ARAB WORLD

Banking & Finance

FINANCIAL TIMES SPECIAL REPORT | Tuesday May 29 2012

Busy builders
Saudi Arabia has begun one of the worlds biggest stimulus packages but there are questions over long-term funding Page 4
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Need for funds is at its greatest

With lending hit by eurozone woes and uprisings, even oil-rich states ask who will supply funds in future, says Michael Peel
he booming international oil price may mean that Middle Eastern governments blessed with large crude reserves have never been richer but neither has their regions need for finance been so great. As popular uprisings have occurred from the Maghreb to the Levant, countries have been either gripped by instability or pushed into programmes of heavy spending on state benefits and infrastructure. At the same time, the eurozone crisis is compounding concerns about the ability of Gulf petrostates and corporations to gain access to financing, as European banks pull back from the Middle East and north Africa (Mena). The result, according to Moodys, the credit rating agency, is likely to be a sustained reduction of lending at a time when the Gulf Co-operation Council faces an estimated $1.8tn of capital investments over the next 15 years. Ashok Aram, Deutsche Banks chief executive for the Middle East and north Africa, says the region faces multiple financing difficulties. Regional banks are experiencing low levels of credit growth

Inside this issue

Stock exchanges Imbalances in access and liquidity continue to keep the region on the periphery Page 2 Debt With billions of dollars of Islamic debt maturing this year, spotting problems early will be key to negotiations Page 2 Islamic banking The industry has struggled to create enough tools to manage short-term liquidity Page 2 Bonds Saudi Arabia, the religious focal point for one billion Muslims, has heartened investors with large deals Page 2 FDI Gulf investors who flocked to north Africa during the oil boom are concentrating on business closer to home Page 3 North African bourses Sentiment in Egypt is much better than it was but bankers are watching out for devaluation Page 3 Sovereign wealth funds Except for Qatar, pressure to spend locally has iverted funds away from trophy investments Page 4 Private equity After two convulsions, a steady stream of deals has started to illuminate the darkness Page 4

as they repair balance sheets. This can only be solved through a significant expansion in debt capital markets, he says. In the short term, the solution is an rise in credit costs for longer term funding and a filtering process where only the strongest deals survive. Governments and businesses have been moving to shore up existing funding sources and agonising over how to gain access to fresh ones. Countries such as Saudi Arabia and Qatar are hesitating on plans to develop their stock markets, torn between the tempting prospect of bringing in more foreign ownership to boost their economies and fear of what fresh volatility may bring. As European banks withdraw, analysts say Asian financial institutions are already taking up some of the slack, especially in areas such as project finance. Bankers also say regional companies will increasingly turn to the debt capital markets to service their financing. Looming Islamic bond maturities will prove a test for that growing industry, as traders bet on what could be the first sukuk default in the United Arab Emirates. On foreign direct investment, political and legal uncertainties have damped growth in countries where there have been uprisings, while creating new possibilities in some states now seen as havens of stability. Egypt, Tunisia, Libya and Morocco which has seen protests but not a full popular revolt have all suffered from higher borrowing costs and stricter credit rules, according

to the business and financial services practice of Frost & Sullivan, the consultancy and business researcher. Egypt, fresh from a presidential election that many hope will restore a measure of stability, suffered a foreign direct investment outflow of $483m last year, compared with an inflow of $6.4bn the previous year. Many stock markets have proved volatile, with investors torn and oscillating between concerns about uncertainty and the sense that these are some of the ripest emerging market opportunities in the world. Egypts stock exchange, having fallen by half last year, has rebounded by about a third this year. Tunisias bourse is up a little less than 10 per cent and Moroccos down a little more than 10 per cent. These two like those of other countries in the region have suffered from a drop in European investment because of the euro crisis. In the Gulf, investors yearn for alternatives to the accessible but thinly traded UAE stock markets. While Gulf markets saw trading volumes of $1.6tn in 2006, that collapsed to $300bn in 2010 and recovered only marginally last year. Saudi Arabia, the big prize, remains almost off-limits for foreign investors because of rules curbing their participation a source of frustration, given the markets broad range of stocks and sprightly trading volumes. A years-old proposal to merge the UAEs Dubai and Abu Dhabi bourses creating a market to
Continued on Page 3

