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Islamic Banking Need for Innovation in
Capital Markets and Product Design Alpen
Capital Bank Sarasin Alpen
Investment Banking
Private Banking SANJAY
VIG MANAGING DIRECTOR / MEMBER-ADVISORY
BOARD June 2008
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Presentation Outline

• Islamic Finance History
• Islamic Market Outlook
• Challenges in Islamic Finance
• Desired Innovations in Islamic Finance
• Key Areas for Product Innovation

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Islamic Finance - History

• Started in Egypt in 1963, on a low key
• Took the form of a savings bank based on
  profit-sharing
• Neither charged nor paid interest, invested
  mostly by engaging in trade and industry,
  directly or in partnership with others, and
  shared the profits with their depositors
• In the 70s, realization / emerging need to
  establish Islamic financial institutions
• Local Islamic banks formed in Dubai, Pakistan and
  Malaysia
• In the 80s and 90s Islamic banks quickly
  evolved to provide short term credit facilities
  by using the Murahaba structure
• 2000s saw a reverse flight of capital,
  particularly due to hostile western
  jurisdictions, and reinvestment within the region
• Increased demand for Islamic products Islamic
  finance available for longer tenor project
  finance
• Sukuk became popular and accepted as an
  investment by conventional banks
• Pace of new products picked up significantly
  between 2004 2007
• Musharaka, Mudaraba, Murabaha Reverse Murabaha,
  Islamic RMBS, CMBS, Ijara, Wakala, Musawama,
  Aarboun

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Islamic Market Outlook continues to be positive

• Increasing demand for Sharia-compliant financial
  products and services has lead to strong growth
  for the Islamic banking industry
• USD500 billion of Sharia-compliant assets
  worldwide
• Sharia-compliant assets have grown by 10 pa over
  the past 10 years
• Islamic banks market share 17 in the GCC
• Global Sukuk issuance, currently estimated at
  USD70 billion, is set to exceed USD100 billion by
  2010
• Outlook for structured finance is positive,
  although volumes still are quite low
• Listed Sukuk on the DIFX doubled to USD16 billion
  at the end of 2007, up from USD8 billion in 2006
• The largest Sukuk listed on the DIFX are those of
  government related entities DP World, DIFC and
  Jebel Ali Free Zone

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Continued growth expected in the GCC
Islamic banking assets by market ( Bn)

2010
2005
CAGR
24
33
21
33
25
25
Islamic share (by 2010)
52
24
NA
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Key driver
Overall market growth and conversion of
conventional bank
Expansion of Islamic banks
KFH Boubyan Bank
Strong government support
Conventional certain Islamic Banks offering
Islamic products
Government support, foreign Islamic entrant and
industry development
Source Internal Research
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GCC Islamic Index Market Performance
Global GCC Islamic Index in comparison with
equity Indices

Out-performance by Islamic index indicates strong
interest in Islamic assets
Conversion into Islamic presents an opportunity
for shareholder value creation
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Challenges in Islamic Finance

• Need for uniformity in Sharia-compliant financial
  code
• Restrictions in some jurisdictions on
  externalization of ownership of assets ? Issue
  true sale of assets to SPVs costs incurred
  therein are substantial
• Sharia currently restricts opportunities for
  financial derivatives and hedging, making
  synthetic securitization structures more
  difficult to implement
• More complex legal structures and consequently
  higher advisory fees
• Monitoring corporates on an ongoing basis to
  determine their adherence to Sharia principles
• Investors generally demand higher returns to
  compensate for relative illiquidity, smaller size
  and lack of proven legal and bankruptcy systems
• Developing a risk-return benchmark (reference
  rate) not necessarily associated to LIBOR
• Islamic Finance principle of pro-rata risk
  sharing makes tranching of debt challenging, and
  may therefore prevent full-scale securitizations

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Innovation Why is it necessary?
Innovation
New concept / Replication
Research
Client need
Final Product

• Bridge gap between products on offer in the
  market and client needs
• Provide customers with a wider range of products
  to manage funding, liquidity and risk management
  needs
• Sustain growth in Islamic Banking

Key to the further enhancement of Middle East
Capital Markets
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Desired Innovations in Islamic Finance

