Russian SPFS – Not a Serious Sanctions “Buster”

AA Explains SPFS and Venezuela : "Много шума из ничего"

Regular readers of this blog, by all evidence a select group of a handful of individuals or perhaps even more sadly bots, will recall the “great hysteria” (or in some quarters joy) of 2016 that CIPS, the China International Payment System, was poised to be the final nail in the coffin of the primacy of the dollar.

AA dispatched that canard in short order with two posts here and here.

Recently the good folks at Bloomberg reported that Weary of Sanctions, Venezuela Mulls Using Russian Payment System.

Fair enough.  When in a desperate situation, one is likely to consider all sorts of things, including those not likely to be of much utility.

Venezuela has issued its own crypto currency el Petro as a way of countering sanctions. It has also discussed using the Russian ruble in bi-lateral trade with the Russian Federation.

So why not consider the SPFS?

The question is whether the SPFS is a solution. Or like el Petro not much of a solution.

At this point the Система передачи финансовых сообщений (the Financial Messaging System – clearly more sinister in the Cyrillic than English) has not yet risen to the level of a new imaginary threat.

What is missing so far is an assessment of whether joining SPFS will give Venezuela a significant way around US sanctions, especially if Venezuela is de-SWIFT-ed.

Before SPFS becomes a source of unwarranted hysteria or joy, AA will “put the spike in that optic” with a hopefully timely prophylactic post making "the call".

Summary: SPFS is not a significant work-around to sanctions and does not herald the end of the role of the US dollar in the global economy.

Some basics about international cross-border payments to set the stage.

Payments versus Payment Instructions

Both the SPFS and SWIFT are systems for the exchange of messages relating to financial transactions. Neither SPFS nor SWIFT hold bank accounts. Neither makes payments.

They simply relay messages containing financial information, including payment orders, between the institutional holder of an account and the bank where the account is held and vice versa.  Note that individuals may not be members of either system.

How messages are sent to one’s bank is only one part of the issue.  More important is the willingness of the bank to make the requested payment.  

The bank that is asked to make the payment will make the payment or not depending on a variety of factors.  These include the balance in the customer’s account, whether the bank grants an overdraft facility to that specific customer and for what amount, and any legal constraints.

Sanctions are a possible legal constraint. The branch or affiliate of a bank located in a foreign country will generally have two laws to consider: that of its home (parent) jurisdiction and that of the jurisdiction of its location, though the US “doctrine” of “secondary sanctions” or as Europeans both “old” and “new” like to put it “extraterritoriality” also comes into play.

The payment will be either in (a) the national currency of the country where the bank holding the account is located or (b) the national currency of another country.

Payments in the national currency of the paying bank’s location are fairly straightforward.  They are made through the payment systems in that country or as “book transfers”.

A book transfer takes place when the recipient of a payment (the beneficiary) has an account with the bank that has been instructed to make the payment by its customer.  That is, both parties have an account with the paying bank in the same currency.

Unless the party instructing the payment states otherwise, the paying bank will debit the account of the instructing party and credit the account of the beneficiary on its books.  No money will leave the paying bank. A book transfer is simply an accounting entry.

Generally beneficiaries like to get their payments credited to the accounts they use most often.  They may have an account with the paying bank, but really don’t use it as their primary account.

They could receive the book transfer there and then send the money to their main account at another bank.  But that is not costless both in terms of time and bank payment charges.

Or they can tell their counterparty to send the payment directly to the main account at that other bank.

Of course, there could be non-commercial reasons for favoring a book transfer, e.g., desire for confidentiality, desire to avoid exposure to a certain juridiction's laws, etc.

Payments in another national currency are more complicated.

By luck it may be that the bank that has to make the payment holds an account for the beneficiary in the foreign currency of the payment.  Then unless instructed otherwise by its customer (who has been told by the beneficiary where it wants the money sent) the bank will make a book transfer. As above, the money never leaves the paying bank until the beneficiary issues a subsequent payment order that itself is not a book transfer at that bank.

In some rare cases, there is a local payment “utility” for making foreign currency payments.  For example, CHATS in Hong Kong. There are few of these.  They offer fewer options for making payments in terms of number of participating banks and ultimately number of customers (potential beneficiaries). If the money is to be used outside the local system, it will almost certainly need to transit a payment system in the country of the currency of the payment.

In most cases, neither of these alternatives apply—book transfers or CHATS-like systems. So, a bank in Russia, France, or Germany seeking to make a payment in US dollars will likely route that payment through a bank in the USA.

