CA-3.4 CA-3.4 Istisna'a and Parallel Istisna'a
Introduction
CA-3.4.1
This section sets out the minimum capital adequacy requirement to cover credit and market (price) risks arising from entering into contracts or transactions that are based on the Sharia rules and principles of Istisna'a.
Apr 08CA-3.4.2
Istisna'a and parallel Istisna'a contracts would attract a risk weighting as per the credit standing of the respective counterparties (See section CA-4.2).
Apr 08CA-3.4.3
An Istisna'a contract refers to an agreement to sell to or buy from a customer, a non-existent asset which is to be manufactured or built according to the ultimate buyer's specifications and is to be delivered on a specified future date at a predetermined selling price.
Apr 08CA-3.4.4
The bank, as the seller, has the option to manufacture or build the asset on its own or to engage the services of a party other than the Istisna'a ultimate buyer as supplier or subcontractor, by entering into a Parallel Istisna'a contract (please refer to paragraph CA-3.4.12).
Apr 08CA-3.4.5
The exposures under Istisna'a involve credit and market risks, as described below. Credit exposures arise once the work is billed to the customer, while market (price) exposures arise on unbilled work-in-process (WIP).
Apr 08CA-3.4.6
There is a capital requirement to cater for the credit (counterparty) risk of the bank not receiving the selling price of the asset from the customer or project sponsor either in pre-agreed stages of completion and/or upon full completion of the manufacturing or construction process.
Apr 08CA-3.4.7
This section also sets out the capital adequacy requirement to cater for the market risk that a bank incurs from the date of manufacturing or construction, which is applicable throughout the period of the contract on unbilled WIP inventory.
Apr 08CA-3.4.8
This section is applicable to both (a) Istisna'a contracts that are executed without a Parallel Istisna'a contract and (b) Istisna'a contracts that are backed by independently executed Parallel Istisna'a contracts.
Apr 08CA-3.4.9
This section makes distinctions between the two main categories of Istisna'a:
(a) Full Recourse Istisna'a
The receipt of the selling price by the bank is dependent on the financial strength or payment capability of the customer for the subject matter of Istisna'a, where the source of payment is derived from the various other commercial activities of the customer and is not solely dependent on the cash flows from the underlying asset/project; and(b) Limited and Non-recourse Istisna'a
The receipt of the selling price by the bank is dependent partially or primarily on the amount of revenue generated by the asset being manufactured or constructed by selling its output or services to contractual or potential third party buyers. This form of Istisna'a faces "revenue risk" arising from the asset's ability to generate cash flows, instead of the creditworthiness of the customer or project sponsor.Apr 08CA-3.4.10
In full, limited and non-recourse Istisna'a contracts, the bank assumes the completion risk that is associated with the failure to complete the project at all, delay in completion, cost overruns, occurrence of a force majeure event and unavailability of qualified personnel and reliable seller(s) or subcontractors in a Parallel Istisna'a.
Apr 08CA-3.4.11
The selling price of an asset sold based on Istisna'a is agreed or determined on the contractual date and such a contract is binding. The price cannot be increased or decreased on account of an increase or decrease in commodity prices or labour cost. The price can be changed subject to the mutual consent of the contracting parties due to alteration or modifications to the contract or unforeseen contingencies, which is a matter for the commercial decision of the bank and can result in a lower profit margin.
Apr 08CA-3.4.12
In cases where a bank enters into Parallel Istisna'a to procure an asset from a party other than the original Istisna'a customer (buyer), the price risk relating to input materials is mitigated. The bank remains exposed to the counterparty risk of the Parallel Istisna'a seller in delivering the asset on time and in accordance with the Istisna'a ultimate buyer's specifications. This is the risk of not being able to recover damages from the Parallel Istisna'a seller for the losses resulting from the breach of contract.
Apr 08CA-3.4.13
The failure of the Parallel Istisna'a seller to deliver a completed asset which meets the buyer's specifications does not discharge the bank's obligations to deliver the asset ordered under an Istisna'a contract, and thus exposes the bank to potential loss in making good the shortcomings or obtaining the supply elsewhere. The obligations of a bank under Istisna'a and Parallel Istisna'a contracts are not inter-conditional or interdependent, which implies that there is no legal basis for offsetting credit exposures between the contracts.
Apr 08Credit Risk
Full Recourse Istisna'a
CA-3.4.14
The receivable amount generated from the selling of an asset based on an Istisna'a contract with full recourse to the customer (buyer) shall be assigned a RW based on the credit standing of the customer as rated by an ECAI that is approved by the CBB. In case the buyer is unrated, a RW of 100% shall apply. (See section CA-4.2).
Apr 08Limited and Non-Recourse Istisna'a
CA-3.4.15
When the project is rated by an ECAI, the RW based on the credit rating of the project is applied to calculate the capital adequacy requirement. Otherwise, the RW shall be based on the 'Supervisory Slotting Criteria' approach for Specialised Financing (Project Finance) as set out in section CA-4.3.
Apr 08CA-3.4.16
In cases where a group of contractors are engaged in a particular project, the risk rating or weightage will follow the obligations of various contractors. If the risk is undertaken by a main contractor, the risk rating of the main contractor is to be used.
