Exploiting strengths

Published in The Gulf, 1 February 2016

Bahrain is searching for ways to re-invent its banking hub credentials.

The latest data from the Central Bank of Bahrain (CBB), released in January, showed a further decline in the value of assets held by the country’s banks. The consolidated balance sheet of the banking system was $190.5 billion at the end of the third quarter of last year according to the CBB, compared to $191.8 billion at the same point in 2014. It might only be a small drop, but it highlights the fact that the authorities in Manama have yet to find a way to revive a sector that has been struggling for the best part of a decade.

Since 2008, the overall size of the Bahraini banking system has fallen by around 25 per cent, according to ratings agency Standard & Poor’s (S&P). That fall has not been across the board, but concentrated in one particular part of the market.

Local retail banks have actually been steadily expanding since 2008, with assets growing from $63.5 billion in 2008 to $81 billion by the end of September 2015, while Islamic banking institutions have been stable, with their balance sheet barely changing from $24.7 billion in 2008 to $25.5 billion last year. Instead, the main problem has been with the position of wholesale banks, which have been gradually reducing the value of their balance sheets in Bahrain. Given the worsening regional economic environment and the country’s uncertain political climate, there are few reasons to suppose that trend will change soon.

The decision by Fitch Ratings to revise its outlook on Bahrain from stable to negative in early December won’t have helped things either. The change to the sovereign outlook prompted Fitch to make similar changes to its outlook on two of the country’s big banks, National Bank of Bahrain (NBB) and Bank of Bahrain & Kuwait.

S&P’s outlook on Bahrain is also classified as ‘negative’. Both it and Fitch have said that they could lower their BBB- ratings this year if the Bahrain economy or the government’s financial position worsens more than expected. Such a move would push the country’s debt into junk bond territory.

Nor will Bahrain’s position be helped by predictions that its economy may contract in 2016. The low oil price means that government budgets are under pressure across the region, but weaker economies like Bahrain are in the most vulnerable position.

“Some smaller, more vulnerable economies, such as Bahrain and Oman, could even be tipped into outright recessions [in 2016],” warns Jason Tuvey, Middle East economist at London-based research firm Capital Economics.

But while there are reasons for pessimism, Bahrain does have a few strengths that it can exploit.

Chief among those advantages is a decent pool of local talent. According to the CBB, locals represent around 77 per cent of the work force in the banking sector and 68 per cent in the wider financial services industry. That is far ahead of many other regional centres.

“Local human resources is our main resource, our main wealth,” says Abdulrahman al Baker, executive director of financial institutions supervision at the CBB.

Manama is also a relatively cheap place to do business, compared to other Gulf commercial centres. Renting office space in the capital currently costs around BD7-9 per square metre per month for the best quality developments, according to real estate consultancy CBRE. The figure has been stable since late 2012 and remains below where it was in 2009. At a time of low oil prices and stretched budgets, there is much to be said for being a low-cost business centre.

“The Bahraini value proposition is suited for all types of financial services, because of the experience and the diversity [of the sector in Bahrain], but I think it is particularly suited for areas where what matters above all is skill and reasonable cost of operation,” says Jarmo Kotilaine, chief economist of the Economic Development Board (EDB). “I think that is in particular the case with mid-office and ancillary services.”

One other advantage that Bahrain has over the likes of Qatar, Dubai or Abu Dhabi is its proximity to the Saudi market, which is by far the largest economy in the region. However, Saudi Arabia has been building up its own financial hub, the King Abdullah Financial District in Riyadh. Last year it also took measures to make it easier for international investors to put money into its stock market, the Tadawul.

Such factors could undermine the position of Bahrain as a base from which to target the Saudi market. As one international executive based in Dubai puts it, half-jokingly, “Bahrain might well be close to the Saudi market but Riyadh is even closer.”

All this is reflected in research that ranks the relative strength of financial hubs in the region and beyond. In the most recent Global Financial Centres Index, published by research group Y-Zen in September, Dubai was the best-placed hub in the Gulf and 16th best globally. You had to scroll all the way down to 50th place before Bahrain appeared, some four places lower than the previous year’s index.

In some market niches, Bahrain is better placed, however. The brightest spot remains Islamic finance, where the country has managed to sustain its regional leadership position. That in part stems from the fact that Bahrain is the home base of standard-setting bodies such as the Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the International Islamic Financial Market (IIFM), but there are also 25 Islamic banks in the country, including six retail banks and 19 wholesale banks.

Globally, the Islamic finance industry has been growing healthily in recent years, which is to Bahrain’s advantage. However, even here it is not all good news as some parts of the market appear to be struggling, not least the sukuk market where activity has been coming under pressure. The number and value of Islamic bonds issued has been falling steadily in recent years and that trend is likely to continue.

In a report issued in January, S&P said that a combination of the rise in interest rates by the US Federal Reserve in mid-December, along with the continuing low oil price and the complexities involved in issuing sukuk, means that activity in this area of the market is likely to remain subdued this year. The ratings agency predicts that the total value of sukuk issuance is likely to be in the range of $50 to $55 billion for 2016, compared to $63.5 billion in 2015 and $116.4 billion in 2014.

Going forward, Islamic banks, like their conventional counterparts, are also bound to be affected by the weaker levels of economic growth in the region as a result of falling oil revenues and reduced government spending. In its review of the Bahraini economy in December, S&P noted that competition between retail banks is likely to put some strain on their profitability, something which ought to encourage further consolidation among them. It also pointed out that Bahraini banks are still heavily exposed to the real estate and construction sector, which is still in a correction phase.

All this means that Bahrain’s credentials as a financial hub are looking rather stretched.

For the foreseeable future, when international financiers think of the Gulf they are likely to continue to think of the opportunities in places like Dubai, Riyadh, Abu Dhabi or Doha before they turn their attention to Bahrain.

Saudi retail in need of therapy

Published in MEED, 19 January 2016

Growth looks certain to slow down in the Saudi retail market, with declining confidence and rising costs.

The Saudi retail market is one of the largest in the region, with sales worth $118bn last year, according to research firm Euromonitor International. That makes it more than twice as large as the UAE or Moroccan markets and significantly larger than the Egyptian market too.

Saudi retail sales have also been growing far faster than in other large markets around the region, with a healthy 10.3 per cent growth predicted for 2015/16 by Euromonitor. However, there are plenty of clouds on the horizon and the sector could soon start to slow.

In recent years, the market has been helped by the growing population and rising disposable income, not least as a result of generous government handouts. That has encouraged many of the larger retailers to set ambitious expansion plans. For example, fashion retailer Fawaz Abdulaziz al-Hokair Company says it will grow from 2,100 stores to 3,200 outlets by 2019. Jarir Marketing Company, an electronics and stationary provider, plans to expand its network from 36 to 60 stores by 2018, and Saudi Company for Hardware (SACO) plans to open at least 10 new stores by 2018, taking its total to 35 outlets.

One notable characteristic of the market is that many of the country’s largest retail groups are family controlled. As well as Fawaz al-Hokair, notable family-owned businesses include the likes of Al-Bandar Trading Company and Abdullah Al-Othaim Markets Company.

Several of these are traded on the Saudi Stock Exchange (Tadawul), where they have been gaining support from investment banks. In their most recent reports on the sector, local investment banks Al-Jazira Capital and Al-Rajhi Capital both gave an ‘overweight’ recommendation for Al-Othaim Markets and Al-Jazira did the same for Fawaz al-Hokair.

“The main family-owned retail players in the kingdom are quite strong,” says Fatemah Sherif, a senior research analyst at Euromonitor. “The key players are expected to continue to succeed with store expansion plans across supermarkets, apparel and footwear stores, and pharmacies.”

However, many of these local businesses could come under pressure as a result of recent reforms that will make it easier for international retailers to enter the market. In September, the Saudi Arabian General Investment Authority (Sagia), announced that foreign investors would be allowed to own 100 per cent of some retail and wholesale businesses. Kuwaiti research firm Markaz says the decision could attract $2.7bn in investment over the next year. Without the need to find local partners, it could also mean some family-owned retail groups start to lose market share to international rivals.

In the meantime, there are plenty of other headwinds facing Saudi retailers. Low oil prices are hurting the economy and feeding through to lower consumer confidence. Jason Tuvey, Middle East economist at London-based research firm Capital Economics, points out that ATM cash withdrawals and point-of-sale transactions slowed markedly in the second half of 2015, and growth in personal loans is at its lowest level in five years.

“A number of indicators suggest that household spending in the kingdom has softened in recent months,” says Tuvey. “With a fiscal squeeze in the pipeline, we expect household consumption to be much weaker over the coming years than in the previous decade.”

His firm is predicting consumer spending to grow at an annual rate of 2-3 per cent in the coming years, compared with 6-7 per cent over the past decade.

Other factors could yet slow the market even more. Belt-tightening by the government has, among other things, included efforts to restrict public sector wage growth, cut subsidies and introduce new taxes.

