GULF capital markets may have grown and deepened in the last two years, but they are still illiquid and the links between them are limited. If the region's non-oil economy is to take off, it needs an integrated capital market which can connect companies in one Gulf Arab state with equity or debt investors in others. Emirates Bank Group, Dubai's second biggest bank, has taken a step in this direction by setting up a merchant bank with a Gulf-wide remit.

History and Structure

The Emirates Bank Group, which had assets of $4,300 million at the end of last year, is 80 per cent owned by the government of Dubai. The heart of the group is Emirates Bank International (EBI). One of the more adventurous of the UAE's commercial banks, EBI has been an arranger on several syndicated loans in the region and introduced the UAE's first mutual fund in August.

The creation of the new investment bank - Emirates Merchant Bank (EMB) - is part of a strategy that will enable the group to expand into corporate and investment banking in the Gulf and beyond, while keeping a strong position within its home market.

EMB has been created within the skin of an existing offshore subsidiary of EBI, which was set up in 1991 and registered in the Bahamas. It has capital and reserves of $75 million, soon to be raised to $100 million, and has already taken part in the biggest pan-Arab share issue of recent years, the $291 million offering by the Bahrain-based Arab Insurance Group (Arig) in November.

As of October, the bank's total balance-sheet footings were AED 5,400 million ($1,469 million), including assets which it is managing for the Emirates group. As its predecessor was used by the group purely as a vehicle for collecting offshore deposits, this year was EMB's first as an investment bank.

Suresh Kumar, general manager of EMB, says the new bank will offer underwriting, asset management, treasury and advisory services to clients across the Gulf. It will also provide treasury and asset management for other parts of the group and run its mutual funds and other collective investment products.

'Our focus is going to be regional and international. We see regional capital markets beginning to evolve a little more rapidly than they did five years ago,' Kumar says.

Because of its offshore status, EMB cannot do business within the UAE so the group is setting up another subsidiary, to be known as Emirates Financial Services, which will cover the local market. This company is waiting for approvals from the UAE Central Bank. EBI itself will continue to focus on corporate and government business in the UAE and abroad, while the local retail market is covered by another subsidiary, Middle East Bank.

EMB made its mark in the region with the Arig offering, a complicated deal involving dozens of institutions from the Arab world and a global depositary receipt which was arranged by Western banks. EMB co-ordinated the distribution of shares in the UAE, Oman and Qatar, working with local banks and brokerages in each country. Says Kumar, alluding to a few difficulties: 'It eventually turned out to be a good exercise.'

Strategy

In the Arig deal, EMB worked closely with local institutions in other Gulf states. This is likely to set the pattern for EMB's future in equity underwriting because the Emirates Bank Group's distribution network is confined to the UAE.

'We're looking at the possibility of setting up a presence in the region [outside the UAE], but very often it's not necessary unless we're planning to tap the retail market,' says Kumar. For now, the bank will distribute securities and other investment products through the networks of local banks and investment firms that it used on the Arig offering.

Two big banks - National Bank of Kuwait (NBK) and Saudi Arabia's National Commercial Bank - co-ordinated the Arig deal and Kumar looks forward to further co-operation with them, rather than competition, for future business of this type. 'We'll be happy to work with them. I think the market is bigger than anyone can do alone,' Kumar says.

All the Gulf Arab stock markets have seen a frenzy of activity in the last couple of years, with new listings almost every week. At the same time, local reticence about global capital markets has been overtaken by growing enthusiasm. Yet Kumar warns that if a major offering in the region goes wrong, local investors could recoil.

'The market will remain very fragile initially and if confidence is dented by bringing in half-hearted efforts which bomb, then the pitch is going to be queered,' he says.

Because it is relatively large, well-known and rated at investment grade by Standard & Poor's, Arig is the kind of company which has the best chance of using the capital markets to its advantage.

EMB will probably expend more effort on the lower Gulf, where markets are more open, than in Saudi Arabia or Kuwait. Investors in the UAE and Oman tend to be more averse to risks than their counterparts further north, and EMB will have to keep their trust.

'I see it as a block-building approach where you add things gradually,' says Kumar. 'If, for example, I sold Russian or Bulgarian debt to someone who's saving for his son's education and if that sale has been achieved only because it's Emirates Bank that's selling it, then we're putting our credibility at risk.'

Shares and bonds

When it comes to underwriting, equity is likely to provide more business than debt. The Emirates Bank Group is not a complete newcomer to the primary debt market - it has issued its own certificates of deposit and floating rate notes since 1993, in both US dollars and local currency.

'We knew we were ahead of time so we didn't promote them aggressively,' says Kumar.

Although Gulf Arab companies are familiar with equity and loan finance, debt securities are new territory for all but a handful of sophisticated institutions like Aluminium Bahrain and the offshore investment banks. However, there are signs of change, notably in Oman where a local bank is launching a $25 million Eurobond and another is planning a local-currency convertible bond, the region's first. Emirates Bank International itself is considering issuing international bonds, though no decision is likely to be taken till next year.

'We hope to try and encourage [bond issues]. The syndicated loan route has been the norm, but debt instruments are on the way,' says Kumar. Bonds mean credit ratings, and Kumar believes that corporate attitudes towards ratings have softened since the first controversial foray into the region last year by Moody's Investors Service, when local banks complained loudly about unsolicited ratings which they thought were too pessimistic.

However, local investors will need to be persuaded of the merits of debt issued by Gulf Arab companies. 'What is needed now is - this sounds a little patronising - an educational programme.'