Islamic Finance - Islamic Capital Market - Structure of shari'ah-based government
A system with regulatory bodies in charge of central administration is known as a Shari'ah governance structure. It comprises of the Shari'ah boards of each Islamic Financial Institutions(IFI) as well as the Shari'ah advisory or supervisory board (SSB) of such authorities, which is the highest Shari'ah authority in the system. The Shari'ah Advisory Council (SAC) of Malaysia's central bank, Bank Negara Malaysia, is the top Shari'ah authority overseeing the country's Islamic banking and Takaful sectors (BNM). In Malaysia, the highest authority to decide on Shari'ah concerns relating to the Islamic Capital Market(ICM) is the SAC of the Malaysian Securities Commission (SC). The Islamic Financial Institutions (IFIs) each have their own Shari'ah board to provide guidance on how to adhere to the requirements established by advisory councils. Islamic banking systems have always been the primary emphasis of Islamic finance growth in other centrally controlled systems, such as those in Sudan and Pakistan. In these nations, the ICM is still in its infancy. The only country with a central framework to oversee existing ICM systems is Malaysia because the other jurisdictions lack one. Nonetheless, several of these other nations, including Pakistan, Bahrain, and Sudan, do have centrally regulated Islamic banking sectors. The authorities in a system that is centrally run have a number of tools at their disposal to manage each IFI's Shari'ah governance structure. Before they can begin operations, all IFIs inside the system must first get a licence from the SC or the central bank. As a result, the authorities are able to guarantee that the IFI has the appropriate mix of scholars who are qualified to serve on the Shari'ah board. For instance, in Malaysia, the SC of Malaysia must formally approve and licence the employment of Shari'ah consultants for Islamic unit trusts and Islamic Sukuk. Some jurisdictions do not follow this practise. The SAC of the regulators imposes restrictions on the Shari'ah board's authority. For instance, the SAC of the BNM will decide which Islamic contracts are appropriate for Islamic finance plans. The various banks' separate Shari'ah committees are responsible for ensuring that their financial institutions abide by these resolutions. The same is true for ICM products and equipment in Malaysia, where the SAC of the SC of Malaysia has final authority over Shari'ah clearance. Similar practises are common in Indonesia, where the council of Indonesian scholars must approve and endorse all submissions. The highest Shari'ah authority in Indonesia is separate from both the central bank and securities agency, unlike Malaysia or Pakistan. The council of Indonesian scholars, an independent group, is the highest body in Indonesia to make decisions on Islamic financial problems. Although Islamic funds or banks may have their own Shari'ah boards, this council must nonetheless give final permission. There is no SSB to manage the entire industry in a non-centrally governed system, such those typically seen in the Middle East. Instead, each IFI has established their own SSB, as well as Islamic windows, departments, and funds. These boards frequently have well-known Shari'ah experts as their chairmen. Because of their market presence in the Islamic finance sector, they lend legitimacy to both the IFIs they represent and the Islamic goods they recommend.
