Number 915 10 August 2009 Client Alert Latham & Watkins Corporate Department Assessing the Middle East Sovereign Bond Market For the first time in recent memory, Gulf countries are seeking external capital by tapping the international capital markets through sovereign bond offerings. Introduction Bond issues by Middle East sovereigns and quasi-sovereign issuers have dominated Middle East debt capital markets activity in 2009, generating $16.2 billion of fresh debt capital yearto-date. This market was ignited in April 2009, when the Emirate of Abu Dhabi and the State of Qatar, within a few days of each other, each priced and sold $3.0 billion of sovereign bonds. Middle East Sovereign and Quasi-Sovereign Bonds in 2009 These highly successful bond offerings which tied as the largest Middle East sovereign debt issuances on record generated a bond yield curve which helped the market analyze and price subsequent bond offerings by quasi-sovereign entities. The strength of the bond market was illustrated recently by Dolphin Energy Ltd, which issued a $1.25 billion 10-year amortizing bond priced all-in at 100 basis points less than the $2.85 billion of concurrent bank funding. Date Issuer Instrument Amount Type August 2, 2009 July 16, 2009 Dolphin Energy Ltd. RasGas (Ras Laffan Liquefied Natural Gas Company Limited (3)) 5.888% 4.500% Bonds due 2012 July 16, 2009 RasGas 5.500% Bonds due 2014 July 16, 2009 RasGas 6.750% Bonds due 2019 June 11, 2009 Qtel (Qatar International Finance Limited) 5.900% June 11, 2009 Qtel 7.875% June 9, 2009 May 21, 2009 Kingdom of Bahrain (CBB International Sukuk Company (No. 2)) Aldar (Atlantic Finance Limited) CBB International Sukuk 2 (Ijarah) 8.750% Guaranteed $1,250,000,000 Quasi-Sovereign $500,000,000 Quasi-Sovereign $1,115,000,000 Quasi-Sovereign $615,000,000 Quasi-Sovereign $900,000,000 Quasi-Sovereign $600,000,000 Quasi-Sovereign $750,000,000 Sovereign $1,250,000,000 Quasi-Sovereign Latham & Watkins operates as a limited liability partnership worldwide with affiliated limited liability partnerships conducting the practice in the United Kingdom, France and Italy and an affiliated partnership conducting the practice in Hong Kong. Under New York s Code of Professional Responsibility, portions of this communication contain attorney advertising. Prior results do not guarantee a similar outcome. Results depend upon a variety of factors unique to each representation. Please direct all inquiries regarding our conduct under New York s Disciplinary Rules to Latham & Watkins LLP, 885 Third Avenue, New York, NY 10022-4834, Phone: +1.212.906.1200. Copyright 2009 Latham & Watkins. All Rights Reserved.
