Why are we issuing this paper?
1. This Consultation Paper seeks public comments on the DFSA's proposals to
enhance the PIB regime with regards to the way Islamic Contracts should be
treated for prudential purposes. The proposals involve changes to the
following modules of the DFSA Rulebook:
Who should read this paper?
2. The proposals in this paper would be of particular interest to Authorised Firms
Managing a Profit Sharing Investment Account but will also be of interest to
Authorised Firms in Category 1, 2, 3 or 5 when investing in or holding Islamic
Contracts when calculating Credit Risk or Market Risk in respect of such
How is this paper structured?
3. In this paper, we set out:
(a) the background and overview of the proposals (paragraphs 7 to 11);
(b) a detailed description of the drafting (paragraphs 12 to 21).
How to provide comments?
4. All comments should be forwarded to the person specified below. You may, if
relevant, identify the organisation you represent in providing your comments.
The DFSA reserves the right to publish, including on its website, any
comments you provide, unless you expressly request otherwise at the time of
What happens next?
5. The deadline for providing comments on the proposals is by close of business
on 9 March 2008. Once we receive your comments, we will consider if any
further refinements are required to these proposals. We will then proceed to
enact the changes to the DFSA's Rulebook. You should not act on these
proposals until the relevant changes to the DFSA Rulebook are made. We
will issue a notice on our website telling you when this happens.
Comments to be addressed to:
PO Box 75850
or e-mailed to: firstname.lastname@example.org
6. Defined terms are identified throughout this paper by the capitalisation of the
initial letter of a word or of each word in a phrase and are defined in the
Glossary (GLO) module. Unless the context otherwise requires, where
capitalisation of the initial letter is not used, the expression has its natural
meaning. Some proposed changes to GLO are in Appendix 3Appendix 3
7. Consultation Paper 52
, issued on 4 December 2007, contains proposals to ensure the DFSA's regime is in line with the standards which prevail in
advanced jurisdictions. Although the proposals in this paper are not
specifically linked to any proposal in Consultation Paper 52
, they form part of
the overall key policy review currently being undertaken by the DFSA and
were contemplated in that paper.
8. In order to ensure the DFSA's regime is in line with international standards,
including the standards produced by the Islamic Financial Services Board
(IFSB), the DFSA has examined its prudential regime for Islamic finance. We
have also observed an increase in conventional firms investing in or holding
Islamic instruments, and we consider that guidance may be required on the
treatment of such instruments for capital purposes.
Overview of the proposals
9. The main aim of the proposals is to enhance the PIB regime by providing
more detail on the way Islamic Contracts should be treated for prudential
10. At present, the treatment of Islamic Contracts for prudential purposes is set
[PIB chapter 3]
. The proposed enhancements include:
• amending Table 2 of
[PIB chapter 3] to be in line with the "Capital
Adequacy Standard for Institutions (other than insurance institutions)
Offering Only Islamic Financial Services" (CAS 1) issued by the IFSB, and
to deal with a wider range of Islamic Contracts;
• prescribing the treatment of Islamic Contracts financed other than by a
PSIA, including those held by conventional institutions; and
• providing Rules on treatment of Market Risk for Islamic Contracts held in
a Trading Book, whether financed by a PSIA or otherwise.
11. The substantive provisions are based on CAS 1, the only changes of
substance being those that are necessary to implement them in the context of
the PIB regime.
Detailed description of the drafting
[PIB chapter 3] has been substantially enhanced with new Guidance on the
treatment of Islamic Contracts, as well as new Rules relating to Market Risk.
(a) Guidance on the treatment of Islamic Contracts
13. Table 2 under
[PIB Rule 3.5.3] is proposed to be relocated as Guidance under
[PIB Rule 3.5.2]. The table has been enhanced to include the provisions in
CAS 1 dealing with the minimum capital requirements for Islamic Contracts,
specifically relating to relevant risk weightings or applicable capital charges.
14. This table and the other Guidance under
[PIB Rule 3.5.2] are intended to assist
Authorised Firms in calculating their PSIACOMcredit (see Rule 3.4.2).
15. It is also relevant to an Authorised Firm which invests in or holds Islamic
Contracts, when calculating Credit Risk for such contracts. We have inserted
Guidance to that effect under
[PIB Rule 4.1.1] and consequential amendments
have also been made to [PIB Rule 4.10.1].
(b) Market Risk
16. Proposed new PIB section 3.6 is based on provisions in CAS 1. This section
has been inserted to assist Authorised Firms in calculating their
PSIACOMmarket (see Rule 3.4.2), and is also relevant to an Authorised Firm
when calculating its Market Risk Capital Requirement in respect of Islamic
Contracts it invests in or holds. We have inserted Guidance to that effect
[PIB Rule 5.1.1]
(c) Economic substance
17. The proposed new Guidance under
[PIB section 3.2] emphasises that an
Authorised Firm undertaking Islamic Financial Business or otherwise investing
in or holding Islamic Contracts, should give due importance to the economic
substance of the transaction, in addition to the legal form of the Islamic
(d) Management of PSIAs
18. We have taken the opportunity to move
[PIB Rule 3.7.1] to the ISF module as
Rule 4.3.1. This Rule prohibits an Authorised Firm from utilising funds of PSIA
holders to finance its corporate activities. This Rule has been moved because
it relates to systems and controls (as opposed to capital requirements) and is
therefore more appropriately placed under chapter 4 of the ISF module which
sets out rules relating to systems and controls.
(e) Displaced Commercial Risk
19. Consultation Paper 52
contains proposals which if implemented will enable
Authorised Firms to offer Financial Services to a wider range of Clients. That
paper, amongst other things, deals with enhanced disclosure requirements for
20. As this paper focuses on prudential requirements for Authorised Firms
Managing a PSIA, the DFSA invites comments on whether the current ratio of
35% for Displaced Commercial Risk (please refer to
[PIB Rule 3.4.2]
appropriate, in light of the proposed broader access set out in Consultation Paper 52
21. The Displaced Commercial Risk ratio essentially measures the likelihood that
an Islamic bank will feel obliged to support returns to its PSIA holders for
commercial reasons, even though in principle those holders bear the full
investment risk, with no guarantee of principal. Full support would imply a
ratio of 100%; no support at all would imply a ratio of 0%.
|Issues for consideration|
Are the proposed amendments clear and unambiguous?
Do Authorised Firms see any practical difficulties with the new Guidance and
Rules for the treatment of Islamic Contracts for prudential purposes? If so,
what are they and how should they be addressed?
Does the 35% Displaced Commercial Risk ratio remain appropriate? If the
changes proposed by CP 52 are implemented should the ratio be revised?
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