The issues of inequitable risk allocation eroding industry profit margins, cash flow crises due to late payments and the lowest bidders promising ambitious timescales are the reality for participants in the Middle East construction industry. Together with a myriad of disputes, these problems are having an effect that is being felt far and wide.
Each participant acknowledges that the situation cannot be sustained and something needs to change. DLA Piper and MEED’s recently published industry report, ‘Time for Change: Construction in the GCC reaches a tipping point’, identified that a more mature funding environment has an important role to play in unlocking that change.
More active involvement by funders has the potential to: enhance due diligence on the viability of each project (paving the way to more realistic completion times and budgets); lead to better developed projects at contract award; promote greater diligence with respect to contract administration; assert greater financier control through the use of project bank accounts leading to more timely payments; and enhance standards in relation to anti-bribery, corruption and modern slavery.
While international funders insist on higher governance and standards as a matter of course, evidence suggests that some larger local funders are now also insisting on greater levels of scrutiny. This is a welcome move away from relationship managers providing funds on a ‘names basis’, which has historically caused difficulties for local institutions.
The biggest hurdle is that greater due diligence and enhanced standards come at a greater cost and inconvenience, which can be a difficult sell for some funders. One local UAE funder comments: “There’s too much competition”.
This is true. There are more than 50 financial institutions in the UAE, which translates to very little leverage for the handful of banks trying to drive change. Developers who do not see the long-term benefits of these checks and balances, especially those under pressure to push through unrealistic project timeframes and budgets, will naturally choose a funder who asks fewer questions.
Many contractors are also promoting the use of export credit agency (ECA) funding, not only because of the competitive advantage it brings, but also because of the improved cash flow profiles it creates. However, ECAs are also reluctant to push for too much change as they do not want to put hurdles in the way of businesses attempting to win work in circumstances where competitors will not face those same hurdles.
Change from the top
While some funders have expressed a desire to be ‘agents for change’, real change requires a top-down approach. Funders are looking to their governments and central banks to implement risk management legislation akin to the Organisation for Economic Co-operation & Development rules, which establish common guiding principles for regulating international investment.
There is also the option of adopting the Equator Principles or International Financial Corporation’s Performance Standards, which would help institutions (and consequently developers) determine the environmental and social risks involved in projects.
Currently there are just three Middle East financial institutions signed up to the Equator Principles: Oman’s Bank Muscat, First Abu Dhabi Bank and Bahrain’s Ahli United Bank.
A change of this nature needs a huge shift in priorities, focusing on factors other than cost. However, central banks and governments would not be driving through changes from a standing start. The region already has a well-established project finance market in the utilities sector and public-private partnership structures are being adopted in other sectors. Historically at least, most of these projects have been funded by international and local banks, with international project finance standards applied, including detailed funder due diligence of project viability and contract terms, a focus on whole life costing, independent contract administration and more reliable cash flows.
International developers working alongside Middle East governments will also encourage the adoption of international working practices.
The operational cost of assets in the Middle East is severe, so the cheapest option is only better in the short term; something Middle East governments are starting to recognise. In Dubai, for example, large public institutions, such as the Roads & Transport Authority, have created ‘asset sustainability’ goals.
The Middle East construction market is also seeing an increase in the amount of whole life asset reports being commissioned and a rise in the number of facility manager contracts being awarded. Awarding contracts to developers who deliver quality projects aimed at prolonging the economic life of assets through innovative engineering will create a barrier to entry for low-cost players.
Can funders drive much-needed change in the Middle East construction industry? Incrementally, perhaps. However, the resounding cry from funders in the market is that real change, on a national level, requires government-led, all-party collaboration as well as a general desire to focus on the long-term sustainability (over short-term affordability) of projects.
|Access ‘Time for Change: Construction in the GCC reaches a tipping point’ here|
About the authors
Suzannah Newboult (pictured) is a partner at DLA Piper
Natalie Roberts is a senior legal consultant at the firm