IFR 5.4 IFR 5.4 Prudential Requirements
Application and Interpretation
IFR 5.4.1(1) This section applies when calculating
Credit Riskor Market Riskin respect of Islamic Contractsinvested in or held by an Authorised Firm Managing a PSIA, which is an Unrestricted PSIA.(2) In (1), the Islamic Contractsreferred to are contracts which are funded by the PSIA.(3) In this section, the term "investing in or holding Islamic Contracts" means investing in or holding as a principal.
Initial and Ongoing Capital Requirements
IFR 5.4.1 Guidance1. An
Authorised Firmundertaking Islamic Financial Businessis required to maintain initial and ongoing Capital Requirementsin accordance with Rules in part 2 of Chapter 3 of PIB.2. In accordance with Rules in part 3 of chapter 3 of PIB, an Authorised Firmundertaking Islamic Financial Businessis required to ensure that only the eligible components of capital are included in the calculation of capital.3. In accordance with PIB Rule 3.15.9, an Authorised Firmundertaking Islamic Financial Businessis required to exclude from T2 Capitalany amount by which the total of the Profit Equalisation Reserveand the Investment Risk Reserveexceeds the Displaced Commercial Risk Capital Requirement.4. For the purpose of calculating Capital Requirements, an Authorised Firmundertaking Islamic Financial Businessor otherwise investing in or holding Islamic Contractsshould give due importance to the economic substance of the transaction, in addition to the legal form of the Islamic Contracts.
Systems and Controls in Relation to PSIAs
In addition to Rule PIB 3.2.4, PIB 3.2.5, GEN Rule 5.3.1 and this module, an
Authorised Firm Managing a PSIAmust ensure that its senior management establishes and maintains systems and controls that ensure that the Authorised Firmis financially sound and able at all times to satisfy the specific prudential requirements arising out of such business.
IFR 5.4.3 IFR 5.4.3(1) In addition to Rules in IFR 5.2.4, an
Authorised Firm Managing a PSIAmust set out in a written policy how it proposes to organise and control the activities that arise from such business and ensure that its activities are conducted in accordance with Shari'a.(2) The policy must as a minimum address, where appropriate, the following matters:(a) how the interests of shareholders and PSIAholders are safeguarded;(b) how the Authorised Firmwill limit exposures of PSIAholders to the Authorised Firm;(c) a description of the controls to ensure that the funds of the PSIAare invested in accordance with the investment guidelines agreed in the investment contract;(d) the basis for allocating profits and losses to the PSIAholders;(e) the policy for making provisions and reserves and, in respect of PSIAs, to whom these provisions and reserves revert in the event of a write-off or recovery;(f) the Authorised Firm'spolicy on the prioritisation of investment of own funds and those of Unrestricted PSIAholders;(g) how liquidity mismatch will be monitored;(h) the basis for allocating expenses to PSIAholders; and(i) how the Authorised Firmwill monitor the value of its assets.
[Deleted][Deleted] DFSA RM106/2012 (Made 23rd December 2012). [VER6/12-12]
Displaced Commercial Risk
IFR 5.4.4 IFR 5.4.4
Authorised Firm Managing a PSIA, which is an Unrestricted PSIA, must calculate a Displaced Commercial Risk Capital Requirementin respect of its PSIAbusiness.
