Islamic finance Indonesia: ISLAMIC TRADE FINANCE - ITFC - Angels Products Indonesia

This BLOG will also follow up on "Islamic trade finance". This item often gets neglected, but will proof to be of big importance for the Indonesian Islamic banks in the years to come.

The Indonesian Islamic banks are therefor invited to keep us updated on any remarkable deals.

2009 was a successful year for the Islamic Trade Finance Corporation ITFC ( a division of the Islamic Development Bank IDB) and especially the deal with Angels Products Sugar Refinery in Banten-Indonesia got a lot of international attention.

PT ANGELS PRODUCTS – INDONESIA

The International Islamic Trade Finance Corporation (ITFC) inherited the pioneering mantle of its trade finance expertise and its application of innovative Islamic finance products developed over a period of more than 30 years to develop markets and trading capacities to help the member countries of the Organization of the Islamic Conference (OIC) do business more effectively amongst themselves and with the rest of the world. This savoir-faire, positions ITFC at the forefront of international trade finance and as a vehicle for enhancing economic development.

Since its launch a little over two years ago, the ITFC has been a strong advocate and champion of Shariah-compliant tradefinancing, given that Shariah or Islamic law is concerned with the welfare of the society as a whole as well as the individual’s well- being. The Islamic finance system provides an alternative model which, by its very nature, binds both the real and financial economies and thus encourages risk-sharing, promoting entrepreneurship and discouraging speculative behavior.

This particular US$25 million trade financing operation for the Indonesian raw sugar refiner, PT Angels Products, offers an alternative Shariah-compliant financing solution, as it is designed on structured Murabaha basis with strong risk mitigants in place.

PT Angels Products uses the funds for the purchase of raw sugar to be stored, processed and refined into white sugar for industrial use. The warehouse financing has a maximum tenor of three months on a revolving basis. On the other hand, Peterson Mitra Indonesia, on behalf of Control Union, is responsible for the monitoring and collateral management of the transaction, up to the release of raw sugar. The legal documentation was done in-house at ITFC, and the deal was concluded and signed on October 1, 2009.

ITFC has not only innovatively moved the deal structure to a higher level, it designed the first of its kind structured Murabaha trade financing in Indonesia in favour of PT Angels Products, which can only be described as leading the way in market and structure development.

Structuring the transaction on a Murabaha basis, means the financier - in this case ITFC- buys from the seller at a cost incurred on the commodities which is expressed explicitly. ITFC then sells it to the beneficiary – in this case PT Angels Products - by adding a profit or mark-up thereon which is known to the buyer and ITFC is paid once the client takes delivery of the raw sugar as shown in Figure 1 hereunder.

Figure 1: Schematic flow of the transaction

1. PT Angels Products pays 20% of the invoice into ITFC’s Collection Account to ensure commitment of client and gives an additional security margin of the commodity under collateral management for ITFC. Once ITFC receives the documents for payment, it will ensure that the 20% deposit from PT Angels Products is in ITFC’s Collection Account before making payment for the invoice

2. Goods are shipped and documents are presented.

3. ITFC pays the supplier for the raw sugar.

4. Raw sugar is delivered to the PT AP’s warehouse under Collateral Management where the weight of the sugar is verified and CM issues Warehouse Receipt to ITFC.

5. ITFC issues invoices to PT AP for the smaller quantities of sugar to be purchased for refining. PT AP pays into the collection account for taking delivery of small quantities of the shipment stored in the warehouse.

6. ITFC sends release instruction to CM for release once payment is received on the volume requested with corresponding markup and line management fee.

7. PT AP takes delivery of raw sugar.

Under this well-designed Murabaha operation, solid risk mitigants were put in place. These include the issuance of the warehouse receipts in the name of ITFC hence making ITFC the owner of the physical goods. This is different from conventional trade financing whereby the goods are being pledged to the financier.

Moreover, risk is mitigated at every stage of the operation; at the operational level, a comprehensive insurance covering marine shipment to land transportation until the products are stored at the warehouse with the ITFC designated as loss payee.

To safeguard the commodity until its release, a collateral manager was appointed by ITFC and a collateral risk premium of 20% is deposited by the client which gives the ITFC a 125% safety and collateral margin against the financing. For each import transaction, the C&F value of sugar is submitted by the beneficiary/borrower to the structured trade finance team at ITFC, who have to validate the pricing before any arrangement made for honoring the payment to be made to the supplier. In this way, overpricing is mitigated by ITFC through verifying that the price of sugar in the spot market and the price that the company had hedged is positioned in the futures market and is in a close range to ensure that ITFC is not overpaying for the goods which are its collateral in the financing.

Furthermore, as part of its performance risk criteria, the client is obliged to provide and adhere to a schedule of undertaking on the goods being stored in the warehouse.

This structured trade finance operation brings out the true essence of the Murabaha concept whereby the ITFC, acting as a trader, calculates and charges varying mark-up/profit for the raw sugar sold to the buyer. Unlike other vanilla Murabaha transactions, the financier is directly involved in the transaction by buying in bulk and then selling the raw sugar in small quantities to the client (as shown in figure 2 hereunder).

Figure 2: Illustration of the unique feature: Charging and Invoicing the Mark-up