While that payment transits the US payment system, it is subject to US law. Authorities in the USA may block the payment.  Thereafter a subsequent review of completed transactions can result in fines and other penalties.

As mentioned above, the USA applies a doctrine of “secondary” sanctions for actions by non US parties outside the USA.  So a bank in Moscow or Minsk could fall afoul of US sanctions.

The method for transmitting payment instructions is only part of the “problem”.  Substituting one messaging system for another by itself is not a workaround for sanctions.

One has to have a willing bank.

This is the critical factor because there are many ways--not all of them as convenient or quick or secure as others-- to get a message to one's bankers.

Messaging System Coverage

When considering an alternative to SWIFT, one has to look closely on the relative geographic and institutional coverage.  Will the alternative meet the needs of party seeking or being forced to switch?  Or in other words can it use the alternative to communicate with all or a large percentage of those banks and countries it wants to communicate with?

According to SWIFT-published statistics as of April 2019 SWIFT:

1. Was connected to participants in more than 200 countries.
2. Had 11,367 live users.
3. Handled some 2.7 billion messages relating to financial transactions during the month of April.  This includes more than just payment orders, though these were the bulk.

Statistics on SFPS are not as detailed.

1. What we do know from the Central Bank of Russia is that as of 1 July 2019, there were 397 live participants in the SPFS, almost all from the Russian Federation.
2. According to Bloomberg article cited above, a financial institution in Belarus (a subsidiary of Gazprom as identified elsewhere) was a member.  And reportedly the central banks of Southern Ossetia and Abkhazia.
3. Let’s call that 4 “countries”.  AA suspects that Venezuela has little current business with 3 of them.  And prospects for significant business with them are limited. (To use a “charitable” term).
4. AA couldn’t find any statistics regarding number of transactions processed but recalls reading somewhere that some 10% to 16% of domestic Russian payments were made using SFPS.
5. This is a red flag of sorts.  It seems that SFPS is more of a "fire extinguisher" than a replacement for SWIFT.  It’s there in case Russia is de-SWIFT-ed.  Not to replace SWIFT today.
6. There’s more that confirms that assessment. According to a Russian news source, Alma Obaeva, Management Board Chairman of the National Payments Council in Russia said this April that if Russian banks are obliged to join SFPS (currently they are not), they only need connect to the system.  Usage is optional.

What can we conclude from this comparison?

1. SPFS lacks the coverage to give Venezuela a workable alternative to dealing with its correspondents outside of Russia and three rather small countries.  
2. Remember: if a foreign bank isn’t a member, it can’t get a message through SPFS. So SPFS offers no way for Venezuela to communicate with Mexico, China, Brazil, India, Cuba, etc.  to name just a few of its major trading partners.  Its current major trading partner the US is another kettle of fish.
3. SPFS doesn’t seem to be widely used by Russian banks, though AA supposes one could argue that if all Russian banks are connected, they would get a message from Caracas.  
4. But Venezuela almost certainly doesn’t need to deal with 397 or more banks in Russia.  It would probably deal with just a handful, if that many.
5. In such a case, Venezuela would be better served establishing a bi-lateral system for sending and receiving messages with Russian banks. This would be cheaper and quicker.
6. Most banks these days offer customers a PC-based SWIFT like system (meaning it uses the same message formats that SWIFT does).  Such systems can be modified to accommodate a large number of transactions per day and to be linked to the customer's accounting system for Straight Through Processing.
7. There are press reports of discussions to connect with the Chinese, Iranian, Indian and other systems.  These seem mostly aspirational.  
8. SPFS may indeed grow and link to these other centers.  New currencies may supplant the dollar sometime in the future.
9. Pero el presidente Maduro no tiene tiempo para esperar.  His problem is today not in the future.
10. In the future when these alternatives have fully blossomed, surely the world proletarian revolution will have occured, transforming the US Government from an adversary of the Bolivarian Revolution to a supporter.  

Why Did the Russian Federation Create SPFS and NSPK?

The answer to this question is important in understanding what these systems are designed to do.

Prior to sanctions being imposed on the RF related to Ukraine, Russian banks almost exclusively used (and thus relied) on SWIFT to send instructions for domestic ruble payments.

Russian banks similarly relied on Visa and MasterCard to provide processing services for domestic credit and ATM cards. Both these firms conducted these processing services from outside the RF, outside the jurisdiction of the RF.  Russian banks also issued primarily domestic Visa and MasterCard cards.