Middle East Sovereign and Quasi-Sovereign Bonds in 2009 (continued) Date Issuer Instrument Amount Type April 30 2009 April 30 2009 Mubadala Development Co PJSC Mubadala Development Co PJSC 5.75% 7.625% April 9, 2009 State of Qatar 5.150% April 9, 2009 State of Qatar 6.550% April 6, 2009 April 6, 2009 February 26, 2009 Emirate of Abu Dhabi Emirate of Abu Dhabi 5.500% 6.750% State of Israel 5.125% Bonds due 2109 $1,250,000,000 Quasi-Sovereign $500,000,000 Quasi-Sovereign $2,000,000,000 Sovereign $1,000,000,000 Sovereign $1,500,000,000 Sovereign $1,500,000,000 Sovereign $1,500,000,000 Sovereign TOTAL $16,230,000,000.00 The recent demand for Middle East sovereign debt raises a number of questions. Why the strong demand now for Middle East sovereign bonds? Markets thrive when a ready and willing supply coincides with strong demand. The current market for Middle East sovereign bonds illustrates this situation. On the supply side, Middle East governments need large amounts of capital to finance their ambitious industrial, energy and infrastructure projects. Until recently, most Gulfregion governments relied almost entirely on revenues generated from the sale of oil and natural gas to fund their capital needs. For the first time in recent memory, Gulf countries are seeking external capital by tapping the international capital markets through sovereign bond offerings. Why is this? Many Middle East countries have young and growing populations. These governments are seeking to build the infrastructure that will attract businesses and further investment that will help to diversify their economies away from being entirely dependent on oil and gas revenues and that will create future jobs for their burgeoning young populations. In the case of certain countries, such funding is needed to bridge the short-term funding gap until massive energy projects are completed and come on-line. In the case of other countries, such funding is needed to make up for investment losses experienced in the recent financial crisis. Some Middle East countries are running fiscal deficits, sometimes for the first time in many years, as a result of low oil prices in late 2008 and early 2009. On the demand side, the investment landscape has changed dramatically over the past year. Many institutional investors such as insurance companies, pension plans, mutual funds and hedge funds suffered significant losses in corporate equities and corporate bonds and are now seeking greater safety. Many such investors have excess cash because they were reluctant to invest during the second half of 2008. They are looking to put that cash to work in investments that provide safety and generate modest returns. Although sovereign bonds in general offer lower yields than corporate bonds, they have great appeal to many institutional investors in the current environment. In particular, these investors like the bonds of Middle East states, whose obligations are backed by the cash flow generated by large petroleum and natural gas reserves. 2 Number 915 10 August 2009
Will the bond market deliver better pricing than the bank market? Many of the international and regional commercial banks are severely capital constrained and are not in a position to lend the enormous amounts of capital being sought by Middle East states. As a result, it is now possible that the bond market which traditionally has priced its debt higher than the bank market may be willing to provide financing on more aggressive terms. This is illustrated by the refinancing by Dolphin Energy Ltd., which on August 2, 2009 issued $1.25 billion of 5.888% in a $4.1 billion refinancing of debt incurred to finance the construction of its pipeline. Dolphin s 10-year amortizing bond was priced at 337.5 bps higher than US Treasuries and all-in (when pricing is assessed over the respective base rates, and banks up-front fees are included) was around 100 bps cheaper than the bank funding. The bond pricing undercut bank margins because lenders are still relatively constrained by the aftermath of the credit crunch, which has pushed up funding costs and reduced liquidity. Why is it easier for repeat issuers to go to market? Sovereigns who regularly access the debt capital markets can do so more quickly and often at more attractive pricing. This is because the rating agencies will be familiar with the credit and will have a current sovereign rating in place, the country will have bonds in the market, which will generate a yield curve for the sovereign credit, and the sovereign will have a body of investors and credit analysts who are familiar with the country and its credit story. Prior to the State of Qatar offering in April 2009, the State of Qatar had not accessed the international bond markets since 1999, except for a 2003 sukuk offering, and it had no bonds outstanding in the market, except for some Riyal-denominated domestic bonds issued by Qatar Central Bank into the local market. As a result, the underwriters in effect were required to reintroduce this credit to the credit agencies and to the market. This