Fear of floating: Raising finance in the Gulf

A lack of secondary market has made small businesses and investors alike wary of a public offering. Change is on the way
Fear of floating: Raising finance in the Gulf
By Sara Hamdan
Mon 01 Oct 2012 09:56 PM

Over the last year, Nasdaq Dubai has undergone a major makeover. Amid management shuffles and a merger with the Dubai Financial Market, the two new, prominent listings this summer were bright spots in a long period of cloudy uncertainty for the revamped exchange. Emaar listed a $500m sukuk, or Islamic bond, in June, followed by a $650m sukuk by Jafza in July. As more and more companies issue sukuk and bonds to raise debt or list on public exchanges to raise equity instead of turning to banks for financing, it helps develop the region’s capital markets scene.

The key to deepening this market, however, lies not just in having more companies issue bonds or go public. It is also about the development of a solid secondary market, where investors are actively buying and selling securities from each other — as opposed to dealing directly with the issuer.

While this is commonplace in mature markets in the US and Europe, few listings and issuances and low trading volumes mean that the Middle East still lacks a real secondary market.

“To have a liquid secondary market, you need two things: more companies to issue bonds and you need investors who are aware of good opportunities,” Henry Azzam, chairman of Deutsche Bank for the Middle East and North Africa region, said in a recent report by consultancy The Prospect Group. “Without a secondary market, as there is in the West, a bond market will not become viable.”

Decision makers are aware of this and have taken steps to stimulate a secondary market for trading stocks and bonds.  In July 2011, the Qatari stock exchange announced plans to launch a secondary market to allow small and medium sized companies a chance to go public. Listing criteria would be more lenient than those for the main market for more established companies. This followed a similar announcement by Dubai’s stock market in April 2011. The idea was to give a chance for more companies to list — not just the Emaars of the region — which in turn would give investors a wider universe of securities to trade.

Similarly, major companies like Emirates Airline, which has government affiliations, have been encouraged to issue bonds in the local market to raise money.  Strong demand exists for bonds like these by investors in secondary markets.

There were even initiatives specifically targeting the fragmented realm of Islamic finance — either helping Sharia-compliant companies list or encouraging the issuance of sukuk. All of these plans were timely: many were announced last year right when lending to companies by banks had become more stringent than ever.

But were these plans fully executed and did they work?  Were more companies issuing sukuk and bonds to raise debt or listing on exchanges to raise equity, rather than turning to banks for financing? Is there a promising outlook for a local secondary market scene for trading securities of any kind?

In equities, there has been slow progress. About $1.37bn was raised in regional IPO markets in the first six months of this year, compared to $396.47 in the first half of 2011 — nearly tripling growth, according to a report by Ernst and Young. A large chunk of the new listings came from Saudi Arabia, including the $364.65m listing of Al Tayyar Travel Group on the Tadawul exchange.

Still, the IPO market — particularly in the United Arab Emirates — remains disturbingly quiet compared to the heyday of 2005. New listings, particularly of smaller companies, are few and far between, with highly anticipated listings like Daman this year postponed until 2015 in hopes of improved market conditions.

As for bonds, flashy new issuances like those of Emaar and Jafza have a positive impact on the sophistication of the market. Still, there are not enough of them coming to the market, particularly of highly rated companies. This is especially true of sukuk, where demand is great.

“There are still simply too few sukuk in the market and those that have been issued have traditionally seen their investor class comprised of a majority of conventional and not Islamic investors,” says Dominic Harvey, a partner at law firm Vinson and Elkins in Abu Dhabi, who has also authored a report on the topic.

“The logical outcome of this must surely be that Islamic investors are unable to purchase enough sukuk.”

With this imbalance in supply and demand, Harvey says that holders of sukuk feel unable to sell or trade out of their positions for fear of not being able to find another sukuk in which to invest. As a result, the prevailing culture among sukuk holders in the Middle East is to buy sukuk and hold all the way until maturity, rather than selling to a secondary buyer in the interim.

“The problems this causes with liquidity are obvious,” he says.  “And the sort of vibrant secondary market for sukuk that exists for conventional bonds is sorely lacking.”

Secondary market trading is possible, he says, but the chief culprits preventing this are lack of supply and incorrect valuations.

For shorter-term financial securities like stocks and bonds, a secondary market is essential to providing liquidity and diversity of investments. But the issues are just as urgent for the development of a secondary market for longer-term investments, such as private equity. Investors in private equity deals, typically held for an average of ten years, usually look to secondary investors or a public listing as a means of exiting the investment. During dry spells like the one experienced in the last few years — with a mix of distressed assets, a stalling IPO market, and cautious investors — the case for a stronger secondary market becomes increasingly important.

In the Middle East, however, this is a relatively young industry, with 70 percent of private equity firms in the region established in the last five years. There aren’t enough companies and investors in the market yet, nor funds nearing the end of their term and seeking an exit, to speed up the evolution of a secondary market any time soon.

“In the MENA region, many funds are not yet near the end of their life, so they continue to hold their positions in hope of a market improvement,” says Yahya Jalil, director of private equity at The National Investor, an investment firm in Abu Dhabi. “This means there isn’t as much pressure to buy and sell, which limits the secondary market.”

There is, analysts say, an increasing focus for global investors to allocate capital to emerging market private equity, and the Middle East can continue interacting with potential investors around the world and educating them about lucrative private equity opportunities in the region to develop a fuller investor base.

Still, there have been patches of secondary private equity deals across the region recently.  In Egypt, as the political landscape changes and Egyptians in need of cash sell off assets at discounts, investors have been quick to jump on the occasional good deal. Many of these transactions have taken place in the secondary marketplace.

“Most of the deals, if not all, involve Egyptians selling and foreigners buying,” says Omar Bassiouny, head of mergers and acquisitions at law firm DLA Matouk Bassiouny in Cairo. Most of these foreigners, he says, come from the Gulf.

From January until August 2012, Bassiouny’s team has closed nine deals — seven of which were secondary transactions.

Pockets of activity like the Emaar bond issuance and Bassiouny’s private equity deals this year hold promise for the development of a stronger secondary marketplace for short and long term investments in the region. There is a long way to go, but at least there is evidence of a modest start.

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