This document discusses challenges around liquidity in Islamic capital markets. It notes that information search costs are high due to the embryonic stage of the industry. There is also a lack of global connectivity as the community is fragmented. This, combined with a lack of structured workflows, leads to a lack of liquidity. The document proposes a screen-based "Global Situation Room" as a solution to bridge the gap between listing and liquidity, and bring about global connectivity and diversification.

1. LIQUIDITY & ISLAMIC CAPITAL MARKETS
MARKETS SALES AND TRADING TREASURY
ISLAMIC FINANCE
SAYD FAROOK, GLOBAL HEAD ISLAMIC CAPITAL MARKETS
01 OCTOBER 2010

2. Challenges in Islamic Capital Markets
Information search cost very high
(Industry : embryonic stage)
+
Lack of Global Connectivity
(community fragmented)
+
Lack of Structured workflow
=
Lack of Liquidity

3. CONCLUSION
FROM LISTING TO LIQUIDITY
GAP: OVER THE COUNTER
SOLUTIONS: SCREEN BASED IF ‘GLOBAL SITUATION ROOM’
CONSEQUENCES
GLOBAL CONNECTIVITY & DIVERSIFICATION

4. AGENDA
• Islamic Treasury & Interbank Markets Focus
• Liquidity Status
• Unique Characteristics of Islamic Capital Markets
• Spurring Liquidity: Key factors and impediments

5. ISLAMIC TREASURY & INTERBANK
MARKETS FOCUS
WHY TREASURY SHOULD BE THE FOCUS
OF ISLAMIC CAPITAL MARKETS
DEVELOPMENT

6. FLOW OF FUNDS
ISLAMIC CAPITAL MARKETS
Islamic finance has attracted investment from institutional investors, but seems to be a
retail driven market thus far given the large asset base of commercial banks
Suppliers of Capital
RETAIL INSTITUTIONAL Financial Intermediary
Awqaf/ Takaful (1%)
$951B
Mass Affluent Endowments 100
Funds (5%)
90
Sukuk (10%)
Sovereign Wealth 80
Investment
Funds 70 Banks (10%)
60
Pension Funds 50
Commercial
40 Banks
30 (74%)
UNHWI/HNWI 20
10
0
Takaful
Treasury remains the
Source: E&Y, The Banker
major sweet spot in terms
of liquidity

7. LIQUIDITY POSITION OF ISLAMIC BANKS
Consistent liquidity surplus: Islamic banks have continued to demonstrate their excess
liquidity before, during and after the global financial crisis, as investors seek a safe
haven, while complying with Shari’a principles.
INTERBANK RATIO NET FINANCING/DEPOSITOR & SHORT TERM FUNDING
Source: Bankscope Source: Bankscope
Liquidity excess flows directly into treasury funds pool, particularly after GFC.

8. FLOW OF FUNDS TO CAPITAL MARKETS

9. LIQUIDITY STATUS
WHERE ARE WE RELATIVE TO WHERE
WE SHOULD BE?

10. WHY IS LIQUIDITY DESIRABLE?
WITHOUT LIQUIDITY:
• Costs are higher
– Issuance & coupons – Higher costs for issuers
– Trading – Higher Brokerage Premiums & Wide Pricing
• Risks are higher
– Perceived Risk of holding instruments
– Mark to Market Calculations & VAR more accurate
• Market inefficient (even with solid primary markets)

11. VOLUMES & LIQUIDITY
IIMM: OVERNIGHT MUDHARABAH VOLUME TRANSACTED THROUGH MONEY MARKET
BROKERS 1996-2010
Recovery from Period of Rapid
Asian Crisis Economic Growth
Monthly Volume (MYR Million)
Overnight Mudarabah Total
Financial Crisis
* USD to MYR: 3.19 (as-on 01/08/10)
Source: IIMM, Oanda

12. POST GFC MARKET CONDITIONS
COMMERCIAL BANKS INVESTMENT BANKS
(ex-Dubai) demonstrating (ex-Qatar) consumed
high liquidity deployable liquidity reserves
EASING CONDITIONS
SPREADS TIGHTENING, PLACEMENTS TO SOLID BANKS
TREASURY
OLD GUARD INCREASING
SUPPORT DEMAND
FUNCTION FOR
REPLACED PERFORMANCE