FINANCIAL TIMES TUESDAY MAY 29 2012

Arab World: Banking & Finance

Debt maturity puts experience to the test Banks hit by a shortage of products
Restructuring Camilla Hall reports on the complexities of sharia compliance
As investors looked on in dismay at the 2009 default of Islamic bonds from Saudi Arabia to Kuwait, many critics forecast the demise of the Gulfs shariacompliant industry. Islamic bond structures were seen as too complicated and too far removed from the real economy. While financial instruments appeared to be based on collateral, they turned out to be just like any other conventional product. At least $10bn of Islamic debt is maturing in the Gulf this year, according to Zawya, the data provider. The high value of maturities is explicable given that 2007 was a bumper year for sukuk issuance and most had five-year tenors. The complexity of the sharia-compliant sukuk structures made the debt restructuring talks more difficult and discussions ground on for months, even years, with little progress. The financial crisis caught Islamic banking unawares and left it struggling to convince investors. However, after a spattering of Islamic debt restructurings, bankers hope the industry is better placed to understand such debt workouts. Trying to spot problems early will be key to companies chances at successful negotiations. Theres no cookie-cutter restructuring, says Afaq Khan, chief executive of Standard Chartereds Islamic unit in Dubai. Each restructuring will bring a different angle, but we should take comfort that practical solutions with a win-win for everybody have been found. The restructurings, such as Kuwaits Investment Dar, Saudi Arabias Saad Group sukuk, or Bahrains Gulf Finance House, have taken years to unfold and some remain unresolved. Deals that appeared favourable several years ago at the height of the financial crisis have not held their ground as the economic slowdown has dragged on. That has forced companies to return to the drawing board and restructure again. Analysts are concerned about a number of upcoming Islamic debt maturities. Distressed debt traders are circling companies at the same time as some Islamic bond yields rise. With a $1.1bn Islamic loan maturity looming, Arcapita, the Bahrain-based Islamic investment bank, has filed for Chapter 11 bankruptcy protection to protect its $3.6bn in global assets from any possible legal challenge from hedge funds. Dana Gas, the Sharjahbased energy company, has hired Blackstone to help it manage its upcoming $920m sukuk payment after receivables rose on the back of unrest in Egypt. Dubai government-owned Jebel Ali Free Zone Authority and Dubai International Financial Centre Islamic bonds also are a concern. All restructurings need to be approved by a sharia board, further complicating the process. Bond restructurings tend to be more difficult than discussions over
Afaq Khan, chief executive of Standard Chartereds Islamic unit

the repayment of bank loans. Hedge funds, which do not depend on relationships with the company, are often more aggressive at the negotiating table than banks, which may want to maintain good relations. To avoid such complex debt workouts, companies have felt under pressure to spell out their Islamic bond structures more clearly in

prospectuses. Sukuk buyers are also paying more attention to the small print after the financial crisis signalled the end of buying without really understanding the product, bankers say. Lessons have been learnt from the financial crisis after Islamic finance industry sharia-compliant structures defaulted publicly for the first time. Companies and creditors have as a result learnt to act more quickly and have changed the way they structure debt in the first place. Youve seen a lot of businesses try to not let things slip to a restructuring rather theyre proactively pushing out maturities. Theyre sizing up the refinancing risk theyre willing to live with, says Muhammad Farhan, head of Islamic finance for HSBC in Saudi Arabia. One of the problems is the lack of specific advice. One has to question the quality of advice thats available in the sharia-compliant sphere, says Harris

Irfan, managing partner at Cordoba Capital, a shariacompliant advisory firm in Dubai. Its very hard to find the right advice. Unlike conventional restructurings, in which multitudes of investment boutiques and larger firms compete for business, there are few examples of specialist outfits offering specific Islamic advice to companies in distress. Small teams or individuals offer the service in the larger investment banks. While some high-profile Islamic restructurings have removed the shock factor that hovers around the fear of default, companies still face few options when it comes to advise on debt management. With so much debt maturing over the coming months it will soon become clear what lessons have been taken on board. Though some sharia-compliant restructurings have taken place there are still few examples to guide companies in the right direction.

Sharia compliance Islamic lenders have limited options, says Camilla Hall
While Islamic banking has expanded rapidly in the Gulf, its usefulness as a single source of finance has been curbed by a shortage of products that shariacompliant institutions can buy and sell. Assets under management at Islamic banks have grown at a tremendous pace over the past decade, but the industry has struggled to create enough financial tools to help manage shortterm liquidity. Unlike in more developed markets, such as Malaysia, the sukuk market in the Gulf is still in its early stages of formation and cannot yet support the short-term cash management needs of the banks. To tackle the dearth in short-maturity products, both governments and investment banks have a role to play as assets under management are forecast to double to $990bn by 2015 from $416bn in 2010, according to Ernst & Young. The market requires much more short-dated product in order to enable Islamic banks to effectively manage their liquidity, says Yavar Moini, an executive director at Morgan Stanley in Dubai. Commodity murabaha Islams version of interbank short-term lending and syndicated loans that generate funds through the buying and selling of products, such as precious metals, have become the tool of choice. However, their popularity has drawn the ire of Islamic scholars who criticise the structure, saying that it is not in reality backed by assets. Efforts to develop Islamic short-term liquidity products have been multifaceted. Solutions have run from deepening the sukuk market to creating more complex structured products that are taking time to catch on. With a more liquid Islamic bond market, participants can trade longer-dated maturities in short timeframes, so allowing them to earn a return on their cash. In recent years the central banks of Bahrain and the United Arab Emirates have introduced short-term liquidity management tools, such as Islamic certificates of deposits and short-dated sukuk, to support their banks. In Qatar, which has separated its Islamic banks from its conventional lenders, the government sold billions of dollars in Islamic debt to help lenders. The split between the two types of banks is forcing shariacompliant institutions to pay more attention to the management of their funds. Saudi Arabia recently sold its first sovereign-guaranteed Islamic bond, another step towards developing the local market that also took advantage of low borrowing costs. However, because of the