IFR 5.4.4 Guidance1. An
Authorised Firms Managing a PSIA, on an unrestricted basis is subject to a unique type of risk referred to as Displaced Commercial Risk. This risk reflects the fact that an Authorised Firmmay be liable to find itself under commercial pressure to pay a rate of return to its PSIAholders which is sufficient to induce those investors to maintain their funds with the Authorised Firm, rather than withdrawing them and investing them elsewhere. If this "required" rate of return is higher than that which would be payable under the normal terms of the investment contract, the Authorised Firmmay be under pressure to forgo some of the share of profit which would normally have been attributed to its shareholders (e.g., part of the Mudarib's share). Failure to do this might result in a volume of withdrawals of funds by investors large enough to jeopardise the Authorised Firm'scommercial position (or, in an extreme case, its solvency). Thus, part of the commercial risk attaching to the returns attributable to the PSIAis, in effect, transferred to the shareholders' funds or the Authorised Firm'sown capital. It also reflects situations whereby an investor may be permitted to exit from an asset pool at par while the fair value of such assets may be lower than their carrying amounts and where the Authorised Firmin certain circumstances may provide for the shortfalls.2. In an Unrestricted PSIA, the account holder authorises the Authorised Firmto invest the account holder's funds in a manner which the Authorised Firmdeems appropriate without specifying any restrictions as to where, how or for what purpose the funds should be invested, provided that they are Shari'a compliant. Under this arrangement, the Authorised Firmcan commingle the investment account holder's funds with its own funds or with other funds which the Authorised Firmhas the right to use. The investment account holders and the Authorised Firmgenerally participate in the returns on the invested funds.3. In a Restricted PSIA, the account holder imposes certain restrictions as to where, how and for what purpose the funds are to be invested. Further, the Authorised Firmmay be restricted from commingling its own funds with the restricted investment account funds for purposes of investment. In addition, there may be other restrictions that the investment account holders may impose. In other words, the funds provided by holders of Restricted PSIAsare managed by the Authorised Firmwhich does not have the right to use or dispose of the investments except within the conditions of the contract.4. An Authorised Firmsundertaking Islamic Financial Businessis also exposed to fiduciary risk which arises where the terms of the contract between the Authorised Firmand the investor are breached and where the Authorised Firmdoes not act in compliance with Shari'a.5. An Authorised Firmis required to apply the Capital Requirementsspecified in chapters PIB 4 and PIB 5 to any other business it carries on.
IFR 5.4.5(1) An
Authorised Firm's Displaced Commercial Risk Capital Requirementis based on 35% of the CRCOMand Market Riskcapital requirement of assets funded by Unrestricted PSIAholders, and is calculated using the following formula:
PSIACOM = [PSIACOMcredit + PSIACOMmarket] × 35%.(2) PSIACOM is the
Displaced Commercial Risk Capital Requirement;(3) PSIACOMcredit is the Credit Riskcapital requirement for assets funded by Unrestricted PSIAholders and is calculated in accordance with Rules in part 3 of chapter 4 of PIB; and(4) PSIACOMmarket is the Market Riskcapital requirement for assets funded by Unrestricted PSIAholders and is calculated in accordance with Rules in PIB chapter 5.
Credit Risk and Counterparty Risk for Islamic Contracts
IFR 5.4.6(1) An
Authorised Firm Managing a PSIA, which is an Unrestricted PSIA, must calculate its PSIAComcredit in relation to all Islamic Contractsfinanced by Unrestricted PSIAsin the manner prescribed in this section.(2) An Authorised Firmmust, when undertaking the calculation in (1), apply an appropriate risk weighting for the relevant Islamic Contract.
IFR 5.4.7 IFR 5.4.7(1) In this section:(a) "E" represents the
Exposuredetermined by an Authorised Firmas applicable to an Islamic Contract; and(b) "CRW represents the risk weighting or capital charge assessed by an Authorised Firmas appropriate to that Islamic Contract.(2) Where an Islamic Contractis in the Non-Trading Book, an Authorised Firmmust determine the PSIACOMcredit for that contract by applying the following formula:
E × CRW × 8%.(3) Where an
Islamic Contractis in the Trading Book, an Authorised Firmmust determine the PSIACOMcredit for that contract in accordance with the methodology in PIB A4.7 and PIB A4.8 as appropriate.(4) An Authorised Firmmust calculate its PSIACOMcredit of all contracts by:(a) identifying all Islamic Contractsto which this section applies;(b) valuing the underlying investment or asset of each contract and reducing the value of any such investment or asset in the manner stipulated in Section 4.9 of chapter 4 of PIB, the result of which constitutes E for that contract;(c) determining the risk weighting or capital charge appropriate to each contract, which will constitute the CRW for that contract in accordance with Rules in Sections 4.10, 4.11 and 4.12 of chapter 4 of PIB;(d) applying the respective formula in IFR Rule 5.4.7(2) or (3) to determine of PSIACOMcredit in respect of each contract; and(e) summing the PSIACOMcredit of each contract to determine the PSIACOMcredit applicable to the Authorised Firm.