A 2014 shutdown of credit card processing for sanctioned banks rang the first alarm bells in Moscow.  Calls by the British PM and some other politicians around the same time to de-SWIFT the RF led Moscow to realize that its domestic financial system was vulnerable to disruption by foreign powers and companies. You can read more about it here.

So the RF began building these alternative systems to protect itself, including issuance of a Russian card “Mir” and expansion of business relations with other card providers, China’s Union Pay, etc.

A Few Words on the “De-Dollarization”

The main cause of de-dollarization is and will remain policies of the US Government.  Fiscal policies and trade policies.  And overuse of sanctions.

While these trends were present in prior US Administrations, the current Administration seems to be doing its “best” to undermine the US dollar and international institutions which by and large have supported the US’s dominance of the global economy.  

Acting a brake on de-dollarization will be the absence of credible alternatives.  A credible alternative currency would have to have a market of size that was liquid. With an abundance of good investment opportunities. Good regulation.  Transparency. A market where one could rely on a reasonably fair legal system to protect one’s interests.

Would you want to put substantially all your reserves into securities issued by the Government of China?  The Government of Russia?  Or invest in those markets in non-government securities?

Or would you prefer to dabble in the DFM or other GCC markets?  Should we put our reserves into Dana Gas Sukuk or GFH shares? The Goldilocks Fund?  Or invest in a state-owned company with a free float of 10% of its shares?  That like many state-owned firms has non-commercial motives for at least some of its decisions. Subject yourself to the jurisdiction of the eminent courts of Sharjah?

Currently the EU is the most credible alternative. But only to a point as evidenced by the fact that it has not (yet) supplanted the US.  If the EU splinters, it and the Euro will lose the position they currently hold vis-à-vis the US dollar.

Another brake is the size of the US commercial and financial market.  If you’re a company contemplating whether to deal with Iran or Venezuela, you have to weigh the relative size of the US and Iranian or Venezuelan markets, the ability to place debt or equity in the USA versus the Iranian or Venezuelan markets. If you can only be in one of these markets, which would you chose?  

Seems to AA that this is a relatively easy choice to make.

The Curious Case of Bahrain Middle East Bank (BMB) Bahrain

Perhaps Somewhat Less Currently

Read the update here.  Massive losses at BMB, the bank is likely fatally wounded barring a miracle. 

An introductory note.  There is a financial group from Brunei that uses the acronym "BMB". This post is not about that group, but about the Bahrain Middle East Bank in Bahrain.

AA generally follows the bigger fish (admittedly a relative term) in the GCC.  But BMB caught my eye.

BMB is small bank not a financial force of any measure and has been “limping along” for years.

What’s interesting about it are two scandals, the last of which caused the Central Bank of Bahrain to come down with “both boots” on the Bank.

As well there appear to be some hints as the fate of the AlFawares Group of Kuwait which dropped from sight roughly two years ago.

2013 “Scandal”

In April 2013 BMB’s Board suddenly fired the bank’s CEO and CFO as well as some other officers.

For the first official word on the cause, let’s turn to note 5 from BMB’s 1Q13 interim financial statement.  Unfortunately, the copy online is a picture and so AA can’t cut and paste the text, but has laboriously copied it.

“Subsequent to the approval of the 31 December 2012 consolidated financial statements (the “consolidated financial statements”) by the Shareholders on 28 March 2013, the Board and new management team of the Bank have discovered certain transactions and balances which were not reported in the Bank’s consolidated financial statements. As the Board of Directors was not provided with complete information and documentation relevant to these transactions and balances; based on review of the underlying documentation for the transactions and balances and extensive evaluation, the Bank has concluded that assets and liabilities arising from these transactions, along with certain other assets and liabilities which were previously reported and accounted for as customer deposits under discretionary portfolio management program, should now be reported and accounted for as Bank’s assets and liabilities.  Furthermore, in line with the International Financial Reporting Standards, the Board and new management team have concluded that since key information was not available at the date of approval of the consolidated financial statements, the corresponding figures are not required to be restated.  As a result, the assets and liabilities of US$ 138,383 thousands and US$ 143,093 thousands respectively have been reported in the consolidated financial position of the Bank as at 31 March 2013."

Recognition of these assets and liabilities increased BMB’s balance sheet from USD 55.3 million to USD 190.5 million.

