inceif_18 nov 2015_presentation slides

P R O F E S S I O N A L • R E S P E C T • I N T E G R I T Y • D Y N A M I C • E X C E L L E N C E

S T R I C T L Y P R I V A T E & C O N F I D E N T I A L

Managing Risks in Sukuk Industry

Presenter: Nik Ahmad Zaki Nik Abdullah

RHB Bank

18 November 2015

Risk Management Symposium

BNP Paribas – INCEIF Centre for Islamic Wealth Management

Lanai Kijang, Bank Negara Malaysia

1 STRICTLY PRIVATE & CONFIDENTIAL

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Overview

• Who are the market participants in the industry and their relationships

• What are the major risks involved in investing into sukuk and how it affects sukuk market in current local market and global market situations

• How are these risks addressed and managed respectively by practitioners

• Challenges in Sukuk Capital Market

• Liquidity Risks

• Hedging Instruments for Interest Rates , Credit and FX

• Conclusion and Q&A


Sukuk Capital Market Relationships

Govt / GLCs Corporation

Banks

Non-Bank FI

Fixed Income / Sukuk

Syndicate

Funds Management Insurance companies

Banks

Retirement Funds

Retail Investors / Private Bankers

Issuers Investors

Takaful companies Foreign Issuers

Foreign Investors

Corporation


Potential in Regional Sukuk Market ( e.g. Indonesia , Thailand)

•Malaysian Government and Corporate Bond/ Sukuk markets have developed strongly with quite large relative to GDP today

•However, in other regional markets such as Indonesia and Thailand, there are still growth potential relative to Malaysia

•We expect regional Sukuk Market to be developed going forwards in the future


What are the risks involved?

Global Sukuk

Market Risks

Interest rate risk

FX Risk / Market

Risk

Other Related

Risk Credit Risk

Liquidity Risk


Liquidity Risk

A market which is liquid, when price the buyer offers and the price the seller is willing to accept will be fairly close to each other. Investors, then, will not have to give up unrealised gains for a quick sale. When the bid offer prices grows, then the market becomes illiquid. For example, in a buyer’s market , buyers will tend to demand steep discounts from sellers

Large price movements may also accompanied from any buying/selling activity especially to the downside.

Interest Rate Risk

The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship

Interest rate risk affects the value of sukuk and it is a major risk to all sukuk holders. As interest rates rise, sukuk prices fall and vice versa.

Credit Risk / Default Risk

The risk of loss of principal or loss of a financial reward stemming from a Issuer’s failure to repay a sukuk or meet a contractual obligation.

Credit risk arises whenever a Issuer is expecting to use future cashflows to pay current sukuk obligation.

Credit risk is closely tied to the potential return of an investment, the most notable being that the yields on sukuk correlate strongly to their perceived credit risk.

FX Risk / Market Risk

The risk of an investment's value changing due to changes in currency exchange rates due to an adverse movements in exchange rates.

It can also affect investors making international investments. For example, if money must be converted to another currency to make a certain investment, then any changes in the currency exchange rate will cause that investment's value to either decrease or increase when the investment is sold and converted back into the original currency.

Definition of the risks involved


Risk #1 – Liquidity Risk Diverging Monetary Policies Across the Globe driving the Technicals


Risk #1 – Liquidity Risk Emerging Markets Suffer Funds Outflows for Three Consecutive Months Since July 2015

Source: EPFR


Risk #1 – Liquidity Risk Local Market Liquidity have been affected as well…


Managing Liquidity Risks, Challenges and Outlook

Managing the wide bid offer spread / prices via:-

Selecting Sukuk with benchmark Issue Size

Analyse the bid offer during high and low volatility situation

Monitor the rotational play and flight to quality between DM and EM, IG vs. HY

Repurchase agreement / facility for the Sukuk

Analyse the inherent technicals characteristics of the Issuance ( Demand vs Supply, Maturities & Redemptions)

Analyse the Bid to Cover Ratio on recent Primary Issuances

Banks and JLA/JLMs have to be prepared with Market Clearing levels for Primary Issuances to avoid Execution risks

Challenges in 2015 and Outlook

The challenging market will continue until tightening phase in the future by US Fed and other Central Banks shows any signs of easing on its monetary policies.

Challenges in developing standardised Liquidity framework for Islamic Banks and Takaful Companies

Challenges in Basel III and Liquidity Coverage Ratio from banks investment standpoint for Sukuk with non conventional Islamic structures such as Mudharabah and Musyarakah which may affects its liquidity and returns payoff structures


Risk #2 – Interest Rate Risk

•Malaysian Corporate Bond/Sukuk market serves investors and corporate issuers well with good levels of liquidity

•Except when Interest Rates are rising or there is fear of rates rising

•Characterized by selling of existing of existing bond holdings, unwillingness to buy new bonds/sukuk and mark-to-market lossess fuelling redemptions and liquidating in a difficult selling environment

•In general, bid offer spreads widen significantly and liquidity declines markedly

•We have experienced long low interest rates environment since 1998 and this might change in the future


Risk #2 – Interest Rate Risk & Inflation Risk Inflation moderated , but OPR to Stay Put this Year

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• Inflation moderated in September on lower fuel prices. CPI slowed down to 2.6% in Sept 15, from 3.1% in August 15 and 3.3% in July 15, driven by decline in transportation costs following the cut in retail prices in Sept

• OPR likely to remain stable for the rest of 2015 and into 2016 at 3.25%.