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Islamic Finance – Islamic Capital Market - Shari'ah governance: its framework and procedures2/21/2023 Islamic Finance – Islamic Capital Market - Shari'ah governance: its framework and procedures
Any advanced financial system will inevitably produce a capital market. The development of an ICM has typically been preceded by Islamic banking and Takaful. The only two nations with an Islamic financial industry that have fully developed ICMs that deal with stock, bonds or Sukuk, and derivative instruments are Malaysia and Bahrain. The most significant issue in the field of Islamic finance is perhaps shari'ah governance. The Islamic Financial System (IFS) is only protected by shari'ah governance, which also assures that procedures adhere to shari'ah guidelines and that financial products are compliant with shari'ah. Presently, the Shari'ah governance reporting formats that are in use within the Islamic finance sector seem to be in conflict with one another. On one hand, a number of nations, like Malaysia, Sudan, and Pakistan, favour a centralised approach in which regulatory agencies, such central banks or securities commissioners, take the lead in advancing Shari'ah initiatives inside the industry, alongside Shari'ah boards of private institutions. The financial sector is solely governed by the Shari'ah boards of private organisations in some Middle Eastern nations, such as Bahrain and the United Arab Emirates. As long as integrity is guaranteed by all Shari'ah regulating authorities, either practise is allowed. Islamic Finance – Islamic Capital Market - Islamic forward, futures, option, and swap contracts2/21/2023 Islamic Finance – Islamic Capital Market - Islamic forward, futures, option, and swap contracts
Three Islamic financial contracts are thought to perform similarly to forward and future contracts. A future delivery is sold in exchange for an advance payment from the buyer. Salam sales have the ability to "lock in" a product's price for the future. "Urbun" is the term for the down payment given to the vendor. The right (but not the obligation) to purchase the underlying asset would be granted to the payer upon payment of this down payment. The strike price used in Urbun is likewise "locked in" for future delivery. A unilaterally binding promise to sell or buy items in the future at a predetermined price is known as a wa'd. The idea of "Urbun"—to mimic the performance of options in the traditional market—has been championed by Islamic finance. While 'Urbun cannot completely replace a conventional option's features, it can offer some of their benefits. 'Urbun offers some downside protection for an investor, similar to options. An investor's down payment grants them the option to buy a certain asset at the striking price, which is a predetermined price. If the value of this asset rises, the investor will profit. Otherwise, under the 'Urbun principle, the exposure to loss is constrained to the amount of the down payment given. In summary, "Urbun" offers upside potential as well as downside protection. Wa'd and Salam are helpful in lowering the risk that the parties to a contract must take, just like 'Urbun. Wa'd is simply the unilateral promise or commitment made by one party to buy or sell a specific asset. It is deemed effective to "guarantee" the investment of Sukuk investors when the issuer of Sukuk Mudarabah and Sukuk Musharakah commits to buying the venture's assets at the time of default in paying projected periodic profit distribution. Investors in Sukuk are subject to market risk in the absence of this purchase undertaking provision. Salam, which means "forward sale" in Arabic, is used to pay the purchase price in advance for an object that will be delivered in the future. The market risk associated with the asset is lessened or mitigated because the price is determined in advance. The price has already been determined, therefore the risk is reduced regardless of how volatile the asset value may be. Islamic Finance – Islamic Capital Market - Futures, options, swaps, and forwards
Forwards and futures are used in the traditional financial market to protect against changes in commodity, stock, and currency values. This is accomplished by "locking in" the commodity, share, or currency's future price. Although an option is related to a holder's right to buy or sell, it is nonetheless a useful tool for hedging investment risk. An useful tool for giving both downside protection and upside possibilities is an option. A swap is a helpful tool for preventing a mismatch between the assets and liabilities of a financial organisation. A swap enables two parties to exchange cash flows in real time based on a notional amount associated with underlying assets. Islamic Finance – Islamic Capital Market - Islamic-Structured Products.
Islamic Capital Market / ICM instruments also include Islamic-structured goods and Islamic derivatives. These products' primary goal is to reduce financial risk in accordance with Shari'ah guidelines. The four primary instruments that make up conventional hedging tools are forwards, futures, options, and swaps. Islamic Finance – Islamic Capital Market - Contracts used in Sukuk trade