The major change on the liability side was in Deposits from Financial Institutions. As per note 10, some USD 124.078 million of that category was from “quasi-government interbank placements”.

The other increase USD 18.644 million in Borrowings was described as “a secured loan from financial institutions”.  That loan does not appear in the 2Q13 financials nor do some USD 25.7 million in Trading Securities.  AA presumes it was a “repo” like transaction.

In a statement dated 12 June 2013, BMB’s new CEO stated that based on the work of an “independent team of forensic experts” “it was discovered that during 2011, 2012, and Q1 2013 BMB was the subject of various unauthorized transactions, potentially involving fraudulent activities”.

So this was a multiyear activity, roughly coinciding with the tenure of the previous CEO.

BMB’s FY 2013 Annual Report provides additional details.

“2013 was a challenging year for BMB. In April 2013, the Board of Directors became aware that the Bank had potentially been the subject of a major fraud. The then Chief Executive Officer, Chief Financial Officer and a number of other senior staff at BMB were immediately suspended and the Board of Directors commissioned urgent internal and external investigations into the activities of the Bank and the then management team. These investigations uncovered a number of serious potentially criminal activities including the apparent misappropriation of significant funds. As a result a number of senior executives, including the then Chief Executive Officer and Chief Financial Officer, were dismissed. Official investigations relevant to these executives remain ongoing. As a result of prompt and decisive action substantially all misappropriated funds have been recovered by BMB. However, given the serious nature and magnitude of what took place, BMB has instigated criminal and civil legal proceedings against a number of parties. These matters are currently being investigated by the appropriate legal authorities in the Kingdom of Bahrain.  Throughout 2013 the Board and management carried out a full review of all external contractors, legal and professional advisers to the Bank. This has led to a number of changes and corrective measures and the application of a more rigorous approach to selecting and measuring the performance of third party contractors. BDO’s contract to act as Internal Auditor of BMB was terminated in May 2013. In September 2013, EY was appointed to replace KPMG as External Auditor of the Bank."

AA’s first thought when he read all this, particularly the bit about “quasi-governmental interbank placements”, was that a friendly government decided to help out BMB. Best guesses for that would be Kuwait (given the apparent shareholding by/related to Sh. Ali Khalifah Al Sabah) or Oman (given the then CEO’s prior roles with government institutions in Oman).

As a small bank with USD 30 million in equity, it would be very risky to place USD 140 million or so with the Bank.  However, by using a trust structure, all assets placed would be legally immune to any financial distress at BMB.

The Bank would enjoy the earnings from managing the discretionary account to increase its small income as well as develop a reputation in asset management as a potential new line of business.

So it appeared that the fraud was that certain members of senior management then appropriated these funds for their own use.

But there are some loose threads:

1. Once the assets were recovered why wasn’t the trust or discretionary account structure maintained/reinstated? If the documentation was deficient, then that could be corrected.
2. That suggests some sort of “problem” with the owner of the funds. What that is isn’t clear.
3. This would seem to pretty decisively counter AA’s initial thought that the provider of the funds was a Kuwaiti or Omani quasi-governmental body trying to help out either the major shareholder or the then CEO.
4. Also, as per point 3 in the “Key Audit Matters” section of the auditors’ report in BMB’s 2017 financials, it’s noted that in the category Due to Financial Institutions a “single bank in the region” is owed USD 127.4 million and “has been a depositor since September 2010.”
5. That certainly seems like a long time to keep one's funds with a bank. Why would that be?
6. Note that the descriptor does not include the phrase “quasi-governmental” as in the 1Q13 interim report.  Now it’s just a “single bank in the region.”  And the region is potentially very large, depending on the definition used.
7. You will no doubt note as AA did that this amount is some USD 3.3 million greater than the original amount recorded in 1Q2013. It seems strange that the regional financial institution would add such a small amount to the deposit.
8. Two possible explanations.  The deposit is not in USD but in another currency and the change is due to changes in the FX rate.  Or interest has been capitalized. Or both factors are present.  There's not enough information in the financials to determine the answer.

2018 - 2019 "Scandal"

A bit of history to set the stage.

Back in February 2014, AlFawares transferred 42.97% of its ownership stake in the bank to AN Investment W.L.L. a Bahraini company “controlled by the same shareholder as AlFawares Holding Company” as per page 22 of BMB’s 2013 FY AR.

