A series of headline-grabbing deals by GCC investors is reinforcing the lucrative investment banking opportunities available to international banks in the region.

The Abu Dhabi Investment Authority (Adia) stepped into the breach in late November, lending Citigroup $7.5bn to boost its balance sheet. The loan is convertible to shares in 2010, making Adia the single largest investor in the bank, with a 4.9 per cent stake. The cash injection will help the bank to recover from losses accrued because of the crisis in the US high-risk mortgage market.

The deal aligned one of the world’s largest sovereign wealth funds with one of the world’s largest banks. Together with Saudi Arabia’s Prince Alwaleed bin Talal al-Saud, GCC investors now own almost 10 per cent of the bank. It is a prime example of Gulf investors’ buying-power and demonstrates the longstanding trend for GCC institutions to look beyond their own borders for investment opportunities.

The deal also indicates the growing significance of GCC investors in global financial
markets. This is a two-way relationship. Inter-national financial institutions are increasingly looking to the GCC for investment banking business, as mergers and acquisitions and capital market-related activity accelerates.

International capital

Adia is one of the oldest and most experienced institutional investors in the region. But other major corporates and government-related investment entities are actively investing, and raising large sums of money. Private equity firms in Dubai, such as Dubai International Capital (DIC) and Istithmar, are among the regional investors looking for services from global investment banks.

These companies have staged international share offerings, such as for Kingdom Hotel Investments and Dubai ports operator DP World, and purchases for regional heavyweight corporates, such as Saudi Basic Industries Corporation (Sabic), which bought GE Plastics for $11.6bn in May. They are targeting acquisitions and bankers to structure deals, as well as international equity capital, conventional debt and sharia-compliant finance.

“The market has got more sophisticated in a short space of time,” says Julian Mylchreest, head of investment banking for central and eastern Europe, Russia, Commonwealth of Independent States, Middle East and Africa at Citigroup. “This is not dumb money or the place of last resort.”

In anticipation of greater demand for services and recognition that regional clients are no longer prepared to be served out of London or New York, international institutions are arriving in force in the region.

“There will be winners and losers,” says Emmanuel Volland, director of ratings agency Standard & Poor’s. “Banks will be better placed with international experience or a strong foothold in the market and a distribution network.”

International banks have set up in the Dubai International Financial Centre (DIFC), where the financial free zone has welcomed banks seeking to establish a regional hub. It is one of the easiest regions to set up in and the most competitive market, as well as being home to a potential client base of boutique investment houses and private equity players.

Financial centres

International investment banks are also establishing offices in Saudi Arabia, where the Capital Market Authority has mandated the separation of commercial and investment banking activity and opened its doors to foreign players. The kingdom is home to some of the region’s biggest companies, offering the potential for future large transactions indicated by the scale of the GE Plastics deal. Firms are vying for their attention, putting staff on the ground and developing their sharia-compliant structuring expertise.

However, Abu Dhabi is also emerging as a centre of investment and merger and acquisition activity, and Doha has launched the Qatar Financial Centre to support the growth of its gas-based economy. Almost 400 financial institutions are crammed into Bahrain, the majority of which serve the wholesale market and half of which are focused on the Saudi market. Kuwait is a harder market for international banks to penetrate and is served by established local players NBK
Capital and Global Investment House.

However, large transactions are dominated by only a handful of global players, among them Citigroup, HSBC, JP Morgan, Deutsche Bank, Morgan Stanley and Goldman Sachs.

“There are a lot of people competing but you can differentiate,” says an international investment banker. “There are four or five names cutting it on the most complicated deals, although there are a further 20 institutions competing for work.”

The number of big clients is still small despite the increase in investment volumes, government moves toward privatisation, the number of private equity firms and the volumes of international capital market activity from regional companies. Competition for their business is fierce.

Mylchreest estimates there are up to 25 major clients in the region all being pursued by international investment banks. The field shrinks further as a single international institution cannot be a trusted banker to all the key companies in a particular sector competing for acquisitions.

“There are not that many clients here,” says Mylchreest. “It is a narrow channel but they are big and have deep pockets. The group of decision-makers is small and you have to deliver something new as well as good ideas.”

Investment banking mandates are won on reputation and trust. Relationships with regional institutions are key to the ability of international banks to pitch successfully for business.

Building relationships

“If you are coming in cold this is a challenging market,” says Mylchreest. “Breaking into relationships in this region is tough but once you establish them, there is a tremendous amount of trust.”

Guarding relationships is paramount. Much of the client-banker trust hinges on having a local presence. Here, banks with longstanding retail operations, private banking or corporate banking relationships have the edge in terms of track record and access.

HSBC has been present in the UAE for more than 60 years, and in Saudi Arabia since the 1970s. It is a legacy the bank is keen to promote, along with the size of its global balance sheet. HSBC reported pre-tax profits of $1bn from the entire Middle East and North Africa (Mena) region in 2006.

“We are very close to all of the local governments and key corporations and have worked with them for a long time,” says David King, Middle East managing director of business development and global banking, Mena, at HSBC. “HSBC can call on local and international resources. But no one owes us a living and we must compete.”

Establishing an office is a show of commitment to the host country. However, banks are still doing business from outside their target markets. Citigroup does not have an office in Saudi Arabia following the sale of its stake in Saudi American Bank in 2004. Since then, the bank has been involved with transactions with Sabic, Saudi Aramco and Saudi Oger. However the bank plans to set up an office in the kingdom as it is rebuilding its client base.

Most of its competitors are already present in Saudi Arabia. Goldman Sachs has already joined with the local National Commercial Bank to launch an investment banking business, Morgan Stanley has a wholly owned subsidiary and Deutsche Bank launched a brokerage subsidiary in the kingdom in July. JP Morgan is expected to launch its investment banking subsidiary by the end of the year.

The value of global investment banks to regional clients is their international contacts. The vast majority of major acquisitions are still outside the region, and this is where global financial institutions are able to use their networks to source deals. This knowledge of corporates elsewhere, and the ability to bring in staff from other markets, is supported by banks’ familiarity with foreign regulators.

Exploring potential

In terms of capital raising, the opportunity for international banks without a local licence lies in the largely unexplored potential for large local companies to stage an initial public offering (IPO). Banks are eyeing these corporates, hoping to advise on and structure a global issue and market it to their own client base of international investors.

The number of offerings is expected to increase following the region’s largest IPO in November - $4.9bn worth of shares in DP World. The issue was marketed globally to high international institutional demand. Deutsche Bank and Merrill Lynch were the joint book runners on the global offering, along with Dubai-based Millennium Finance Corporation and Shuaa Capital.

International banks are also positioning themselves as the channel through which local corporates can access the international debt markets. JP Morgan is lead manager, book runner and underwriter for Dubai developer Nakheel’s $750m sukuk launched in early December, and is marketing the issue to its institutional clients around the world.

“If you are structuring a sukuk, a global distribution network is a benefit,” says Volland. “If you are a small boutique, there is no way you can place it.”

Banks already established in the market enjoy some protection against new competition thanks to the rising cost of market entry, which acts as a barrier to new players. Firms must weigh the cost of soaring rents and staff salaries against their expectation of future profits. In addition to high set-up costs, underpricing services to grab market share puts pressure on new entrants, who, in the future, are expected to narrow their focus to particular markets

“Few banks have the goal to set up in every market,” says Volland. “It is expensive, it is difficult to hire good people and difficult to get a licence. And when you enter a market, it is difficult to generate revenues. We will see banks be more selective.”

Key fact

Mena region pre-tax profits of HSBC broke the $1bn barrier for the first time in 2007.

TABLE: Locations of international banks