It is still too early to talk of the green shoots of recovery after the global financial crisis, but following a moribund 2008, the $15bn-plus worth of bonds issued in Gulf states over the past three months represents a welcome revival of the GCC debt markets.
Tapping the bond market has emerged as an increasingly attractive financing option for governments planning large capital spending programmes, and corporates needing to raise funds at a time when bank credit has all but dried up.
On the demand side, investors burned by underperforming equity markets have been compelled to look seriously at buying into fixed-income instruments such as bonds.
The recent clutch of large issues in the Gulf has been led by the hydrocarbons-rich states of Qatar and Abu Dhabi. Qatar started the trend in late March with the launch of its $3bn sovereign bond.
To support government spending, Abu Dhabi also raised $3bn in late March as part of a $10bn two-year bond programme. That debt offering was heavily oversubscribed as investors offered to buy $7bn worth of bonds.
Other Gulf states are now considering bond issues amid robust global appetite for sovereign-rated emerging market debt.
UK-based financial data provider Dealogic estimates that another $20bn worth of conventional debt and sukuk (Islamic bond) issues may be issued this year.
In March, the Central Bank of Kuwait announced plans to issue KD200m ($697m) worth of one-year treasury bonds. Bahrain is the only Gulf state that has issued a sukuk in the past six months, a $750m five-year issue that went to market in June. Its value was increased from the $500m originally planned amid signs of robust investor demand.
The strong market reception for these issues has proved a tonic for the region’s capital markets. “We have had a dramatic number of issues,” says Nish Popat, head of fixed income at ING Middle East.
“There is a lot of liquidity out there and some quality issuers, much of which would have been benchmarked with other emerging market debt. In addition to Qatar and Abu Dhabi, we have got quasi-sovereign bonds such as those from Qatar’s RasGas [Ras Laffan Liquefied Natural Gas Company] and Qtel [Qatar Telecom], and Abu Dhabi’s Aldar [Properties] and Mubadala [Development Company] coming out.”
Strong investor appetite is the common theme. RasGas’s $2.3bn bond issue in mid-July is reported to have received offers of more than $15bn, for an issue that will comprise $500m worth of three-year maturity bonds, $1.12bn worth of five-year bonds and $615m worth of 10-year maturity bonds. Mubadala attracted more than $9bn worth of offers from investors for its $1.75bn bond in April.
The bonds have attracted investors from far and wide, with three-quarters of the bonds sold over the past three months going to investors from outside the region. Asian appetite for Middle East debt has increased strongly over the past six months, say analysts, and European investors are also being courted.
“We have seen risk appetite coming up in the past few weeks,” says Delphine Arrighi, fixed-income strategist for the Middle East and Africa at the UK’s Standard Chartered Bank. “Assets from the Middle East are seen as some of the most risk-rewarding now when it comes to corporate and government bonds, especially Qatar and Abu Dhabi. There is still good relative value here in the region so we continue to see good appetite from offshore investors.”
While Gulf investors are also buying bonds, issuers are looking to raise ever-larger sums of money, and it pays to have a global reach.
The tough global financial conditions are still having an effect on fixed-income markets. Sovereign issuers have tended to price the bonds less aggressively than in the past to ensure a strong reception. Bahrain’s sukuk was priced at 340 basis points over US Treasury bond rates, similar to Qatar’s $3bn bond issue.
“The region used to be extremely sensitive on pricing,” says Rajiv Shukla, managing director of debt capital markets at HSBC Middle East. “Now it is about getting the funding and locking it in, irrespective of what the margin is. [This is] helped by the fact that [US] Treasury and Libor [London interbank offered rate] base rates have been so low.”
The pipeline of sovereign issuance is intended to boost the number of corporate debt issues. “Governments have spent the past two years trying to develop a local government bond yield curve and give some incentive for corporates to move away from bank lending and become less reliant on government funding,” says Arrighi.
Corporate sukuk are also in need of added momentum. “With benchmark issuances from key sovereigns, the debt capital markets are starting to normalise,” says Khalid Howlader, senior credit officer for the Middle East at ratings agency Moody’s Investors Service.
“That helps bring some pricing stability to the Gulf markets and leaves the door open for corporate sukuk.”