Imbalances keep Gulf region on the sidelines

Stock exchanges Simeon Kerr reports on the constraints conspiring to keep global interest subdued

unfavourable profit rates of these low-risk tools, there is still a gap in the market for investment banks to create new products. Theres a lot of work being done on the investment banking side to come up with more ways to manage short-term liquidity rather than to place it with the central bank, says Muhammad Farhan, head of Islamic finance for HSBC in Saudi Arabia. This may not be as swift as we want it to be, but we see a lot of momentum. The sukuk market in Saudi Arabia, the Arab worlds largest economy and home to the worlds largest Islamic bank, may have an advantage over some of its other Gulf counterparts, thanks to a strong institutional investment sector. Some bankers complain Islamic lenders are slow on the uptake when it comes to new products, even when they have been crafted to meet their needs. With many western banks retrenching from the sharia-compliant industry in the region there has been less of a focus on innovation. While much of the discussion focuses on how Islamic banks can put their cash to work, HSBC says its shariacompliant structuring business in the region is dominated by liquidity creation as opposed to investment tools.

ulf markets should be an enticing prospect for global investors as oil prices underpin strong economic fundamentals in most of the Gulf Co-operation Council states. But imbalances in access and liquidity continue to keep the region on the periphery of more exciting emerging markets elsewhere. Institutional investors are faced with a dilemma. The huge market of Saudi Arabia is largely offlimits, whereas the more easily accessible markets of the United Arab Emirates have limited trading volumes. Gulf markets boasted trading value of $1.6tn in 2006, a peak that collapsed to a trough of about $300bn in 2010 and that only enjoyed a modest recovery in 2011. Saudi Arabia, the biggest economy, has a large equities market that stands up to scrutiny compared with other emerging markets. With a broad base of listed companies, the healthy volumes are an interesting prospect. Participants have been expecting the market to be opened to foreign investors this year, though outsiders are already trading via swaps with intermediaries. The Saudi Arabian stock market is anticipated to open to qualified financial investors, says Christian Kern, head of regional equity research for JPMorgan. It is expected that, with their potential

entry, the overall equity market volumes will continue to grow in Saudi Arabia. But other analysts and fund managers are more hesitant. Saudi Arabia may be more concerned about controlling capital flows than luring foreign money, given ample domestic liquidity, says Raghu Mandagolathur, head of research at Kuwait Financial Centre, or Markaz, an investment bank. He says a return of domestic liquidity in Saudi Arabia, along with other markets such as Qatar and Kuwait, will define these exchanges fortunes in coming months. The UAE is one market that could do with a return of foreign capital to revive liquidity levels. The emirates dire liquidity levels of 2011, which prompted dozens of brokerages to go out of business, have returned after a brief rise in activity in the first quarter. Among the UAEs 100-odd listed companies, about 60 per cent of trading activity was concentrated in the leading five stocks in April, while half of the companies traded less than $1m. What we saw [in the first quarter] was a function of market performance. When it started to dwindle because of international pressure and sentiment, liquidity instantly dropped, says Fadi alSaid, head of investments at ING in Dubai. Regulatory changes to allow short selling and market making activities, identified by managers as an important driver of change, are being considered by the federal regulator in Abu Dhabi. Officials, however, have already doused optimism by pushing back the target date for the introduction of reforms to the end of 2012. Market participants continue to

Some bankers complain Islamic lenders are slow on the uptake when it comes to new developments
Although many Islamic banks remain highly liquid in local currency, they are facing the need to generate more short-term dollarbased funding, creating opportunities for investment banks. Commodity murabaha remains the dominant product for short-term liquidity management, while there has been a rise in short-term repurchase activity, says Mr Moini. Repurchase agreements, known as repos, allow banks to lend out an asset to a counterparty and get a return on the transaction. Still, neither of these has provided the perfect shortterm liquidity management solution for Islamic banks, analysts say. Some lenders remain cautious and slow in using such tools. Both tools have also been criticised by the more conservative elements of the industry, which see the products as a means of mimicking conventional ones. Despite some progress, bankers agree that Islamic lenders have limited options when it comes to raising short-term funds or putting to work short-term money. Its still an issue, says Afaq Khan, chief executive of Standard Chartereds Islamic banking arm in Dubai. There is a sense of urgency to address this. A lot more needs to be done, weve not seen much.

Market makers: the Dubai exchange which, if unified with Abu Dhabi, could challenge Saudi dominance

Bloomberg

believe such regulatory changes could herald a new dawn for UAE markets, which if unified and more liquid would challenge Saudi dominance. The UAEs two stock markets,

Among the UAEs 100odd listed companies, about 60% of activity was concentrated in the leading five stocks
Dubai and Abu Dhabi, have for years been studying a proposal to create a unified platform. Officials say the proposal remains live but has been delayed by questions

about how to value Dubais publicly listed exchange in any merger. The political issue of control over the unified bourse has generated further complexities. Jeff Singer, chief executive of Nasdaq Dubai, has called for a taskforce to be created by the government and the private sector to co-ordinate decision-making in a push to fix the markets and increase trading levels sufficiently. One popular solution would be the privatisation of state-owned companies to broaden the make-up of listed companies on the Abu Dhabi and Dubai bourses, where the real estate and banking sectors are over-represented. Nasdaq Dubai, despite a merger

with the Dubai Financial Market, continues to face the low-liquidity vicious circle that persuades domestic companies to choose busier foreign exchanges for initial public offerings. For example, NMC Health, this years sole UAE public listing so far, listed in London. Shuaa Capital, which with many UAE brokers has radically downsized its retail brokerage arm, says companies and markets need to do more in terms of transparency and to compete for investor attention at a global level. The investment bank says it is finalising plans to launch a corporate brokerage arm to help manage the complex task of generating liquidity and improving access to information.

