85 pc Gulf Sukuks are not Sharia’ah compliant?
The significant issuance and new rating activity herald the market’s next stage of expansion and maturity, comments Moody’s Investors Service in its special report ‘Arabian Gulf Corporate Bond Market: 2007 Review and 2008 Outlook’

Buoyed by high liquidity from record oil and gas prices, the Middle East and Gulf Co-operation Council (GCC) region, in particular, experienced a break-through year as far as the gradual establishment of a liquid and rated corporate bond market was concerned. Both conventional and Islamic (Sukuk) financing flourished in equal measure, showing only some softening in the latter part of 2007 on the back of less attractive global market conditions. Moody’s expects much of this pent-up supply to come to market in early 2008, although much will depend on market recovery. Total corporate bond issuance in the GCC (excluding project and structured finance) reached US$23.7 billion close to year-end 2007, of which US$11.7 billion was Sukuk, thus comfortably surpassing 2006 issuance levels of US$14.6 billion, including US$9 billion in Sukuk. Moody’s believes that the near-term market potential could be up to US$50 billion.

Record issuance despite soft landing
Development of a deep, rated corporate bond market continued in 2007, with debt increasingly being the primary source of growth financing. Total bond issuance in the GCC reached US$47.8 billion in 2007, with corporate issuance now representing every second dollar issued. Corporate issuance rose more than 62 per cent to US$23.7 billion, with this figure likely to have reached US$30-35 billion, if the markets had not deteriorated in the final quarter. Issuance across both conventional and Shari’ah-compliant bonds (Sukuk) was evenly strong, with both representing fairly equal shares of the market. Sukuk was driven both by large investor appetite and liquidity for Islamic instruments, and regional ambitions to develop centres for a Shari’ah-compliant secondary market. Here, the Dubai International Financial Centre (DIFC) is emerging more and more as the primary hub, with over US$16 billion of Sukuk listed at the year-end.

The year 2007 saw Moody’s rate its first corporate Sukuk, the US$650 million Ijara Sukuk issued on behalf of Saad Trading Contracting & Financial Services Company in the Kingdom of Saudi Arabia. This was soon followed by more than US$6 billion of additional rated Shari’ah-compliant transactions, with benchmark issuances by both DP World, DIFC Investments and Jebel Ali Free Zone, the latter representing the first company to issue in domestic currency on a large scale. Equally significant, the proportion of rated versus unrated issuers has increased exponentially, with close to 54 per cent of total 2007 issuance (including issuers first rated before 2007) now rated by Moody’s, unlike 28 per cent in 2006. In total, Moody’s rated close to US$12.7 billion of new corporate debt in the GCC in 2007 of a total now exceeding US$14.6 billion.

Issuance has also become more diverse, with 2006 still being dominated by a small handful of large issuers. Whilst in 2006, a total of 13 corporates tapped into the capital markets, this number increased to 18 in 2007. More importantly, the market was no longer dominated by a few issuers. While in 2006, three issuers alone had made up nearly three-quarters of the total market, this figure dropped to 41 per cent in 2007. There were also greater contributions from GCC countries outside of the United Arab Emirates (UAE), in particular from Saudi Arabia, whose contribution rose from 7 per cent to 31 per cent in 2007. This, in fact, underlines Saudi Arabia’s large potential, which Moody’s expects to grow further going forward. Nevertheless, 65 per cent of total issuance came from the UAE (and Dubai in particular), which remained the engine in 2007.

According to Moody’s, three key trends have fuelled issuance (and new rating activity) in 2007 and are likely to support this trend going into 2008:

Rising financing requirements driven by large-scale infrastructure investments and/or international expansion through M&A
The vast majority of 2007 issuance was driven by substantial infrastructure expansion activities, which themselves are being fuelled by strong economic activity and non-oil diversification, as well as widespread population growth (both organically and from expatriate immigration).

Moody’s estimates that over 50 per cent of 2007 issuance was motivated by infrastructure spending in a wider sense, including tourism, transport and energy-related expansion. Most of these funds are thus directed at inward investments. A further 21 per cent of issuance was real-estate-related, with arguably narrowly-defined boundaries between real estate and infrastructure. This predominantly includes purchases of land banks and funding of construction activities, and again was largely directed at the respective local economies. Finally, Moody’s regards around 26 per cent of issuance as related to mergers and acquisitions (M&A), and driven largely by Abu Dhabi National Energy Company (TAQA) and SABIC.

