ISLAMIC

CAPITAL MARKET

Mahyuddin Khalid
OUTLINE

u DEFINITION OF STRUCTURED INVESTMENT PRODUCT

u ISLAMIC STRUCTURED INVESTMENT PRODUCTS (SIPs)
u STRUCTURING ISLAMIC SIPs
u PRINCIPLES IN STRUCTURING ISLAMIC SIPs
u TYPES OF ISLAMIC SIPs
u UNDERLYING CONTRACT AND MODEL OF ISLAMIC SIPs

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 DEFINITION OF STRUCTURED INVESTMENT PRODUCT

u Investment instrument especially created to meet

specific needs that cannot be met by standardised
financial instruments available in the market

u The U.S. Securities and Exchange Commission

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.
This Photo by Unknown Author is licensed under CC BY-NC-ND

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DEFINITION OF STRUCTURED INVESTMENT PRODUCT

u Securities Commission Malaysia (SC Malaysia) in its

definition of SIPs, specifically when defining the
underlying reference in its Guidelines on the Offering
of Structured Products (2007):

‘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;
This Photo by Unknown Author is
licensed under CC BY-SA

‘underlying reference’ means any security, index, currency,

commodity or other assets or reference, or combination of
such assets or reference
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DEFINITION OF STRUCTURED INVESTMENT PRODUCT

u generally, a pre-packaged investment

strategy which is based on derivatives (ie.
options etc) but which features protection
of principal

u The two common elements in a

Structured Product are:
–1. A bond product or another element of
capital safeguard.
–2. An alpha generator –which is any financial
instrument (i.e. a stock, currency, etc.) SOURCES : Khairuddin Zakaria, SIDC

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 FEATURE OF COMMON SIPs

SIPs are structured investment
products that have no resemblance
to any particular asset class or any
standardised financial instruments.
SIPs combine two or more financial
instruments, one of which is
generally in the form of a derivative,
to create a single ‘structured and
packaged product’. In other words,
SIPs involve securities embedded
with a derivative instrument
The returns on SIPs 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 instruments.

Some SIPs offer capital protection

features on some or all capital
should certain requirements be Some SIPs, besides offering potential
returns, also offer hedging
satisfied. Other SIPs, besides offering
mechanisms like dualcurrency
capital protection if held to maturity,
structured products.
also offer minimum guarantees on
the performance of the investment.
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STRUCTURING ISLAMIC SIPs

underlying asset in Islamic SIPs should be Sharīʿah-compliant

Islamic SIPs should be established using contracts and principles that do

not contravene Sharīʿah principles

relationship between the investors and the issuers/managers must be

clearly defined in accordance with the underlying contracts and principles
applied
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GENERAL STRUCTURED OF SIPs

Source : isra , icm principle & practices

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GENERAL STRUCTURED OF SIPs

u The basic operations of Islamic SIPs are as follows: investors place their proceeds with the issuer/ manager for
investing in Islamic SIPs. In other words, the issuer/manager collects investors’ proceeds through the sale of
Islamic SIPs. The relationship between issuer and investors is commonly an agency relationship (wakālah) or
investor–manager relationship (muḍārabah).
u The issuer then divides the portfolio into two and manages each portion accordingly: the larger portion of the
portfolio will be invested in a relatively secure investment such as Islamic fixed income instruments or Islamic
money market instruments. This is to ensure that the capital investment is protected, even when the leverage
side fails to perform as anticipated at maturity date.
u The smaller portion will be used to buy options, employing the concept of ʿurbūn (earnest money) or waʿd
(promise). This leverage side is meant to optimise the return on investment. It can generate a relatively high
profit rate on the capital if it performs well; otherwise, the investors will lose their money in this portfolio.
u However, their capital is protected because the performance of the bigger portfolio and alike will cover up the
entire capital of the investors. For instance, if 90% of the capital is invested in the fixed income instrument and
10% is invested in the high risk instrument, the fund manager will ensure that the return from the fixed
income can cover the whole amount of 10%. Therefore, assuming the 10% portfolio suffers loss, the capital is
still protected.

