Decoupling debunked

  • 05 Jan 2009
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Many saw the Middle East as a safe haven in 2008, believing that its equity markets would be immune to a global financial downturn. But the fallout reached the Middle East in the second half of the year, making the global outlook for equity deals gloomier than ever. Bankers are now pinning their hopes on a record-breaking Gulf IPO, expected in 2009. Robert Vielhaber reports.

While at the beginning of 2008 there was still talk about the Middle East being insulated from the global economic slowdown, the so-called decoupling theory turned out to be bunkum.

"International investors, particularly hedge funds, have retreated from the Middle East and other emerging markets, as fund redemptions in their home markets have increased," says Lorcan O’Shea, head of Middle Eastern equity capital markets at Merrill Lynch in London.

By the end of November, around one half the value of equity markets in the Gulf Cooperation Council (GCC) had been wiped off. The outflow of foreign investors, who were estimated to hold one third of the entire market capitalisation of the GCC, hit the region hard.

"The current weakness in the equity market follows a similar slowdown in the region in March 2006, when markets lost between 40%-60%," says Rody Yared, head of equity capital markets for Middle East and North Africa at JP Morgan in Dubai. "At that time, price levels were not sustainable as the majority of indices were trading at very high price earnings ratios."

In 2008, Saudi Arabia’s Tadawul stock exchange, by far the biggest equity market in the region, saw the worst decline, losing nearly 60% of its value after reaching the highest level of the year in January.

This fallout came in a year where equity bankers had pinned high hopes on Saudi Arabia in particular, partly as it is the largest stock market in the region but also because it is the one market that foreign investors are not yet allowed to participate in.

In 2008, the Capital Market Authority (CMA), the country’s regulator, took progressive steps towards opening the exchange for non-Arabic investment, and for the first time allowed non-Arabic investors to participate in trading on the exchange through swap agreements.

"We worked extensively with the CMA on how foreign investors might access the market and were the first European bank to execute a total return swap," says Chris Laing, co-head of emerging Europe and Middle East ECM at Deutsche Bank in Dubai. "The next step in opening the market will be the listing of Saudi Arabian GDRs, which is likely over the next 12-24 months."

Equity bankers are, however, aware that the Saudi market will be exposed to similar dynamics as other global equity markets. "The key challenge for the Saudi market over the medium term will be to educate international investors on the market, on sectors, on trading mechanics, on regulation and on the economy in general," says Merrill’s O’Shea.


Trading suspended

Amid the turmoil in the Middle East, one market that received a great deal of attention was the Kuwait Stock Exchange (KSE), on which trading was suspended as share prices continued to fall.

In November, the KSE, the oldest market in the Gulf region, was shut down for the first time in its history after it had fallen 35% in three months. By mid-December 2008, the stockmarket was down 34%.

Trading was halted on November 13 following a court order, and the market remained shut for two trading days until being re-opened following a request by the Kuwaiti government.

"Some of the markets in the Middle East are not as liquid as they are in the US and Europe," says Durk van der Zee, head of Middle Eastern ECM at Royal Bank of Scotland in Dubai. "As a result, the impact of the financial crisis on these markets has been a bit more dramatic."

JP Morgan’s Yared agrees: "Some Middle Eastern markets have reacted more to the recent volatility than comparable markets in other parts of the world, perhaps because of the lack of previous experience among some local investors."

The cooling of the Kuwait exchange followed a long and sustained boom, which might have given some investors the impression that profits were easy to come by. For many of them, the recent crash marked the first time they would have experienced losses on investments.

Local commentators argued that suspending the exchange sent the wrong signal to local as well as foreign investors, that the market should have been given a chance to recover without intervention. They pointed out that the decision to shut down the exchange was taken by the courts rather than the KSE board. Global Investment House, a local investment bank, said in a research note that "the move to close down the market infused further panic by shattering investor confidence."

Following the closure of the exchange, the government introduced further measures to restore balance in the equity market. The Central Bank of Kuwait asked for the establishment of a special investment fund that would be managed through the Kuwait Investment Authority, the government’s sovereign wealth fund.

The central bank’s proposal recommends that the KIA buys stocks listed on the Kuwait market and says that, as a supporting measure, up to 10% of listed companies could be bought for an estimated $12.5bn.

A similar fund is planned in Oman, where the ministry of commerce and industry said on November 20 it would set up a $390m investment fund, 60% of which would be provided by the government directly, while 40% would be provided from pension funds and the private sector.

The Oman fund would buy shares, thus supplying liquidity to the market, while simultaneously aiming to be profitable in the long run.


Abu Dhabi intervenes

In the United Arab Emirates, government intervention took on a similar shape when it became clear in October that the global financial crisis would effect the UAE’s banking sector, and two factors would combine to reduce liquidity.

One was the departure of speculative money, which had flowed freely into the UAE as international investors were expecting the dirham to appreciate. Many were expecting the government to break the dirham’s peg to the dollar, which would have freed the dirham to rise. The other was the fact that it has become increasingly difficult for banks to raise funds in foreign markets as credit spreads have shot up and debt capital markets have been effectively shut off.

