IIFM and ISDA launch Shariah compliant profit rate swap standard (By IFN)

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GLOBAL: The International Islamic Financial Market (IIFM) and the International Swaps and Derivatives Association (ISDA) have launched standards for profit rate swaps for Shariah compliant hedging; as the growing global business of Islamic financial institutions point to the need to mitigate foreign currency risks.

The new agreement, known as the Mubadalatul Arbaah (MA) standard, follows the ISDA/IIFM Tahawwut (Hedging) Master Agreement launched in March 2010.

“Islamic financial institutions have largely shown resilience in the current difficult financial environment and some are even going through an expansion phase. However, due to the inter-linkages with the global financial system, the balance sheet of Islamic financial institutions are exposed to fluctuations in foreign currency rates and also cash flow mismatches due to fixed and floating reference rates,” said Khalid Hamad, chairman of the IIFM.

The standards allow for the bilateral exchange of profit streams from fixed rate to floating rate, or vice versa.

While some quarters still disagree on the use of hedging under Shariah, it cannot be denied that Islamic banks need an instrument to protect against foreign currency risks. Banking giants such as Abu Dhabi Islamic Bank (ADIB) and Dubai Islamic Bank reported foreign currency exposure on assets worth AED70.68 billion (US$19.24 billion) and AED85.17 billion (US$23.2 billion) for 2011, respectively.

In its financial statements, ADIB also noted that a 5% increase in the US dollar exchange rate would decrease its net profit by AED116.55 million (US$31.2 million) in 2011, against a decline of AED67.41 million (US$18.35 million) in 2010.

The new standard from IIFM and ISDA will provide product schedules based on two separate structures for transacting MA to mitigate cash flow risks. The documentation was developed under the guidance and approval of the IIFM’s Shariah advisory panel, in coordination with Clifford Chance as external legal counsel, as well as other global market participants.