Many of these issues spell trouble for retailers, in particular the introduction of a sales tax, or value-added tax (VAT), and a ‘sin’ tax on cigarettes and sugary drinks. There are still many unanswered questions about these taxes, including when they will be introduced, at what rate and which goods they will be applied to. Whatever the answers, they are bound to affect sales.

In the meantime, other state decisions are already having an impact. In its December budget, the government announced cuts to subsidies on fuel, electricity and water. Major retailers have been adding up the cost of these measures which are, in some cases, substantial.

Al-Othaim Markets says it expects its costs to rise by SR16m ($4.3m) this year. Others affected include Aldrees Petroleum & Transport Services Company, which, among other things, owns and operates coffee shops through its Super 2 Division. It says higher energy and electricity prices will mean a SR27m increase in its costs this year.

The impact on some other retailers is lower, but still significant. SACO has estimated it will take a hit of SR4-6m as a result of the changes. Saudi Automotive Services Company (Sasco), which operates petrol stations, motels, restaurants and convenience stores, said in a statement issued to the Tadawul in late December that it will also be affected, although “the actual value of this impact cannot be determined at this moment”.

All these rising costs will affect consumers, as will the prospect of rising interest rates, and are in turn likely to dent sales.

“The increase in gasoline prices will erode disposable income, as will an increase in interest rates on credit card and personal loan debt,” says James Reeve, deputy chief economist at the local Samba Financial Group.

“Nor are consumers likely to benefit from any bonus salary payments this year, and for that reason alone it seems doubtful that consumption will offer much contribution to growth. There are already signs that shoppers are becoming more cost-conscious when choosing brands.”

The ability of different retailers to deal with rising costs and more parsimonious consumers will become clear as new trading figures are released, but the early signs are not promising. In mid-January, Jarir Marketing announced its results for 2015, which showed a 5 per cent drop in net profits in the fourth quarter compared with the same period last year.

But for all the problems they are facing, Saudi retailers continue to have one vital advantage over their peers elsewhere in the region. Cinemas are banned and there is precious little else in the way of legal entertainment in Saudi Arabia, leaving shopping as one of the few legitimate leisure pursuits available.

That alone should ensure the market remains more buoyant than in most parts of the region.

“Shopping is the key entertainment form in the country,” says Fatemah Sherif, a senior research analyst at Euromonitor, which is predicting growth of up to 11 per cent a year for retail sales between now and 2020.

Islamic banks search for growth

Published in Salaam Gateway, 13 January 2016

With oil prices low and concerns about a slowdown in China gathering pace, the outlook for many Islamic financial institutions is rather worrying. The problems are perhaps most evident in the Gulf countries, where low oil revenues are leading to cuts in government spending and tighter liquidity, but slower economic growth is also on the cards for other Islamic finance strongholds in South and Southeast Asia.

In its Islamic Finance Outlook Report for 2016, launched at the World Islamic Banking Conference in Bahrain in December, consultancy firm Middle East Global Advisors described the growth prospects for Islamic finance in the next 12 months as “muted.” Its survey of Islamic finance executives found that 49 percent of them thought the low oil price would slow the growth of Islamic banking, while 21 percent cited interest rate volatility and 9 percent pointed to the slowdown in China as the biggest worries.

These concerns are understandable, particularly in regard to oil prices. “Typically, when oil prices turn south then Islamic wealth creation globally tends to grow much more slowly,” says Jarmo Kotilaine, chief economist at Bahrain’s Economic Development Board.

None of these issues are likely to go away anytime soon. But despite all the difficulties, there is still plenty of room for growth, given the relatively small market share that Islamic financial institutions have in most countries.

The ICD Thomson Reuters Islamic Finance Development Report 2015: Global Transformation predicts that the value of Islamic finance assets will rise from around $2 trillion in 2015 to more than $3 trillion by 2020, with most of that growth coming from Islamic banks.

Banks are targeting a diverse range of areas in pursuit of that growth. According to the Middle East Global Advisors survey, 46 percent of executives think that asset and wealth management services will be the biggest driver of bank revenue growth in the next three years, followed closely by investment banking (43 percent), commercial and industrial loans (40 percent), cross-selling of services (23 percent), and mortgages and personal loans (21 percent).

On a more tactical basis, the survey found that 21 percent of banks were looking at new product launches as their primary focus for growth in 2016, followed by 20 percent looking to expand their financing portfolio. In addition, 14 percent said they were targeting higher fee income and 13 percent said they were eyeing entry into new markets.

How banks approach the task of growth depends to a great extent on the conditions in individual markets. In some countries, there is a strong need for educating the local population first.


In Kazakhstan, for example, the market is in its infancy. The first law regulating the sector was passed in 2009 and there is still only one provider in the market, a subsidiary of Abu Dhabi’s Al Hilal Bank, which set up operations in 2010. Perhaps unsurprisingly, 71 percent of people in Kazakhstan say they have never heard of Islamic banking, according to the Kazakhstan Islamic Finance 2016 report produced by Thomson Reuters. However, 46 percent say they would be interested in using Islamic banking services and products.

It is a similar situation in non-Organisation of Islamic Cooperation (OIC) countries. In Canada, for example, the major local banks have yet to become involved in Islamic finance domestically and no corporate sukuk has yet been issued.

The Canada Islamic Finance Outlook 2016 report from Thomson Reuters estimates that Islamic mortgage products alone could be worth $2.3 billion in the first year following their launch, rising to $17.7 billion in five years. Other areas that the report suggests look promising include mutual funds and takaful.

For the industry to meet its potential in the years ahead, it will need to move into new markets like these. But it will also have to develop its product portfolio within countries where it is already strong. In this second group of countries, the challenges are different but just as daunting.

“One third of the banking assets in the GCC are now Shariah-compliant,” says Ashar Nazim, financial services customer leader for the MENA region at consultancy firm EY. “That means that, going forward, Islamic banks will be competing head-on with big conventional banks. Many of these Islamic banks lack a distinct value proposition beyond Shariah-compliance. Therefore we expect strong headwinds.”

Could the sukuk market rebound in 2016?

Published in Salaam Gateway, 6 January 2016

The sukuk market is going through a tough time at the moment, with a steady fall in both the number and value of instruments issued in recent years. With 2016 now upon us, the question for the industry is whether that trend will continue or if something will happen to turn its fortunes around.

According to a Thomson Reuters report published in early December, the number of sukuk issuances fell from 834 in 2013 to 809 in 2014. The full-year figures for 2015 are not yet available but the decline appeared to be accelerating, with only 513 issues in the first nine months of the year. The trend has been even more pronounced in terms of the amount being raised via these issuances, with the figure falling from $137 billion in 2012 to $117 billion in 2013, $102 billion in 2014 and just $49 billion in the first nine months of 2015.

“It’s a big slowdown [in 2015]. The big fall in issuance is really the story,” said Mark Smyth, chief investment officer of Luxembourg-based Tawreeq Holdings, speaking at the World Islamic Banking Conference in Bahrain in early December.

One big factor in the slowdown has been the decision earlier in 2015 by the Malaysian central bank to move away from sukuk as a liquidity management tool for the country’s Islamic banking sector. But the sector has also been affected by a variety of other factors, including the performance of the bond market more generally.

“Some issues are specific to the global Islamic finance industry, others are quite clearly tied to the general bond market,” says Smyth. “I think most bankers would agree that it’s a particularly tricky read these days–the financial markets, geopolitical tensions–all these things play into tough trading for bond markets and fixed income.”

There are a few reasons why the dynamic might change over the course of 2016, however. Among them is the fact that banks need to raise capital to comply with Basel III regulations.

In addition, a lot of oil-producing governments need to cover their ever-widening budget deficits. Both these factors mean that the sukuk market could be far healthier, although it is not clear to what extent issuers might favour conventional bonds over sukuk.

Another positive development is greater clarity on interest rates. One thing holding issuers back last year was uncertainty over what action the US Federal Reserve might take on interest rates. That has now been lifted to some extent, following the mid-December decision by the Fed to raise interest rates by 0.25 per cent, its first rise since 2006. The likes of Saudi Arabia, Bahrain and Kuwait all raised their interest rates in response, to maintain their currency pegs to the US dollar. Further rate rises may follow, but the direction of travel is at least clearer.

In the longer term, the sukuk market needs to expand into new areas if it is to thrive. Mohammad Farrukh Raza, managing director of IFAAS, an Islamic finance advisory firm, says there are several promising areas that have yet to be explored properly, but which would help to the sector to develop and mature.

“I think there are two pools that are seriously under-tapped in this market,” he says. “First of all, the corporate sector, and also retail sukuk. There is a lot of opportunity out there, but due to the lack of awareness among corporates, it’s simply not happening. The retail sukuk is another area that is almost completely ignored … The GCC markets need to investigate this more and develop structures that are geared towards the sukuk market and that will bring a lot of new liquidity into the market.”