13. PRIMARY MARKET ISSUANCES &
TIME TO ISSUANCE
Total Issued Corporate
Quasi-Sovereign Change in Total Assets (Top 75 Islamic Banks)
Assets Top 75 Islamic Banks
Top 75 Islamic Bank
80 Sovereign issuances, the bread & Assets in 100blns axis 350
butter of treasury placements, is far
70 from sufficient to relieve demand 300
Required
60 level of
250
issuance
50
USD Blns
200
40
150
30
100
20
10 50
0 0
2005 2006 2007 2008 2009
ISSUANCE PROCESS 2-9 MONTHS
Due to structural complexities and added layer of heterogeneous Shari’a due diligence, sukuk
issuance process can take anywhere between 2 to 9 months

14. MARKET DEPTH
Smaller base of willing secondary market investors
10 Contributors
7 Contributors

15. MATURITY PROFILES
20
Traditional Bonds
18
Islamic Sukuk
16
14
Few USD Eurobond
issuance beyond 5
12 years
Yield
10
8
6
4
2
0
06/07/2009 01/04/2012 27/12/2014 22/09/2017 18/06/2020 15/03/2023 09/12/2025 04/09/2028 01/06/2031 25/02/2034
Maturity

16. UNIQUE CHARACTERISTICS
OF
ISLAMIC TREASURY & INTERBANK
MARKETS

17. LIQUIDITY CHALLENGES
The VALUE of an ASSET is derived from the ABILITY to sell it in a MARKET
SURPLUS OF LIQUIDITY SHORTAGE OF LIQUIDITY
Liquid Inter-Bank Market
Islamic Financial Institutions IFI’s have limited ability to tap
(IFI’s) are generally more liquid short-term funds to meet cashflow
than their conventional peers requirements
Low Returns Lender of Last Resort
Limited short-term investments Most banking failures are due to
(overnight-month), hence IFI’s liquidity shortages. There is a
earn low returns on liquid assets need for a “lender of last resort”
MATURITY MISMATCH/GAP
Long-Term Assets
IFI’s main investments are long-term e.g. sukuk, project finance, real
estate
Short-Term Liabilities
IFI’s main funding is from short-term customer deposits

18. INFRASTRUCTURE CONSTRAINTS
POOR INFRASTRUCTURE
Treasurers complain of the requires that most transactions are
difficulties in executed on
DISCOVERY, EXECUTION & UNRELIABLE & DIFFICULT TO
CONFIRMATION AUDIT TELECOM BASED
SERVICES
RELATIVELY HIGHER
OPERATIONAL RISK,
COSTS & TRANSACTION
PROCESSING TIME
Shy away from
SMALLER TICKET
TRANSACTIONS
UNABLE TO CAPTURE
HIGH VOLUME
small ticket corporate and
SME transactions

19. LOGICAL EVOLUTION OF
ISLAMIC CAPITAL MARKETS
Unique Solutions
• Bespoke transaction
platform
• Multiple instruments
• Global connectivity
• Shari’a compliant process

20. SPURRING LIQUIDITY
KEY FACTORS AND IMPEDIMENTS

21. FACTORS AFFECTING LIQUIDITY
SOVEREIGN
PUBLIC SECTOR
USD & MYR
INITIATIVE
Sovereign Securities
& REPO Facilities CERTAINTY
UNIFORMITY
Clear legislative
Easily classified &
framework and security
understandable instruments
enforcement rules
TRANSPARENCY EFFICIENCY
Price discovery, Seamless
full information transaction execution,
PRIVATE SECTOR
disclosure and dissemination settlement & processing
INITIATIVE
CONNECTIVITY
SIZE
Unified transaction
Invested institutions
platform exploiting
with market making
connectivity
capabilities INSTRUMENTS
Innovative
Asset Backed
Negotiable Instruments