"There was speculative money that entered the market during the fourth quarter of 2007, because expectations of the dirham to gain in value were mounting," says John Tofarides, a banking sector analyst at Moody’s in Dubai. Investors had hoped the dirham would gain between 20% and 30% in value.

"Both hedge funds and currency investors have rushed to bring dirham deposits into banks," he says.

Investors had mainly put this hot money into certificates of deposit with the central bank, where they could withdraw the money quickly if needed.

In June, it became clear that the central bank had no intention of revaluing the dirham and investors subsequently pulled their money out. Analysts estimate that $50bn of speculative money was pulled out of the UAE during July and August. The resulting imbalance of the financial system forced the UAE government to step in with a Dh120bn ($32.68bn) liquidity package for financial institutions in the seven emirates.


Gulf Bank rights rescue

While this liquidity injection was critical for the banking sector in the Middle East, few banks have needed recapitalising. One exception is Kuwait’s Gulf Bank, which announced a rescue rights issue in November.

The bank said it would raise $1.37bn in the equity market to cover losses it had incurred through derivatives trades, where five of the bank’s clients bet on currency derivatives and then refused to pay to cover the losses.

To cover the losses, Gulf Bank’s board proposed the issue of 1.25bn shares for Dh0.3 each, in a deal that would double the bank’s share capital. The transaction is underwritten by the Kuwait Investment Authority, the local regulator.

"The rescue rights issue of Kuwait’s Gulf Bank appears to be an isolated incident," says Merrill Lynch’s O’Shea.

"The deal is related to the bank’s risk management and activities in the derivatives markets. It does not appear to be a general problem that could affect other banks."

Several Middle Eastern companies have relied on foreign markets to fund their operations, especially for the financing of big infrastructure and property developments.

While big recapitalisations of financial institutions via the equity market, characteristic of some European banks, cannot be expected in the Middle East, a large number of businesses will need financing in 2009 and beyond, either through bank loans or the equity market, if the bond market continues to be shut. It is estimated that $15bn worth of loans will mature in the region in 2009 and companies will turn to local banks and potentially to their shareholders to cover their funding needs. "Similar to Europe, rights issues are a common way for Middle Eastern companies to finance growth," says van der Zee at RBS.

Equity bankers also expect listed companies to make greater use of private placements. In these deals companies are often interested in exploring structured issues in the form of equity-linked offers or mandatory convertibles.

"There are several issuers in the region with projects that will be profitable and they need equity to fund their business," says Adam Key, head of Middle Eastern equity markets at Citigroup in Dubai.

"However, given the volatility, investors are very wary of investing. If volatility in the Middle East normalises, then risk appetite will return and investors will start to put money into equity offerings again."


Record IPO expected

The one aspect that sets the Middle East apart from Europe and the US is a macroeconomic outlook that remains relatively stable. Over the past five years, GCC countries grew at an annual rate of around 7%, according to the International Monetary Fund. "GCC countries have built very large reserves, and there is no sign of an immediate slowdown in government spending," says Laing.

On the back of an outlook for positive growth, equity bankers are pinning hopes on the IPO of property developer Nakheel, which is planning a deal in 2009 in what might become the largest equity offering in the GCC to date.

Nakheel is rumoured to be considering raising up to $15bn in an IPO and is likely to list shares on the recently rebranded Nasdaq Dubai exchange (formerly the Dubai International Financial Exchange), in addition to a listing in London.

Bankers in the Middle East say that JP Morgan is mandated for the listing, while Morgan Stanley is also said to be close to the transaction.

By listing on Nasdaq Dubai, Nakheel would follow Dubai-based port operator DP World, which raised $4.96bn on the exchange in October 2007 in what was the largest Gulf IPO to date.

Although DP World’s deal is widely regarded as a success and it became one of the first companies to list exclusively on Nasdaq Dubai, the performance of the shares has been disappointing, dropping to around $0.30 in December from a listing price of $1.30.

Laing at Deutsche Bank argues that DP World would be trading at exactly the same price had the company listed in London. "There have been good trading volumes and investors were able to get in and out of their investments in decent size," he says.

Others agree. Merrill’s O’Shea recognises the negative press the DIFX/Nasdaq Dubai has received, but says, "we should not overlook the fact that we are currently operating in one of the worst bear markets since records began — not an easy environment in which to develop a new stock exchange."

  • 05 Jan 2009

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 417,761.51 1606 9.02%
2 JPMorgan 380,362.89 1737 8.21%
3 Bank of America Merrill Lynch 364,928.71 1322 7.88%
4 Goldman Sachs 269,252.76 932 5.81%
5 Barclays 267,252.43 1082 5.77%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 HSBC 45,449.36 196 6.56%
2 BNP Paribas 38,734.80 217 5.59%
3 Deutsche Bank 37,615.10 139 5.43%
4 JPMorgan 34,724.19 118 5.01%
5 Bank of America Merrill Lynch 33,835.53 112 4.88%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 22,475.46 105 8.65%
2 Morgan Stanley 19,057.00 101 7.34%
3 Citi 17,812.08 111 6.86%
4 UBS 17,693.89 71 6.81%
5 Goldman Sachs 17,333.10 99 6.67%