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.