Contributors
Michael Peel Middle East Correspondent Camilla Hall Gulf Correspondent Simeon Kerr Dubai Correspondent Robin Wigglesworth Capital Markets Correspondent Abeer Allam FT Correspondent Stephanie Gray Commissioning Editor Steven Bird Designer Andy Mears Picture Editor For advertising details, contact Mark Carwardine: +44 (0)207 8734881; email; mark.carwardine@ft.com or your usual representative.

Saudi issuance is important signal to companies

Bonds The kingdom has dominated sukuk sales, writes Robin Wigglesworth
Saudi Arabia, long the sleeping giant of the Islamic debt markets, is finally shaking off its torpor and has dominated global sales of so-called sukuk so far this year. Sukuk are bonds that are structured to comply with Islamic principles and hare strictures against interest. Rather than a fixed coupon, the instruments pay a profit rate. Interest soared in the years preceding the financial crisis, but issuance plunged in the wake of the credit crunch and concerns that some structures did not adhere closely enough to Islamic law. However, sukuk sales rebounded to a record $32.6bn last year, according to Dealogic, and this year has started strongly, with almost $14bn of issuance already. The average yield has also steadily declined, to a low of 3.58 per cent, according to the HSBC-Nasdaq Dubai sukuk index. Malaysia has long dominated the market, followed by the United Arab Emirates. However, after years of disappointing activity, Saudi Arabia the religious focal point for 1bn Muslims around the world has heartened investors and bankers with a spate of large, well-received deals in 2012. Its a big vote of confidence in the sukuk market, says Mohammed Dawood, managing director of Islamic global markets at HSBC Amanah, the British banks Islamic arm. Saudi Arabia is the biggest economy in the Middle East and the fact that the government itself is now issuing sukuk is an important signal for other companies and the wider region. The largest deal was the domestic, government-guaranteed 10-year SR15bn ($4bn) sukuk sold by the General Authority of Civil Aviation to finance the expansion of the King Abdulaziz International Airport in Jeddah. Crucially, given its government guarantee, the sukuk set a local benchmark against which other domestic issuers can price their own potential Islamic bonds. However, it was a $1.75bn debut international sukuk by Saudi Electricity Company that arguably caused the biggest stir. The company received orders of $18bn as investors piled into an international bond that many saw as another proxy for the government, which itself has no cause to borrow given its oil wealth. While Middle East investors bought about 40 per cent of the SEC sukuk, bankers working on the deal said that there were plenty of conventional larly from the banking sector. Banque Saudi Fransi, for example, has filed a prospectus for a $2bn Islamic bond programme in London that aims to raise longerterm funding than is available in the domestic market. The first instalment came in mid-May, when the Riyadh-based Islamic Bank sold a $750m, five-year sukuk, which attracted orders of $4bn and paid a profit rate of 2.95 per cent. The recent Saudi Arabian sukuk were important milestones for the global sukuk market, Mr Dawood says. We expect a lot more in the coming year. There has also been heartening news out of the UAE, where Dubai recently sold a two-part $1.25bn Islamic bond. Aside from affirming the emirates rehabilitation, after its 2009 debt crisis, the larger $650m tranche had a 10-year tenure. This is a rare duration for the sukuk market outside Malaysia, where investors have typically preferred shorter-term bonds. The largest tranche in the recent SEC sukuk also had a 10-year maturity. Yet in other areas innovation has taken a back-seat role to more standardisation. After some high-profile and debilitating clerical concerns over some structures, bankers are mainly focusing on three types ijara, murabaha and mudaraba-wakala. The sukuk market is less bespoke and more standardised these days, Mr Dawood says. We need continual refinements, but in a co-ordinated fashion, with the approval of all parties, scholars, regulators, investors and borrowers. However, uncertainty about how the instruments would be treated in a restructuring continues to cloud the market. The Islamic debt market is constrained by its requirement for real, tangible assets to underlie all transactions. Although many banks have dabbled with structures that either are only asset based rather than asset backed with some even backed by revenue streams from intangible assets scholars generally frown on these. This means, however, that many potential borrowers cannot tap the sukuk market as they do not have the physical assets required to place the structures, and that sukuk generally cannot be increased in size, no matter how large the order book. The requirement for tangible assets is still a big constraint for the market, says one senior banker. It will still be some time before the sukuk market really hits its stride.

We need continual refinements with the approval of scholars, regulators, investors and borrowers
institutional investors as well. This brought total sukuk issuance from Saudi Arabia to $7.2bn this year, already surpassing the full year peak of $5.7bn in 2007, according to Dealogic. Further issuance is widely expected, particu-