Khalid Hamad Abdul-Rahman Hamad, executive director of banking supervision at the Central Bank of Bahrain, agrees that more needs to be done in this regard.

“We should encourage more innovation in sukuk structure and call for more issuances of sukuk by Islamic financial institutions, corporates, sovereigns and multilateral development banks,” he says.

Amid the gloom, it is worth pointing out that sukuk is still the second-largest segment of the global Islamic finance market, making up 16 percent of the industry’s total asset base in 2014, according to the Thomson Reuters report. Since 2012, the total amount of outstanding sukuk has grown by an average of 8.3 percent a year, more than twice the rate for the industry as a whole.

However, its relative strength within the industry highlights the lack of diversity in Islamic finance more than any particular strength in terms of sukuk. If the sukuk market does manage to grow this year, it could lead the way for expansion of the industry more generally.

Maintaining standards

Published in The Gulf, 1 January 2016

New regulations could help Bahrain maintain its strong position in the Islamic banking market, but there are plenty of headwinds for the industry.

The Central Bank of Bahrain (CBB) says it will launch a central sharia board for Islamic banks early in 2016. Previous reports had suggested that the board would be in place before the turn of the year and it is not clear what has caused the delays.

Nonetheless, the move could provide a useful fillip to the local Islamic banking sector at a time when the economy is having to face up to a tougher regional environment, with low oil prices and reduced state spending.

The new board will oversee product development and compliance by Islamic financial institutions in the country, provide guidance to the CBB when it is setting new regulations, and to the courts in legal cases involving Islamic finance. This should help to ensure there is greater clarity in the way that sharia principles are applied - an important issue given that a lack of standardisation is often blamed for holding back the growth of the Islamic finance industry. But there are many other issues that are hobbling the industry and Bahrain will have to continue to innovate if it is to maintain its position as a regional Islamic finance hub.

The central sharia board initiative is being supported by the Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI), which is based in Bahrain and which is one of several organisations around the world that sets standards for the industry.

“We have had a lot of discussions with the Central Bank of Bahrain regarding the central sharia board,” says Khairul Nizam, deputy secretary general of AAOIFI. “It could help us in getting a stronger adoption of our standards. In Malaysia, for example, they have a central sharia board and that board uses our standards as the basis of their work. Having a central sharia board can definitely help to promote the adoption of standards.”

However, he notes that the initiative is not bound to succeed. “When it comes to central sharia boards, there’s no one size fits all model,” he adds. “It has worked in some jurisdictions and hopefully it will work in Bahrain, but it may not be a suitable model in some other jurisdictions.”

Bahrain is already home to 25 Islamic banks, including six retail banks and 19 wholesale banks. The most recent to be granted a licence was Sudan’s Bank of Khartoum, which officially launched its presence in the country in early December.
Some of the local banks appear to be doing very well. Recent research by consultancy firm Middle East Global Advisors (MEGA) named Bahrain Islamic Bank as the best performing Islamic institution globally in terms of return on average equity and return on average assets - both key indicators of a banks’ performance and its ability to create shareholder value.

Such metrics are not a reflection of size, however, and most sharia-complaint institutions remain very small. Speaking at the World Islamic Banking Conference (WIBC) in Manama in early December, CBB governor Rasheed al Maraj suggested this was a problem.

“The Central Bank of Bahrain continues to strongly encourage Islamic banks to merge or acquire other institutions,” he said. “Given a tougher regulatory environment, challenges to their business model and increased competition from Islamic as well as conventional competitors, the preferred path, particularly for Islamic investment banks, is to merge in order to create institutions of size. Not only will this increase their chances of survival by enabling them to participate in larger deals but also help them attract the right human resources.”

Overall, Bahrain punches well above its weight in Islamic finance. The country has the seventh largest Islamic finance market in the world, with assets of around $73 billion, according to Thomson Reuters. It is not far behind Qatar and Kuwait, which have Islamic finance assets of $87 billion and $98 billion respectively, despite having far larger economies. Bahrain also easily outpaces the likes of Turkey, Indonesia and Egypt in this regard.

However, the performance of the Islamic finance sector more generally has been rather muted of late. Sukuk issuance has been falling for the past few years, for example. According to a report published by Thomson Reuters in early December, the number of sukuk issuances fell from 834 in 2013 to 809 in 2014 and there were only 513 issues in the first nine months of 2015. The amount raised via these sharia-compliant bonds has been dropping at an even more alarming rate, from $137 billion in 2012 to $117 billion in 2013, $102 billion in 2014 and just $49 billion between January and September 2015.

In addition, the industry is struggling to break out from a narrow base. Around 74 per cent of all Islamic finance assets are held by banks, with a further 16 in the form of sukuk, according to Thomson Reuters. That leaves other areas like Islamic insurance and funds particularly small. In geographic terms, Islamic finance has also made little headway. As it stands, 65 per cent of the industry’s assets are in just three countries - Malaysia, Saudi Arabia and Iran. Such failings are widely recognised in the industry, not least in Bahrain.

“Islamic finance is full of good principles and fair practices. However, the industry has failed in publically communicating them,” said Khalid Hamad Abdul-Rahman Hamad, executive director of banking supervision at the CBB while speaking at the WIBC.
Local banking executives agree. “The potential of Islamic finance is more than what has happened already,” says Ahmed al Mutawa, chairman of the local Gulf Finance House (GFH). “There is a need to create greater awareness of Islamic finance, even in Islamic countries. A lack of awareness, a lack of understanding, limits the areas in which Islamic finance can operate and that’s why we see this [geographic] concentration. Once there is a better understanding I think it will reach broader areas and more economies around the world.”

Such comments suggest that the industry’s problems are principally down to a lack of decent marketing. Certainly that is a factor, but there are more technical issues at stake too. In his speech Hamad noted that the industry is weak in a number of important areas, citing the lack of an active and efficient capital market or well-developed money and credit markets. He also noted that there are skills shortages in many key areas of the industry, including sharia auditing and chief executives and chief finance officers who are well acquainted with Islamic finance.
As with standardisation, the need to develop skills and talent is an issue facing the industry around the world. Some claim that Bahrain is in a better position than most in terms of its skills base, at least within the Gulf region. The central bank says that Bahrainis account for 77 per cent of the workforce in banks and around 68 per cent of all staff in its wider financial sector.

“Although there are many centres of Islamic finance now in the GCC that might compete with Bahrain, at the level of human resources Bahrain is still the best,” says Al Mutawa of GFH. “It’s a more indigenous workforce in Islamic finance rather than an expatriate one. That’s their strength. This is not true in the other GCC countries.”
Another shortcoming of the global industry that is frequently noted is the lack of liquidity management tools, something which makes life harder than it otherwise would be for sharia-compliant banks.

“Liquidity management is quite limited and varies from country to country,” said Riaz Riazuddin, deputy governor of the State Bank of Pakistan, the country’s central bank. “Concerted efforts are required to address this issue. Limited liquidity management instruments have been among the key issues faced by Islamic banks in most jurisdictions.”

The Bahrain authorities have been making efforts to tackle this issue over the past year. In April 2015 the CBB launched a sharia-compliant liquidity management tool, called wakalah. This is aimed at absorbing the excess liquidity of local Islamic retail banks by allowing them to place their spare funds with the central bank. The instrument lasts a week at a time and is made available to the banks every Tuesday. Any money deposited with the central bank is invested on behalf of the retail banks in a sukuk portfolio.

The market would also be helped by the issue of more sukuk by the government. But although there is a clear need for states across the GCC to fund their growing budget deficits, there is an expectation that the Manama government favours conventional bond issues over sukuk these days.

Najla al Shirawi, chief executive of SICO, a Bahraini wholesale bank, says she expects Bahrain to concentrate on conventional issues in the short term. “For Bahrain we will see more conventional issues. For other countries it will mostly depend on the local appetite. Saudi will see just straightforward conventional issues. In the UAE it will be a combination.”

In the meantime, it is not clear at this stage how popular the wakalah facility has been with local banks. But such initiatives, along with the forthcoming central sharia board, do at least help the country to maintain a reputation within the Islamic finance industry as an important hub.

“Any jurisdiction that has thought of Islamic finance will always come to Bahrain to learn from their experience,” says Nizam.

“Bahrain as a jurisdiction has provided the top leadership for Islamic finance for a long time, and I’m not just saying that to be nice.”

Warning signs in Palestine

Published in MEED, 13 December 2015

The West Bank leadership look as vulnerable and weak as the economy it oversees.

With so many crises in the region, from Syria to Libya to Yemen, one long-standing problem is in danger of being ignored. Yet the situation in the Palestinian territories is deeply worrying, with warnings that the Palestinian Authority (PA), led by Mahmoud Abbas, could be close to collapse.

US Secretary of State John Kerry raised the possibility in an ominous speech to a US-Israeli forum in Washington on 5 December. “There are valid questions as to how long the PA will survive if the current situation continues,” he said.