reintroduction required extensive new due diligence about the country s assets and liabilities, its legal system and leadership structure, and credit analysis of its cash flows, financial governance and financial strength. The underwriters and Qatari officials had to make a number of presentations to the rating agencies, and answer follow-up inquiries, in order to re-familiarize the agency analysts with the country s credit metrics. In addition, the underwriters and Qatari officials had to conduct a full roadshow to meet with institutional investors in Europe and the US and to educate them about Qatar s credit story. After the successful State of Qatar bond offering, however, it was much faster and easier for State of Qatar-related issuers such as QTel and RasGas, which benefit from the implied credit of the State of Qatar, to go to the market. What type of disclosure is required for a sovereign bond issuer? What about financial information? Disclosure is a key factor for investors in deciding whether to invest in a sovereign bond. The disclosure required for a sovereign bond issuer, however, is substantially different from that required for a corporate bond issuer. A well-written and informative offering memorandum can play a significant role in marketing a sovereign bond offering, particularly for first-time or infrequent issuers. Sovereign bond offering memorandums focus on macroeconomic issues, including the stability and strength of the nation s currency, the stability of its banking sector, transparency in state budgeting, state liabilities, trade-balance-related disclosure and disclosure about state-owned entities that generate the most meaningful revenues. In the case of the State of Qatar bond offering, the State of Qatar included summary financial information about the country s revenues and expenditures for the previous four years, and a projection of revenues 3 Number 915 10 August 2009
and expenditures for the current year. The offering memorandum included a summary of the internal and external government indebtedness. It also included summary financial information for Qatar Petroleum, the largest stateowned company in the country. Governments are often sensitive about disclosing certain information, particularly if it is not already publicly available. The large numbers of governmental officials involved in the process of preparing an offering memorandum make it important for underwriters and legal counsel to identify and access the individuals with the best understanding in order to obtain accurate and reliable information. Why do Middle East issuers now rely on US capital markets? The US bond market is an important and logical market for Middle East sovereigns because the US has the largest and deepest institutional investor base and capital markets in the world and because the key Middle East currencies such as the UAE Dirham, the Qatari Riyal and the Saudi Riyal are pegged to the US dollar. Middle East sovereigns can issue US dollar denominated bonds into the US market without incurring the substantial currency hedging expenses that would be required if the bonds were issued in a currency such as Euros or Sterling. While there is always the risk that the Middle East currencies may de-peg from the US dollar, most analysts believe that this risk is remote. Should Middle East sovereigns and quasisovereign register their bonds with the US SEC? While it is actually relatively easy for sovereign governments to register securities with the US Securities and Exchange Commission, most Middle East sovereigns have elected to issue bonds into the US institutional market using the exemptions provided by Rule 144A. While Rule 144A itself requires relatively little in the way of substantive disclosure and financial information, US institutional investors require a high standard of disclosure and transparency from sovereign and quasi-sovereign issuers. In addition, international underwriters demand so-called 10b- 5 opinions from legal counsel and comfort letters from the accountants to the issuer. It is the demands of the market and the requirements of the underwriters, rather than SEC rules, that dictate the extent and quality of the disclosure in sovereign bond offerings. Is there a market for Shariah-compliant sovereign bonds? Sukuks are shariah-compliant vehicles similar to bonds, but structured as ownership interests in asset-backed securities. Despite the overall decline in the volume of sukuks in 2009, the market for sovereign sukuks has recently become more active. For example, in April 2009, Indonesia issued a $650 million five-year sukuk, while in May the Kingdom of Bahrain sold $750 million of five-year sukuks and Malaysia issued a $688 million sukuk as the first in a two-part series. Given the capability of sovereigns to access the capital markets through this alternative financing structure, we anticipate that additional sukuks may be issued by Islamic sovereigns during the remainder of 2009, not only to access capital, but to establish a yield-curve benchmark for longer term Islamic securities. Are there restrictive covenants in sovereign bonds? Sovereign bonds contain covenants, but they are limited. The most common restrictive covenant in a pure sovereign bond is a simple negative pledge, which prevents the issuer from pledging assets to layer future debt ahead of the sovereign bonds. Quasi-sovereign bonds are a different story, and they may contain restrictive covenants more typical of bonds issued by corporate issuers. Project bonds issued by quasi-sovereign entities will contain, among other things, restrictions on additional debt, restrictions on distributions to shareholders, limitations 4 Number 915 10 August 2009
