Credit Ratings For Islamic

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Oct 28, 2013 (3 years and 11 months ago)

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Credit Ratings
-

Islamic Instruments



The Pakistan Credit Rating Agency

PACRA



Credit Ratings For Islamic

Instruments





May 07’12


1

ADNAN AFAQ

MD PACRA

Credit Ratings
-

Islamic Instruments

About PACRA

1. PACRA, Pakistan’s first rating agency


1994



Banks AMC Insurance Refineries IPPs Corporate
Sukuks


2. JV : IFC + Fitch Ratings + Lahore Stock Exchange


3. To date + 1,500 rating opinions

Rated 85% of debt instruments in Pakistan


4. Recognized by Apex Regulators


Pakistan &



Bangladesh

5. Development work for World Bank:
Bond Market
-

NBFI sector


6. We do:

Risk Advisory,


Specialized Training on Risk Management








Corporate
Governance Assessment (IFC model
)




2

Credit Ratings
-

Islamic Instruments

Development of Credit Ratings

Coverage of rating agencies (~ 90% of World GDP)

3

Credit Ratings
-

Islamic Instruments

Why Credit Rating?






1.
Bank Deposits

2.
Tax Payers’ money

3.
Listed Companies

4.
Insurance

5.
Real Estate Projects

6.
Mutual Funds

4

Whenever

Public
Money

is invested

Disclosure of

Risk &
Return

is imperative

1.
Risk & Return Correlation


2.
Transparency:
Independent view of risk

Credit Ratings
-

Islamic Instruments

Why Credit Rating














5

Management

Investor

Regulators


Market condition


Market action/inaction


Not possible to


capture without



quantification



Matching of


Risk & return

Identify Risk Factors

Enterprise Risk level

Systemic Risk


Transparency



Relative Position


Greater Access to Capital



Timely Action

Credit Ratings
-

Islamic Instruments

Crux of Islamic Finance

1.
Transaction must have
real economic
purpose

1.
No
undue speculation
allowed
[
Gharar
]

2.
No exploitation or

3.
sinful
activities
permitted



2.
Underlying concept:
Sharing of
risks

&
rewards



3.
Riba
:

Interest

& other Unlawful gain are prohibited





6

Credit Ratings
-

Islamic Instruments

World Sukuk Markets


Total Sukuk Size: $215 b outstanding







Source:
www.zawya.com

7


20,278


34,004


53,077


85,575


43,281

-
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
2008
2009
2010
2011
1Q12
Amount in USD Million

New Sukuk Issuance

Credit Ratings
-

Islamic Instruments

World Sukuk Markets


Main Players:


Malaysia
(60
-
70% of new issuances globally)



Saudi Arabia


UAE


Pakistan



Latest happenings


Malaysia
-

Largest Islamic bond Plus highway $10bbn


Saudi Arabia
-

rise in activity
: Civil Aviation, Saudi bin
L
a
din




SATORP


South Africa
-

Treasury
Sukuk

proposition


Thailand
-

Tax Incentive


Oman
-

Infrastructure
Sukuk

proportion


Japan
-

Changes in tax & stamp duties


Ireland
-

Finance Bill 2010 facilitate Islamic Finances


Preparing Launch


Azerbaijan


Kazakhstan


Australia


India


Japan


Singapore


Nigeria


Ireland

8

Credit Ratings
-

Islamic Instruments


Resembles a conventional lease agreement


Late payment charges paid to charity



Financier commissions the construction/manufacture of asset


Simultaneous forward
Ijara

agreement



Sale of agreed asset at cost plus agreed profit margin


Provides liquidity to the customer



Funds entrusted with a corporate for use in pre
-
agreed
business


Profit & loss sharing



Similar to
Mudaraba

but this is an equity stake


Profit & loss sharing



Introduction to Sukuks

9

Ijara

Istisna’a

Murabaha

Mudaraba

Musharaka


a)
Plural of
Sak



meaning
‘certificates’

in Arabic


b)
Beneficial
ownership

interest in a tangible asset &/or resulting cash flows

c)

Risks associated with structure type


Credit Ratings
-

Islamic Instruments

Sukuk Ratings

1.
Rating looks through the structure of the Sukuk at
the
originator

of the transaction.


10

Step 1; Base rating = originator’s Rating


Step 2; Notching
[
U
P


Down
]
dependent on:



Type of claim or underlying contract


Ijara

ensures predictable returns due to fixed rentals while


Musharaka

is equity
-
based and hence less predictable



Quality of assets underlying the transaction



Mechanisms like reserves can further enhance credit


2.
Sukuk rating will be IDR
plus
one or multiple notches
depending on strength of afore
-
mentioned factors

Credit Ratings
-

Islamic Instruments

Credit Risk Assessment Pyramid

11

Ownership

1

Governance

2

Management

3

Business Risk

4

Financial Risk

5

Relative Positioning




Macro
-
Economic
Environment




Business Life
-
cycle

Long
-
term
Sustainability

Short
-
term
Sustainability

11

Credit Ratings
-

Islamic Instruments

Credit Ratings


An Introduction

12

Credit Quality

Rating Category

Exceptionally Strong

AAA

Very Strong

AA

Strong

A

Adequate

BBB

Speculative

BB

Highly Speculative

B

High Default Risk

C

Default

D

Investment
Grade

Speculative

Rating Scale


To measure relative credit risk

Credit Ratings
-

Islamic Instruments

Default…

Failure to perform an obligations laid down in the
agreement


Failure to pay amounts due;




Very strict adherence to covenants (promise)

Brings

Market Discipline

Creates Credit History

13

Credit Ratings
-

Islamic Instruments

Limitations of Sukuk

1.
Enforcement

not ensured (lack of legal precedent)


Interpretation may differences between Shariah and local courts



2.

Register able
asset not always transferred
to SPV:


Due to Foreign ownership


Cumbersome


Expensive

14

Credit Ratings
-

Islamic Instruments

Iranian Sukuk Market

Source: SEO Iran
15


3,096


3,702


962


1,443


5,243


1,571

-
1,000
2,000
3,000
4,000
5,000
6,000
2006
2007
2008
2009
2010
2011
Amount in USD Million

Iran
-

New Sukuk Issuances

Credit Ratings
-

Islamic Instruments

Any

Q & A ???



Thank You!

16