IFR 5.4.7 Guidance1. The DFSA considers that this
Guidancewill assist an Authorised Firmin applying the appropriate risk weighting or capital charge to each Islamic Contractfor the purpose of IFR Rule 5.4.7. Accordingly, the DFSA expects an Authorised Firmmanaging PSIAs, which are Unrestricted PSIAsto pay due regard to this Guidance.2. The Rules in this section and this Guidanceare also relevant to an Authorised Firmwhich invests in or holds Islamic Contracts, when calculating CRCOMfor Islamic Contractsunder PIB chapter 4.3. Table 2 contains Guidance on how an Authorised Firm Managing a PSIA, which is an Unrestricted PSIAshould apply risk weightings for Islamic Contractsin respect of calculating relevant E and CRW for its PSIACOMcredit component of the PSIACOM.
Islamic Contract type
Underlying investment or asset
Binding Murabaha for the Purchase Orderer (MPO) Asset with an Authorised Firmbefore purchase by the Counterparty Apply the appropriate percentage from the second column in the table in PIB Rule A4.6.5 Accounts receivable for the contract, i.e. amounts due from the Counterpartyless any provision for doubtful debts CRWin accordance with PIB chapter 4 Murabaha and Non-binding Murabaha for the Purchase Orderer (MPO) Accounts receivable for the contract, i.e. amounts due from the Counterpartyless any provision for doubtful debts CRWin accordance with PIB chapter 4 Mudaraba and Musharaka Where the underlying investment meets the requirements for inclusion in the Trading Book Market Risk Capital Requirementfor the exposure associated with the underlying investment determined in accordance with PIB chapter 5 Investment in commercial enterprise to undertake business ventures other than trading activities (or other than those which meet the requirements for inclusion in the Trading Book) CRW of 400% on the exposure Investment in real estate assets and other movable assets, using underlying Ijarahand Murabahacontracts CRW of the lessee for the underlying Ijarah contracts or the CRW of the counterparty of the underlying Murabahacontract, in accordance with PIB App4 Ijarah/Ijarah Muntahia Bittamleek Asset with an Authorised Firmavailable for lease before purchase by the Counterparty— for both contracts with both binding or non-binding promise to lease Apply the appropriate percentage from the second column in the table in PIB Rule A4.6.5 Residential real estate where the lessee has the right to purchase property at the end of the lease and the lessor has a legally enforceable first charge over the property Apply the appropriate percentage in accordance with PIB Rule 4.12.17. Total estimated value of lease receivables for the whole duration of the Ijarah, less any recovery value of the leased asset CRW of Ijarahlessee, in accordance with PIB Section 4.12 Full recourse Istisna'a— with or without parallel Istisna'aand limited / non-recourse
Istisna'a with/without parallel Istisna'a
Net balance of the work-in-progress CRW of the Istisna'abuyer, in accordance with PIB Section 4.12 Total amount receivable from the counterparty, pursuant to contract billings CRW of Istisna'abuyer, in accordance with PIB Section 4.12 Salam and parallel Salam Value of the underlying asset receivable for the Salamcontract CRW in accordance with PIB Section 4.12 Assets acquired 100% Balance in relevant accounts receivable CRW in accordance with PIB Section 4.12 Kefala The amount of the guarantee CRW in accordance with PIB Section 4.12 Sukukheld in the Non-Trading Book Receivables from the Sukukstructure, including the principal and any returns associated with it, arising from any of the following as underlying contracts:
Musharaka CRW applicable to underlying Ijarah, Salamor Murabahacontracts, in accordance with PIB Section 4.12
Sukukprovides recourse to the issuer, CRW applicable to the issuer or CRW applicable to underlying contracts of the Sukukis in accordance with PIB Section 4.12, whichever is higher Usufructs/services CRW applicable to underlying service provider or usufruct owner, in accordance with PIB Section 4.12. If the Sukukprovides recourse to the issuer, CRW applicable to the issuer or CRW applicable to underlying service provider or usufruct owner in accordance with PIB App 4, whichever is higher Leased assets The higher of CRW of the underlying leased assets and that of the issuer Investment agency The higher of CRW of the underlying assets and that of the issuer Muzara'a(share of produce of the land) Musaqa(share of produce of the trees) Mugarasa(share in the land and the trees) 100% Mixture of tangible and intangible assets The higher of CRW of the underlying assets and that of the issuer Where the underlying investment meets the requirements for inclusion in the Trading Book Market Risk Capital Requirementfor the exposure associated with the underlying investment determined in accordance with PIB chapter 5 Bai' Bithaman Ajil Residential and commercial properties
