Selling debt: State-owned enterprises regularly issue bonds

The government’s strong fiscal balance means Abu Dhabi has only needed to issue a limited number of sovereign bonds. When the emirate has sold government securities at all, it has mainly been for the purpose of establishing a yield curve for the private sector.

While the government may have only rarely tapped international capital markets, a few 100% state-owned enterprises (SOEs) – including the Tourism Development and Investment Company (TDIC), Mubadala Development Company and International Petroleum Investment Company (IPIC) – have floated debt in recent years and are likely to continue to do so. In the past these entities acted largely independently when it came to issuing bonds, but recently the Debt Management Office (DMO) – an organisation in Abu Dhabi’s Department of Finance (DoF) established in 2009 – has taken on the task of monitoring the debt issued by major issuers and providing a forum to coordinate issuance.

SOVEREIGN DEBT: Abu Dhabi’s government has issued just three bonds since the launch of its first sovereign bond in 2007, a five-year, $1bn note that matured in August 2012. It then turned to the markets in April 2009, issuing five-year and 10-year bonds, each with a face value of $1.5bn. Because Abu Dhabi regularly runs fiscal surpluses, the government does not need to issue this debt. The point of these sales is to build a yield curve – the relationship between the yield, or interest rate, and the length of the bond – that can be used for pricing private sector debt issuances. Without sovereign debt as a benchmark, it can be difficult for the market to determine interest rates for other bonds.

Given that the last government bond was issued in April 2009, Abu Dhabi could benefit from a new sale to refresh its benchmarks in the debt marketplace. As Saeed Almazrouei, the director at the DMO, told OBG in May 2012, the government plans to sell additional bonds to build a better yield curve, but he added that no firm date has been set. “We will issue again, but there is nothing imminent,” he said. If Abu Dhabi were to sell more debt, it would almost certainly be attractive for investors looking for a low-risk place to park their funds, particularly if the global economy continues to experience the instability that characterised 2011 and the first half of 2012. In the summer of 2011, the yields on Abu Dhabi’s government bonds hit historic lows, as global investors moved out of stocks in response to falling prices and into assets perceived to be safer. As of August 2011 Abu Dhabi’s 10-year bond was yielding about 3.2%, down from 4.8% six months earlier.

However, investors are well aware that Abu Dhabi relies heavily on its oil revenues, and to the extent that these sales are in any way imperilled, the markets will respond. In early 2012 the emirate’s government bond yields rose in response to Iran’s comments about disrupting traffic through the Strait of Hormuz. Similarly, in January Abu Dhabi’s credit default swap spreads – an indication of the likelihood that the government will not be able to repay its debt – rose to their highest level in two years. However, as Fitch Ratings pointed out in March 2012, compared to other GCC oil producers, Abu Dhabi would be better insulated from a possible closure of the international shipping lane than its neighbours, with the Habshan-Fujairah oil pipeline now fully operational. This pipeline, which can transport 1.5m barrels per day, delivers oil over land to the Gulf of Oman, bypassing the strait. Notably, Fitch added that it would not change the rating of Abu Dhabi’s sovereign debt, suggesting that any risk would be minimal. Indeed, in the wake of Iran’s rhetoric, neither Standard & Poor’s nor Moody’s, the other two main ratings agencies, modified their ratings for Abu Dhabi’s long-term debt, which currently stand at AA and Aa2, respectively. In fact, Abu Dhabi continues to enjoy one of the highest sovereign credit ratings in the GCC region.

STAKEHOLDER RELATIONS: To the extent that the market registers any concerns regarding the risks faced by Abu Dhabi’s economy – whether induced by Iran or otherwise – it is the responsibility of the DMO to manage relations with key stakeholders, including ratings agencies and bondholders. This is accomplished in part by annual non-deal road shows that the office carries out in the US, Europe and elsewhere. At these events, DMO representatives meet with current and potential bondholders, providing updated data and answering any questions that they might have. According to Almazrouei, investors often inquire about the emirate’s economic diversification plans, the fiscal balance, inflation, debt holdings by the government and the SOEs, the stability of the banking system, and the performance of the Abu Dhabi Investment Authority, the emirate’s largest sovereign wealth fund. Investors have also been concerned about the Arab Spring, although Abu Dhabi has relatively low unemployment and ranks well on corruption and human capital indices published by international organisations such as the World Bank and IMF. Notably, the UAE has generally been the recipient of money inflows in the wake of political instability in other Arab countries, strongly suggesting that the UAE is perceived to be relatively stable.

OVERSIGHT: The DMO is also actively involved in the debt issuance activities of the SOEs. It is important to note first that the public debt sales of these entities have far exceeded those of the government, with SOEs turning to investors to meet their financing requirements. As of early 2012 Mubadala had outstanding bonds with a face value of $3.25bn, while this figure stood at $10.5bn for IPIC and $2bn for TDIC. Since the establishment of the DMO, the government has increased its oversight of these bond issuances. In this respect, the DMO has two primary responsibilities. The first is to manage risk, and twice a year officials from the office meet with each SOE to review their debt liabilities, evaluating currency, interest rate and maturity risks. The second is coordination, in terms of timing and content. The government would like to avoid a scenario in which all of the SOEs are tapping capital markets at the same time. It would also like to ensure that, at least for broad macroeconomic indicators, the SOEs are providing investors with the same data to avoid confusion.

However, the actual business decision of whether to issue bonds is in the hands of the SOE, not the DMO. This is an important distinction, as delineating the precise role and responsibilities of the SOEs and the government regarding these bonds has created confusion in the past, notably in 2010 in the wake of major debt troubles at Dubai World, a conglomerate linked to the government of Dubai. While the economy in Abu Dhabi was and still is quite different from that of its northern neighbour, markets were more generally rattled by a perceived lack of government support for SOEs in the UAE, and, in response, Moody’s downgraded the debt ratings of Mubadala and IPIC (both of which went down one notch to Aa3) and TDIC (down two notches to A1).

The government of Abu Dhabi reacted quickly to this move, however, with the DoF issuing a statement reaffirming its support for its SOEs as follows: “TDIC, Mubadala, TAQA and IPIC are all 100% government-owned and play a crucial role in the government’s strategy for diversifying the economy. The government has a strong fiscal position and reserves that give it all the capacity needed to meet its commitments to these companies from its own resources.”

The government stopped short of issuing an explicit guarantee, but the long-term financial impact of doing so may not have been significant. While it is difficult to gauge with precision what would have happened had the state explicitly backed the debt of its SOEs, these companies have continued to issue debt on the markets since that time, and without any significant difficulty, despite broad global economic challenges and regional instability. For example, Mubadala issued $1.5bn in bonds in April 2011, while IPIC twice tapped international markets in the same year, including a $3.75bn issuance in October.

CAUTION: Nevertheless, there is a sense that Abu Dhabi’s SOEs are moving more cautiously at present, and are focusing more on deleveraging than on borrowing, as would be consistent with the government’s focus on fiscal consolidation. The DMO’s efforts to monitor and coordinate debt issuances will also likely reduce any financial risk associated with SOEs, which play an important role in diversifying the economy.