As per records at the Bahraini MOICT (www.sijilat.bh) AN Investments CR 86835 was owned at least in 2016  by two sons of Sh. Ali AlKhalifah Al Sabah, former Minister of Finance and Oil Minister of the State of Kuwait. 

According to the MOICT website, on 26 December 2016, a request was filed to change the ownership of ANI to the names of three Turkish nationals: Huseyin Basaran (70%), Murat Solak (15%) and Ardases Saro Kavafyan (15%). This provides an indication that the sale of ANI to the Turkish three "amigos" probably took place in December 2016.

After a 26 March 2017 voluntary purchase of BMB shares and a subsequent rights offering later that year, ANI wound up owning some 81% of the bank.

Fast forward to 15 November 2018, BMB announced that its Board had met to approve September financials on 7 November but did not approve them due to the Central Bank of Bahrain putting forward “some observations that require resolution”.

In that same announcement, BMB noted that on 8 November 2018 the Central Bank of Bahrain issued a directive to the bank “restricting” the following:

1. Dealing with “specific Trade Finance related parties”.  From the Arabic we learn this means dealing with related parties to the bank in trade finance.
2. Interbank dealings with banks that are not licensed by the CBB.  The Arabic uses the term (مرخصة).  While this term is often used to mean “licensed”, AA suspects that BMB is not dealing with unlicensed banks in Bahrain, but this refers to banks elsewhere.  The CBB doesn’t license  banks in foreign jurisdictions, their own regulators, if any, do. Think of Citibank or NBAD.  However, it is likely that the CBB has set some guidelines as to which non-resident foreign banks Bahraini banks may deal with.  For example, it may forbid dealing with so-called “shell” banks, banks not licensed at all, or banks subject to international sanctions, etc.  So AA is reading (مرخصة) to mean banks outside Bahrain that the CBB does not allow Bahraini banks to deal with.
3. Making any new investments or credit.

11 minutes later that same day a second announcement from BMB was published by the Bahrain Bourse that advised that the two directors representing AlFawares one of whom was Chairman of the Board had resigned on  7 November.

On November 22, BMB published another announcement stating that the CBB had issued “additional formal directions” on 15 November as follows:

1. The Board must resign immediately
2. The CEO and CFO must step down from their positions as the CBB does not consider them “fit and proper”.
3. The Bank must raise capital before year end
4. The Bank must stop dealing with specified related parties for trade finance
5. Further, as a result of identified violations and irregularities, the CBB is unable to comment on the bank’s 30 September financials.

Now you may be wondering as initially AA did why BMB’s announcements seem to be tardy.  On November 8, the Bahrain Bourse suspended trading pending release of the September financials. So timeliness of announcements wasn’t as critical as it would have been if BMB were still trading.

BMB’s AGM was held on 30 December.  According to the published minutes, shareholders holding 80.81% of shares were present.  This means that AN Investments was there.  Mr. Taqi al Alawi from the MOICT acted as Chairman.  A new slate of directors was elected.  None of them seem to have any relationship to ANI.  

The representative of ANI complained that the CBB had not approved Mr. Solak to serve as a director and demanded that the CBB should give this approval and that he should be elected as a director.  Mr. al Alawi noted the comment and proceeded.

To date BMB has not published its 3Q18 financials. And there has been complete radio silence from the Bank both on its website and the Bahrain Bourse.

So what are we to make of this?

From where AA sits, it appears that the CBB thinks this episode is more egregious than 2013. Or it has a "two strikes" rule:

1. The entire board was forced to resign. This indicates that the CBB believes that either (a) the Board was complicit in whatever irregularities occurred or (b) manifestly derelict in carrying out its functions.
2. The two AlFawares directors luckily resigned before the CBB’s directive requiring resignation of the board, thus avoiding the ignominy of being forced to resign by the CBB and possible impact on their eligibility for other board positions in Bahrain and elsewhere.  
3. Or perhaps it was more than luck.  Back when Iraq invaded Kuwait, foreign correspondents pulled their funding to Kuwaiti-owned banks in Bahrain.  Bahrain did not have the financial resources to support these banks.  A full-fledged banking crisis was on the offing.  Sh. Ali Al Khalifah then Minister of Finance of the State of Kuwait (in exile) provided the funding directly.  AA was told by his mentor that Bahrain never forgot that act.
4. The fact that the new board appears to have been chosen by the CBB with no apparent input from ANI investments also suggests (at least to AA) that the CBB assesses that the problem is not one of individual board members but an “institutional” one at the ANI level.
5. For the CBB to declare an officer of a bank as “not fit and proper” is a pretty damning assessment.
6. For the CBB to "fire" a board of directors as well.
7. For the CBB to not accept a person as a suitable candidate for the board of directors is a similar judgment.