But there are obstacles to overcome. Despite regular recent sovereign issuance, governments and corporates are not issuing debt with a wide range of maturity dates, transparency standards are still poor by international standards and the region’s ratings culture remains undeveloped.
The reality is that the Gulf’s debt capital markets still have a lot of ground to catch up if they are to rival major financial centres such as London. Debt securities make up barely 3 per cent of assets under management, compared with the global capital market average of 33 per cent.
Nonetheless, the sovereign issuance will inevitably help to galvanise corporate issuance and thereby deepen the Gulf’s debt capital markets. It is already happening among quasi-sovereign corporate entities – Qatar Telecom went to the market with a $1.5bn bond in April, following swiftly in the wake of the sovereign’s heavily oversubscribed bond issue in April.
If the conventional debt market is beginning to revive as a result of better pricing, sukuk has some way to go to return to its position of a couple of years ago.
According to US ratings agency Standard & Poor’s, the value of issuance in the global sukuk markets fell by about 56 per cent to $14.9bn last year, from $26.6bn in 2007.
Sukuk has suffered more than conventional paper in the downturn. “I see sukuk growing as a function of the general debt capital market growth,” says Howlader. “So if $20bn of debt was issued this year, about $4-5bn may have been sukuk.
“But if there are no debt capital markets, there is no sukuk. The key drivers – favourable spreads and pricing – affect both equally.”
Aside from the Central Bank of Bahrain, which has been a regular sukuk issuer, only the UAE emirate of Ras al-Khaimah has shown enthusiasm for sharia-compliant issues, with its government planning for a $500m five-year sukuk. However, Saudi Arabia is starting to buck the trend. Saudi sukuk issuance in the first half of the year reached $3.6bn, nearly twice the level for the whole of 2008, when just $1.9bn worth of sukuk was issued in the kingdom. Saudi Arabia-based Islamic Development Bank (IDB) is finalising a planned $500m sukuk issuance.
Depending on the pricing, IDB may yet increase the size of the issuance. Saudi bank NCB Capital anticipates a $24.6bn pipeline of GCC sukuk issues this year.
“Conventional bonds, rather than sukuk, have been selling and Islamic banks do not have a lot of new paper to invest in, but there is a lot of issuance in the pipeline,” says Popat. “The Central Bank of Bahrain sukuk issue had a bit of generous pricing built on top of it, but was snapped up quickly and then traded very aggressively.”
Saudi Arabia has ambitions to become the most active bond market, albeit starting from a low base. In June, the kingdom’s financial sector regulator, the Capital Market Authority, approved the creation of a debt securities market on the stock exchange (Tadawul).
Four corporate bonds, including three bonds from the quasi-sovereign Saudi Basic Industries Corporation (Sabic) and one from Saudi Electricity Corporation (SEC), worth about SR21bn ($5.6bn), were listed on the Tadawul on 14 June.
“Certainly the new platform has the potential to galvanise corporate issuance,” says Howard Handy, chief economist at Riyadh-based Samba Financial Group. “All the ingredients now seem to be in place. There is a corporate sector that is desperately short of credit, a Saudi public that is continuing to build bank deposits despite negative real interest rates, and a sophisticated trading platform. The potential appetite for new sukuk appears to be very strong and a number of Saudi firms are mulling the launch of sukuk over the next few months.”
Saudi sentiment has been boosted by the prospect of a secondary sukuk market. “We are encouraged by the finance minister’s May announcement that a new state-owned mortgage securities company will be established by the end of this year,” says Handy.
The company will purchase mortgages from private or public-sector lenders and then securitise the loans into sukuk, which could then be traded on a secondary debt market. The establishment of the new firm will be linked to the rollout of the long-awaited mortgage law.
All are agreed that the logical end-point of the Gulf’s various bond programmes is a larger and deeper debt capital market in the region. The cataclysmic economic events of the past year have provided a window of opportunity for Gulf financial authorities to tap rising investor demand for Gulf sovereign paper, while developing a genuine corporate bond culture.
A more sophisticated debt capital market is clearly not beyond the capability of the region’s financial authorities, and the timely confluence of tight credit markets and latent investor appetite for sovereign-backed emerging market debt makes the prospect a compelling one.