Thursday, 17 December 2009

Abu Dhabi/Dubai: Who's in Control?

Following Monday's surprise announcement, there's been discussion about the terms of the deal between Abu Dhabi and Dubai. In short which Emirate has the upper hand? 

What follows is a re-worked comment to an article at The Emirates Economist blog. There is a discussion there along with some other useful posts, which I suggest those interested in this topic take a look at.

Because details of the funding and any side agreements have not been revealed, we have no way of knowing.

Despite these limitations, we can engage in some hopefully informed speculation.

My own view is that Abu Dhabi has the most leverage.

I look forward to hearing your views, particularly those with different positions.  This is after all a "suq" and one should never take the first price (or opinion) as the last word without a big of haggling.

In large part though not exclusively, I've relied heavily on the 14 Dec Government of Dubai announcement. There are some risks with basing an argument on this document as to do assumes that it was crafted with each word and phrase carefully pondered before its selection That may not have occurred for time and what might be described as "cultural" reasons.

First, the funding itself.

I'm reading two statements from the press release to mean that funding is being provided in stages and with conditionality. First, "The Government of Abu Dhabi has agreed to fund." Not has funded. Of course, on the day of the announcement it's highly unlikely that funds would have been disbursed. The deal was probably struck hours before the release was issued. But there is another indication. In a following paragraph, it states that use of the remaining US$5.9 billion (after the apparent preference to Nakheel sukuk holders) is conditioned upon Dubai World securing creditor agreement to a standstill.

While there's no way of knowing for certain at this point, it sounds like that cash is not yet in hand. I'm guessing (hopefully an informed guess but note that word) that the funding is going to be phased in as needed and as milestones are met. Why? Because this is the tactic that Abu Dhabi took with the recent US$5 billion sale of the second tranche of the US$20 billion bond issue. As you'll recall while NBAD and AlHillal subscribed for US$5 billion, they only paid in US$1 billion immediately with another $1 billion to come within a week or so and then the remainder over the year. It would seem likely that Abu Dhabi would continue the same tactic rather than giving a carte blanche to Dubai.

If this analysis is correct, Abu Dhabi has tremendous leverage over Dubai. Particularly, if negotiations with creditors are difficult. And even more so because I believe that there are more economic shoes to drop in the Emirate (as described below).

There is I admit a second interpretation here – Dubai has the funds or will have them all shortly. And that this statement is designed to put pressure on DW's creditors to conclude a deal.

Second, the form of the financing.

It would have been quite easy for Abu Dhabi to have subscribed to the remaining tranche of the existing US$20 billion bond offering. And to use surrogates – the Central Bank or commercial banks as was recently done. And much quicker since legal documents for these existing bonds were already in place. As well, there was ample unfunded capacity on the second US$10 billion tranche. As noted above, at least US$8 bllion.  So Abu Dhabi's incremental purchase in the existing bond issue could have easily provided funds for the Nakheel bond.

So why wasn't this route taken?

One answer is of course to make the commitment of Abu Dhabi clear. But, by and large the market saw the hand of Abu Dhabi behind the Central Bank and the two commercial banks' purchases. What is the benefit? Discretion. As public entities, both the Central Bank and commercial banks would have to disclose material terms of the bonds – interest rate, repayment and very importantly if there were any material conditions – pledge of collateral, options to acquire assets, etc. – associated with the bonds. They would also be obligated to report any material changes to the bonds' terms or any delays in repayment. In a state to state deal, particularly one between two absolute rulers, disclosure can be what the two parties want. There are no Central Bank or listing regulations. Nor IFRS to deal with.

A direct state to state deal also puts Abu Dhabi's hand a bit closer to Dubai's throat, though it also puts Dubai's hand on Abu Dhabi's. A default to a commercial entity would have to be reported. There is more opportunity for discretion in a government to government deal.

Third, the relative positions of the two parties.

In the context of Dubai's debt, US$10 billion is not solution. It's temporary life support. It's likely Dubai will need more assistance in dealing with its debt. There are the indications that the Emirate itself has a cashflow problem: trade creditors to the government are reportedly among those with past dues. As well, even with bankers and investors' well known affliction of financial ADD, Dubai is likely to find its access to financing constrained for a while. The winding down of the real estate machine, which has driven a good portion of economic "performance", is going to have more than one bout of knock-on effects on the economy.

If so, there will be plenty of future opportunities for Abu Dhabi to apply pressure.

Dubai's main leverage is a Samson-like bringing down of the temple. A weapon perhaps more useful as a threat than for actual use as Dubai is likely to be ground zero in any such application.

Fourth, Abu Dhabi's primary goals may be more political than economic. The more dependent Dubai is for financial support the more it will have to accommodate itself to enhanced pre-eminence for Abu Dhabi and to the latter's policies and wishes.

In this context allowing Dubai to retain its flagship assets and its "face" may be small prices to pay.


Abu 'Arqala said...

This provides a bit of support for my contention that the Government of Dubai itself appears to be having cashflow problems.

Raza said...

