Dr.

Mohammad Mahbubi Ali

ISLAMIC STRUCTURED PRODUCTS: Tazkia Islamic Bussiness School
PRINCIPLES AND PRODUCT STRUCTURING Bogor Indonesia

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 CONTENTS
Introduction
Section 1: An Introduction to Structured Products
Section 2: Islamic Structured Products
Section 3: Islamic SPs: Examples of SPs
Section 4: SPs: Investment vis-à-vis hedging
Section 6: Common Shariah Issues in SPs

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 DEFINITION
 Structured Products is a combination of derivatives and
traditional financial instruments such as stocks and bonds,
which are pooled into a single financial instrument.
 Synthetic Investment instruments specially created to meet
specific needs that cannot be met from the standardized
financial instruments available in the markets.
 The U.S. Securities and Exchange Commission (SEC) defines
structured securities as securities whose characteristics of
cash flow rely upon one or more indices or that have
embedded forwards or options or securities where a return
to the investor and payment obligation of the issuer are
contingent upon, or are highly sensitive to, changes in the
value of underlying assets, indices, interest rates or cash
flows. 3
SP UNDER SC’S GUIDELINES

 Structured product’ means any investment

product that falls within the definition of
‘securities’ under the SCA [Securities Commission
Act] and which derives its value by reference to
the price or value of an underlying reference;
 Underlying reference’ means any security,
index, currency, commodity or other assets or
reference, or combination of such assets or
reference.

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 COMMON FEATURES OF SP
 SP are structured investment products where no resemblance to any
particular asset class, or any standardized financial instruments is to be
found
 It combines two or more financial instruments, one of which is generally a
derivative, to create a single “structured and packaged product
 The returns are linked to the performance of an underlying asset or
benchmark such as interest rates, equity markets, commodities, corporate
credits, foreign exchange markets, real estate or other financial instrument
 Some structured products offer the feature of capital protection of some or
all of the capital if certain conditions are met.
 Some SIPs, besides offering potential returns, also offer hedging mechanisms
like dual currency structured products.

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TYPES OF STRUCTURED PRODUCTS

 Interest rate-linked notes

 Equity-linked notes
 FX and Commodity-linked notes
 Hybrid-linked notes
 Bond Linked Notes
 Index Linked Notes
 Currency Linked Notes
 Commodity (Contracts) Linked Notes
 Credit Linked Notes
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BUILDING BLOCK IN STRUCTURING ISLAMIC SPS

Avoiding the negative list

Observing the necessary requirements and nature of contract used
 At fund raising level: wakalah or mudharabah
 At Activities level: Tawarruq (Commodities Murabahah), purchasing basket of share,
“Islamic option” using wa’ad or urbun, etc
Capital protection, how it is achieved?
 Through portfolio management and balancing
 Third party guarantee
 Subsidiary to subsidiary
 Different branches of International financial institution

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GENERAL STRUCTURES OF ISLAMIC SP

Profit
Initial Proceed
maximasation
proceeds allocation portfolio
Manager (SP
Client
Structurer)

Capital Protected
Investment
Portfolio

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TYPES OF ISLMIC SP
 Equity-linked notes
 Interest rate-linked notes
 FX-linked notes
 Commodity linked notes
 Bond-linked notes

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UNDERLYING CONTRACTS AND MODELS

• Wakalah
At fund • Mudharabah
raising level

• Wa’d
At activities • Urbun
level •
•
Tawarruq
‘Inah
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‘URBUN MODEL

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HSBC AMANAH ISLAMIC EQUITY-LINKED STRUCTURED
INVESTMENT-I

HSBC HK or Paris

Wakalah fi Istithmar
Client HSBC

Islamic Fixed
Income

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ISLAMIC ALL-STARS RESTRICTED MUDHARABAH STRUCTURED
INVESTMENT-I (ISLAMIC ALL-STARS – CIMB ISLAMIC

Index “Islamic All-

Stars
Mudharabah
Muqayadah
Client CIMB

Islamic Debt
Instruments

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WA’D MODEL

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MAYBANK STRUCTURED ISLAMIC DEPOSIT STRIDE-I
Wa’ad to purchase

Copper and
Return on Investment wheat
(if the wa’ad is exercised)

Reference Underlying
Mudharabah
Client Maybank London Metal Exchange (LME)
Copper spot
Chicago Board of Trade
(CBOT) Whaet spot

Capital Protected (100%

NIDC

Investment into NIDC

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WA’DAN MODEL

Cash
ISLAMIC Wa’d (Promise 1) To sell P1 asset
ACCOUNT Index
CLIENT (Shariah or other
compliant reference
Securities) Wa’d (Promise 2) to buy
P1 underlying

Equities

E.g:
1) Deutsche Bank Structured Product
2) LLB Top 20 Middle East Total Return Index (ABN Amro N .V)

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ISLAMIC HEDGING

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PREAMBLE
 Risk is the possibility that the outcome of an event cound be
adversed.
 Hedging is a mechanism to reduce risk.
 Besides investment, SPs are also structured for hedging purposes:
 Islamic Profit Rate Swaps
 Islamic Currency Hedging
 Islamic Option