Greater awareness of corporate governance and financial transparency, with ratings regarded as an important step in adopting higher disclosure standards
At the same time, there have been a number of companies that have obtained credit ratings as part of a wider strategy to become more transparent and accountable, whilst at the same time providing them with a higher degree of readiness to tap the markets. Oman Power and Water Procurement Company, the first ever corporate rating in the Sultanate of Oman, is largely prohibited from raising long-term debt, yet it regarded its rating as an important tool in promoting the country’s electricity industry and regulatory framework.

Government-sponsored initiatives to create a liquid corporate bond market as part of the creation of more diversified regional financial centres
Whilst not the single driving force, government initiatives to create a liquid bond market have certainly contributed positively to issuances in 2007. Abu Dhabi’s decision to obtain a sovereign rating and issue a benchmark-sized bond – though admittedly far from requiring the funds – was the single biggest event in the region in terms of supporting the development of the capital markets. Although government-related issuers, particularly in Dubai, have been able to test the waters, it is the government itself that should be creating the yield curve around which the wider market can grow. Dubai itself has been positioning its Dubai International Financial Exchange (DIFX) to increasingly become the regional hub for Sukuk. This position has been further enforced by the Emirate’s ability to not only attract Dubai-based issuance, but also a growing number of instruments from outside Dubai, notably the Sukuk issued by the Ras Al Khaimah Investment Authority and Dar Al Arkan Real Estate Company of Saudi Arabia.

2008 Outlook: considerable funding potential
While the GCC markets have not been directly affected by the recent turmoil, given limited sub-prime exposure, growing domestic economies and large liquidity from record oil and gas prices, markets have been affected with spreads at the year-end on average of 40 to 80 basis points wider than earlier in the year.

In some cases, this has lead to companies reverting to cheaper bank financing and deferring their capital markets activity. Indeed, Moody’s estimates that up to US$10 billion worth of financing were either deferred or bridged through the banking market in the last quarter due to less attractive capital markets. It is therefore likely that new issuance and rating activity will remain robust throughout 2008, although companies may want to first establish whether conditions are worsening or improving, and may ultimately have to grow accustomed to more expensive financing terms.

Given the large amount of liquidity in the local markets, but more importantly the unchanged need for large-scale financing, major government-related borrowers with sound credit stories are likely to experience fewer problems, particularly when demonstrating flexibility on tenor and currency. Global credit woes make the GCC market increasingly difficult to predict. However, the fundamentals remain strong and will ultimately continue to drive new issuance (and thus rating) activity. The biggest single driver remains inward investment, which will continue to require financing, and covers everything from roads, ports, power plants, hydrocarbon assets and tourism projects. Such financing demands have the potential to double issuance volumes over the next couple of years, possibly already in 2008 if markets settle and if both pent-up 2007 and future demand materialise.

Moody’s also notes that there is substantial short-term bridge financing in the wider market, as companies have financed acquisitions on a short-term basis through the bank markets, particularly amongst the large consolidators in the regional telecom sector. Some sovereign wealth funds and government holding companies have been raising short-term funds in preparation for acquisitions, such as the US$5 billion syndicated loans raised by Dubai World. Qatar alone has plans to raise up to US$15 billion next year. Overall, Moody’s estimates that total corporate bond issuance in planning or consideration over the coming 12 months could be up to US$50 billion.

Moody’s expects the market to continue to become more diversified, as Saudi Arabia and Qatar in particular become more prominent issuers. Abu Dhabi’s decision to publish its Aa2 sovereign rating and issue a bond, thus creating a local benchmark, is also likely to support gradual increases in activity in the UAE’s capital, with Dubai currently driving issuance in the Federation.

Moody’s also expect further activity from lower-rated entities–those with no government ownership–in the Baa range over time, although we do not see the emergence of a rated high-yield market as imminent. Generally, the widening of the rating universe from higher to lower-rated entities is a longer-term process, one necessary for a true diversification of credit risk and return. In the interim, higher-rated government-related infrastructure spending is likely to continue to dominate ratings in the region.

Shari’ah compliance debate
Recently, we have seen heightened debate surrounding the true Shari’ah compliance of Sukuk structures, with the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) stating that up to 85 per cent of Sukuk issued in the Gulf do not strictly comply with Shari’ah law. This is due to the presence of the par value repurchase undertaking, which ensures that any repayment risk remains with the originator of the transaction, and not with the issuing vehicle and its underlying assets. According to the AAOIFI, such a promise is in violation of the concept of risk and profit sharing, which underpins the principle of a Sukuk.

Moody’s defers opinion on Shari’ah compliance with the scholars who provide the Fatwa on each Sukuk. From a Moody’s credit risk perspective, the par value repurchase undertaking for an ‘asset-based’ Sukuk (the majority of current issuance) is a central element in order for the Sukuk to be viewed as a senior unsecured instrument and thus for it to obtain the same rating and have similar credit risk characteristics as the transaction originator.