The situation he was referring to is one of increasing violence and mutual distrust. Over the course of this year, Israel has continued to expand its illegal settlements in the West Bank and there have been sporadic but increasingly regular attacks by Palestinians in Jerusalem and the West Bank and occasional rocket launches from Gaza.

“I’ve had a lot of discussions with both sides over the past three years, and let me tell you the level of distrust between them has never been more profound,” said Kerry. “I am concerned that unless significant efforts are made to change the dynamic – and I mean significant – it will only bring more violence, more heartbreak, and more despair.”

If the PA does collapse, Israel would have to deploy large numbers of security forces to the West Bank and take over services such as schools, hospitals and policing, all of which would only increase the likelihood of violence.

Given the weakness of the Palestinian leadership and the intransigence of the Israeli government, there is no easy way out of the current situation. Kerry, however, reached for a familiar potential solution to at least some of the problems, saying that “strengthening the Palestinian economy will enhance security for Israelis and Palestinians alike”.

International actors have been trying to turn the Palestinian economy around for years without success. Sami Abdel-Shafi, an academy associate at London-based think-tank Chatham House, points out that the biggest donor, the EU, has had little to show for its beneficence. 

“For more than 20 years, the EU has spent more than €6bn to try to assist Palestinians with their economic development and with their other needs, but the results on the ground don’t really testify to that very much,” he says.

He describes the notion of a viable Palestinian economy as a “myth” these days. “In many publications out there, the GDP of Gaza in the past few years is listed as being in the modest billions of dollars per year. I live in Gaza and I can tell you that there isn’t productivity that amounts to even $1m per year,” Abdel-Shafi says.

It is hard to see the economy improving without a comprehensive political situation. In the meantime, the value of lost opportunities continue to mount. A study earlier this year by the Rand Corporation, a US think-tank, suggested that a peaceful two-state solution would lead to a $173bn boost to the economies of Israel and Palestine over 10 years, with a $123bn windfall for the Israelis and a $50bn boost for the Palestinians.

By contrast, a full-scale violent uprising would lead to their economies losing $296bn over the decade, with $250bn lost from the Israeli economy and $46bn from the Palestinian.

The potential benefits and costs are greater in absolute terms for the Israelis, but in proportional terms it is the Palestinians who have the most at stake, as their economy is just a fraction of the size of Israel’s. “The Palestinians have a much greater incentive to move from the present situation than the Israelis,” says Ross Anthony, a co-author of the study.

Certainly, the Palestinian territories could do with an economic lift. Overall unemployment is running at about 27 per cent, according to the Washington-based IMF, but some observers say it is as high as 67 per cent among young Palestinians in Gaza.

The IMF is predicting GDP growth this year of about 2.9 per cent for the West Bank and Gaza, which it says represents stagnation given the rate of population growth.

The problem is that the economic and the political spheres cannot be easily separated and it is political problems that are causing the Palestinian economy to under-perform so badly. Abdel-Shafi says donors should try to decouple Palestinian economic development from the political process.

“If the Palestinians do achieve a sovereign state, they will definitely need a viable economy to support their state,” he says. “If they don’t achieve sovereignty soon, they are still entitled to a dignified life.”

However, separating the two strands is a hard and potentially impossible task to achieve. In the meantime, the situation is becoming ever more fragile. Unless some progress is made soon, the prospects look bleak, something that was evident in the warning Kerry issued to Israel when he said it needs to do more to assist the Palestinian President Mahmoud Abbas, also known as Abu Mazen.

“How is Israel advantaged to have chaos in the West Bank or to have another war with Gaza?” he asked the audience in Washington. “Strengthening Abu Mazen is now and has been for years – and it hasn’t happened sufficiently for years – critical, because if you don’t strength the one person who is most committed to non-violence you send an incredibly negative message to all the rest of the people who are frustrated.”

Steady growth needed in sovereign issuances

Published in MEED, 7 December 2015

Islamic bonds are expected to play a greater role in propping up government finances and government-related issuers are expected to have the upper hand in the market.

There is no getting away from the fact that the sukuk (Islamic bond) market is going through a tough time. Globally, the value of issuances dropped sharply in 2015, according to data from US/Canada-based Thomson Reuters. In the first nine months of the year, sukuk issuance totalled about $48.8bn, compared with $79.5bn in the same period in 2014.

Part of that fall stems from the decision by the Central Bank of Malaysia to move away from using sukuk as a liquidity management tool for the country’s Islamic banks. Just as important, however, was the fact that no one else came to the market to pick up the slack. Uncertainty over US interest rates has been among the factors that seem to be holding some issuers back.

This trend is certainly visible in the Gulf. The GCC is the second-most important market for sukuk after Malaysia, with a total market share of between 20 and 30 per cent in recent years. However, issuance in the main Gulf markets has been on the slide.

In Saudi Arabia, the value of sukuk issuance has dropped from $15.2bn in 2013 to $12.1bn in 2014 and $5.4bn in the first nine months of this year. Issuance in the UAE fell from $7.1bn to $5.7bn and then $4.7bn over the same period.

However, there is some hope that sovereign issuance may start to turn things around. GCC governments need to raise finance to deal with their ballooning budget deficits and the bond market is an obvious place to turn, whether in terms of conventional or sharia-compliant finance.

“In the GCC and more generally as well, the funding requirements of sovereigns are lending a bit of a new lease of life to the sukuk market,” says Jarmo Kotilaine, chief economist at Bahrain’s Economic Development Board.

When making a decision on what type of bond to issue in the past, Gulf governments have more often than not opted for conventional bonds over sukuk. One consequence of this is that Islamic banks have plenty of liquidity available that could be used to invest in any sukuk that are launched.

“A lot of the Islamic institutions have more liquidity than the conventional institutions,” says Najla al-Shirawi, CEO of Securities & Investment Company (SICO), a Bahraini wholesale bank. “Most of the conventional institutions were buying the conventional issues from the government. So that sucked up a lot of their liquidity. The Islamic institutions have not seen the same pace of Islamic issues from the governments, so the liquidity remained intact.”

Given that banks are the dominant buyers of sukuk, that is a position that will be welcomed by many Gulf finance ministries as they try to put their fiscal house in order. Oil prices are expected to rise only slowly at best over the coming years, which means deficit management is likely to be one of the most important issues facing governments for some time to come.

“There is a pool of Islamic liquidity that is available and will play an important role in bridging these [fiscal] deficits,” says Nitish Bhojangarwala, assistant vice-president of the financial institutions group at Moody’s Investors Service, a US ratings agency.

The banks are, however, being adversely affected by other aspects of the current fiscal climate. Along with issuing more debt, governments have also been drawing down some of their savings to help cover their spending needs. In some cases they have done this by selling off assets held by their sovereign wealth funds, but they have also been drawing down their bank deposits.

Across the region, the authorities play a critical role in providing deposits for both conventional and sharia-compliant banks and, while their withdrawals have been relatively limited so far, the potential consequences of this are far-reaching. Even at the current rate of withdrawals, there has been an notable impact, with banks having less money to lend or to invest in bonds or sukuk.

“A lot of liquidity in the GCC environment is driven by the government deposits within the system,” says Bhojangarwala. “In 2015, we started seeing a sharp reduction in the deposit growth, which then means on the asset side banks will scale back as well. That is what we are seeing on the sukuk side. Credit appetite in general has come down, primarily driven by the reduction in deposit growth.”

All this creates a rather uncertain picture for the sovereign sukuk market in the region and there are mixed views on the likely extent of sovereign issues in the future. Bahrain is expected to concentrate on conventional issues in the short term, but others such as the UAE and Saudi Arabia could see a mix of both conventional and Islamic issues. The Kuwaiti government is also thought to be looking at a sukuk listing, possibly in 2016, according to Bhojangarwala.

In Oman, the recent sukuk issue by the government could lead to further activity, according to Hamood al-Zadjali, executive president of the Central Bank of Oman.

“The government of Oman has issued its first sovereign sukuk with a successful initial offering,” he said, speaking at the World Islamic Banking Conference in Bahrain in early December. “This is expected to help to some extent liquidity management issues in the Islamic banking sector and also to have a positive impact on Oman’s capital market in general and the sharia-compliant financial market in particular. The successful launch of this first sovereign issue will pave the way for future issuances.”

The best outcome is probably slow and steady growth in sovereign issues in the near term, so that other potential issuers are not crowded out of the market. If governments become too enthusiastic with sukuk issues, they could take up too much of the available liquidity, meaning the region’s large corporates might find it difficult to sell any sukuk issues of their own.

As it is, the tough market conditions look likely to continue for many issuers in the short term, but government-related issuers are expected to have the upper hand.

“There is liquidity there, but it is for specific players,” says Mohammad Farrukh Raza, managing director of IFAAS (Islamic Finance Advisory & Assurance Services), a consultancy specialising in Islamic finance and based in the UK.

