Bounce back: Renewed vigour in the sovereign bond market

The emirate’s reputation as a safe haven – a sentiment supported over the past 12 months by its stability during much regional and international turmoil – plus the ability of its government-related entities (GREs) to negotiate restructuring packages with their creditors, have recently created some very positive conditions for a revival of the sovereign bond market.

This is likely to be given a further boost by the eventual fruition of plans to issue the UAE’s first federal bonds, which may happen before the end of 2012. The market is also benefitting from a global surge in demand for Islamic debt instruments (sukuk), as well as dependable conventional issues.

Meanwhile, NASDAQ Dubai (formerly called the Dubai International Financial Exchange) has been rebuilding its presence in the debt market, with ambitious plans to develop a major locally based trading platform for this. The Dubai Financial Market (DFM), with whom NASDAQ Dubai merged, also currently acts in part as a secondary market for bond and sukuk issues in the emirate, and also plans expansion. GOVERNMENTS & GREs: Dubai’s economy is dominated in value terms by a handful of GREs, while it is also host to many hundreds of small and medium-sized enterprises (SMEs) – around 50% of all SMEs in the UAE are based in Dubai. Until now, bond issues have been the preserve either of the government, or these GREs, while the SME sector remains largely outside the capital markets. Major efforts are now under way to change this market profile, particularly via encouraging SMEs to list (see overview), but mainly via IPOs rather than via bonds. For now then, bond issues remain the preserve of the government and the GREs.

Indeed, a scan across the bonds on the DFM in mid-December 2012 shows six conventional Dubai government bonds, one of which had matured, and two bonds from Emirates, the government-owned airline, one of which had also matured. On the Islamic side, four government sukuk and two others, matured sukuk from Amlak and Dubai Global – both GREs – were listed.

STILL ISSUING: Government bonds are issued through the Department of Finance, while the GREs issue their own. After the global financial crisis hit Dubai in 2008-09, bond issues from either of these sources ground to a halt, however, not resuming until September 2010, when Emaar Properties announced it was issuing a $500m convertible bond and the government a $1.25bn sovereign bond on the same day. The latter, first fruit of a $4bn Euro Medium-term Note Programme, launched in 2009, was four times over-subscribed in Europe, with an initial $500m, five-year maturity tranche carrying yield of 6.75%, while a second, $750m 10-year tranche carried a yield of 7.875%.

This demonstrated that Dubai still had access to international bond market funding, if at a substantially higher price than it had once enjoyed. The emirate is a recent arrival on the bond market though, with the government issuing its first-ever bond only in 2003 – in dirhams – with this paying a coupon of 3.1%.

The Emaar bond, meanwhile, which was eventually launched in January 2011, had a maturity date of 2015 and a coupon rate of 7.5%, demonstrating some investor caution towards local debt. Dubai’s GREs were still continuing to negotiate debt deals – although Emaar was in a much better position than many.

GLOBAL DEMAND SURGES: Indeed, going forward to July 2012, Emaar launched another $500m issue, this time as a sukuk. In this instance, the profit rate – the Islamic equivalent of the yield – was 6.4%, demonstrating that international investor confidence in the Dubai bond and sukuk market had significantly strengthened in the year and a half in between the two issues – as well as demonstrating the growing strength of global demand for sukuk. This issue was nine times oversubscribed.

Emaar is not the only Dubai entity to have benefitted from this trend, either. In April 2012, the government returned to the bond market, also with a sukuk, this time a $1.25bn, two-tranche issue that was 3.5 times oversubscribed by institutional investors.

The first, five-year tranche of $600m was priced at 4.9%, while the second, 10-year tranche was set at 6.45%. These were both significantly lower than the 2010 issue, with the year seeing this profit rate tighten even further. By July, the $600m portion had fallen to just 4%, while the 10-year tranche had fallen around 70 basis points since its launch.