FINANCIAL TIMES TUESDAY MAY 29 2012

Arab World: Banking & Finance

Stock markets Egypt defies the odds
Despite the political upheaval, the periodic violence and weak economic performance, the Egyptian stock market, remained among the biggest global winners this year, advancing by about 34 per cent to date. Although the EGX 30 started at a low base after losing 50 per cent last year following the popular uprising that toppled Hosni Mubarak and a subsequent capital flight by foreign holders of Egyptian stocks, the robust performance has surprised observers. The EGX 30 was ahead of MSCI Emerging Market, which gained about 10 per cent and of MSCI World that rose 7.5 per cent. The performance started to change when people realised the situation was not so bad after the first anniversary of the revolution [January 25] went fine, says Sbastien Hnin, portfolio manager at The National Investor, an investment research group. You still have some issues progressed as planned. It is conditional on Cairos ability to line up other sources of credit to meet a funding deficit of $11bn until next April. Analysts, however, remain cautiously optimistic as the country has already elected a parliament and voted last week for a new president in the first election since Mr Mubarak was forced to step down last year. A free presidential election would give a positive signal to investors and prove that the ruling military council is committed to hand over power to civilians, despite a chaotic transition period, analysts say. Minoush Abdelmeguid, an investment banker and managing director at Union Capital, says the environment is still tough. The country is still in labour, she says. There is definitely devaluation coming on its way. Investors want to understand before they make a decision. Yet there are some positive signals and the sentiment is much better than last year; the reserves are picking up, tourists are still coming and inflation eased. The Saudi government pledged a $2.7bn aid package for Egypt and deposited $1bn to ease foreign reserve pressures. While Morocco, along with other north African countries, was supposed to gain from the political uncertainty in Egypt, the euro crisis has spilled over to its southern neighbour. Casablanca stock exchange has dropped by 11 per cent so far this year. Morocco is under pressure because 80 per cent of the trade is with Europe, says Mr Henin. The bulk of tourism and remittances come from Europe. Tunisia, whose stock market advanced by 8.2 per cent so far this year, also suffers from its reliance on European tourism and investment, curtailed sharply by the eurozone crisis. Tunisia, which sparked the Arab uprising when it toppled its president last year, had a more orderly power transition than Egypt. The market rebounded to levels close to the pre revolution value, yet it remains mainly dominated by local investors. It remains the most expensive market in the region, says Mr Henin. There were a lot of hopes to have IPOs, but we have not seen anything significant. . Sbastien Hnin, portfolio manager at The National Investor

Egypt elects: leading presidential candidates say they favour a free market economy and will work towards attracting foreign investment

The performance started to change when people realised things were not so bad
related to the economy, for instance tourism is down and you have a lot of strikes and demands for salary increases. Despite the gain, foreign investment in Egypts stock market remains limited though the shares remain relatively cheap, at 22 per cent less than the emerging markets average. The potential devaluation of the Egyptian pound is a big concern for foreign investors, who have withdrawn billions of dollars from Egyptian equities each month since May 2011 after steady inflows in 2009 and 2010, according to EPFR Global. The JPMorgan Africa fund, which pulled out of Egypt last year, has not yet returned. Negotiations with the International Monetary Fund over a $3.2bn loan have not

Uncertainty casts a cloud over FDI

Investment The eurozone crisis has exacerbated the drop in interest, writes Abeer Allam

Getty

Abeer Allam

he initial optimism surrounding the Middle Easts popular uprisings, sparked by political corruption and unemployment, has given way to mounting concerns over the political and legal uncertainty that has stymied foreign investment, at least in the short term. Cash-rich Gulf investors, who flocked to Egypt and other parts of north Africa during the recent oil boom, are opting to invest at home and to wait until the political situation is clearer. The drop in investment in north African states has been exacerbated by the unfolding eurozone crisis, which has resulted in an increased international cost of borrowing, restrictive credit rules and a liquidity crunch. This has affected investment in countries such as Egypt, Tunisia, Morocco and Libya, where European foreign direct investment is a main component of the gross FDI, according to the business and financial services practice for Frost & Sullivan. As Egyptians voted last week in the first presidential election since a popular revolt ended the 30-year rule of Hosni Mubarak last

year, foreign investors are closely watching the outcome which will shape the political and the economic agenda of the most populous Arab nation. Egypt posted FDI outflows of $482.7m in 2011, compared with inflows of $6.4bn a year earlier. Leading presidential candidates, including former regime officials Ahmed Shafiq and Amr Moussa, and Islamists Abdel Moneim Aboul Fotouh and Mohamed Morsi, say they favour a free-market economy and will work towards attracting foreign investment. But Mr Aboul Fotouhs suggestions to cut energy subsidies by half to energyintensive industries, and reassess FDI on the basis of technology transfer rather than job generation, has made some investors wary. The problem is lack of visibility, investors will not take the risk, says Sbastien Hnin, portfolio manager at the National Investor (TNI). They also want to rely on having cheap energy to export competitive goods but it will be more challenging to get such advantage. Foreign investors and analysts are less concerned about electing a Muslim Brotherhood candidate because they believe he will work well with the Islamistdominated parliament. Still, the vague nature of the future relations between the army and the president, or the role of the presidential authorities in

writing the constitution, add to the confusion. The Egyptian economy has been hit by a drop in tourism as well as the lack of decision making by officials afraid of being accused of corruption, analysts say. Allocating land for projects, for instance, has all but stopped because land has been the centre of corruption cases in the post-Mubarak era, economists say. Foreign investors complain that, while elections have provided a glimmer of hope, a rising sentiment of populism and the absence of clear labour and taxation laws, has cast shadows over investment decisions. The risk of tax code uncertainty puts me off anything in Egypt in the short term, says an important Gulf investor. The labour-intensive

investments will carry a lot of risk in new Egypt. The advantages of Egypt are the big market and cheap labour. If I have a problem with laws on how to hire workers and compensate

I do not expect the presidential election will alleviate the problem. Workers get away with anything now
them, it wipes the advantage away. Since former Mr Mubarak stepped down as president on February 11 last year, the country has been facing strikes in both the public and private sectors. Workers have pressed for

salary increases and a change of management. I do not expect the presidential election will alleviate the problem for anyone, says one foreign investor. Workers get away with anything now, but without any accountability. Foreign investment is critical to job creation to stem an unemployment rate that hit 12.6 per cent in the first quarter of 2012. About 3.4m working age people are unemployed, or 62,000 more than in the fourth quarter of last year, according to the government. In general, there are investors who did not lose hope in Egypt because the fundamentals are still the same, says Mohamed Abu Basha, an economist at EFG-Hermes, the regional investment bank.