“Not everyone will be able to tap the market in the near future. Historically we have seen a lot of players come to tap the market periodically; now we will see a few players tap the market regularly in the near future. I think the market at the moment is ‘wait and see’. [Investors] will only touch good, government-related entities that have issued in the past as well. That’s where the funding will go in the near future.”

Islamic finance in search of the mainstream

Published in MEED, 6 December 2015

Sharia-compliant banking has been expanding quickly, but the industry seems impatient for even faster growth.

At the World Islamic Banking Conference in Bahrain in early December, the delegates were asked a simple question at the start of the first day: what did they think of the performance of the industry over the previous 40 years? The answer they gave was rather stark. A clear majority, 58 per cent, said it had been disappointing.

Other, more in-depth, research has also found there is a sizeable pool of unimpressed Islamic finance professionals. A survey by UAE-based consultancy Middle East Global Advisors, the results of which were launched at the conference, found that about 33 per cent of industry executives think the financial performance of Islamic banks has been below or far below their expectations over the past five years.

You would not know it from all this evidence of gloom, but the sector is actually growing at a fairly healthy clip these days. It is just that the growth rate does not seem to be enough for some market participants.

A third of banking assets in the GCC are now sharia-compliant, according to UK consultancy EY, and globally the industry now controls at least $2 trillion in assets. Ashar Nazim, financial services customer leader in the Middle East and North Africa (Mena) region for EY, says his firm expects the industry to expand its asset base by an average of 14-15 per cent a year in the next few years, matching the rate it has enjoyed over recent years.

Most other corners of the global banking industry would be very happy with such a performance. Indeed, Islamic lenders have been outpacing conventional banks in many of their core markets. In Saudi Arabia, for example, Islamic lenders grew their asset base by 18 per cent in 2014, compared with growth of 7 per cent by conventional banks, according to EY.

It was a similar story in Kuwait, where the respective growth rates were 13 per cent for Islamic financiers and 4 per cent for conventional banks. In Bahrain, conventional lenders suffered a 1 per cent fall in assets last year, while Islamic banks posted a 7 per cent rise. Across the main GCC markets, only the UAE saw conventional financiers outpacing their Islamic peers, although there was little to distinguish between them, with 18 per cent for sharia-compliant institutions compared with 19 per cent for the others.

For anyone who wants to strike a more pessimistic tone, however, there are plenty of industry weaknesses they can point to. One major shortcoming has been the industry’s narrow reach, both in terms of the range of products it offers and where its customers are located. According to EY, about 93 per cent of Islamic banking assets are held in just nine countries and the top three markets – Saudi Arabia, Malaysia and the UAE – account for almost 64 per cent of the total. The remaining core markets include three in the GCC – Kuwait, Qatar and Bahrain – and three outside the region – Turkey, Indonesia and Pakistan.

Many in the industry recognise the need to expand, both in terms of reaching new countries and serving more market segments. Riaz Riazuddin, deputy governor of the State Bank of Pakistan, the country’s central bank, points to several areas that he says Islamic banks could and should do more to target.

“The current practices of Islamic finance have been keeping in close proximity to conventional financial products,” says Riazuddin. “It blurs the [distinctiveness] of services offered by sharia-compliant institutions. There is a need for these institutions to explore new models and markets. Islamic banks need to reach out to strategic sectors such as agriculture, SMEs [small and medium-sized enterprises] and housing, especially low-cost housing.

“Most of the Muslim countries have agriculture as one of the main sectors contributing to GDP. Islamic banks need to capitalise on this opportunity. Similarly, SMEs remain of paramount importance for achieving growth objectives [and] most of the Muslim-dominated countries have a significant proportion of their populations having housing needs. Islamic financial institutions can contribute to the expansion of this sector.”

Others share some of these views. Hamood Sangour al-Zadjali, executive president of the Central Bank of Oman, made a similar point at the conference in Manama, saying the industry was unduly focused on a few areas, such as real estate. “We look forward to increased focus on the SME sector in particular,” he says.

However, the industry is not necessarily well placed to expand into new areas as fast as some might want, as it faces plenty of tricky hurdles. Efforts to standardise sharia-compliant methods and products has been a long-running and slow process, for example, and is still only making fitful progress. Some countries such as Bahrain are setting up national sharia compliance boards, which could help.

“The main purpose of the Central Sharia Board is to have more centralisation of the Islamic standards,” says Abdulrahman al-Baker, executive director of financial institutions supervision at the Central Bank of Bahrain. “This is important because that will grow the market more. It’s going to be implemented soon, possibly in 2016.”

As welcome as such a move is, it does nothing to address the broader challenge for an Islamic bank that might want to offer services in many different jurisdictions.

“The standardisation problem has existed for decades,” says Jinesh Patel, CEO of the Bahrain-based GFH Bank. “There is a confusion across jurisdictions, across sharia boards. Until we get these basic tenets right, it’s going to be very difficult to trickle this down to everybody who is not just Muslim but non-Muslim.”

Liquidity management

Liquidity management issues are another factor. Here too there has been some progress, in the shape of sovereign sukuk (Islamic bond) issues, for example. However, the rather tepid market in sukuk at the moment suggests this does not yet represent a full fix for the industry and there is a shortage of alternatives.

“Some of the fundamental issues the industry has faced over the past couple of decades have unfortunately still not been addressed,” says Usman Ahmed, CEO of Citi Islamic Investment Bank, a wholly-owned subsidiary of US-based Citicorp Banking Corporation. “The biggest of those is how do you manage liquidity in the short term. The inter-bank Islamic market is not developed.”

Such problems are at least within the ability of the industry to deal with, even if doing so tends to happen at a slow place. There are other issues beyond the industry’s influence however, which are also having detrimental effects on the sector. Perhaps the most notable is the fall in oil prices over the past 18 months, which is hurting many of the economies where Islamic banking is most solidly established.

“The growth rate of Islamic finance in the near term will be tested by the fact that the global economy is in something of a soft spot,” says Jarmo Kotilaine, chief economist at the Economic Development Board in Bahrain. “The fact that there has been this period of commodity price weakness will have an impact, simply because a lot of the countries that have pioneered Islamic finance are more affected by this than other countries. Typically, when oil prices turn south then Islamic wealth creation globally tends to grow much more slowly.”

On top of that, the impact of the slowdown in China and other emerging markets is likely to be negative. The survey by Middle East Global Advisors found that 49 per cent of industry professionals think continued low oil prices are the most likely factor that could slow the growth of the Islamic banking sector in the year ahead, while 21 per cent cite interest rate volatility and 16 per cent say commodity price movements more generally. A further 9 per cent point to the slowdown in the Chinese economy as the most likely cause of any deceleration, while 4 per cent say a possible resumption of the European debt crisis is the greatest risk.

The main base for an Islamic bank is likely to determine which of these factors is the most important for them. As the survey highlights, some at least have close ties to Europe, where Islamic banking is still in its infancy. In markets such as the EU, there are some less technical issues the industry might also need to address if it is to make the most of its potential. Perhaps the thorniest nettle of all to grasp is the name of the sector itself.

Militancy fallout

As some industry executives recognise, the current political climate makes anything with the word ‘Islamic’ in the name a harder sell in some markets. “Unfortunately brand Islam is broken in the West,” says Nazim. “Therefore the sharia part has to be embedded in the proposition. You’ve got to show the economic and the business impact of Islamic finance, rather than just sharia compliance, if you want to go mainstream.”

Ahmed al-Mutawa, chairman of GFH, takes a similar view, suggesting that a name such as ‘ethical banking’ might be an easier proposition in some markets. However, he also points out the industry is still very young.

It is just 40 years since Dubai Islamic Bank effectively created the modern Islamic finance industry and Al-Mutawa suggests that people in the industry should bear that in mind and be realistic about how long change can take before they get too despondent about the industry’s potential.

“You still have to think of Islamic finance as a young industry,” he says. “Even in the Islamic world, traditional banking has the advantage of being here a lot longer. People have got used to it. To shift them from one banking style to the other will take time and effort.”

Saudi Arabia faces uncertain future

Published in MEED, 2 December 2015

Capital spending programmes are likely to be radically curtailed over the coming year, particularly when it comes to new projects.

When Saudi Oil Minister Ali al-Naimi said in late October that the government was looking at the idea of cutting fuel subsidies, it merely confirmed something many outside Saudi Arabia’s leadership had been saying for most of the year. At a time of low oil prices, there are some difficult decisions to be made by the authorities in Riyadh. While a year ago, the idea of cutting fuel subsidies would have been all but unthinkable, now the government is having to adapt to rather different circumstances.

UK bank HSBC estimates that Saudi Arabia’s hydrocarbon receipts will be 45 per cent lower for 2015-17 than they were for the preceding three-year period, which it describes as “the biggest terms of trade shock in a generation”. It estimates that the government is facing a deficit of 19 per cent of GDP this year, and further shortfalls of 15 per cent and 11 per cent in the next two years.