Good post as usual Abu Arqala. I posted these at the Emirates blog to get your comments - thought I would post them here too.

Politics behind Dubai's bailout (Part 1)

The Dubai government confirmed that Abu Dhabi had agreed to provide US$10 billion to help Dubai World meet its obligations, including the Nakheel bond. The remainder of the funds will reportedly be used to meet operating expenses and debt servicing costs till April 2010. The key question is what drove Abu Dhabi’s decision to provide support at the 11th hour; and, more fundamentally, what drove Dubai’s decision to announce its intention to seek a debt standstill.

In terms of the latter, given that they are the majority owners in the troubled corporates, Dubai’s authorities must have known for some time that some of its entities were going to have refinancing problems in the current global/market climate; markets certainly thought things could go belly-up very early on. Despite this, Dubai’s authorities publicly maintained, very aggressively at times, that investors/creditors need not worry. Since the Dubai authorities cannot be assumed to be obtuse or devoid of integrity – they have been dealing with markets/commercial credit for decades and would hence know the deep commercial and political fallout of a default announcement - what drove this public stance?

There are a number of possibilities: (a) face-saving/ego issues: if we stick our head in the sand, the problem will go away, or we cannot stand the shame of being forced to ask others for help; (b) expectations that the global and domestic economy would improve faster than was being projected, as a consequence of which, refinancing needs would become lower; (c) confidence in the ability of Dubai/related-corporates to raise financing on international capital markets or bilateral help (Iran, Saudi Arabia, Kuwait, Qatar or other Arab countries); and/or, barring everything else, (d) confidence in being bailed-out by Abu Dhabi due to the reputational damage Dubai’s failure would have for the UAE as a federation. Since the Dubai authorities waited right till the end to realize that nothing but a debt standstill request would work, some combination of the above possibilities may have been at play.

Working through these questions, being market/creditor-savvy, and aware of financial regulations, the Dubai authorities would have known that being arrogant and ignorant about financial problems will not make them go away – (a) can hence be ruled out.

In terms of (b), this can be discounted simply because the authorities in Dubai would have known that property prices in the emirate are unlikely to recover anytime soon given tight credit conditions (domestically/internationally), negative market sentiments (domestically and globally), and delays in project completion/start (locally and GCC-wide). Further, nearly every commentator was of the opinion that Dubai’s property prices would fall further; hence expectations of being able to secure even lower prices would keep demand from returning. That would keep the real estate sector on edge.

Raza said...

Part 2:

As far as (c) is concerned, although the Dubai government had been successful in raising financing at fairly favourable rates in October, it was unlikely that quasi-sovereign entities with large exposure to real estate (that is, no real net worth) would be able to raise financing except at prohibitively extortionate rates and that too with an explicit sovereign guarantee. Secondly, it was unlikely that market would give the amount of money needed to repay all creditors on time. And in any case, with a dismal outlook for the real estate sector, even if these corporate were able to raise financing, it would simply be postponing the problem for another day: sooner or later, Dubai’s coporates would have to deleverage, and there would not be a better time to initiate this, given a worldwide collapse in asset-price bubbles. Finally, it was unlikely that markets would commit the amounts Dubai needed at the 4 percent they had been able to get from Abu Dhabi.

The above discussion leaves option (d) as the only possibility as to why Dubai chose to announce its intentions on November 25: Dubai always believed that it would ultimately be bailed out by Abu Dhabi simply because of the reputational damage Dubai’s failure would bring to the Al-Nahayan sponsored UAE federation, and what that would imply for the sustainability of the federation going forward; note that it is unlikely that there was a formal agreement between Dubai and Abu Dhabi regarding financial support, since if that were the case, the situation would not have been allowed to reach the proportions it did on November 25. And while it may not have been willing to accept the conditions that came linked with Abu Dhabi support, the severe market reaction led the government to concede.

Dramatically then, at (literally) the 11th hour, the government of Abu Dhabi jumped in, despite the fact that during the time between Dubai’s standstill request and the bailout, anonymous Abu Dhabi public officials had been quoted as saying that support would be on a ‘case by case basis’ – i.e., selective and not blanket. This begs the question as to what persuaded Abu Dhabi to dole out the cash, after remaining eerily quiet while Dubai made audacious statements about having Abu Dhabi’s support, in the aftermath of Dubai’s November 25 announcement and even after Dubai has announced getting support from Abu Dhabi on December 14. There could be several possibilities: the severity of the investor response and its implications for UAE corporate world as a whole forced Abu Dhabi into bailing Dubai out; the recognition that if Abu Dhabi lets Nakheel fall – a strategically important corporate for Dubai – the federation’s future would be at stake – Dubai would pull out of the federation and declare its independence; pressure on Dubai/Abu Dhabi to ensure that such a large sukuk instrument does not fail; and/or, the fear and embarrassment of what would happen if Dubai turned elsewhere for support.