Plant and equipment
CRW in accordance with PIB chapter 4 Arboun Where an Authorised Firmhas made the purchase deposit CRW in accordance with PIB chapter 4 Where an Authorised Firmhas received the purchase deposit No CRW is applicable Where the contract would meet the requirements for inclusion in the Trading Book Market Risk Capital Requirementfor the exposure associated with the underlying investment determined in accordance with PIB chapter 54. Where an Islamic Contractis not listed in Table 2, an Authorised Firmshould consult with the DFSA, on a case-by-case basis, to determine the:a. contract type and the underlying investments or assets to calculate the E; andb. appropriate risk weighting or the capital charge for such contract to calculate the CRW.5. In some cases, as stipulated in the relevant parts of column 3 of Table 2, the calculation of capital requirement should be carried out as prescribed in PIB Rule A4.6.5 and in accordance with PIB chapter 5.6. In determining the E of a Binding Murabahafor the Purchase Orderer(MPO), as per PIB Rule A4.6.5, E should equal the total acquisition cost of the asset (purchase price and other direct costs) less market value of the asset (net of any haircut) less any security deposit provided.7. In determining the E of Ijarah/ Ijarah Munthia Bittamleekcontract, as per PIB Rule A4.6.5, E should equal the total acquisition cost of the asset (purchase price and other direct costs) less the market value of the asset (net of any haircut), less any Arboun(earnest money deposit received from the potential lessee).8. In addition to paragraph 7 above, in the case of an Ijarah Muntahia Bittamleekcontract, the exposure may be reduced by the recovery value of the leased asset, only in cases where there is a reasonable basis to conclude that the leased asset can be repossessed and effectively redeployed as a leased asset to another Counterparty. This is important because the asset leased under the Ijarah Muntahia Bittamleekcontract is usually customised equipment or large pieces of equipment which are integrated with other assets of the lessee and hence are unsuitable for repossession and releasing to another lessee.9. In determining the E of an Istisna'acontract, the exposures arising from such a contract should not be netted off against exposures arising from a Parallel Istisna'acontract entered into by an Authorised Firmfor procuring the underlying investment for the Istisna'acontract.10. In determining the E of a Salamcontract, the exposures arising from such a contract should not be netted off against exposures arising from a Parallel Salamcontract entered into by an Authorised Firmfor procuring the underlying asset for the Salamcontract.11. Off-balance sheet exposures for import or export financing contracts based on Murabaha, where the underlying goods or shipment are collateralised and insured, should attract a 20% CCF to an Authorised Firmthat issues or confirms the letter of credit.12. Where Mudarabaand Musharakacontracts are used to invest in commercial enterprise to undertake business ventures other than trading activities (or other than those which meet the requirements for inclusion in the Trading Book), the E is measured as the amount invested in the commercial enterprise less any specific provisions. If there is a guarantee and such guarantor is not connected to the commercial enterprise, then the CRW for the guarantor will be applied for risk weighting for the amount of any such guarantee.13. In addition to the relevant Rulesprescribed in PIB chapter 4 and PIB App4, an Authorised Firmmay consider the following types of collateral as eligible collateral for Credit Riskmanagement:a. Hamish Jiddiyyah(security deposit) only for agreements to purchase or lease preceded by a binding promise;b. Arbounwhere earnest money deposit held after a contract is established as collateral to guarantee contract performance; andc. in Mudarabainvestment in project finance, an Authorised Firmmay use the collateralisation of the progress payments made by the ultimate customers to mitigate the exposures of unsatisfactory performance by the Mudarib.14. Where an Authorised Firmplaces funds under a Mudarabacontract, subject to a Shari'a compliant guarantee from a third party and such a guarantee relates only to the Mudarabacapital, the capital amount should be risk-weighted at CRW of the guarantor provided that the CRW of that guarantor is lower than the CRW of the Mudarib(as a Counterparty). Otherwise, the CRW of the Mudaribwill apply.15. An Authorised Firmplacing liquid funds with a central bank or another financial institution on a short-term Mudarababasis in order to obtain a return on those funds, may apply the CRW applicable to the Mudarib(as a Counterparty), provided the Mudaribeffectively treats the liquid funds placement as its liability, although normally such placements are not treated as liabilities of the Mudarib.