Such predictions serve to highlight an uncomfortable truth for the Saudi government. Despite years of insisting that economic diversification was at the heart of its economic strategy, and despite countless billions invested in education, infrastructure and industrial developments, the government and the country as a whole are still as dependent on oil and gas revenues as ever.

Oil reliance

“Diversification in Saudi Arabia has been a bit of a mirage. Any diversification that has taken place has been towards areas like petrochemicals and plastics, and they are sectors that are heavily reliant on oil,” says Jason Tuvey, Middle East economist at London-based research firm Capital Economics.

So the question now is how the government can and should react to a period of fiscal constraints as a result of low oil prices. UK/US credit ratings agency Fitch Ratings estimates that the breakeven oil price for the kingdom in 2014 was about $101 a barrel. That is not going to decrease without large cuts to state spending programmes or increases in non-oil revenues, or perhaps a combination of both.

International observers have been urging the government to face up to these challenges with a comprehensive approach for some time. Tim Callen, head of the Washington-based IMF’s mission to Saudi Arabia, said in September that “substantial and sustained fiscal adjustment will be needed over the next few years”.

Among the measures that the government could take, Callen identified expanding non-oil revenues, reforming energy prices and controlling the public sector wage bill. “Now is a good time to undertake a review of the whole civil service in Saudi Arabia,” he said. “To look at those positions that are really needed for [the] provision of public services and the government’s economic and social programmes. Then to try and identify those positions that may not be so essential, and then over time reduce those positions as people retire from the civil service.”

Such remedies would not be easy for the Saudi authorities to accept and the reality is that, for the sake of political expediency, the axe will fall far more heavily on capital spending programmes than on current spending. The authorities are extremely wary of prompting any discontent or protests by cutting public sector wages or pensions, for example. It is far simpler to cancel the building of a football stadium, or delay the start of construction of a motorway.

Just how quickly the government will be willing to cut large project spending remains open to question, but a partial answer may come in December when Riyadh issues its budget for the coming year. Such documents have often borne a rather tenuous connection to reality in the past; they have tended to use an overly conservative projection for oil prices, and therefore underestimate government revenues. On the other side of the accounts, they have tended to widely undershoot when it comes to state spending.

Nonetheless, the budget can offer a useful signpost of government priorities and intentions. This time, it may even be based on a more realistic forecast for oil revenues.

The expectation in the market is that capital spending programmes will be radically curtailed over the coming year, particularly when it comes to any new projects. “The government will continue with ongoing projects but it is taking a far more conservative approach to starting new projects,” says Paul Gamble, a director in the sovereign group at Fitch Ratings.

Schemes at risk

Just where the cuts will come remains, to some extent at least, a matter for conjecture. Local media reports have pointed to the cancellation of sports stadiums around the country. Road-building programmes and other elements of the country’s transport infrastructure, such as some long-distance rail lines, have also been identified as being at risk. The grand project to build a network of economic cities around the country is looking rather threadbare these days. The only one that is making significant progress is King Abdullah Economic City.

Utilities projects could also suffer. In mid-October, MEED reported that the state-owned Saudi Electricity Company had shelved a project to convert the PP9 power plant to a combined-cycle facility. The scheme would have increased the plant’s capacity by about 240MW. Other power and water projects could well follow in its wake.

All this is not an entirely new situation for the state. “The Saudis have been in this position before,” said Callen. “If you go back to the drop in oil prices in the first half of the 1980s, deficits of more than 20 per cent of GDP were recorded in a couple of years.”

The response then was an indication of what might happen now. Tuvey points out that during the 1980s the government cut capital spending by more than 98 per cent from peak to trough in response to low oil prices. It took until 2009 for spending to fully recover.

The danger is that if the cuts are too rapid and too deep, it could send the economy into recession, or at least cancel out any hopes of growth. The structure of the Saudi economy is such that any drop in government spending is likely to hit the non-oil economy quite hard. “Non-oil growth is heavily dependent on government spending, particularly capital spending,” says Gamble.

The most recent data from the purchasing manager index compiled by research firm Markit shows that the non-oil economy is still growing, but there are already some worrying signs. In particular, the data for new orders in September, which is a leading indicator for future economic activity, appears to be slowing down. Output also showed slower growth.

The sense of a slowing economy is reinforced by recent figures from the Gulf Projects Index, compiled by MEED. As of late October, it showed a decline in the Saudi projects market of almost 1 per cent year-on-year. While that is not a big figure, the decline is only likely to accelerate in the year ahead as government spending is pared back further.

The problem for the Saudi authorities is that the cuts to capital spending are not likely to be enough on their own to deal with the fiscal challenges the state faces. That explains the public acknowledgment by Al-Naimi that subsidies may also have to be cut.

There are some other options the government is already implementing, including using some of the savings it has squirrelled away during the years of high oil prices. The country’s central bank, the Saudi Arabian Monetary Agency (Sama), had some SR724bn ($193bn) in net foreign assets at the end of last year. This is according to local bank Samba, which expects that figure to have dropped to SR594bn by the end of this year and to SR520bn by the end of 2016.

Bond market

The government has also been enthusiastically tapping the bond market since the summer. Samba expects Riyadh to sell about SR100bn of bonds to local banks this year and a further SR190bn in 2016. The debt issuance is expected to cover about half the budget deficits this year and next, with the rest being paid for by the drawdown of savings.

There is, however, a further complicating factor in all this, in the shape of a relatively turbulent political environment. For Saudi Arabia, many of the recent regional developments appear threatening, including the chance of Iran re-entering the international mainstream following the deal to remove some sanctions in return for Tehran abandoning its apparent nuclear ambitions. That feeds into sectarian fears in Riyadh of a Shia crescent coming to dominate the region, from Tehran through Baghdad and Damascus.

To the south, the war in Yemen is proving both costly and increasingly intractable, and is exposing the country to allegations of war crimes against Yemen’s civilian population. The conflict is also throwing up some delicate domestic political issues. The campaign is closely associated with the Deputy Crown Prince Mohammed bin Salman, the son of the king, and if it goes badly he may well suffer in any political fallout.

Unease within the royal family about the direction in which the newly installed leadership is taking the country broke into the open in September and October, when two anonymous letters, apparently written by a senior royal, leaked into the media. The letters criticised King Salman and his appointed successors, and called for the king to be replaced. How serious the threat is to the king is unclear, but the Al-Saud family has shown a willingness to act ruthlessly in the past. In the early 1960s, Prince Faisal forced King Saud from power, and was in turn assassinated in the following decade by another member of the royal family.

At the same time, the country faces the threat of political violence by supporters of Islamic State in Iraq and Syria, and, more broadly, sectarian violence against its Shia minority in the oil-rich Eastern Province.

This complex political environment makes the decisions the government needs to take on economic issues all the more difficult. Leaders will be alert to the risk of unrest and, unlike at other times in the past, it will be more difficult for them to simply dip into their coffers and offer financial inducements to the population to remain quiet.

Having said all that, there are some positive elements. The government’s low debts and large savings mean it has time to adjust its spending patterns gradually. And at this stage, most forecasters are still expecting the economy to carry on growing. Added to that, the banking system is in robust shape and can continue to lend to businesses. There is no doubt that a cut in government spending will have a detrimental effect on the economy, but it is not expected to lead to a sharp contraction as yet.

“Growth in Saudi Arabia remains favourable. We do expect growth to slow this year compared with 2014, but we expect it to remain robust at 2.8 per cent,” said Callen, at the time of the publication of the IMF’s latest review of the Saudi economy in September. “The Saudi economy is continuing to do quite well despite the oil price drop.”

Oil prices

Ultimately, the future direction of the economy and the projects market depends largely on the direction that oil prices take in the coming months and years. Many observers suggest prices may rise gradually from late 2016 onwards. That would certainly ease the pressure on the government, but it seems unlikely that the oil price will rise by enough to cut the government’s fiscal deficit entirely.

That in turn means the outlook for the projects market is likely to remain more subdued for the foreseeable future, notwithstanding the need for the country to diversify its economy and its sources of income.

“Although the financial position looks OK, it’s the structure of the economy that is the longstanding issue,” says one economist at a Saudi bank. “How do they diversify and get more Saudis into the private sector, particularly with a workforce that’s growing fast and a very young population? I’m not seeing convincing evidence of a systematic approach to this.

“I think they’re going to wait and see where the oil price goes. It’s a bit of a hand-to-mouth exercise. I’d hesitate to say they’re thinking in medium terms. I think they will wait to see where the price goes and if it stays flat in 2016, then they’ll probably keep cutting and cut more severely. So it’s going to be oil price dependent.”

Unwelcome shock

Published in The Gulf, 1 December 2015

Riyadh reacted to a recent downgrade by S&P with heavy criticism of the ratings agency, but S&P is far from being alone in its analysis of the Saudi economy.