• Uniformity of acceptance
• A consistent ruling of Islamic law on the
  religious compliance of assets and transaction
  structures is yet to emerge. Sharia boards from
  different Islamic financial institutions may have
  different interpretations and advice
• A unified Sharia board at a national /
  international level is necessary to encourage the
  development of new Islamic finance instruments as
  it gives wider geographic acceptance and
  diversity of / to investors
• Uniformity should lead to lower legal and
  structuring costs
• Wider geographic spread diversification of
  issuer, investor bank portfolio base
• Need to tap different markets to expand its
  reach. There are several emerging markets (e.g.
  India, Pakistan and Indonesia) with a tremendous
  potential for Islamic Banking
• A strong legal framework enforceable system
  would encourage a wider acceptability and
  distribution network across Non Islamic markets
• Will allow Islamic banks to diversify their
  portfolios beyond their home markets, thereby
  reducing portfolio risk

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Desired Innovations in Islamic Finance

• Increased sophistication and faster turnaround to
  launch new products
• Focus on a constant need to establish new
  products, meeting diverse customer needs. Need
  for bankers to continuously brainstorm with
  Sharia scholars to foster innovation and enable
  launch of new products.
• Increased secondary market trading
• The secondary market trading in Sukuk / other
  instruments is still at a nascent stage. A proper
  secondary pricing model, acceptable to Sharia
  needs to be developed
• Credit quality of banks issuers need to be
  standardised
• Ratings of Islamic banks and Islamic paper is a
  strong step in this regard
• Credit quality of Islamic financial institutions
  on an upward trend
• Sophistication of products towards expanding the
  Islamic Finance reach

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Key Areas for Product Innovation

• Sukuk
• Growing number of countries are considering
  tapping the Sukuk market to diversify their
  investor base and deepen domestic capital markets
• Diversity Market increasing moving from the
  lease and lease back Sukuk structures of first
  generation towards Sukuk based on co-ownership
  contracts (Musharaka Sukuk) or management
  agreement (Wakala Sukuk or Investment Agency
  Sukuk)
• Listing Need for a global Sukuk market where
  securities are listed on international exchanges
  such as London, Dubai, Singapore, Hong Kong, New
  York or Paris
• Securitization Structuring Structuring of
  Sukuk in the future is expected to incrementally
  move towards more complex Sharia compliant
  securitizations.
• Liquidity A more liquid market, enabling
  transparent and efficient secondary pricing of
  Islamic Sukuks, will encourage greater
  disintermediation

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Sukuks A significant development in Islamic
Banking
International Sukuk Issuance (20012007)
Corporate and Sovereign Sukuk Issuance

Leader issuance volume
Substantial growth opportunities in nonGCC,
Islamic markets
Source Bloomberg
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Key Areas for Product Innovation

• Islamic Funds
• Expanded at a CAGR of 22 over the past 5 years
• MENA and Asia Pacific account for 65 of global
  Islamic funds
• However, penetration of these funds in the GCC is
  still minimal, accounting for only 1 of GDP
• Need for Retail investors to commence tapping the
  Sukuk as an investment asset
• Limited stock of Islamic securities restricts
  diversity
• Private Equity
• Gaining momentum. Venture Capital and Private
  Equity are ideal Islamic compliant investment
  structures
• Acquisition finance as a structure has to gain
  popularity and acceptability

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Key Areas for Product Innovation

• Takaful
• Premiums reached nearly USD 2.5 billion in 2007
  and are expected to reach USD 7.5 billion by 2015
• Malaysia accounts for 90 of customers worldwide
• The recent boom in real estate and infrastructure
  related projects in the GCC has created
  substantial demand for mortgage protection
  products and home owners Takaful plans
• Need to continuously develop new products and
  complexities towards meeting the increased demand
• Infrastructure and Project Finance
• Islamic financing structures are increasingly
  used USD 167 billion estimated in
  infrastructural related projects in the coming
  years
• New legal frameworks, establishment of financial
  free-zones will encourage foreign banks
  participation in infrastructure and project
  finance.
• Islamic banks should develop advisory activities
  towards ensuring preference for Islamic financing
  instruments

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Key Areas for Product Innovation

• Islamic REITS
• Malaysia is currently a leading IREITS issuance
  market
• The real estate boom in the Middle East will lead
  to increased demand for IREITS. DIFC and CBB
  issued new regulations related to issuance and
  listing of Islamic trusts
• IREITS not established in China and India,
  however, demand could be significant in the
  future
• SEBI issued draft IREIT guidelines in December
  2007
• Structured Finance
• New legal frameworks encouraging securitization
• Financial free zones DIFC, QFC strong legal
  framework based on European, US and Far Eastern
  models, increasing acceptability of Islamic
  structures governed by these regulations
• Relaxation of foreign ownership restrictions for
  property in the Middle East, increasing
  possibilities of securitization