Apr 08CA-3.4.17
The limited and non-recourse Istisna'a financing structure is required to meet the characteristics as set out below in order to qualify for the treatment mentioned in paragraph CA-3.4.15 above:
(a) The segregation of the project's liabilities from the balance sheet of the Istisna'a ultimate buyer (or project sponsor) from a commercial and accounting perspective which is generally achieved by having the Istisna'a contract made with a special purpose entity set up to acquire and operate the asset/project concerned;(b) The ultimate buyer is dependent on the income received from the assets acquired/ projects to pay the purchase price;(c) The contractual obligations give the manufacturer/constructor/bank a substantial degree of control over the asset and the income it generates, for example under BOT (built, operate and transfer) arrangement where the manufacturer builds a highway and collects tolls for a specified period as a consideration for the selling price; and(d) The primary source of repayment is the income generated by the asset/project rather than relying on the capacity of the buyer.Amended: April 2011
April 2008CA-3.4.18
Please Note: Insurance is normally part and parcel of the project risk financing. However, it is not regarded as a credit risk mitigating technique.
Apr 08Exclusions
CA-3.4.19
The capital requirement is to be calculated on the receivable amount, net of (i) specific provisions, (ii) any amount that is secured by eligible collateral (as defined in section CA-4.7) and/or (iii) any amount which is past due by more than 90 days. The portions that are collateralised and past due are subject to the treatment as set out in chapter CA-4.
Apr 08CA-3.4.20
Any portion of an Istisna'a contract that is covered by an advanced payment shall carry a RW of 0%, or the amount of the advanced payment shall be offset against the total amount receivable or amounts owing from progress billings.
Apr 08Applicable Period
CA-3.4.21
The credit RW is to be applied from the date when the manufacturing or construction process commences and until the selling price is fully settled by the bank, either in stages and/or on the maturity of the Istisna'a contract, which is upon delivery of the manufactured asset to the Istisna'a ultimate buyer.
Apr 08Offsetting Arrangement between Credit Exposures of Istisna'a and Parallel Istisna'a
CA-3.4.22
The credit exposure amount of an Istisna'a contract is not to be offset against the credit exposure amount of a Parallel Istisna'a contract because an obligation under one contract does not discharge an obligation to perform under the other contract.
Apr 08Market Risk
Full Recourse Istisna'a
(a)Istisna'a with Parallel Istisna'a
CA-3.4.23
There is no capital charge for market risk to be applied in addition to provisions in paragraphs CA-3.4.14 to CA-3.4.22 above, subject to there being no provisions in the Parallel Istisna'a contract that allow the seller to increase or vary its selling price to the bank, under unusual circumstances. Any variations in a Parallel Istisna'a contract that are reflected in the corresponding Istisna'a contract which effectively transfers the whole of the price risk to an Istisna'a customer (buyer), is also eligible for this treatment.
Apr 08(b)Istisna'a without Parallel Istisna'a
CA-3.4.25
A capital charge of 1.6% (equivalent to a 20% RW) is to be applied to the balance of unbilled WIP inventory to cater for market risk, in addition to the credit RW stated in paragraphs CA-3.4.14 to CA-3.4.22 above.
Apr 08CA-3.4.26
This inventory is held subject to the binding order of the Istisna'a buyer and is exposed to the price risk as described in CA-3.4.11.
Apr 08Foreign Exchange Risk
CA-3.4.27
Any foreign exchange exposures arising from the purchasing of input materials, or from Parallel Istisna'a contracts made, or the selling of a completed asset in foreign currency should be included in the measures of foreign exchange risk described in section CA-5.5.
Apr 08Summary of Capital Requirement at Various Stages of the Contract
CA-3.4.28
The following tables set out the applicable period of the contract that attracts capital charges for (a) Full Recourse Istisna'a (b) Limited and Non-Recourse Istisna'a.
(a) Full Recourse Istisna'a(i) Istisna'a with Parallel Istisna'aApplicable Stage of the Contract Credit RW Market Risk Capital Charge Unbilled work-in-progress Based on ultimate buyer's rating or 100% RW for unrated buyer.
No netting of Istisna'a exposures against Parallel Istisna'a exposures.
(See paragraphs CA-3.4.14 to CA-3.4.22)
(See section CA-4.2)Nil provided that there is no provision in the Parallel Istisna'a contract that allows the seller to increase or vary the selling price. See paragraph CA-3.4.23 If the seller is allowed to vary the selling price of the asset, then under the market risk treatment 15% capital charge on net long or short position plus 3% capital charge on gross positions. Amount receivable after contract billings Upon full settlement price by an Istisna'a buyer. NA NA (ii) Istisna'a without Parallel Istisna'aApplicable Stage of the Contract Credit RW Market Risk Capital Charge Unbilled work-in-progress Based on ultimate buyer's rating or 100% RW for unrated buyer. 1.6% capital charge on work in progress inventory.
See relevant paragraphs under CA-3.4.25 to CA-3.4.26Progress billing to customer. Based on ultimate buyer's rating or 100% RW for unrated buyer.
(See paragraphs CA-3.4.14 to CA-3.4.22) (See section CA-4.2)NA Upon full settlement price by and Istisna'a buyer. NA NA (b) Limited and Non-Recourse Istisna'a
Istisna'a with Parallel Istisna'a (for project finance)Applicable Stage of the Contract Credit RW Market Risk Capital Charge Unbilled work-in-progress Based on project's ECAI rating if available or supervisory slotting criteria that ranges from 70% to 250% RW.
No netting of Istisna'a exposures against Parallel Istisna'a exposures.
(See sections CA-4.2 and CA -4.3)NA Amount receivable after contract billings NA Upon full settlement price by and Istisna'a buyer. NA NA Apr 08