At this point you’re probably thinking, AA what about AlFawares?  What have these scandals to do with AlFawares?  Probably nothing.

But BMB is entwined with AlFawares.  As mentioned at the beginning of this post, roughly two or so years ago, AlFawares’ star began to dim. 

Part of the problem seems to be that the members of the AlSabah family branch associated with AlFawares wound up on the wrong side of a family dispute in Kuwait -- not the Amir's side.

AA suspects there were also financial problems.  

AA has no doubt that like any typical Kuwaiti punter, AlFawares built its empire on OPM piled upon other OPM.   AA recalls reading in al Qabas that Gulf Bank was pursuing legal action against the group for unpaid debts.

As to concrete examples of financial difficulty we don’t have to look beyond BMB’s 2017 annual report.  In note 7 we see that BMB has fully provided the USD 3.533 million installment sales receivable which is guaranteed by AlFawares and two associated companies of AlFawares.

Clearly, if the guarantees were worth anything the Bank would have called them.

Additionally, it’s hard for AA to imagine that the CBB would tolerate provisioning if the guarantees had value. That the Bank has not called on the guarantees suggests they have very little value. 

The amount here is small. It is not a loan for USD 300 million but just USD 3 million.  That suggests that the three entities are in dire straits indeed.

The sale of ANI to the three Turkish “amigos” is perhaps another sign of financial distress. Giving up one’s bank is a hard move.

Other indications that AlFawares is inactive or defunct are the disappearance of AlFawares Kuwait’s website.  On AlFawares Egypt’s website all the links are to pages under construction or dead-ends. You can’t really conduct business if the first thing a prospective client sees is that your website looks untended and untethered.

Does this mean that the good shaykhs from AlFawares are sleeping rough under an underpass on the First Ring Road somewhere?  

Not bloody likely.  Any Kuwaiti punter worth his salt has salted away money somewhere "safe" and "discreet" as Mubarak al-H is reported to have done.

Update Gulf One Investment Bank Bahrain

Last December while commenting on the ongoing woes of Dana Gas, I mentioned that there were other firms in even worse shape and cited Gulf One Investment Bank in Bahrain.

It’s time to take another look at G1 as AA ventures off his well worn path of larger institutions in Bahrain.

As per its 2018 annual report, G1 has extended its string of losses in 2018 to five years.

Over the period from FYE 2013 (its last profitable year) through FYE 2018, G1 has:

1. Lost (but not in the sense of misplaced) approximately USD 92 million in equity, a 69% drop from FYE 2013.  Driven primarily by cumulative net losses of some USD 82 million over the period.
2. Suffered a decline of approximately USD 79 million in investments, a 73% drop from FYE 2013. Driven primarily by USD 57 million cumulative net losses in Investment Income.

You can see the details in G1’s 2018 and 2017 Annual Report both on Page 8.

This is rather a dismal record.

But Gulf 1's Board is confident in the future as evidenced by these quotes from the MD&A section of the 2018 Annual Report.

“The Bank made important strides in 2018 towards repositioning its business on a sustainable path, including expanding its income-based business and realising value from its private equity portfolio. In particular, the Board has undertaken a critical review of the challenges facing the Bank and is now evaluating significant structural changes that would put the bank on a stronger footing without affecting the range of activities it currently undertakes.”

So far the important strides have yet to be reflected in the financials.

As to the critical review, лучше поздно, чем никогда.

And again.

“The bank’s journey towards the realization of the value of its private equity investment continues into 2019. This process will have a favourable impact on the Bank’s ability to grow its successful income generating investments to take the bank to profitability and growing shareholder value.”

With cumulative losses of some USD 57 million in investments the bank’s journey towards the realization of the value of its private equity portfolio would seem to a very long term journey.  It will take some rather incredible multiples to cover these losses and generate an appropriate return.  But then 千里之行，始於足下.

 A few other observations.

Regulatory Issues

It pays to read the auditors’ opinion carefully.  In the section “Report on Other Legal and Regulatory Requirements” tucked away in the third bullet point is the phrase “except for the matters discussed in note 1” we are not aware of any violations of ….