Market watchers generally link this progress directly to the emirate’s ability to restructure debts – with confidence in this evidently gaining momentum in 2012 thanks to major deals with Dubai World (DW) and Dubai International Capital (DIC) in 2011, while Drydocks World and Limitless – both DW units – reportedly close to terms in mid-2012.

Indicative too of this returning confidence are the fortunes of two other key GRE bonds – a Jebel Ali Free Zone (JAFZA) $2bn sukuk due in November 2012 and the $1.25bn Dubai International Financial Centre (DIFC) Investments sukuk, due in June that year.

The good news on these was that JAFZA announced in May that it had received permission for an early redemption on its bond, while DIFC Investments paid off its sukuk on time, via a $1.04bn five-year loan from a range of Dubai’s banks, plus Standard Chartered, using the DIFC’s property portfolio as backing.

WIDENING & DEEPENING: Thus, Dubai’s sovereigns and GREs are clearly now back in business on the debt market. The hope is that these large bond and sukuk issuers will once again help put the emirate back on the map as not only a centre for regional issuances, but for global ones, too.

Indeed, prior to the financial crisis, the DIFX had already established itself as the main centre for the issuing of aggregate bonds within the region. According to figures from the Kuwait finance house, Markaz, in 2007, some 16 bonds and sukuks, worth a total of $18.64bn, were listed on the DIFX, far ahead of the Saudi Tadawul exchange, its closest rival, which had four issues, worth a total $4.53bn.

As of December 2012, according to public data made available on its website, NASDAQ Dubai, the DIFX’s successor, had 10 Islamic securities , seven equities, three fixed-income securities and two funds all listed as part of their offerings.

POSITIONING: Part of the strategy for NASDAQ Dubai is to make the emirate more of a centre for both conventional and Islamic issuance, developing the local bond market so that regional issuers will no longer travel to Europe or beyond to access the debt markets.

To help facilitate this, the exchange has made some important changes in recent months. It has joined the Gulf Bond and Sukuk Association – the first securities exchange to do so. Membership of this should boost the exchange’s profile while also bringing more standardisation and transparency in issues, which should in turn help to promote further activities.

The second important change has been the development of NASDAQ Dubai’s Central Securities Depository (CSD) to allow for the international transfer of debt. The exchange is the only one in the Middle East region with direct access to Euroclear too, the largest international CSD. The exchange also has direct access to another international CSD, known as Clearstream.

PLANS FOR THE DEBT MARKET: In March 2012 the exchange also announced plans to abolish its existing requirement that debt holdings be kept at its CSD only, allowing investors to choose other CSDs if they prefer. The Euroclear connection has been extremely important in building the exchange’s CSD, with figures from NASDAQ Dubai showing that in 2011, the value of sukuk held there for safekeeping rose 36%.

“We are constantly looking at the debt market now,” Hamed Ali, the acting CEO of NASDAQ Dubai, told OBG. “We have a three-phase plan – first, to build our listings, second to build our CSD, and third to build a platform where people can trade debt.”

TIMING: The issuance of bonds and sukuks in the region is also being helped by the current low activity of the equities market, with debt issuance a preferred alternative both for speed and efficiency. While an initial public offering (IPO) can take a long time to be launched, it can take as little as 10 days for a debt issue, according to some at NASDAQ Dubai.

At the same time, the disclosure rules for debt issue are not as complex or time consuming as for an IPO, while many regional entities are still in the market for fund raising, given both the continued fallout from the global downturn and the need to make new investments at a time of tightened bank lending.

While some GREs still face challenges in restructuring their debts, considering the good progress made so far, backed by Dubai’s sound longer-term prospects, yields and profit rates are likely to continue to fall, while bond and sukuk issuances correspondingly increase in number and volume.

With NASDAQ Dubai building its debt market in tandem with this increase in volume, the next few years could well see several major regional and international issuances starting to come from within the emirate’s markets. “We do not want issuers to go abroad when they can easily just come here,” Ali told OBG.