on mergers and transfers of assets, limitations on liens, limitations on asset sales, limitations on affiliate transactions and so forth. What is sovereign immunity? What does it mean to waive sovereign immunity? Is this waiver enforceable? In general, sovereign immunity is a doctrine that the sovereign or state cannot commit a legal wrong and is immune from civil suit or criminal prosecution hence the saying, the king (or queen) can do no wrong. In connection with any sovereign bond offering, the issuer will contractually waive any rights that it may have to claim sovereign immunity. However, to our knowledge, the effectiveness of a waiver of sovereign immunity has never been tested before a Middle East court or any other legal authority in the Middle East. Investors understand that it may be not be possible to enforce a default judgment against a sovereign issuer if the sovereign chooses to default and not pay. In reality, investors rely on the discipline imposed by the capital markets to ensure that sovereigns honor their obligations. What are quasi-sovereign bonds? How are they different from sovereign bonds? Quasi-sovereign bonds are not issued directly by the state, but are issued or guaranteed by an entity owned or controlled by the state. As a result, even though they do have an actual guarantee from the state, the market regards them as having been issued with the implied faith and credit of the state. Since the State of Qatar and Emirate of Abu Dhabi bond offerings in April 2009, Qtel and RasGas, entities owned or controlled by the State of Qatar, and Mubadala, Aldar and Dolphin Energy, entities owned or controlled by Abu Dhabi, have completed bond offerings raising approximately $9.5 billion in new financing. Underwriters believe that the disclosure about these quasi-sovereigns contained in the offering memoranda for the State of Qatar and Emirate of Abu Dhabi bond offering generated awareness and excitement about these credits and facilitated these subsequent successful offerings. In fact, one of the objectives of these sovereign bond offerings was to open those markets to quasisovereigns and domestic corporations. If you have any questions about this Client Alert, please contact one of the authors listed below or the Latham attorney with whom you normally consult: William H. Voge +44.20.7710.4789 bill.voge@lw.com London Bryant B. Edwards +971.4.704.6323 bryant.edwards@lw.com Dubai Craig A. Stoehr +974.410.1522 craig.stoehr@lw.com Doha Dipti Thakar +974.410.1532 dipti.thakar@lw.com Doha 5 Number 915 10 August 2009
Relationship of Middle East Quasi-Sovereign Issuers to the Sovereign Date Issuer Amount Relationship to the Sovereign August 2, 2009 Dolphin Energy Ltd. $1,250,000,000 Dolphin Energy Ltd is owned 51 percent by Mubadala, which in turn is 100 percent owned by the Abu Dhabi government. July 16, 2009 RasGas $2,230,000,000 RasGas is owned owned 70 percent by Qatar Petroleum, a company wholly owned by the State of Qatar, and 30 percent by indirect wholly owned subsidiaries of ExxonMobil. In addition, Qatar Petroleum issued a completion guarantee. June 11, 2009 Qtel $1,500,000,000 The State of Qatar is Qtel s most significant shareholder, owning directly or indirectly 55 percent of Qtel s outstanding voting shares. In addition, the State of Qatar holds a golden share which gives it certain control rights. May 21, 2009 Aldar $1,250,000,000 Entities owned by the Abu Dhabi government or the ruling family of Abu Dhabi control approximately 38 percent of Aldar, a publicly listed company, giving the Abu Dhabi government and ruling family effective control. April 30 2009 Mubadala Development Co PJSC $1,750,000,000 Mubadala is 100 percent owned by the Abu Dhabi government Client Alert is published by Latham & Watkins as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the attorney whom you normally consult. A complete list of our Client Alerts can be found on our Web site at www.lw.com. If you wish to update your contact details or customise the information you receive from Latham & Watkins, please visit www.lw.com/lathammail.aspx to subscribe to our global client mailings program. Abu Dhabi Barcelona Brussels Chicago Doha Dubai Frankfurt Hamburg Hong Kong London Los Angeles Madrid Milan Moscow Munich New Jersey New York Orange County Paris Rome San Diego San Francisco Shanghai Silicon Valley Singapore Tokyo Washington, D.C. 6 Number 915 10 August 2009