currency Swap (Two Sales Structure): DFT Terms confirmation (wa ad) USD Leg DFT Terms confirmation (wa ad) EUR Leg Exercise Notice Exercise Notice Murabaha Sale Murabaha Sale 6th May 2014 19 Two Sales Structure: Exercise of wa'ad In the Two Sales Structure, each party may exercise the wa'ad granted to it by the Undertaking Party on an Exercise Date On any Exercise Date, both wa'ads may be exercised in respect of the ICRCS The wa'ad contained in the DFT Terms Agreement for the USD leg is exercisable and the wa ad contained in the DFT Terms Agreement for the EUR leg is also exercisable If a wa'ad is exercised, the Undertaking Party must buy Assets from the Exercising Party and execute a Murabaha Sale Confirmation evidencing the Murabaha Sale between the parties: there are two Murabaha Sales in respect of each Exercise Date in respect of a ICRCS 6th May 2014 20 10
Two Sales Structure: Exercise of wa'ad Party A and Party B have now entered into a ICRCS The Calculation Agent determines Profit in relation to each leg of the ICRCS in respect of the first Calculation Period If Party B exercises Party A s USD wa ad, the cash and asset flows will be as follows: Party A Payment (Cost plus Profit (i.e. USD Amount)) FPR Assets (Copper) sold by Party B Party B If Party A exercises Party B s FLPR wa ad, the cash and asset flows will be as follows: Party A FLPR Assets (Zinc) sold by Party A Payment (Cost plus Profit (i.e. EUR Amount)) Party B 6th May 2014 21 ICRCS: Profit Types Profit can have different formulations: Profit Type 1 = Profit for Initial Exchange / Final Exchange of Capital Amount in USD or EUR Profit Type 2 Fixed Profit Rate = Profit for interim profit rate payments linked to fixed profit rate Profit Type 2 Floating Profit Rate = Profit for interim profit rate payments linked to floating profit rate i.e. LIBOR / EURIBOR 6th May 2014 22 11
PRS /ICRCS Templates Points to Note Agency arrangements Broker arrangements Tax, especially VAT Sale of commodity as is, where is Exclusion of Vienna Sales Convention Calculation Agent duty Deed 6th May 2014 23 Developing Government Sukuk for Investment Purposes www.cliffordchance.com Clifford Chance, 10 Upper Bank Street, London, E14 5JJ Clifford Chance 2014 Clifford Chance LLP is a limited liability partnership registered in England and Wales under number OC323571 Registered office: 10 Upper Bank Street, London, E14 5JJ We use the word 'partner' to refer to a member of Clifford Chance LLP, or an employee or consultant with equivalent standing and qualifications 12