Islamic repo agreements struggle for traction
DUBAI May 10 (Reuters) - Islamic repurchase agreements may struggle to gain wide acceptance as a tool for financial institutions because the industry lacks clear rules governing their use, participants at a major industry conference told Reuters.
Liquidity management products such as Islamic repos were one of the main themes at the annual meeting of the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) in Manama this week.
The shortage of such instruments is becoming increasingly problematic for Islamic finance as the industry grows, bankers and analysts said. By allowing investors to lend out assets for short periods, Islamic repos could help to solve the problem by giving banks a way to balance their short-term liquidity flows with demand.
So many in the industry are keen for AAOIFI, one of the world's top standard-setting bodies in Islamic finance, to set guidelines for how repos should be structured and used.
"Some banks are flush with deposits and they need to manage this liquidity," Srinivasan Gopalakrishnan, assistant vice president at Bahrain-based Al Salam Bank, told Reuters. "A lot of participants want AAOIFI to be more active, and for it to move faster."
Khaled Al Fakih, AAOIFI's secretary general, told Reuters before the meeting: "We would like to see insightful debate on repo and hedging that can help us develop standards that can benefit the industry."
But creating instruments that are widely recognised as obeying Islamic principles is proving particularly difficult in the case of repos, and participants at this week's meeting said there was no conclusive outcome from the discussions.
Five possible methods to create an Islamic repo were outlined in a speech by Yousef Abdullah Al Shubaily, sharia scholar at Dubai-based Minhaj Advisory, but there was no consensus on which should be favoured.
"There was not much depth" in discussions, said Zarizan Ibrahim, sharia manager at Malaysia's CIMB. "More research should be done."
Another delegate said: "They discussed the elements and functions in general...but there were no recommendations."
In conventional repos, an investor borrows an asset for a predetermined period during which he receives income from it. The very phrase "Islamic repo" is controversial among some scholars who fear the instruments might simply replicate conventional financial products without addressing a real economic need.
"Conceptually the benchmark is conventional financial products, and this fundamentally presents an issue for scholars," said Paul McViety, legal director at law firm DLA Piper.
Religious principles look likely to constrain the use of Islamic repos. Calculating margin calls on repos may be problematic since it can be seen as using an implicit interest rate. Trading the assets behind repos with third parties could be disallowed by some scholars because of Islam's ban on pure monetary speculation; this makes Islamic repos less attractive economically.
Another issue is the practice of netting, which allows firms to effectively cancel positions within their trading books by setting them off against each other. Netting is not recognised by regulators in many Gulf countries where Islamic repos might be conducted, according to a report by Bahrain-based International Islamic Financial Market.
Zainal Abidin Mohamed, head of business banking at Malaysia-based AmIslamic Bank, said such issues needed to be addressed head-on.
"If we want to make Islamic banking more international, we need more time to discuss these," he said on the sidelines of the conference.
A hedging master agreement was launched by the IIFM and the International Swaps and Derivatives Association in March 2010, and could help to provide a basis for Islamic repo deals.
But the agreement has not yet gained full, global acceptance and in practice banks have used the template as a reference document, making modifications of their own. This has generated variations in contracts that have increased uncertainty and may be slowing the development of the Islamic repo market.
Nevertheless, market demand is pushing institutions to introduce the instrument. Last August National Bank of Abu Dhabi and Abu Dhabi Islamic Bank executed what they described as the Gulf's first sharia-compliant repo transaction, a one-week maturity deal that was valued at $20 million and was backed by Malaysian and Abu Dhabi government-related sukuk.
They used a collateralised murabaha model for the repo, a common cost-plus arrangement in Islamic finance.
Since then, NBAD has done several other Islamic repo deals, including a $100 million transaction, said Mark Pritchard, vice president and head of Islamic institutional coverage at NBAD's financial markets division.
The deals, including weekly and monthly tenors, have been done with United Arab Emirates and Bahrain counterparties, said Pritchard, adding that his bank hoped to expand the transactions to another Gulf country, which he did not name.
He also said NBAD was looking at potential alternatives to the murabaha model for Islamic repos.
Even if the industry agrees on common standards for repos, past experience with other Islamic hedging products suggests it might take two to three years for an active market to develop, according to Ijlal Ahmed Alvi, chief executive of IIFM.
Some industry participants think the market needs a clearinghouse which would alleviate concerns such as counterparty risk and legal enforceability of contracts. Setting up such a clearinghouse, however, was not discussed in detail at the AAOIFI meeting, and it is not clear who would take responsibility for it. (Editing by Andrew Torchia)