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Key Areas for Product Innovation

• Private Banking
• Tremendous opportunity within private banking led
  by increase in global wealth
• HNWI wealth grew to USD 37 trillion expected to
  reach USD 51 trillion in 2011
• Dow Jones Islamic Index is a strong tool to allow
  diversification of risk across geographies and
  industries
• Islamic banking assets grew three times faster
  than conventional banking assts over the last 5
  years
• Increasing demand for Sharia-compliant products

Source World Wealth Report Cap Gemini, Ernst
Young
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Key Areas for Product Innovation

• Hedging
• Limited availability of hedging products due to
  uncertainty over legitimacy of purpose
  compliance with Sharia
• Some Sharia compliant hedging tools currently
  being introduced include
• Profit Rate Hedging
• Foreign Exchange Hedging
• More sophisticated risk mitigation strategies
  relating to funding costs and anticipated returns
  required

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Country Overview GCC

• UAE
• Witnessed a record growth in Sukuk transactions
  in 2007 with issuance reaching USD 11.1 billion
• Outlook continues to be positive - Khalifa Port
  Industrial Zone USD 10 billion major
  financing will be in the form of a Sukuk
• Islamic private equity funds are expected to
  witness noticeable development
• Bahrain
• Hub of Islamic finance - Many local Islamic
  investment banks
• Central Bank of Bahrain (CBB) amongst the first
  of the worlds Islamic financial regulators
• Increasing issuance of Islamic Sukuks though
  primarily Sovereign / Real Estate
• Saudi Arabia
• Record issuance in 2007 fuelled by increasing
  funding needs of local companies, strong appetite
  from originators and investors and soundness of
  the economy supported by record oil prices
• Growth of Islamic finance products such as
  Takaful and Islamic funds

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Country Overview GCC

• Kuwait
• A market keen to move towards Sukuk and IREITS
• Host of Islamic Investment companies
• 2007 was a landmark year for Sukuk in Kuwait,
  issuance of first Islamic compliant security by
  NIGSL
• Qatar
• Infrastructure related Sukuk to be launched in
  2008
• USD 70 billion needed to finance energy and
  telecoms sectors in the next few years
• Oman
• Does not currently allow Islamic banking
• Corporates are keen to explore the opportunity

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Country Overview International

• Malaysia
• Remains the biggest global Sukuk market
• Banks intend to use Sukuk to develop Islamic
  banking operations
• Islamic finance to account for 20 of banking
  assets by 2010
• Africa
• Huge market potential home to approximately 400
  million Muslim population
• Sudan has a growing number of Islamic banks
  throughout the country Egypt founder of
  Islamic Banking and the biggest Muslim country in
  the MENA region, many new Islamic banks, mainly
  from the GCC region, branching out into the
  country
• Pakistan Indonesia
• Currently small market but potential for
  significant growth over the next few years
• FarEast
• Singapore and Hong Kong stepping up their Islamic
  finance efforts
• Hong Kong to serve as a funding platform for
  China

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Alpen Capital
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Overview

• A leading investment bank providing financial
  solutions to institutional and corporate clients
  across GCC and South Asia
• Alpen Capital provides an array of investment
  banking services by combining the disciplines of
  strategy, organization and leadership
• Alpen Capital has its offices at the following
  locations
• Dubai Dubai International Financial Centre
  DIFC
• Doha Qatar Financial Centre Tower
• Muscat
• Mumbai

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Our Associate Bank Sarasin - Alpen

• Bank Sarasin-Alpen (ME) Limited, based in UAE,
  provides tailor-made Swiss private banking
  solutions and is a subsidiary of Bank Sarasin
  Co. Ltd., based in Switzerland
• Rabobank, which enjoys the highest qualification
  of credit status - AAA rating from prominent
  international rating agencies, is the majority
  shareholder of Bank Sarasin

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Key Islamic Finance Transactions

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Contact Details

• Alpen Capital (ME) Limited
• Bank Sarasin Alpen (ME) Limited
• Regulated by Dubai Financial Services Authority
• Gate Precinct 5, 4th Floor,
• Dubai International Financial Centre
• P.O. Box 121806, Dubai, U.A.E.
• Tel [phone]
• Fax [phone]
• Alpen Capital, LLC Sultanate of Oman
• Regulated by Capital Markets Authority - Oman
• Alpen Capital Investment Bank (Qatar) LLC Qatar
• Bank Sarasin Alpen Qatar, LLC
• Regulated by Qatar Financial Centre Regulatory
  Authority