Authorised Firm Managing a PSIA, which is an Unrestricted PSIA, must calculate its PSIACOMmarket in relation to all underlying Islamic Contractsin the manner prescribed in PIB chapter 5, except as may be provided in Rules IFR 5.4.8 to IFR 5.4.17.
Authorised Firmmust treat Sukukheld in its Trading Bookas equity for the purpose of calculating its Equity Risk Capital Requirementand determine the same in accordance with PIB Rule 5.5.2.
Where investments are made using
Musharakaor Mudarabacontracts with commodities as the underlying assets, an Authorised Firmmust calculate its Commodities Risk Capital Requirementin accordance with PIB Rule 5.7.2.
Authorised Firmwhich is exposed to the risk of foreign currencies and gold under any Islamic Contract, must calculate its Foreign Exchange Risk Capital Requirementin accordance with PIB Rule 5.6.2.
Authorised Firmwhich is exposed to commodities including precious metals but excluding gold under any Islamic Contract, must calculate its Commodities Risk Capital Requirementin accordance with PIB Rule 5.7.2.
IFR 5.4.13(1) Commodities held by an
Authorised Firmfor selling or leasing when executing a Murabaha, non-binding MPO, Salamor Parallel Salam Contractmust be included in the calculation of its Commodities Risk Capital Requirement.(2) Where an Authorised Firmexecutes Salamand parallel Salamcontracts, the resultant long and short positions may be set off for calculating the net open position, provided that the positions are in the same commodity, regardless of how its Commodities Risk Capital Requirementis calculated.
Authorised Firmexecutes Musharakaor Mudarabacontracts for investing in entities or investment vehicles that trade in foreign exchange, equities or commodities, it must include the relevant underlying assets in the calculation of its Market Risk Capital Requirementin accordance with PIB chapter 5.
IFR 5.4.14 Guidance1. This section sets specific
Large Exposurelimits for assets financed by PSIAs, which are Unrestricted PSIAs. The DFSA uses these limits to provide constraints on the amount of Concentration Riskto which an Authorised Firmis subject in respect of its PSIAholdings. In assessing PSIALarge Exposures, an Authorised Firmsmay take advantage of the exemptions and partial exemptions set out in PIB section A4.11.2. An Authorised Firmhas a Large Exposurewhere its PSIAholders' credit Exposureto a single Counterpartyor issuer, or group of Closely Relatedor Connected Counterparties, is large in relation to the Authorised Firm'sTier 1 Capital. Where Exposureto a Counterpartyor issuer is large, PSIAholders risk a large loss should the Counterpartydefault.3. Exposuresarising from assets that are financed by an Authorised Firm'sown funds are dealt with in PIB section 4.15.
IFR 5.4.15 IFR 5.4.15
Authorised Firm Managing a PSIA, which is an Unrestricted PSIA, must not have an Exposureto a Counterpartyor to a group of Closely Related Counterparties or to a group of Connected Counterpartiesthat exceeds any one of the following percentages of its Tier 1 Capital:(a) 25% if financed by its Tier 1 Capital, Unrestricted PSIAsor a non-PSIA funding source; or(b) 40% if financed by the total of its own Tier 1 Capital, Unrestricted PSIAsand a non-PSIA funding source.
IFR 5.4.15 Guidance
In accordance with PIB section 4.15, the aggregate of an
Authorised Firm's Exposureto a Counterpartyor to a group of Closely Related Counterparties may not exceed 25% of the Authorised Firm'sTier 1 Capital. A non-PSIA funding source includes funding from the Authorised Firm’s own capital and capital markets.
The sum of an
Authorised Firm'snon-exempt Large Exposuresmust not exceed 800% of its Tier 1 Capital for Exposuresfunded by the Authorised Firm'sTier 1 Capital, Unrestricted PSIAsand a non-PSIA funding source.
Authorised Firmmust:(a) monitor and control its Exposuresfunded by PSIAs, which are Unrestricted PSIAs, on a daily basis to ensure they remain within the concentration risk limits specified in IFR Rule 5.4.15; and(b) if a breach occurs, notify the DFSA immediately and confirm it in writing.