But that does not mean it is going to happen soon. Morocco may emerge as the winner of uncertainly in the Middle East. It is more stable and predictable than Egypt. Analysts and investors note that Tunisia has clear taxation and labour laws and could be attractive to investors. But the small size of the market could prove a deterrent. Libyas chaotic transition and Algerias nationalist policies, which prompted the government to cancel or renegotiate contracts with foreigners, has made many investors wary. Algeria can afford it now, but it will face unemployment and housing issues in the future; the same issues that we have seen in the Arab countries that revolted, says Mr Abu Basha.

Need for funds is at its height as euros woes and uprisings depress lending
Continued from Page 1

rival Saudis for size remains on ice. Saudi Arabia has been more active internationally on debt financing, where its offerings of Islamic lawcompliant sukuk (bonds) have helped drive a brisk world market this year. The $14bn of sales of sukuk so far this year in a market in which the UAE is also a big presence are on course at least to match the $32.6bn of last year, according to figures from Dealogic, the financial data provider. The biggest Saudi deal was a governmentguaranteed 10-year SR15bn ($4bn) sukuk sold to finance the expansion of King Abdulaziz International Airport in Jeddah, but the highlight for many investors was a $1.75bn bond offered by Saudi Electricity Company. Orders outstripped the offering size 10-fold, reflecting international confidence in the ability of Saudi Arabia the worlds largest oil exporter to honour debt obligations even at a time of heavy public spending at home. Additionally, Dubai made a notable sale, a two-part $1.25bn bond that underscored the emirates improved reputation among international investors after its 2009 financial crisis. Islamic finance is also set to play an important role in the restructuring of the many Arab world compa-

nies that ran into trouble after the international banking crisis hit in 20070-8. Following initial anxiety that the complexity of many sharia-compliant products was hindering efforts to put ailing companies back on their feet, bankers say they are now better placed to deal with billions of dollars of Islamic debt maturing this year. That has not stopped distressed debt traders from taking an interest in companies whose bond yields are rising because of concerns they may not be able to pull off a restructuring. Arcapita, the Bahrainbased Islamic investment bank, has filed for Chapter 11 bankruptcy protection, ahead of its $1.1bn Islamic loan falling due. The fate of a $920m sukuk payment coming due from Dana Gas, the energy company based in the UAE

emirate of Sharjah, is also being closely watched. In project finance, Saudi Arabia the regions biggest economy has led the way, the sector boosted by one of the worlds largest government fiscal stimulus packages.

Islamic finance is set to play a role in restructuring of many Arab groups that ran into trouble in 2007-08
But while local lenders are piling into the market there are concerns this may not be enough to make up for the exodus of international banks. Part of the funding gap is being filled by big state investors such as the Public

Project finance: image of the King Abdulaziz airport upgrade

Pensions Agency, the Public Investment Fund and the General Organisation for Social Insurance, or Gosi, which can argue they are fulfilling a public interest by backing deals that create jobs and boost the economy. Project finance progress is slower elsewhere, although bankers say opportunities are appearing. A cross-country rail project and a new liquefied natural gas terminal are planned in the UAE and there will be huge building needs for Qatars hosting of the 2022 football World Cup. Private equity has, to a degree, defied the political instability in the Middle East, with the number of deals rising 20 per cent last year, even as revolts engulfed the region, according to the Mena Private Equity Association, an industry body. Thriving areas include healthcare in Saudi Arabia and retail in the UAE, although the activity has a strong pragmatic streak. Industry insiders say transaction volumes are up partly because more sellers have begun accepting they have to drop prices from the boom-time valuations that once beguiled them. Many institutional investors remain wary, preferring emerging Latin American, African and Asian markets. It is part of mixed picture that in financing as in politics seems to be embroiled in both the best and worst of times.

FINANCIAL TIMES TUESDAY MAY 29 2012

Arab World: Banking & Finance

Question mark over who pays for projects

Infrastructure Lenders are finding imaginative ways to raise cash, reports Camilla Hall

