haresham baharum

8/3/2019 Haresham Baharum

1/38

Guidance Financial Group

Establishing a Fund forShariah-compliant Investors :Sharing Our Experience

15th September, 2006


2/38

Introduction to

Guidance FinancialGroup



3/38

Guidance Financial GroupBrunei Islamic Financial Services Forum 15 Sep 2006

3

Capital Guidance

CommercialDistribution

NetworkChemicals

Industrial safetyCeramic tiles

Bathroom

equipmentChina & gift ware

MadisonMarquette

Real estateinvestment,

development,and management

Guidance

FinancialGroup

Shariah-

compliantfinancialservices

FinancialInvestments

Public and privatemarkets

investments

INTRODUCTION TO GUIDANCE FINANCIAL GROUP


4/38


4


Capital

Markets

Structuring andasset-backed

securitisation

Investments

Islamic privateequity, real

estate and fixedincome funds

INTRODUCTION TO GUIDANCE FINANCIAL GROUP

Retail

(MortgageBanking)

Sales,distribution

underwriting,processing


5/38

Developing a

Shariah-compliantFund



6/38


6

Varied Fund Types

Guidance Hotel Investment Company (ShazaHotels Fund)

1st Shariah-compliant private equity fund for Asia

1st Shariah-compliant China residentialdevelopment fund

Development of 1st Shariah-compliant mortgage-backed securities (MBS) fund (a fixed income fund)

GUIDANCE FINANCIAL GROUP: INVESTMENT FUNDS


7/38


7

Developing a Shariah-compliant Fund

Some Pertinent Issues to Consider:

Is there a vacuum in the market?

What do potential investors look for?

Level of Shariah compliance

Distribution: Retail or Institutional?

CREATING A NEW FUND


8/38


8

Developing a Shariah-compliant Fund

Some Pertinent Issues to Consider (contd):

Partnership with Experts

Fund Structure: Quick-to-Market approachesFeeder & Parallel Structures

Investment Assets: Readily available or To beCreated

CREATING A NEW FUND


9/38


Case Study:

Development of theGuidance MBS FixedIncome Fund


10/38


10

Case Study: Development of the Guidance Income Fund

Market Size

In 2005, the size of the US Dollar Fixed Income Market isapproximately $25.3 Trillion.

This is larger than the more widely discussed US Equitiesmarket of about $18.2 Trillion

THE US$ FIXED INCOME MARKET

Equities

$18.2

Trillion

FixedIncome

$25.3

Trillion

U.S. Equity

vs.

Fixed Income Market

Capitalization

Sources: Bond Market Association, The Financial Services Fact Book 2006, NASDAQ, NYSE, Amex


11/38


11

A Very Liquid Market

The US Dollar Fixed Income market is very actively traded: in 2005,$555 billion Treasury and $252 billion Mortgage securities tradeddaily, compared to about $80 billion of stocks traded daily amongstthe three major US equities market.

Offers investors tremendous liquidity.

Source: Bond Market Association

0

100

200

300

400

500

600

2000 2001 2002 2003 2004 2005 Jun-06

$

Billions

MunicipalAgency

Mortgage

Treasury


THE U.S. DOLLAR FIXED INCOME MARKET


12/38


12

THE CASE FOR FIXED INCOME INVESTING

Tactical

Asset

AllocationSecurity

Selection

Strategic

Asset

Allocation

Other

Factors

Sources of Long Term Performance

Source: Brinson, Hood & Beebower. Determinants of Portfolio PerformanceFinancial Analysts Journal. May/June 1991

affect a portfolios long-term performance

Asset Allocation is a Primary Determinant of Long-Term Returns

Fixed Income assets offer investors the ability to achievestability of returns while preserving capital. This makes fixedincome a necessary component of any balanced investmentportfolio.

Studies show that types and size of asset classes significantly



13/38


13


Portfolio Contribution of Fixed-Income Asset Class

Comparison of a Shariah-compliant portfolio with no fixedincome investments vs. an unrestricted portfolio

Asset ClassCash

EquivalentsFixed

IncomeInvestments

WorldEquities

Real Estate

Unrestricted

Portfolio

Restricted

Shariah-CompliantPortfolio



14/38


14


Efficient Frontier Analysis

Fixed-income assets are a core investment for an intermediate riskportfolio - they reduce risk for any given target return.

Note: Analysis performed using Wilshire Associates forecast return data


5%

6%

7%

8%

9%

10%

11%

12%

13%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%

Annual Standard Deviation

AnnualReturn

Cash

Fixed

Income

REITs

Global

Equities

For a given return theconstrained Shariah-

compliantportfolio hasup to 25% more risk

Unrestricted Portfolio

Existing Shariah Portfoliow/o Fixed Income

Individual Assets


15/38


15

0%

10%

20%

30%

40%

50%

60%

70%

80%

6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0% 10.5% 11.0% 11.5% 12.0%

Target Return

0%

10%

20%

30%

40%

Fixed Income Allocation as % of Total PortfolioReduction in Risk by Allocating Fixed Income