Source : isra , icm principle & practices

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TYPES OF ISLAMIC SIPs

• An ELN is a type of SIP with its returns tied to the performance of an underlying equity, which can be a
single stock, a basket of stocks or an equity index. It can be structured as a combination of a fixed return
investment and an equity option
• Most ELNs are sold over-the-counter (OTC), may not offer secondary market trading and are designed
Equity- to be kept until maturity. However, the issuer or arranger of the notes may offer to buy back the notes
Linked or provide limited tradability to the investors
Notes
• As for Equity-linked Islamic SIPs, two requirements are to be observed:
• 1. The underlying equity must be Sharīʿah-compliant;
• 2. The concept of an option may be structured using ʿurbūn or waʿd.

• Interest rate–linked notes (IRLNs) are capital-protected instruments where the

Interest
interest and additional returns are linked to the performance of the underlying
Rate–
interest rate index. The return is based on the movement in a specific interest rate
Linked
index such as LIBOR. These are particularly good for investors who seek the
Notes
potential of an increased yield with some credit protection.
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TYPES OF ISLAMIC SIPs

• Fixed income returns where the coupon or maturity payment is tied to the
FX - Linked performance of an underlying which may be a single foreign currency, a basket of
Notes foreign currencies or FX futures

• A c ommodity-linked note (CLN) is a type of SIP where the return is tied to the
Commodity- performance of a commodity or basket of commodities over a certain period. On
Linked the maturity date, investors will get the initial principal amount plus a return, if any,
Notes based on the percentage of change in the underlying commodity.
• In Islamic SIPs, the commodity to be used has to be Sharīʿah-compliant

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UNDERLYING CONTRACT AND MODEL OF ISLAMIC SIPs

Proceed stage:
Murabahah
Main underlying contract: Tawarruq
Wakalah Inah
Urbun
Mudharabah
Waa’ad

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Urbun Model
u Explanation:
1. Investors place the proceeds with the issuer and appoint
the issuer as agent or investment manager to manage the
investors’ proceeds in Islamic SIPs.
2. The issuer invests 90% of the proceeds in Islamic fixed
income instruments with 100 capital protection which
involve, potentially, investment into a commodity murābaḥah
transaction.
3. The issuer invests the remaining 10% of the proceeds by
entering into an ʿurbūn contract to purchase certain Sharīʿah-
compliant underlying assets. The issuer pays 10% of the purchase
price as earnest money (ʿurbūn). If the issuer decides to continue
with the transaction later, the ʿurbūn will be considered part of the
price, hence the issuer will have to pay only the remaining
purchase price (original purchase price minus the ʿurbūn price).
However, should the issuer decide not to continue with the
investment at the maturity date, the ʿurbūn is forfeited and is not
refundable. The decision on whether to proceed with the
investment depends on the performance of the underlying
investment at that time. If the performance is positive, the issuer
will continue with the contract, making profits on the investment.
Otherwise, the transaction will be cancelled, and the issuer will
lose the ʿurbūn amount.
4. At maturity, the issuer will pay back the amount of investment
(which has been protected via fixed income instruments) to the
investors, together with the profit (if any). Hence, the SIPs are
redeemed.
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 Wa’d model
Ø Explanation:
1. The investor places the proceeds with the issuer and
appoints the issuer to manage the proceeds in Islamic SIPs
using the concept of muḍārabah muqayyadah (restricted
muḍārabah).
2. The issuer invests 90% of the proceeds in Islamic fixed
income instruments in the form of Negotiable Islamic Debt
Certificate (NIDC) with 100% capital protection.
3. The issuer enters into an unconditional and irrevocable
purchase undertaking (waʿd) to purchase the Islamic asset in
the form of copper and wheat using the remaining 10% of
proceeds at a certain sale price upon maturity.
4. If the waʿd is exercised, the issuer will get the returns
from the performance of the underlying asset to be
distributed to the investors.
5. Any profit will be shared between the issuer and the
investor according to a ratio agreed up front. However, the
financial loss is borne by the investor except when the loss
is a result of the misconduct, negligence or breach of terms
of the issuer. 14
This Photo by Unknown Author is licensed under CC BY-NC

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