Sovereign wealth funds Attention turns to the home front

Soaring public spending in the Gulf is threatening the budget surpluses of the regions sovereign wealth funds as domestic concerns drive expenditure. Spending has risen fourfold in less than a decade and the price of oil needed for countries to produce surpluses has rocketed. With those flows at risk, funds will face more competition for government revenue. Pressure to spend domestically has diverted budgets away from international trophy investments and into local sectors such as healthcare, education and job creation. As unrest has spread across the Middle East, the Gulf has responded by putting its petrodollars to work at home. Government funding for the regions sovereign investment arms is forecast to rise by 8 per cent this year, compared with an increase of 13 per cent a year ago, according to a recent report by Invesco, the asset manager. While the funding rate has fallen, government revenue is set to rise by 31 per cent this year against 25 per cent in 2010, the report says. In general, higher spending needs have tempered foreign investment, says Rachel Ziemba, a London-based director at Roubini Global Economics. Still, they are relatively healthy international savings due to high [oil] prices and higher output. While domestic spending has diverted some wealth, oil prices of more than $100 a barrel have partially mitigated the impact on sovereign funds. However, with debt woes in Europe re-emerging, the price of oil has already suffered. Qatar has stood out from the other regional funds, taking multiple minority stakes in western blue-chip companies this year. Despite boosting spending at home, Qatar, with its small national population has had a recent splurge of purchases abroad. In recent months, the emirate has bought stakes in companies such as Siemens, Shell and Tiffanys. Analysts say Qatar is less vulnerable to oil price shocks because it is the largest exporter of liquefied natural gas, which is sold on long-term contracts. Qatar is a bit special because it has more cash, lower spending needs and a much higher risk tolerance, says Ms Ziemba. She believes Qatar will have $25bn to $30bn to invest this year, taking its assets under management to between $120bn and $130bn. While Gulf governments are wealthier than their neighbours in the Levant, they are under pressure to show that the petrodollars are reaching the local year period. Mubadala, which announces quarterly results, made a $1.1bn loss last year. Results for the huge Kuwait and Qatar Investment Authorities were not available. Risk appetite at the sovereign funds has also declined since the onset of the financial crisis, according to Invesco, the independent investment managers. Demand has increased for tangible income-generating assets such as real estate and infrastructure, it says. The post-Lehman Brothers stock market collapse left many of the regions funds burnt as bank share prices collapsed and asset values plummeted, causing a pause in activity. Western governments are keen to go to the Middle East and look to sovereign funds for interest, but they have to make their proposals very attractive because the amount of capital available is really rather tight, says Nick Tolchard, head of Middle East for Invesco. Funds will be saying if were going to invest, there needs to be a degree of bilateralism. The Kuwait Investment Authority has turned its attention to Asia, opening an office in Beijing last year. The fund received approval to invest $300m as a qualified international investor, with a view to expanding. In Saudi Arabia, HSBC estimates that, if oil is at $100 a barrel in 2013, then even with oil sold at more than 10 times the cost of production, the kingdom will not generate surpluses. Foreign exchange reserves of the Saudi Arabian Monetary Agency stand at $560.8bn. Analysts have pointed to concerns over Saudi Arabias domestic oil consumption, which they say in the long term could threaten its potential future oil revenue as crude is diverted from the international market.

swift glance across the lowrise landscape of Riyadh reveals what project finance bankers across the region like to see: cranes. And what is on display is not the rusting equipment that has laid dormant in some other Gulf cities, but the hustle and bustle of active construction sites. As the Saudi Arabian government continues with one of the largest fiscal stimulus plans in the world, building infrastructure for its swelling population remains at the heart of the countrys domestic policy. But with international banks taking a step back from long-maturity project finance, curiosity is mounting as to how these plans will be funded here and elsewhere in the Gulf.

Infrastructure for a swelling population remains at the heart of Riyadhs domestic policy
There ought to be more concern over some of the big projects theres still a belief that the larger borrowers, such as Qatar Petroleum, Aramco and Sabic will always get their projects done. But theyll have to push even harder now, says Jonathan Robinson, head of regional project finance at HSBC. With more than $500bn in foreign reserves, the Saudi Arabian government is well placed to finance its petrochemical and infrastructure projects but prudent cash management points to a need to diversify sources. Funding projects looks to be reliant on combinations

of government financing, local banks and Islamic bond issuance. A recent deal closed by National Industrialisation (Tasnee) and Sahara Petrochemical to fund three new factories is an example of how finance is being raised. The companies agreed a 16year syndicated loan of SR5.09bn ($1.4bn) with nine local lenders. They will then raise more funds by issuing an Islamic bond to investors, so diversifying the sources of funding. Though local lenders, flush with local currency liquidity, are helping to fill some of the vacuum left by international banks, they are not able to meet all the financing needs of the kingdoms development projects, bankers say. Local banks tend to rely on short-term funding themselves, so are not well positioned to lend over decade-long periods. They are also restricted by single obligor limits that ringfence the maximum amount that can be lent to one company or institution. In order to fund such projects in dollars, local lenders may have to raise funds in the debt markets. Banque Saudi Fransi sold its first dollar-based Islamic bond this month, attracting orders of more than four times what was required. With these challenges, government funds such as the Public Pensions Agency, the Public Investment Fund and the General Organisation for Social Insurance, or Gosi, can step in to support certain deals that will help to create jobs and boost the economy. A lot of the big financing will be done by the pension funds, says Paul Gamble, chief economist at Jadwa Investment in Riyadh. They have their money. They dont need to go out and borrow. Most government projects can fall back on to those if they want to. Saudi International Petrochemical, known as Sipchem, announced this month that one of its units had signed a SR164.8m loan with the Saudi Industrial

Qatar has stood out from the rest, taking multiple stakes in western blue-chip groups
population. Some governments do not publish their annual budget data, leaving citizens in the dark as to how money is spent. The United Arab Emirates has slowed its purchases of trophy assets, spending windfalls locally and branching out into emerging markets such as Brazil. More than half of the assets of the Abu Dhabi Investment Authority (Adia) are invested in indexed-funds that track global stock markets. While Adia typically receives surplus revenues automatically from the government, investment arms such as Mubadala also bid for funds, according to a recent bond prospectus of the latter. Adia, one of the worlds largest sovereign wealth funds, said last year that it had sharply improved its annualised rate of return in 2010 measured over a 20-