It has been impossible to ignore the financial challenges facing the Saudi government this year. Oil has been at or around $50 per barrel since August while the cost of running the generous welfare state requires something closer to $100 per barrel. Analysts have consistently said cutbacks will be needed, and that message has been echoed by senior officials. In late October, oil minister Ali al Naimi said the government was looking at the idea of cutting fuel subsidies.

Even so, the decision by Standard & Poor’s (S&P) to downgrade the kingdom’s credit rating on 30 October from AA- to A+ appears to have come as an unwelcome shock to the government. The ratings agency said it made the change because of the rapid deterioration in the government’s financial position. Lower oil prices has meant the fiscal deficit is likely to jump from 1.5 per cent of GDP last year to 16 per cent this year. S&P warned further downgrades could be made if the government did not make sizeable and sustained cuts in its deficit.

It did not go down well in Riyadh. “We consider S&P’s credit assessment reactionary, driven by fluid market factors rather than changes in the fundamentals of the sovereign,” said the ministry of finance in a statement. “We believe that S&P’s decision was not only rushed, but analytically inconsistent with the idea of ratings being a medium-term tool.”

Saudi Arabia is often sensitive to criticism, but the facts seem straightforward enough. And while the ministry pointed to “the vast difference in approach and credit view demonstrated by the other agencies”, some of those other ratings agencies have also changed their assessment this year. Fitch Ratings, for example, put Saudi Arabia’s rating on negative outlook in August, citing the worsening fiscal position.

“The decision by Standard & Poor’s is hardly surprising in light of the deterioration in the fiscal position this year and lack of a clear agenda to rein in the budget deficit,” says William Jackson, senior economist at London-based Capital Economics.

In the usual run of things, a downgrade would not make much difference to the Saudi government. It has limited debt and sells its bonds to local banks rather than international investors. This year it is issuing around SR100 billion ($26.7 billion) and next year it is expected to issue a further SR190 billion. “There is plenty of scope for local banks to absorb that,” says an economist at one Saudi bank.

However, the government appears to be looking further afield. Media reports in November indicated that officials in Riyadh are planning to tap the international bond market next year. In those circumstances, any downgrades mean the cost of issuing debt will rise for the government.

Saudi bonds will still look a safe bet for most investors, notwithstanding the recent downgrade and the risk of more to come. Public finances are in a relatively healthy position. The government ended last year with gross debts equivalent to just 1.6 of GDP, according to the International Monetary Fund (IMF). And as well as issuing debt it can also cover its budget shortfall by using the vast savings it accumulated during the recent oil boom.

Nonetheless, the downgrade throws into sharp relief the longer-term issues facing the economy and highlights the need to pursue fiscal reforms and economic diversification. Until it manages to do so, the government’s financial position will be at the mercy of international oil prices, which have stayed stubbornly low in the second half of this year.

Usually, low oil prices provide a spur to global growth, prompting more demand and a reason for oil prices to then rise again. However, that normal pattern is not happening at the moment. “We thought the fall in commodity prices - particularly oil - would create stronger demand and, as we approach 2016, that we would see more growth, but that doesn’t seem to be coming through,” says Keith Wade, chief economist at Schoders, a UK asset manager. “The world economy seems to be stuck with growth around about 2.5 per cent.”

For as long as these factors persist, the pressures on the Saudi economy are not going away. Even if the Saudi government does take the axe to some spending programmes in the forthcoming budget, as many anticipate, it will take time for that to have an effect. The emphasis is expected to be on capital spending cuts but these take time to feed through as commitments made to existing projects cannot always be easily cancelled.

In the longer-term, cuts to subsidies will probably have to be made, as Al Naimi has warned. However, the government is likely to move ahead with such measures with extreme caution, lest it provoke public dissatisfaction and disquiet. “We don’t get the sense that there is an immediate rush to address subsidies in Saudi Arabia,” says Paul Gamble, director of the sovereign group at Fitch Ratings.

And despite the apparent willingness to consider spending cuts in some areas, particularly capital projects, in other areas the reverse is happening. The costs of the ongoing war in Yemen are unknown but likely to be high and even when it ends Riyadh is likely to be pressured to help pay for the reconstruction of the country, given that its bombs have caused so much destruction.

At some point oil prices are likely to recover, but no-one expects them to leap back to the three-figure level any time soon. S&P is predicting an average oil price of $63 per barrel from 2015 to 2018, well below the price needed to balance the government’s books based on its current spending patterns. That means the structure of Saudi Arabia’s economy will continue to pose a challenge unless some fundamental changes are made.

A few days after the S&P downgrade Christine Lagarde, managing director of the IMF, paid a visit to Riyadh where she held talks with King Salman, the finance minister Ibrahim al Assaf and others. Her advice echoed many of the points made by S&P.

“Prudent fiscal management has helped build-up substantial policy buffers over the past decade, but reforms that would put the large fiscal deficit on a firm downward path are needed,” she said, in a statement issued at the end of the trip. “The decline in oil prices has increased the importance of reforms.”

Riyadh can expect the outside world to keep delivering the same message for some time yet, whether it likes it or not.

The last resort for food security

Published in MEED, 26 November 2015

A facility deep inside the Arctic Circle is playing a vital role in ensuring farming in the Middle East has a viable future.

On the side of a mountain on an island in the Norwegian archipelago of Svalbard, deep inside the Arctic Circle, a wedge of concrete sticks out into the cold air. Behind a grey door at its base lies the Global Seed Vault, the world’s most important agricultural collection.

The vault is built 150 metres into the mountain, isolated from the weather and the risk of natural or man-made disasters. Anyone entering has to pass through five locked doors, security cameras and motion detectors. The very definition of food security, the facility has the capacity to store copies of 4 million varieties of crops.

The Global Seed Vault holds more than 830,000 varieties of seeds and other samples from nearly every country in the world. They range from staples such as rice, wheat and sorghum, to eggplant, lettuce and potato. The high-security environment is half a world away from the dry lands of war-torn northern Syria, but these days the two places are inextricably linked.

Until recently the vault was only ever entered by people depositing more precious samples. This year, for the first time, a request was made by a Syrian organisation to remove about 38,000 seeds from the facility, nicknamed the Doomsday Vault.

The withdrawal was made by the International Centre for Agricultural Research in Dry Areas (ICARDA). Its headquarters in Tel Hadya, on the outskirts of Aleppo, Syria, was seized by rebels in 2012, and the organisation relocated to Beirut.

ICARDA runs several research programmes based around farming in dry areas and holds a globally important collection of seeds. The mainly wheat and barley seed it withdrew are for growth in arid areas such as the Middle East.

“Because of the situation prevailing in Syria we had to move to places where we can continue our activities,” says Ahmed Amri, head of the genetic resources unit at ICARDA. “We distribute 20,000-25,000 samples annually. We need to replenish from time to time. This is what we could not do in Syria because the situation there does not allow us to work in the field.”

Since it was set up in 1977, ICARDA has sent almost 1 million seed samples of wheat, barley, grasspea, lentils and other crops to farmers, researchers and breeders in more than 120 countries. Each time samples are sent, fresh ones need to be grown to replenish the gene bank, a safety measure to protect against extinction of a species and to provide countries with a last resort. With the Syrian civil war raging, that replenishment was proving impossible.

ICARDA decided to replicate its collection across two sites, near the Moroccan capital of Rabat and in the Bekaa Valley in Lebanon, but to do so it needed to withdraw seeds from Svalbard. These will be grown out over the next five to 10 years, with fresh samples then sent back to Svalbard.

The organisation is part of a network of 11 agriculture deposits scattered around the world, each one specialising in different crops.This network is in turn supported by the Crop Trust, a body set up in 2004 by the UN’s Food & Agriculture Organisation and Rome-headquartered Biodiversity International. The Crop Trust also helps to fund and run the Svalbard facility, alongside the Norwegian government.

“ICARDA has the most important collection of some wheat, barley and other crops. The whole point of these collections is that farmers, breeders and scientists have access to this diversity and can actually use it,” says Brian Lainoff, a spokesman for the Crop Trust. “The Svalbard global seed vault is the ultimate safety net for this global system.”

But this global back-up system is itself in a vulnerable position. The Svalbard facility is fairly cheap to run, with annual costs of about $100,000, but a secure, long-term funding system for the global network of gene banks is not yet in place.

The Crop Trust is trying to set up a $500m endowment fund to pay for the future running of these gene banks and the Svalbard site, and is looking to wealthy Gulf states to help with funding. To date just $170m has been pledged by 14 countries, including the US, Norway, Germany and the UK. An international pledging conference to raise the rest of the money is due to be held in Washington in April next year, at the same time as the Spring joint meeting of the Washington-based World Bank and IMF.

“We expect and hope government donors will support the endowment fund,” says Lainoff. ”It’s a one-off cost.”

In the build-up to the pledging conference, the lobbying efforts continue apace. In December, a delegation from the Crop Trust is due to visit several Gulf countries to drum up support for the fund.