The violations in question are:

1. Accumulated losses exceed 50% of paid-up share capital.  Resolution can be by an increase of paid in capital (raise new capital) reduce paid in capital to offset the accumulated loses, or wind up the firm.I’m guessing that of the three shareholders would opt for the second – a capital reduction. If that option is chosen, then G1 would have a short respite, if losses were to continue at the levels of the past five years.
2. But there's a wrinkle that complicates this strategy. G1 has insufficient shareholders equity. Central Bank of Bahrain Rulebook Volume 1 LR-2.5.2B requires wholesale bank licensees to maintain minimum total shareholders’ equity of USD 100 million.

G1’s Board has decided to surrender their wholesale banking license in favor of Category 1 Investment Firm.  There are no set amounts for minimum capital required for this license.  Rather the firm and the CBB will agree an amount based on the firm’s business. 

As I noted in December, G1 has no borrowings. There are no deposits taken from other banks or from individuals or corporates.  Its miniscule USD 7 million in liabilities consist of internal accruals.

Shifting from a bank to an investment firm seems to make eminent sense.

Other signs of distress.

1. The last press release on G1’s website is from 2012.
2. The last weekly update if from 2014.
3. The last research bulletin is from 2013.

Unintended (?) Political Commentary from Gulf News on BREXIT

Has today’s Gulf News, the newspaper of record for the GCC, taken a stand on BREXIT in Sir Kim fashion?

“Rats” indeed!

AA has heard of rats leaving a sinking ship.

But not rats sinking the ship.

As to the news article itself, AA has his doubts.  A BofE official with the name Gertjan Vlieghe?  Not likely on PM Bojo's watch.

Analysis of DG Restructured Sukuk Terms - Amended

Lasciate ogne speranza, voi ch’intrate

It's a lot more than just a forum non conveniens 

at least for some folks

In this post we’ll take a look at how investors in DG’s restructured sukuk (the “Nile Delta Sukuk”) fared in the restructuring.

Are they better off?

Our primary source is the Nile Delta Listing Particulars.   Details on the previous sukuk “Dana Gas Sukuk” are here.

This post should be read in conjunction with the post on “DG Sukuk Restructuring - Lessons for Other Investors” (hereinafter “Lessons”) for a more extensive analysis of the replacement sukuk.

First, let’s go back almost two years when AA in his capacity as (الفاضي يعمل قاضي ) gave some sage advice to sukuk holders about elements they should incorporate in the restructured sukuk, if possible.

To wit:

1. Recast the legal agreements to reduce exposure to Abu Yusuf-y legal maneuvering by the obligor/issuer.
2. Get more collateral and take possession now rather than relying on the obligor to deliver it later.
3. Increase amortization via interim payments and a cash sweep.
4. Shorten up the tenor to keep pressure on the borrower.

Recast the Agreements

1. Well, agreements were recast.
2. As described ad nauseam in Lessons the sukuk holders’ legal position hasn’t really improved. 
3. In fact they may be worse off because the Listing Particulars state that the if the Trust Assets (Ijara assets) have not  been transferred and legally registered in the name of the Trustee, then the learned courts of Sharjah may characterize the sukuk not as a financing transaction but a Sale and Purchase agreement.
4. In which case, DG will be obliged to take possession of the assets and return for any monies paid, including interest payments (so-called Periodic Distributions).  This as you will recall is one of the bogus arguments that DG raised with the previous sukuk.  Now the sukuk holders appear to have signed on to this interpretation.
5. AA hopes if this situation comes to pass, the learned courts of Sharjah will NOT opine that the sukuks are a single transaction and include the interest from the year dot in their calculation.
6. As noted in Lessons, the Listing Particulars highlight the risk (lay out a legal strategy?) that this new “ijara” structure may be subject to challenge on what are simply technical matters and not changes in interpretation of Shari’ah compliance principles though the latter remain a risk.
7. As also outlined in that post, the risk of Abu Yusuf-ery remains, the sad result of a confluence of factors associated with so-called Shari’ah compliant transactions, exacerbated by the risk of having to litigate in the eminent courts of Sharjah.
8. Hint:  If you’re looking for Shari’ah compliant structures, AA suggests equity in a firm that does not engage in transactions contrary to Shari’ah. Or you might want to consider sovereign sukuk issuers who are expected to be less prone to employing Abu Yusuf or his “tricks”.