Any de-linkage of the Sukuk performance from the originator, and thus greater reliance on the performance of the underlying asset(s), would significantly alter the rating and risk profile of the affected transactions, as such the instruments would then obtain greater asset risk or equity features. Ultimately, those Sukuk whose performance profile is entirely dependent on assets (securitisation Sukuk) can have ratings and risk profiles completely independent to those of the originator.

Moody’s recognises the importance of debate in this growing market, which may result in a greater diversity of Shari’ah-compliant financial instruments across a wider spectrum of fixed income and equity-related products. Recent trends point towards greater standardisation of legal documentation, but Moody’s will continue to review each Sukuk transaction on the basis of their specific contracts and individual creditworthiness, without opining on compliance with Shari’ah or any other law to the extent that non-compliance does not introduce any new credit risk.

GCC Snippets

Gulf Air moves ahead on fleet upgradation
Gulf Air has ordered 16 Boeing 787 Dreamliners and has taken the options for eight more. The value of the firm order for the new long-haul jets at list price is around US$4 billion, while the total amount can go up to US$6 billion if options are firmed up in the future. The struggling carrier had announced during the Dubai Air Show that it was planning to renew its entire fleet looking to order up to 35 planes. The cash-strapped airline aims to build up a fleet of 45 to 50 aircraft by 2013, compared to 25 aging planes now.

Tax on foreign firms
Bahrain’s Speaker Khalifa Al Dhahrani has called for levying taxes on profits of foreign commercial institutions, arguing that the country needed the extra income for present and future generations. “Bahrain has limited sources of income and relies heavily on oil to fund its spending. Now it needs to diversify its sources, expand its financial assets and preserve the rights of the future generations,” Al Dhahrani said in his proposal.

According to the Speaker of the Council of Representatives, Bahrain has been a champion of free market economy and has facilitated foreign investment and the establishment of international companies in a highly positive fiscal environment. “It is only fair that foreign investors should contribute to the expenses by paying taxes,” Al Dhahrani said. He did not specify the tax rate or suggest a date for applying the new regime. However, Al Dhahrani said that Bahraini and Gulf nationals should be exempted from paying the taxes and that expatriates in the public and private sectors should not be included in the scheme, which should be limited to commercial activities.

Price discrimination for expats condemned
Diplomats, expatriates and human rights activists have strongly condemned a proposal to introduce two separate price scales for basic commodities for Bahrainis and foreigners. The MPs agreed in January to study the possibility of introducing subsidised rates exclusively for local consumers. They blamed inflation for rising crime and violence. The MPs also called for rice, sugar, children’s milk and cooking oil to be added to the list of subsidised products. But Bahrain Human Rights Society assistant general secretary Abdulla Al Deerazi said separate price scales for Bahrainis and expatriates would be a violation of human rights. “We don’t agree with this because it is called discrimination,” he said. “Human rights are being violated when something like this is even considered and where else have you heard something like this? In any country, both expatriates and locals should be treated equally, at least when they’re buying basic commodities”. Indian Embassy First Secretary A K Bhatnagar was also not in favour of such a policy, as he said, “If the prices of commodities are going to be subsidised, it must be uniform for all, regardless of nationality.”



B2C e-commerce market worth over US$3.28bn
An Arab Advisors Group survey of internet users in Saudi Arabia reveals substantial adoption of e-commerce in the affluent and booming economy. The survey shows that 48.36 per cent of users in Saudi Arabia reported purchasing products and services online and through their mobile handsets in 2007. Based on the survey findings, the Arab Advisors Group estimates e-commerce users in Saudi Arabia to exceed 3.5 million consumers, representing 14.26 per cent of the population.

“Saudi Arabia’s large population, its booming economy and increased internet adoption, provide an ideal context for a thriving e-commerce scene. Our major survey revealed a massive size for B2C e-commerce in the country, which presents opportunities for global and regional e-commerce players to tap into this growing market,” commented Jawad Abbassi, Founder and General Manager of Arab Advisors Group. According to the survey, 46.4 per cent of users in Saudi have net access at work, while 36.6 per cent use internet cafes and 34.3 per cent use WiFi hot spots. A full 23.7 per cent do not access the internet, except from their homes.

65pc of GCC pharmaceutical market in Saudi Arabia
Saudi Arabia represents 65 per cent of the US$2.7 billion GCC pharmaceutical market, with its share valued at an estimated US$1.7 billion. Of this, therapeutic classes make up 80 per cent. Broken down, systematic hormones make up US$291 million of this figure; alimentary and metabolism make up US$260 million; respiratory system US$162 million; GU system and sex hormones US$145 million; nervous system US$128 million; cardio system make up US$121 million and musculo-skeletal systems US$111 million. Maher Kheder, Business Development Group Director, Pharma World Holdings, says: “These figures only represent the private market, excluding tender business, and is very encouraging for manufacturers looking to get into the area.”