Simply because the underlying assets of the securitization are non-financial or non-monetary assets, modern Muslim scholars have approved Shari'ah norms governing the issue and trading of these Sukuks. When one of the equity-based contracts, such Musharakah or Mudarabah, is used as the underlying contract for an Islamic Sukuk, a problem occurs. The Musharakah or Mudarabah contracts presume profit and loss sharing in a venture, as stated in study guide one (section 9.2) Any fixed income or condition prohibiting sharing in losses will be seen as being in violation. The problem is that while Sukuk based on either Mudarabah or Musharakah must provide investors with a guaranteed income, these contracts are not permitted to include any clauses that would guarantee either capital or profit. The Wa'd principle is applied in order to address the aforementioned difficulty. In the event that the issuer is unable to pay the anticipated periodic profit distribution, the issuer agrees to buy the Sukuk asset from the venture as part of the Wa'd principle. Because the issuer agrees to buy the Sukuk asset at a price equal to the amount outstanding under the Sukuk issuance, investors are consequently shielded from any loss. This Fatwa, which was granted by several IFIs, including Dubai Islamic Bank, Kuwait Finance House, and many other Shari'ah consultants, permits the issuer of this Sukuk to commit to buying the venture's assets according to a predetermined formula. This takes into account the Sukuk's fixed income component, which is based on the Musharakah or Mudarabah. This can be interpreted by some academics as a "capital and profit" guarantee, which is inappropriate in an equity-based contract. The Islamic Finance – Islamic Capital Market - Trading of Sukuk
Due to the fact that the underlying assets are not receivables or financial assets, trading in Sukuk is legal and free of Riba. It will be assumed that a Sukuk holder has sold ownership rights to an asset when selling Sukuk to another investor on the secondary market. As there is no transaction of money for money, the pricing formula can therefore be of any arrangement, whether it of face or market value. When an ownership right is used to symbolise a Sukuk, selling or trading those Sukuk will be similar to selling a physical asset for cash. Sukuk trading differs from the trading of Islamic bonds in this way. Islamic Finance – Islamic Capital Market - Sukuk
Sukuks are participation certificates with equal unit values that are offered to investors and denominated in money. Sukuks are the end outcome of the securitization process, just as Islamic bonds. Securitization's subject substance is neither an obligation/debt nor a receivable, in contrast to Islamic bonds. Sukuks are papers or securities that can be subscribed to by investors and are made up of tangible assets, usufruct, or an interest in a project. Receivables are seen as being an inherent part of the asset, which is the leased asset, if there are any parts of receivables, such as in Sukuk Ijarah. From a Shari'ah standpoint, these receivables are just incidental to the leased asset. Each holder of a sukuk has an unequal beneficial interest in the underlying assets. As a result, Sukuk investors are qualified to receive a portion of the profits made by these assets. Sukuks represent the pro rata ownership of the underlying assets by investors as well as their pro rata part of the income derived from such assets. Sukuks don't signify that the issuer is owing the investor any money. Shari'ah compliance is unaffected by the issuance of Sukuks because the process of securitization for Sukuk pertains to non-financial assets such tangible assets like buildings, power plants, or motorways. A usufruct, such as the right to use a building, or an interest in a project, such as the creation of a new structure, may also be involved. Asset-based securitization is the term used to describe this type of securitization, as will be discussed later. Due to the fact that Sukuks represent investors' ownership rights in the underlying assets, their issuance is permitted by Shari'ah. Islamic Finance – Islamic Capital Finance - The exchange of receivables
Even while these receivables can be securitized, from the standpoint of international investors, this does not imply that the securities created via receivable-based securitization can be freely traded. AAOIFI Shari'ah Standard No.17, which specifies that securities emerging from pure receivables are not freely traded, contains this ruling. To avoid riba, these securities must be purchased and sold at par value. Receivables aren't seen as pure financial assets in some countries, including Malaysia, who believe they come from business or trading agreements like Murabahah or Istisna. As a result, they are comparable to physical assets that may be freely bought, sold, and swapped. This is predicated on the idea that under the Bay al-dayn or sale of debt principle, trading in such assets at their market value with a willing buyer and willing seller is permitted. Some academics from the Middle East and Pakistan have asserted that these receivables are nonetheless financial assets even though they resulted from business contracts. They can therefore only be traded or sold for their par value if Riba is to be avoided, making them similar to financial assets. The greatest issuer of Islamic fixed income securities, such as Sukuk and Islamic bonds, is Malaysia. The majority of these Malaysian products are based on the securitization of receivables. In 2005, 83% of Malaysia's Islamic fixed income instruments were based primarily on the securitization of financial debts or assets, according to estimates. Some Muslim investor communities have shown strong opposition to the securitization of receivables. As a result, Malaysia is the only country that uses this type of Islamic security. Islamic Finance - Islamic Capital Market - The debt securitization process
Securitization, in its simplest form, is the process of turning anything into its tradable secondary market monetary equivalent in the form of paper or securities. Almost all assets, whether they be financial or physical, can be securitized, according to the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) Shari'ah Standard on Investment Sukuk (Shari'ah Standard No.17). As a result, the securitization process, which is based on Taskik (converting an illiquid asset into a liquid one), is a valid Shari'ah principle. Receivables are obviously a thing that can be securitized under Shari'ah Standard No.17, as the explanation above has shown. |
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