22. LIQUIDITY FACTORS &
TYPICAL TRANSACTION WORKFLOW
INSTRUMENTS CERTAINTY TRANSPARENCY
SIZE
UNIFORMITY TRANSACTION
SOVEREIGN
PLATFORM
BENCHMARK
EFFICIENCY

23. SOVEREIGN SECURITIES
Public Debt and Financing Management Asset and Liability / Liquidity Management
Frequent
Finance Issuance with
yielding various maturities
Sovereign/Quasi assets and tenures
(Shari’a Compliant Assets) Medium Term Note IFI as Investors
infrastructure, (MTN) SPV
receivables, land Offload Establish
non-strategic benchmark
assets yield curve
REPO Facility
Standardised Ijarah/Hybrid
Easier to price
Instruments
Yield curve benchmarking
Frequent issuance and maturities
for riskier instruments
Support exchange between
Diversified distribution buyside & sellside (liquidity)

24. UNIFORMITY
STANDARDISED
DISPUTE
CODIFICATION CAPITAL ISSUANCE
RESOLUTION
OF RULES MARKETS DOCUMENTATION
RULES & FORUM
PRODUCTS
Wakala Ijarah/Hybrid Islamic
Murabaha FX
/Mudaraba Sukuk Commercial Paper
EFFICIENCY CERTAINTY VOLUME
AAOIFI IIFM IICRCA DIFC MIFC

25. CERTAINTY
TRANSPARENT CONSISTENT
Ex-ante Governing Ex-post
Laws & Arbitration Dispute Resolution
CERTAIN
Enforcement
of security

26. FEATURES OF AN IDEAL
ISLAMIC LIQUIDITY MANAGEMENT INSTRUMENT

27. LIQUIDITY MANAGEMENT INSTRUMENTS
Overweight on Murabaha and Wakala
Insufficient
tradable
instruments
Lack of market
makers with
clout
Source: Presenter’s estimates

28. SIZE
Bank name Country Name World Rank World Rank Total Assets Equity th
ASSETS EQUITY th USD USD
2009 2009
Turkiye is Bankasi – ISBANK TURKEY 251 156 86,468,895 10,266,231
Arab Bank Group JORDAN 399 163 50,600,602 8,096,800
Akbank T.A.S. TURKEY 300 168 68,974,073 9,690,355
National Commercial Bank SAUDI ARABIA 302 171 68,653,924 8,229,414
Al Rajhi Bank SAUDI ARABIA 443 178 45,527,923 7,664,240
Emirates NBD PJSC UAE 278 182 76,671,612 8,705,405
Riyad Bank SAUDI ARABIA 425 188 47,039,815 7,529,467
Turkiye Garanti Bankasi A.S. TURKEY 275 199 78,029,708 9,179,556
Maybank MALAYSIA 247 203 88,215,502 7,315,259
Kuwait Finance House KUWAIT 499 213 39,367,852 5,368,898
CHALLENGES SOLUTION
Equity not sufficient for trade desks Islamic banks INCENTIVISED to trade – not HTM
Market clout – ISSUE + TRADE MEGA ISLAMIC BANK (investment grade rating)-
AlBaraka/IsDB?

29. EFFICIENCY – EXECUTION/PROCESSING
Pre-Trade RISK Monitoring
SEAMLESS TRANSACTION EXECUTION AND PROCESSING
News, Data,
Analysis
Get the Realtime Credit Risk Market Risk
prices
Islamic Deal Position /
Capture Risk Management
Automate manual & cost intensive back- Confirmation
office processing generations
Reduce risk for counterparties
AutoPayments
Applies to both interbank and government & Swift Msg
securities markets
Automated Reconciliation
Accounting

30. CONNECTIVITY

31. Challenges in Islamic Capital Markets
Information search cost very high
(Industry : embryonic stage)
+
Lack of Global Connectivity
(community fragmented)
+
Lack of Structured workflow
=
Lack of Liquidity

32. CONCLUSION
FROM LISTING TO LIQUIDITY
GAP: OVER THE COUNTER
SOLUTIONS: SCREEN BASED IF ‘GLOBAL SITUATION ROOM’
CONSEQUENCES
GLOBAL CONNECTIVITY & DIVERSIFICATION