Note: Analysis performed using Wilshire Associates forecast return data

Fixed Income Reduces Risk to Achieve a Given Return

Fixed Income Allocation Reduction in Risk




16/38


16

Note: Allocations are percentage of securities and other investment assets excluding cash; Other includes real estate and other marketable assetsSource: The Federal Reserve; FDIC; Wilshire; Pioneering Portfolio Management, Swenson, 2000


Portfolio Allocation of U.S. Institutional Investors


0%

20%

40%

60%

80%

100%

Colleges and

University

Endowments

Private Pension

Funds

Public Pension

Funds

Commercial

Banks

Life/Health

Insurers

Fixed Income Equities Other

Total Fixed

IncomeAllocation 21.5% 22.6% 33.2% 98.1% 83.7%


17/38


17

TYPICAL FIXED INCOME ASSET CLASSES

The Fixed income class comprises various investment types, best

illustrated by examination of the Lehman Aggregate BondIndex.


Asset

Backed

1.6%

Corporate

Bonds

26.1%

U.S.Treasuries

22.5%

Mortgage

Backed

Securities

38.1%

Agencies

11.7%


18/38


18


OneMonth

CD1-3 YearTreasury

IntermediateTreasury

FreddieMac

Mortgage

Corp.InvestGrade

HighYield

30 YearTreasury

AnnualizedMeanReturn

6.24%

2.2%

10.16% 9.08% 8.83%10.05%8.68%7.83%

1.60% 3.82%

3.41%

2.45%

4.91%

0.47% 0.50%

6.17%

0.62%

ReturnAboveCash

3.92% 2.85% 2.59%

13.27%

0.20%

7.17%

0.55%

Volatility 12.77%

AdditionalReturn Per1% of

Volatility

0.22%

Source: Wilshire; Data from 20-year period from 1983-2002. Freddie Mac MBS is used as a benchmark; its performance is comparable to the MBS issued by otheragencies.



19/38


19

THE U.S. AGENCY MORTGAGE-BACKED SECURITIES MARKET

Source: Bond Market Association

MBS: A Large Well-Traded Product

$71$67

$70

$112

$155

$206 $207

$252

0

50

100

150

200

250

300

1998 1999 2000 2001 2002 2003 2004 2005

$Billions

Average Daily Trading Volume of AgencyMBS 1998 - 2005



20/38


20


Source: Financial services Fact Book 2003. Individual sources are Life/heath insurers: AM Best Company; Commercialbanks: FDIC; Savings Institutions: FDIC.Note: Fixed Income Securities includes government, municipal, and corporate bonds and asset backed securities.

13.5%

53.9%

67.7%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Life/Health Insurers Commercial Banks Savings Institutions

MBS as a Proportion of Fixed Income Securities

MBS: A Large Proportion of Fixed Income Investments for

Commercial Banks and Savings Institutions



21/38


21

STATE OF THE SHARIAH-COMPLIANT FIXED INCOME MARKET

Shariah-compliant investors have relatively limited

access to liquid, high credit, fixed-incomeinvestments

Several pioneering emerging-markets sovereign

sukuks issued recently have made some strides tobridge the gap, but some issues persist: Limited liquidity

High volatility of emerging-markets debt

Need for credit diversification Relative scarcity despite recent issues



22/38


22


Agency Securitization of Residential Mortgages

Two main players: Freddie Mac and Fannie Mae (privately-owned Government Sponsored Enterprises, or GSEs)

GSEs purchase residential mortgage loans from primarymortgage lenders across the U.S.

GSEs pool mortgages and issue GSE-guaranteed mortgage-backed securities (MBS).

The market perceives an implicit guarantee of the USgovernment stemming from lines of credit that enable bothentities to borrow directly from the US Treasury.

MBS investors include retail funds, pension funds, insurancecompanies and banks (20% risk weighting under the BasleAccord).



23/38


23


Declining Balance Co-Ownership Program Pioneered the use of diminishing musyarakah structures in residential financing. Organizing world class Shariah Board

Shariah-compliance from A to Z

Three years product development effort 18 law firms addressing legal complexities Freddie Mac and other strategic alliances, to create the first

program to securitize Islamic mortgages in Wall Street.

Covering the full cycle of product development,marketing/sales, processing/underwriting, and secondarymarketing/ securitization