Obtain More Collateral and Take Possession

1. More described “security” was ostensibly obtained, including some promises of  future security arising from what might charitably be described as high unlikely events, e.g., sale of DG’s fine Egyptian assets or payment of an arbitration award by Iran.   
2. One would need an electron microscope to assess the practical impact on the sukuk holders’ security position of the additional collateral, including the (  في المشمش ) type.
3. AA recommended taking possession of security now rather than waiting to attempt to exercise rights after default.  That didn’t happen.  One sad example: the Ijara assets apparently have not been registered in the name of the Trustee. As noted in Lessons and above, that opens a potential loophole big enough for Donald Trump’s ego to pass through comfortably.

Increase Amortization, Add a Cash Sweep

1. The sukuk holders had a partial victory here.  The sukuk has been reduced to just under USD 400 million.
2. But only the down payment was mandatory.  The additional payment got DG a reduction in rate.  DG made both.
3. But as of now DG have no further obligations to make principal repayments until final maturity of the sukuk in October 2020.
4. To add insult to injury, DG won the right to pay dividends of 5.5% of paid in capital (roughly USD 95 million) a year with the only requirement that after payment of dividends DG maintain USD 100 million in cash and equivalents.
5. To spell it out, it doesn’t matter what DG’s cash flow or income is.  If DG has money in the bank, it can pay dividends of roughly USD 100 million a year as long as after payment it still has USD 100 million in the bank.  
6. A very key point: DG prepares "consolidated" financials that include assets and liabilities of investee companies, including Pearl Petroleum.  Legally, DG does not own these amounts and cannot use them.  
7. In the past I've focused on the Pearl Receivables.  Now it's time to look at Cash and Banks.  Note 15 to DG's FYE 2018 AR page 89 contains information on Current Assets of Pearl appearing on DG's balance sheet - some USD 131 million which would include Pearl cash and A/R.  
8. From the MD&A (page 36) we know that DG's share of Pearl A/R was some USD 18 million.  A rough estimate (note the double caveat here) then is that about USD 100 million of Cash on DG's balance sheet is likely to really be Pearl's cash.  Unless Pearl dividends this money to DG, DG cannot use it for sukuk repayment or other purposes.  
9. The key issue here is whether the dividends restriction is based on the cash appearing on DG's consolidated financials or its parent only financials (not disclosed in the AR).  
10. By AA’s calculation USD 100 million is 25% of the amount due at final maturity.  Of course DG cannot reduce its cash to zero if it is to remain a going concern. Equally it cannot use Pearl's cash for its operations or for debt service.  
11. DG's cash is USD 400 million in bank as per consolidated financials. And on a parent only basis, perhaps USD 300 million.  In either case, DG can pay away just under USD 200 million before final maturity.   
12. Leaving USD 200 million (consoldiated) or USD 100 million (estimated parent only).   50% of the final principal repayment, ignoring cash it must retain for operations. Or in the worst case 25% of the final payment.
13. That appears to leave sukuk holders in the position of hoping that DG can generate aggregate net cash of about USD 300 million during 2019 and the first 10 months of 2020 (consolidated basis) or USD 400 (million parent only).  That’s based on the assumption that DG would not reduce its cash to zero to make the final payment and probably needs to retain at least USD 100 million to assure ongoing operations.
14. If it does not generate that cash, then there will be another restructuring.  As outlined above, the sukuk holders have scant legal leverage.

Shorten the Tenor

1. Tenor was kept reasonably short.
2. While the sukuk holders’ legal and collateral position is weak, the short tenor does keep some pressure on DG.  The threat of another messy restructuring and resultant worsening of banking and public relations may provide some leverage on DG.
3. Perhaps, the sukuk holders just trod the path of a typical commercial bank restructuring.  The lenders know that the proposed terms are not economically based.  That is, the borrower will be unable to make the payments in the time frame given.  But the terms will “sell” back in the head office.  And when the maturity is missed, someone else will be charged with restructuring.
4. In any case the sukuk holders may be in for the financial equivalent of a “Zeno’s dichotomy paradox” restructuring.  Each time they restructure they’ll get half way to full repayment.  At some point, I suppose, the amount will be such that a write-off will be less costly than the professional fees associated with another restructuring.
5. AA gives sound advice or so he imagines.  But, clearly,  (اليد في الميّة مش زي اليد في لنار ). 
6. Sukuk holders probably did as well as they could.  In the desert any water will do.
7. The lesson is to avoid the desert if possible.  Sound advice as usual from AA but of little use to those already "invested" in Nile Delta.
8. A cautionary tale that shows the importance of (فكر في الخروج قبل الدخول )