Cisco to set up research base
Cisco Systems Inc plans to set up a research and technology base in the Qatar Science and Technology Park (OSTP) by investing nearly US$40 million over the next three years. As part of this plan, Cisco will collaborate with Qatar Foundation on a series of projects to help enable QSTP’s vision of transforming Qatar into a knowledge-based economy and facilitating youth employment

Qatar economy set to double in 5-years
Qatar, whose economy is set to double in five years, will develop the “economic diversity” necessary to move away from any future downturn in oil and gas prices, the Minister of Finance Yousef Hussein Kamal said. “For Qatar, the outlook is particularly bright. With the energy sector still accounting for some 60 per cent of our GDP, the growth in oil prices will continue to fuel our economy. At the same time, it will allow us to develop the economic diversity necessary to move away from any future downturn in oil and gas prices in the medium to long term,” Kamal said.

The minister said as of the fourth quarter of 2007, the Middle East Economic Digest figures put the value of projects planned or underway in Qatar at over US$142 billion – more than 20 per cent up on the same period in 2006. With around 50 per cent of these schemes being project financed (and around a further US$55 billion coming through syndications and US$15 billion in bonds), Qatar has a strong incentive to build the infrastructure necessary to attract and retain world-class financial institutions. “This we have done at the Qatar Financial Centre, which has since inception in 2005, attracted and is now regulating some 70 of the world’s leading banks, insurers, investment houses and asset managers,” the minister said. Qatar will further improve its regulatory environment, with the integration of the QFC Regulatory Authority, the Qatar Financial Markets Authority, and the regulatory functions of the Qatar Central Bank into a new single regulatory authority. “With one authority, we believe we will be able to achieve greater efficiency and higher standards of regulation. We are calling it the Qatar Financial Regulatory Authority (QFRA),” Kamal said. He also said between 2002 and 2006, the six member states of the GCC have earned between US$1.2 trillion and US$1.5 trillion in revenues that have been invested both at home and overseas.

Railways planned for Olympic bid
Qatar is planning a 140 km light rail system in Doha to help ease traffic congestion ahead of its 2016 Olympic Games bid. Qatar, which officially launched its bid to host the summer Olympics in January, is expected to spend billions of dollars to revamp its transport infrastructure, irrespective of whether its Olympic bid is successful or not. Construction of the light rail system’s first 85 km is scheduled to begin in 2009, with completion of the metro scheduled for 2015. The network will link all proposed Olympic venues and villages, including the New Doha International Airport, Doha Port and the hotel district.



Kuwait’s shares offer GCC’s best value
HSBC Holding has said Kuwaiti shares offer the best value in the GCC after the Emirate’s Parliament recently eliminated a 55 per cent capital gains tax on equity investments. Kuwait’s parliament also reduced the corporate tax rate levied on foreign companies’ profits to 15 per cent from 55 per cent. Kuwait’s equity benchmark rose 25 per cent last year, under-performing those of its Gulf neighbours.

Kuwait real estate boom predicted
Kuwait will experience a property boom in 2008 due to the creation of the GCC common market and a lower income tax on foreign firms, reported KUNA, citing a report by Al-Mutakhassis Real Estate. Other factors that are expected to boost the real estate market are the release of land by Kuwait Petroleum Company for the creation of 16,000 low cost housing units and plans for a US$14-billion rail link and underground rail network.

World’s first zero-carbon city in Abu Dhabi
Construction work on US$15-billion Masdar City, the world’s first zero-carbon city housing 50,000 people in a car-free environment, is expected to begin in February. Masdar City will be run entirely on renewable energy, including solar power, to exploit the Emirate’s near constant supply of sunshine. “This is a place that will have no carbon footprint and will not hurt the planet in any way,” opined Khaled Awad, director of the Masdar project’s property development unit of the Abu Dhabi Future Energy Company (ADFEC).

Debit card with a Skyward Programme
Credit cards in the UAE totalled 1.53 million in Q3 2007 (up 23 per cent over the same period in 2006); the number of debit cards issued during the same period reached 2.72 million (up 26 per cent over Q3 2006) according to Visa statistics.

“Clearly, cardholders are opting for debit cards as an alternative to holding cash and a preferred method of payment at thousands of points of sale,” said Sanjoy Sen, Country Business Manager for Citibank’s consumer banking business in the UAE. “This is in line with the growing trend among UAE-based consumers towards following sound financial management.”