RHBRI Forecast

2013 2014 2015E 2016F

OPR 3.00% 3.25% 3.25% 3.25%

CPI 2.10% 3.40% 2.30% 2.70%

GDP 4.70% 5.80% 4.80% 4.50%

Deficit 3.9% 3.5% 3.20% 3.10%

USDMYR 3.28 3.50 4.30 4.30


Risk #2 – Interest Rate Risk FFR Expectations from US Fed Members ; providing guidance to the market

“Dot Plot” of Fed Members’ Expectation of Fed Funds Rate Over 2015-2017 and Beyond

Source: September 16-17 2015 FOMC minutes, RHBFIC


Risk #2 – Interest Rate Risk

Key Central Banks Monetary Policies Meetings in Nov – Dec 2015

Source: September 16-17 2015 FOMC minutes, RHBFIC


Managing Interest Rate Risks, Challenges and Outlook

Managing the Interest Rate Risk via:-

Selecting Duration play for investment portfolios

Hedging instruments via Islamic Profit Rate Swap


Standardizations of documents across various jurisdictions

Based on recent briefings organised by BNM and Financial Markets Association of Malaysia (PPKM), we expect more players to participate in Profit Rate Swap to hedge Interest Rate Risk


Risk #3 – FX Risk Ringgit Weakness Derived from Global and Domestic Risks

July-14 - now: Oil price plunged

Jan-June 2015:

Rating downgrade

1MDB debts

July-15 - now: Political uncertainties Declining FX Reserves

Euro debt crisis

August-15 - now: Fed hike

CNY slowdown Foreign outflows


Risk #3 – FX Risk Dollar Index to strengthen further as anticipation of US Fed to hike…

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Dollar Index


Managing FX Risks, Challenges and Outlook

Managing the FX Risks via:-

Hedging instruments via Islamic FX Forwards and Islamic Cross Currency Swaps (ICCS) – managing both Interest Rate and FX Risks



Islamic Collateral Support Annex (CSA) has not been fully developed and adopted by market participants


Risk #4 – Credit Risk Sovereign CDS may have bottomed in 2014


Risk #4 – Credit Risk Some Sovereign CDS exhibit rising credit risk with recent downgrades


Risk #4 – Credit Risk Appetite for DM Assets versus EM Assets driving the Asset Allocation , IG versus HY and Moving up the Credit Curve


Risk #4 – Credit Risk Average Credit Spreads remain stable while Upgrade/Downgrade Ratio declines YTD 2015


Managing Credit Rate Risks, Challenges and Outlook

Managing the Credit Risk of specific Issuer via:-

Active monitoring / assessment of Issuer ability to repay, Issuer’s collateral assets, revenue and cashflow generating ability

Active Rating Agencies Rating reviews on Issuers and general Sectors Calls and Upgrade/ Downgrade Ratio and Trends

There have yet to have a Islamic Hedging instruments for Credit Risks. Sitting ducks with no headging instruments

Monitor Single Issuer CDS level as proxy on Credit Risk measurement



Based on recent briefings organised by BNM and Financial Markets Association of Malaysia (PPKM), we expect more players to participate in Profit Rate Swap to hedge Interest Rate Risk

Moving forward, market players to quote corporate bond/ sukuk based on credit spreads over prevailing MGS/ GII instruments before embarking to Islamic Single Issuer CDS ( if any)

May suggest Islamic Credit Hedging Agency or further development in Re Takaful / Re Insurance

Banks can free up its capital and lend to SME Businesses


Page | 23

Q & A


Page | 25


Page | 26

Appendices


Summary of Macro Headline Risk Key Drivers and Risks to Malaysia Sukuk Capital Market

Declining FX

Reserves

USD94.7bn (7.3m

import, 1.0x ST debt)

Rising inflation

+3.3% in July (June:

+2.5%, May +2.1%) China slowing

growth: Stimulus

and CNY

devaluation

Political

Uncertainties

Fed Hike Delay

Attractive Carry

Relatively Sound

Fundamental

Low external debt

Decent economic

growth

Improving fiscal

Asset quality

US Fed Rate Hike

High borrowings

Govt 57% of GDP

Hsehold 87% of GDP Low commodities

prices

Oil Price Recovery Fund outflows

Weak currency

performance

inceif_18 nov 2015_presentation slides

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