Tip top: cranes stand near rising skyscrapers in the King Abdullah district of Riyadh

Bloomberg

Development Fund to finance building a plant. The scale of building in Saudi Arabia is hinted at by the data for cement sales in the kingdom, which rose 16 per cent in the first four months of this year, compared with the first four months of 2011. However, this pace is not being mirrored across the region as a whole. Generally, we see that there are a number of major infrastructure projects in the GCC [Gulf Co-operation Council] but activity still remains low compared to two or three years ago, says Paul Mansouri, a lawyer at Norton Rose in Abu Dhabi. Although progress is

slow, bankers say project finance opportunities are cropping up again in Abu Dhabi, Kuwait and Doha. The union rail project and a liquefied natural gas terminal in the United Arab Emirates are also luring project financiers. Qatars future World Cup development plans are also expected to create some excitement in the project finance arena, once they begin in earnest. Regardless of the country, international lenders will be hoping for one thing if they are going to lend large sums, and that is government guarantees. They [Saudi Arabia] are firing on all cylinders right now, says HSBCs

Mr Robinson. Saudi Arabia has the largest deliverable capital plan in the Gulf. Anyone can plan projects but not everyone can deliver.

Camilla Hall

Heightened political risk gives opportunities to local investors

Private Equity Many global firms have yet to return to the market, says Simeon Kerr
Private equity has been through two convulsions in the region. First, the global financial crisis undermined the banking system and access to leverage, then the political revolts of the Arab uprisings further shattered confidence. But practitioners are starting to see a light at the end of the tunnel. Data produced by the Mena Private Equity Association, an industry body, indicates that the number of deals rose 20 per cent in 2011 compared with 2010, with the number of exits almost doubling during the same timeframe. People are focusing on identifying pockets of growth and investing in them, explains Imad Ghandour, managing director of CedarBridge, the private equity firm. This is the trend we are seeing maybe the overall macro picture is not that bright, but there are places where you can put money and make money. Hot sectors include healthcare in larger markets, such as Turkey and Saudi Arabia, or retail and franchising in the tourismfocused United Arab Emirates. Dubai-based Abraaj Capital in January sold a Turkish healthcare provider to a consortium led by Malaysias sovereign wealth fund. The Carlyle Group, which in 2009 bought into Turkish healthcare, earlier this year acquired a stake in a big education company in Turkey and a Saudi-based fastfood franchisee in late 2011. Prices are realistic, but you cant bottom fish for good assets right now. Its rare to see deals at distressed levels, says Mustafa Abdel-Wadood of Abraaj Capital. A sense of realism has dawned on sellers, many of whom were clinging to boom-time valuations, allowing a steady stream of deals to illuminate the darkness that had descended on the sector since the financial crisis. It all boils down to price. Thats the biggest stimulator of this activity, says Mr Ghandour. Valuations are now providing some good opportunities in the region after two shocks investors see that life goes on, business goes on. But the apparent recovery in private equity has yet to reignite interest from global funds. Mr Ghandour says institutional investors such as large pension funds have yet to step back into the region in a meaningful way, preferring more attractive propositions in Latin America, Africa and Asia. People look at the Middle East and north Arica as one region. They dont dissect it into different countries, he says. There is uncertainty in Egypt, Syria is there and Iran is an issue right on our borders even though Egypt is growing faster than Europe and the Gulf is booming, this is all being clouded by political risk. Dozens of private equity groups have dropped out of the market since the financial crisis, leaving a handful of companies, including established names such as Abraaj Capital, The Carlyle Group, Bahrains Investcorp and Egypts Citadel Capital. The heightened political risk is an opportunity for regional investors who feel more comfortable in these challenging environments. Hisham El-Khazindar, cofounder of Citadel Capital, north Africa, targeting deals of between $5m and $20m in sectors such as manufacturing and education. The governments have become more aware about the need to foster private equity and not rely on government investment and the financing of private investment by debt banking, says Ziad Oueslati, cofounder of Tuninvest. Other funds are also increasingly looking to small and mid-cap deals, as well as venture capital for smaller businesses. Abraaj says it continues to carry out larger, platform deals as they come to fruition, but says the steadier deal flow comes from small and medium-sized transactions. Some of the most exciting opportunities are below the radar screen, fast-growing companies that need capital and support to get them to the next level, says Mr Abdel-Wadood. Ex-investment banker Salam Saadeh, co-founder of Y+ Ventures, this month plans to have a first closing for a $30m fund focusing on regional digital and mobile companies. Rather than seed capital, the fund will invest in models businesses, helping them to expand, with expectations of at least two deals by the summer. The digital and mobile scene in our region is developing very quickly, with many talented entrepreneurs creating numerous new start-ups on a weekly basis to solve particular problems, says Ms Saadeh.

Prices are realistic but you cant bottom fish for good assets right now. Its rare to see deals at distressed levels
the Cairo-based private equity firm, which has $9.5bn of investments, says political change will generate longer-term growth. As governments shift towards more democratic systems, transparency will increase, economies will be run more efficiently, corruption will be reduced and subsidies will be better directed under the scrutiny of elected parliaments, he told a recent conference. Africinvest-Tuninvest, a private equity group that focuses on small-cap companies, has made about 100 investments in Africa, including $200m worth in