To date, originated and securitized more than US$ 700 million

DECLINING BALANCE CO-OWNERSHIP PROGRAM


24/38


24


ASSETORIGINATION

&

UNDERWRITING

&

CLOSING

CREDITENHANCEMENT

&

SECURITIZATION

WAREHOUSE

PURCHASE

SERVICING /TRUSTEE

PRODUCT

DEVELOPMENT

&

STRATEGICALLIANCES

PORTFOLIOCONSTRUCTION

& ANALYTICS

SUMMARY OF OVERALL PROCESS


25/38


25

ASSETORIGINATION

&

UNDERWRITING

&

CLOSING

CREDITENHANCEMENT

&

SECURITIZATION

WAREHOUSE

PURCHASE

SERVICING /TRUSTEE

PRODUCT

DEVELOPMENT

&

STRATEGICALLIANCES


& ANALYTICS




26/38


26


ASSETORIGINATION

&

UNDERWRITING

&

CLOSING

CREDITENHANCEMENT

&

SECURITIZATION

WAREHOUSE

PURCHASE

SERVICING /TRUSTEE

PRODUCT

DEVELOPMENT

&

STRATEGICALLIANCES


& ANALYTICS


27


27/38


27


ASSETORIGINATION

&

UNDERWRITING

&

CLOSING

CREDITENHANCEMENT

&

SECURITIZATION

WAREHOUSE

PURCHASE

SERVICING /TRUSTEE

PRODUCT

DEVELOPMENT

&

STRATEGICALLIANCES


& ANALYTICS


G id Fi i l G 28


28/38


28


ASSETORIGINATION

&

UNDERWRITING

&

CLOSING

CREDITENHANCEMENT

&

SECURITIZATION

WAREHOUSE

PURCHASE

SERVICING /TRUSTEE

PRODUCT

DEVELOPMENT

&

STRATEGICALLIANCES


& ANALYTICS


G id Fi i l G 29


29/38


29


ASSETORIGINATION

&

UNDERWRITING

&

CLOSING

CREDITENHANCEMENT

&

SECURITIZATION

WAREHOUSE

PURCHASE

SERVICING /TRUSTEE

PRODUCT

DEVELOPMENT

&

STRATEGICALLIANCES


& ANALYTICS


Guidance Financial Group 30


30/38


30

30

AssetOriginator

Guidance

Consumer Single-familyHome Title

Servicing

Rights

Freddie

Mac

FreddieGuaranteed

PC

Guidance

MBS Income

Fund

Investors


ASSET ORIGINATION TO INVESTMENT PROCESS

Beneficial

Co-OwnershipInterests



31/38


31


A challenge to strike an equilibrium between Syariah, legal and

regulatory requirements using creative structuring

Principle challenge arise from the beneficial ownership position thatthe financier takes in the property a position absent in presentmurabahah-based or conventional residential finance products.

Special regulatory rulings or exemptions can play a significant rolein creating an efficient and robust program

WHAT WE LEARNT



32/38


32


Beneficial Ownership

Financier is the beneficial owner of property in an Ijarah model;

Financier is beneficial co-ownerof the property in the Musyarakahmodel that Guidance has adopted;

Syariah percepts dictate that ownership rights and obligations,associated with a typical property-owner, are assigned to financier

Some typical owner obligations include paying for:

insurance certain taxes and assessments structural maintenance and improvements

Exposure to property casualty risks and benefits from insurance and

condemnation proceeds

FINANCING STRUCTURE ISSUES



33/38


33


From Guidances experience, such requirements can be addressed

through creative structuring, creating financing cash flows thatmimic those of conventional loans

Certain residual risks associated with ownership will persist

These are however, immaterial and mostly theoretical and highly

improbable.

Late Payments

Shariah principles strictly prohibit the financier to require an

increase in late payments due Several approaches exist to incentivise consumer to make timely

payments and allow the compensation of servicers for managing latepayments and defaults

FINANCING STRUCTURE ISSUES (CONT D)



34/38

pBrunei Islamic Financial Services Forum 15 Sep 2006


Legal and Regulatory Considerations

Issues that arise from the financiers beneficial ownership position:

Additional transfer taxes, stamp duties at the beginning of theacquisition or refinance transactions

Compared to conventional loans, the personal tax treatment for theconsumer and the corporate tax treatment for the investor ofownership-based financing contracts

Any regulatory restriction on banks, finance companies or Sukuk

issuer relating to real estate ownership Legal status of relationship between the financier and consumer it

has to be that of a financing relationship, and not tenant-landlord

Possibility of foreclosure and perfection of security instrument

FINANCING STRUCTURE ISSUES (CONT D)



35/38

pBrunei Islamic Financial Services Forum 15 Sep 2006


The main challenges arise from the:

Assignment of beneficial ownership through the securitisation chain

Provision of guarantees

SECURITISATION STRUCTURE ISSUES



36/38

Brunei Islamic Financial Services Forum 15 Sep 2006


Assignment of Ownership

Shariah does not permit the securitisation of mere cash flows fromthe financing contracts

Rights and duties of ownership must be assigned as well

This exposes deep-pocketed financial institutions, as beneficialowners, to potential third party liabilities

With assistance from regulatory authorities, Guidance recommendsthe use of a special legal entity acting as the initial owner or co-

owner of the property that is being financed This addresses the management of the ownership liability

SECURITISATION STRUCTURE ISSUES (CONT D)



37/38

Brunei Islamic Financial Services Forum 15 Sep 2006


Issuer Guarantee

The following are key potential issues that need to be addressed in thestructuring of the legal documents:

Shariah prohibits Issuer from being compensated for providing itsguarantee

The object of guarantee is restricted to the consumer debt obligationbut not the consumers promise to acquire the property

The issuers sale of the asset pool to the certificate holder may notbe contingent on the provision of a guarantee

A manager/ administrator of the sukukmay not provide a guaranteeon the underlying payment obligations

Issuer may not be simultaneously a guarantor and investor in thesukuk

SECURITISATION STRUCTURE ISSUES (CONT D)


38/38

Thank You

haresham baharum

Documents