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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.

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.


Regulatory Approval

Standard Chartered started offering its commodities-based contracts in the Persian Gulf in March as the International Islamic Financial Market, a Manama, Bahrain-based agency that sets guidelines, provided standardized legal documentation for Shariah derivatives the same month. The U.K. bank will be the first to provide the products in Malaysia and is awaiting regulatory approval, according to the e-mail.

Islamic contracts can’t be traded or used as a speculative investment under Shariah law, said Aznan Hasan, assistant professor at the Kuala Lumpur-based International Islamic University of Malaysia, in an interview on Dec. 20. Standard Chartered’s products are vetted by a Shariah panel of experts to ensure compliance and that they are backed by a real underlying asset, Syed Alwi said.

“Customers need hedging instruments; if you have a customer who needs to make payment in the future for properties the company bought overseas, they have to hedge their currency,” said Aznan, who sits on several advisory boards including the one at Malaysia’s central bank.


Asia-Pacific Market

The Asia Pacific overtook North America as the biggest market for derivatives in the six months through June and accounted for 38 percent of the global total, according to data from the Washington-based Futures Industry Association published in September. That compares with North America’s 33 percent market share.

CIMB Islamic, the world’s top sukuk arranger this year, is “exploring” Shariah-compliant credit-default swaps to complement the bank’s Islamic profit-rate swaps, cross-currency swaps and cross currency profit-rate swaps, Badlisyah said.

“It’s still very early days for the market but we’ve been receiving interest for our derivatives products from institutional investors as well as companies who need to hedge their positions,” Badlisyah said. “Without effective risk management, Islamic financial institutions cannot grow in a stable and aggressive manner.”


Sukuk Returns

Malaysia, the Asian hub for Shariah-compliant finance, accounts for more than 50 per cent 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 per cent to $15.3 billion this year.

Shariah-compliant bonds returned 12.4 per cent in 2010, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. Debt in developing markets gained 11.7 per cent, 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 per cent Islamic notes due June 2015 rose two basis points to 3.10 per cent today, according to prices from Royal Bank of Scotland Group Plc. The debt has returned 5.8 per cent since it was issued in June.

The difference in yield between the Dubai Department of Finance’s 6.396 per cent 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 per cent 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.” - Bloomberg

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