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FORWARD CURRENCY CONTRACT
A contractually binding agreement between two
parties to sell and buy two different currencies now, at
certain price, but the delivery will be at an agreed
future time.
Elements:
 Binding agreement to sell or buy
 The rate of exchange is fixed when the contract is made. Normally, it
differs from the rate of a spot transaction
 Delivery of the currencies will be made at an agreed future time, either a
specific date or any time between two specific dates, depending on the
contract terms

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ILLUSTRATION ON FORWARD CURRENCY CONTRACT
Example:
 Company ABC signs an agreement to do a forward currency contract with
bank XYZ and the rate will be RM5.20 for EURO1.00.
(Note: Exchange rate for forward contract will differ from the spot value)

 Delivery has been determined to be in three months time

After three months

Dealing date
After two days - Value date
Fixing the rate for (forward contract)
the forward - Spot value date
contract

1 April 2005 3 April 2005 3 July 2005

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CONT’D
 FCC is not allowed because it violates the rule of exchange of currencies,
i.e. spot delivery during the contractual session (qabd al-badalayn fi halat
al-’aqd)
 Alternatively, the mechanism of al-wa’d is used.

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ISLAMIC FORWARD (WA’D)

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ISLAMIC FORWARD (MUWA’ADAH)

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ISLAMIC FORWARD (TAWARRUQ)

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 COMPARISON
FORWARD CURENCY
CONTRACT
The contract is made on the
dealing date (1/4/2005)
This agreement is binding and
enforceable to both parties
Exchange rate is fixed on the
dealing date (1/4//2005)
Delivery is made on the value
date (3/7/2005)
ISLAMIC FORWARD
On the dealing date (1/4/2005), a unilateral
promise is given by one party to do a contract on
3/7/2005, but the real contract will only take place
on the value date (3/7/2005)
Promise given (dealing date) is only binding on
the party who makes the promise
Exchange rate is fixed on the dealing date
(1/4//2005)
The real contract and spot delivery will be made
on the value date (3/7/2005) 25
ISLAMIC OPTION
 ‘Urbun
 Wa’d with fee
 Wa’d and Commodity Murabahah

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SOME SHARIAH ISSUES
 Amalgamation of contracts
 The use of Index
 Islamic Options : wa’ad vis-à-vis urbun
 Two Unilateral Promise vis-à-vis bilateral promise
 The acceptance of tawarruq structure
 The parent gives purchase undertaking to the investors to purchase
back the portfolio at face value.
 Al-wakalah bi al-istithmar vis-à-vis mudharabah

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AMALGAMATION OF CONTRACTS
 In most Structured Products, two or more contracts will be executed
 This gives rise to the issue of amalgamation of contracts
 Differences of opinion on the matter
 Unanimous: Cannot combine sale with loan

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THE USE OF INDEX
How far can we use index in benchmarking the profit
The practice so far:
 Totally conventional index: the underlying and the index are conventional
 The underlying is Islamic, but the index is conventional
 The underlying and the index are Islamic
 More than one indices: Combination of Islamic and conventional

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ISLAMIC OPTIONS : WA’AD VIS-À-VIS
URBUN
Rulings against conventional option
How to replicate conventional option
Wa’ad vis-avis urbun

‘Urbun: Earnest money. A

deposit given to the seller with
a condition that if the contract is continued, it will
be counted in as part of the purchase price, or
otherwise, it will be forfeited by the seller.

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SHARIAH RULING
Fiqh Academy of Jeddah has also allowed
this contract provided that:
1) It is a right given to the buyer to have a
waiting period to rethink about the contract
2) The period must be determined
3) The deposit paid will be considered part of
the purchase price if the buyer decided to
proceed with the contract.
4) If he withdrew, the seller will have the right
to keep the deposit
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 CONT’D

Option ‘Urbun
It is the right to buy or sell It is only the right to buy

The option premium is not part Considered part of the

of the purchase price purchase price if the contract
is later on confirmed
The option contract is tradable ‘Urbun is financial right, but
not tradable, only exercisable
by the option holder.
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OTHER ISSUES

Ownership of the Subject matter during ‘urbun time:

Dividend, if shares
Can we sell on ‘urbun on something which we do not own
Misunderstanding:
“An arboun contract lets the investor to buy an asset at a fixed price at any
point up to the contract's maturity - therefore resembling an options contract.”
Risk Islamic Finance: March 2007
Due to this problem and others, wa’ad has been developed as an alternative to
‘urbun

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 THE ACCEPTANCE OF TAWARRUQ
STRUCTURE
In many structured products, commodity murabahah is widely used to:
 Protect capital
 To benefit from the upside market

Recently, the international Council of Fiqh Academy has condemned and

prohibited the practice of organised tawarruq

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PURCHASE UNDERTAKING BY THE PARENT OR SISTER COMPANY

The Parent gives purchase undertaking to the

investors (represented by the SP manager, which
is its subsidiary or sister company) to purchase
back the portfolio at face value.

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