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Credit Ratings - Islamic Instruments The Pakistan Credit Rating Agency PACRA Credit Ratings For Islamic Instruments May 0712 1 ADNAN AFAQ MD PACRA.

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Presentation on theme: "Credit Ratings - Islamic Instruments The Pakistan Credit Rating Agency PACRA Credit Ratings For Islamic Instruments May 0712 1 ADNAN AFAQ MD PACRA."— Presentation transcript:

1 Credit Ratings - Islamic Instruments The Pakistan Credit Rating Agency PACRA Credit Ratings For Islamic Instruments May ADNAN AFAQ MD PACRA

2 Credit Ratings - Islamic Instruments About PACRA 1. PACRA, Pakistans 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

3 Credit Ratings - Islamic Instruments Development of Credit Ratings Coverage of rating agencies (~ 90% of World GDP) 3

4 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 Whenever Public Money is invested Disclosure of Risk & Return is imperative Disclosure of Risk & Return is imperative 1.Risk & Return Correlation 2.Transparency: Independent view of risk

5 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

6 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

7 Credit Ratings - Islamic Instruments World Sukuk Markets Total Sukuk Size: $215 b outstanding Source: 7www.zawya.com

8 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 Ladin 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

9 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 IjaraIstisnaaMurabahaMudarabaMusharaka 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

10 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 = originators 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

11 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

12 Credit Ratings - Islamic Instruments Credit Ratings – An Introduction 12 Credit QualityRating Category Exceptionally StrongAAA Very StrongAA StrongA AdequateBBB SpeculativeBB Highly SpeculativeB High Default RiskC DefaultD Investment Grade Speculative Rating Scale – To measure relative credit risk

13 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

14 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

15 Credit Ratings - Islamic Instruments Iranian Sukuk Market Source: SEO Iran 15

16 Credit Ratings - Islamic Instruments Any Q & A ??? Thank You! 16


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