If our line of thinking is correct, Dubai must have approached Abu Dhabi for financial help; it is less likely that Abu Dhabi offered on its own (the text of the press release reads “Abu Dhabi has agreed to”). And in return for providing support, Abu Dhabi may have put some conditions:

Their support will not be blanket – Abu Dhabi cannot be expected to pay for every bad decision Dubai took; put differently, Dubai must bear the brunt of the pain. This would explain why Dubai intends to continue talks on debt restructuring with other creditors. Further, Abu Dhabi could also have insisted that the bail-out funds be first used for companies whose failure would have implications for Abu Dhabi as well given the correlation between intra-emirate property markets, stock markets, and banks.

Raza said...

Part 3:
As the one footing the bill for Dubai’s largesse, Abu Dhabi would also want to ensure that it is not put in this position again. This means that since they are committed to keeping the UAE federation intact, Dubai must also clean up its act. The latter could have financial and political implications. In terms of the former, in return for help, Dubai will ensure leverage within its corporate assets is not built-up to such high levels in the future; in terms of the latter, Dubai will agree to a more dominant role for Abu Dhabi in the federal structure (or that it reign in the liberal lifestyle within the emirate and stop pursuing its seemingly independent foreign policy, particularly in relation to Iran with which Dubai enjoys very close relations). And/or, aAside from Dubai’s commitment to be more financially prudent and accept a dominant Abu Dhabi, the latter could also insist that Dubai ensures that its financial support makes commercial sense: that is, Dubai give-up some of its prized assets/shares in prized assets (DP World, Emirates Airlines, centralization of the stock exchanges).

Abu 'Arqala said...


Thanks for your post you raise some very interesting ideas.

One I'm really interested in learning more about is your intriguing comment that if Abu Dhabi had let Nakheel fail, it might have led to the withdrawal of Dubai from the UAE.

Can you expand on that thought a bit?

In such a case, what do you see as Dubai's strategic options? Potential providers of support. Your assessment of the decision: the calculus that being out of the Federation is better than being in it.

I'm asking this because I think this would be a very high risk strategy. I'm not sure Dubai could play Singapore to Abu Dhabi's Malaysia.

I'm interested in your thoughts on this point as well as those anyone else out there who wants to contribute to the dialogue.

Abu 'Arqala said...


Part 1

First a bit of an intro ...

I think the central problem was and remains the amount of the debt.

The first issue: Who was going to break the news to Sh. Mohammed since the solution would require his intervention. Who was going to tell him that Dubai's reputation (and by implication his) could suffer a very serious blow. And that the Dubai project might have to be scaled back. I'm presuming that the Shaykh was not following all the details but rather focused on the macro picture - in addition to his daily duties as Ruler of Dubai and VP of the UAE.

The second: a market solution would be near impossible. As you point out, too big. Too costly. How does one tackle the challenge?

The third: the solution is going to involve some real pain. As the de-leveraging of Dubai Inc begins, it's going to have a knock on effect on other businesses in the Dubai and the UAE.

In such a case there is probably a tendency to hope that a miracle can be found. That if one doesn't own up to the problem, one can work around it. Solve it before everyone else realizes how big it is.

This is what the major US banks did in the wake of the 1980's sovereign debt crisis. They pretended there wasn't a problem. They didn't recognize impairments of these assets. And just about everyone was in on the game - auditors, banking regulators, the government. Only when banks had improved their financial positions a bit did they admit the problem. Spurred in large part by Citi's dramatic making a massive loan provision.

As well, one tries to ring fence the problem as Dubai has tried to do by limiting discussion to Nakheel and Limitless. This makes the problem smaller - at least optically. And may also allow the larger problem to be solved in stages. In more digestible bites. Again before anyone recognizes just how big it is.

Abu 'Arqala said...


Part 2

Now to comments on your post.

(1) Agreed. The Dubai authorities are not mendacious or incompetent.

(2) Their public stance was driven by the size of the problem as outlined in Part 1. And a key issue here was that they had to tell the Shaykh before they went public.

(3) There has been a lot made of the fact that Dubai's pr was less than ideal. Yes. But even with better handling, the market would not have accepted the news with delight. So an enhanced process would have resulted only in a difference of the degree of market reaction rather than cause a different reaction.

(4) I think Abu Dhabi's strategy was one designed to put pressure on Dubai to force changes in economic management and to increase political leverage over Dubai. The former by not giving Dubai a blank check. Dubai therefore is compelled to put its house in order. The latter by setting a process where Dubai will have to come back each time it needs more aid. The bonds provide a lever as well.

That being said,. I don't think that Abu Dhabi particularly wants to humiliate Dubai or take control over prize assets. The goal is an enhanced role in the UAE.

Additionally, in a sense both need each other. So neither is likely to try to hold the other to ransom.

Think Bahrain and Saudi. California and Nevada.

Also having a party on whom one can blame unpopular decisions one would really like to make is quite convenient. "We'd like to do that, but we can't disturb Abu Dhabi" Or "Yes, of course we're with you on Iran, but as a member of the UAE, Dubai can conduct its own trade policy. We really can't force them". And this is something that could be quite useful in dealing with Iran itself.