Risk Management, PRMIA

As a background, it may be mentioned for the uninitiated in the concepts, Islamic financial products need to comply with Shariah laws that prohibits accepting or paying interest. Interest payment , known as Riba or "extra" is forbidded in Islam. Accordingly, Islamic products are based on participAtion in financial ventures. Financial debt is thus avoided. the market for Islamic products, though growing through rapid expansion, are less structured and formalised that conventional financial markets. The market has less legal support and lacks money markets and secondary markets , thereby differentiating its risk profile from conventional markets.

Sukuk is the counterpart of conventional asset backed securities , a type of bond backed by assets.It is a certificate used by the beneficiary to collect funds and entitling, in the process, rights in certain assets. The risk and return in Sukuks thus are linked ton the assets generated from such liabilities. Thus, Sukuks can be Musharakah Sukuks, Ijara Sukuks, Istisna Sukuks and so on. Maturity profile may vary just like bonds, though most Sukuks till date are below 5 year horizon.

While the Sukuk market is growing at a rapid pace reaching total issuance of over USD 30 bn in 2007, there are several challanges faced in the market today.

1. Legal clarity is still an issue , particularly in early termination and default
2. Regulation in the capital market is evolving in many countries making cross border operations difficult.
3. The secondary market is almost non-existent, and coupled with lack of money markets, this heightens liquidity risk.
4. Repo regulations are in formative stages
5.There is absense of central counterparty and multilateral netting
6.Risk management is evolving in Islamic Banks and consequently Sukuks have not been subjected to stress scenarios.
7. Lack of maturity in the market leads to higher costs and difficulty in pricing products in a meaningful manner.
8. The demand for human resources with appropriate skillset far outnumbers supplies.
9. The interface between conventional and Islamic markets are still not well developed
10. Several taxation and valuation issues are yet to be sorted out.

Despite these constraints, the growth prospects of the middle east, the elevated level of oil prices and heighted global interest in Islamic finance is likely to result in strong expansion in the Sukuk markets in the near future. Products and Regulations will get standardised, growth in secondary market will provide more liquidity, risk management practices ( particularly modeling of risks) will improve and regulatory clarity and convergence will see greater cross border growth in this type of asset backed securities in the global financial marketplace.