The attention garnered by ICARDA’s withdrawal of seeds from Svalbard could help to highlight the vulnerable nature of food supply in dry regions, the need for more funding and the fact that all countries ultimately depend on each other and on crop diversity for their food security.

Amri is hopeful that will prove to be the case. “I think our withdrawal of seeds from Svalbard could enhance the capacity of the Crop Trust and the whole system to leverage additional funds,” he says.

Executives jet in to Iran, but legal pitfalls could put brake on investment

Published in Gulf States News, 26 November 2015

The world’s 28th largest economy holds almost as many risks as opportunities for international investors, and questions will persist about doing business in Iran even after sanctions are lifted.

Nothing has yet changed, for all the excitement caused by the agreement to end Iranian sanctions, signed by Tehran and the P5+1 group of six international powers in July. No sanctions have been removed and none will be until the United Nations’ nuclear watchdog, the International Atomic Energy Agency (IAEA), confirms that Iran has met its side of the Joint Comprehensive Plan of Action (JCPOA) by scaling back nuclear activities. When that happens, on the JCPOA’s ‘Implementation Day’, some elements of the trade embargo will be lifted, but many restrictions will remain, as credit insurers and trade financiers have understood since the deal was agreed.

It is not yet clear when Implementation Day will fall, although most expect it to happen in H1 16 – possibly as soon as Q1 16. At that point, there will be two distinct groups of international companies: US firms, for whom not much will change, and European Union companies, who have been flooding into Tehran.

A few areas will be loosened up for corporate America – for Persian carpets or US aircraft parts, for example – but sanctions imposed as a result of Iran’s alleged terrorism-related activity and money laundering will stay; Iran will remain off limits to most US businesses.

The EU will dismantle much of its trade embargo, and US sanctions that sought to prevent third parties from doing business with Iran, known as secondary sanctions, will be removed. Other governments that have broadly followed the EU’s sanctions policy, such as Norway and Switzerland, will probably take a similar position. “US companies are absolutely at a disadvantage as a result of this deal,” said Eytan Fisch, counsel at US law firm Skadden and a former Office of Foreign Assets Control (Ofac) official. “Non- US companies… are going to benefit most from the sanctions relief. They will have the greatest opportunity,” he told GSN.

Businesses that fall between these two groups are in a grey area. Non-US companies that are owned or controlled by US companies or individuals may still be subject to stringent US sanctions. “It is really up to the almost complete discretion of the US government as to what they decide to do,” said Fisch, of this third group. “It’s not clear exactly what will be done. It’s really a big unknown.”

All companies have other issues to navigate. The ban on US dollar transactions with Iran is likely to remain, and US banks will not be able to process most payments involving Iran. The export, or re-export, of any US-made goods to Iran will still be banned. Although European banks will be able to process payments from Iran, many will be cautious about doing so.

“Banks are very much in a wait-and-see scenario,” said British Bankers Association director of financial crime Justine Walker. “How do you really make sure that you carve out your business with Iran in a way that you’re not going to violate your US exposed individuals or business lines? That’s going to take time.”

Many Iranian individuals and companies will remain under US and EU sanctions until the IAEA concludes that Iran is behaving according to the deal. That point, known as ‘Transition Day’, is unlikely to happen for eight years. Among those that continue to be sanctioned will be important economic players, including companies associated with the Iranian Revolutionary Guards Corps (IRGC). The opaque nature of company ownership in Iran means that carrying out background checks on potential partners will be vital (although US due diligence firms may not be able to work on such projects).

Chief executive of London-based law firm W Legal Nigel Kushner said questions remained over companies that are potentially still politically compromised and have previously been placed under sanctions by the EU and UN, as well as Ofac. One example is Tidewater Middle East Company, the main container operator at Iran’s busiest port, Shahid Rajaee at Bandar Abbas, which has been traced to IRGC ownership and operations. “The way I read the asset freeze, it can be argued that any shipment to an Iranian port owned or controlled by Tidewater, or perhaps the Revolutionary Guards, will potentially result in criminal exposure for the shipper or the exporter,” Kushner said. “This issue is absolutely critical and must be addressed and clarified by the EU.”

Tidewater Middle East and associated companies were added to the US Department of the Treasury’s list of specially designated nationals on 23 June 2011, on the basis that it was owned by Mehr-e Eqtesad-e Iranian Investment Company, Mehr Bank and the IRGC, and that it has been used by the IRGC for “illicit shipments”. These companies have no relation whatsoever with giant US international shipping company Tidewater.

There is also the risk that sanctions may be re-imposed if relations between Iran and the west turn sour. Accounting for that ‘snap-back’ will require careful drafting of any contracts, so that international firms can retreat at minimal cost. “It’s imperative that people who jump back into Iran do so with their eyes wide open, knowing the commercial risks,” Kushner concluded. Iranian officials are counseling caution. Deputy oil minister Roknoddin Javadi told Mehr news agency that he expected only five major oil contracts to be signed with international companies before the government’s term ends in August 2017.

Gulf airlines stabilise at cruising height

Published in Gulf States News, 26 November 2015

This year’s Dubai Airshow was notable for a lack of new orders by the big Gulf carriers, but this may mark little more than a pause for breath as the region’s airlines digest huge recent orders.

More than 1,000 exhibitors from 61 countries turned up to the 8-12 November Dubai Airshow, which reflected in its global status to show off some 150 aircraft on the tarmac, from agile drones made by Abu Dhabibased Adcom Systems all the way up to lumbering Airbus A380s decked out in the liveries of Dubai’s Emirates Airline and Qatar Airways.

So far, so normal: what was unusual was the lack of big new orders. Abu Dhabi-based national UAE airline Etihad Airways exercised options for two Boeing 777 freighters, but that was part of an order for 199 planes announced in 2013. There were no equivalent new deals. Instead, the big manufacturers were left to make more prosaic announcements, such as Toulouse-based Airbus Group’s deal to upgrade the cabins of Oman Air’s A330s.

By comparison, the November 2013 show saw Abu Dhabi and Dubai-based airlines set new records, placing combined orders worth more than $170bn, with Emirates committing to an estimated $99bn spend, low-cost carrier flydubai placing an order worth $11.4bn and Etihad spending more than $67bn, while also announcing the acquisition of a 33.3% stake in Swiss carrier Darwin Airline.

The industry has been debating whether this year’s lack of orders represents a natural lull while the airlines digest huge recent orders, or something more significant. Aviation specialist JLS Consulting director John Strickland suggests the former: “I don’t think the lack of new orders was a surprise. The Gulf carriers – not only the big three, but also airlines like flydubai – already have a lot of orders on the books that haven’t been delivered yet. You can’t expect big orders all the time.”

Smaller Gulf airlines, including Dubai Aviation Corporation’s flydubai (see page 11), are still growing. The big three are also still expanding their networks via distinct growth strategies:

● Emirates is focused on organic growth, although it has a management contract for TAAG Angola Airlines and an important co-operation deal with Qantas;

● Qatar Airways places more emphasis on partnerships, being a member of the Oneworld alliance and a shareholder in International Airlines Group (IAG), the holding company of Aer Lingus, British Airways, Iberia and Vueling; and

● Etihad has the most challenging strategy of the three, with a jigsaw of stakes in smaller airlines such as Air Serbia and Airberlin.

Bahrain-based Gulf Air, seen as a poor cousin of the big three since its regional domination declined and the Qatar and UAE airlines grew, is adding new destinations, most recently with flights to Faisalabad and Multan in Pakistan in October. It is also overhauling its fleet: in September, Gulf Air said it would order up to 50 new Airbus aircraft. This deal seems likely to be signed in early 2016.

Gulf Air’s Bahraini senior management is working to turn around the airline’s fortunes. Maher Salman Al-Musallam joined as deputy chief executive (after a 35-year career with the Royal Bahraini Air Force) and has served as acting chief executive since Samer Majali stood down in 2012. Recently promoted to chief operating officer, Nasser Al-Salmi joined Gulf Air in 1988 as a cadet pilot, and rose to chief pilot and, from November 2008, director of flight operations. Among other second-tier airlines, Oman Air plans to expand its fleet to 70 aircraft by 2020, compared to 32 today. Kuwait Airways is working through an order for 37 Airbus aircraft made in February 2014.

Saudi Arabian Airlines (Saudia) is due to receive the first of eight Boeing 787 Dreamliners before year-end, as part of a modernisation programme, which director-general Saleh Bin Nasser Al-Jasser in late October said would include retiring 19 older planes from its fleet (15 Embraers and four Boeing 747 jumbo jets). Laying the cornerstone of Saudia’s new air operations building in Jeddah, Jasser said the airline’s fleet of 124 passenger aircraft was expected to rise to 200 by 2020. Some 50 new Airbuses are due in the period to 2018, 28 of them arriving in 2016, Jasser told another event, in Cairo.

In his most recent statement, General Authority of Civil Aviation president Suleiman Bin Abdullah Al-Hamdan (who is also Saudia chairman) has said the new King Abdelaziz International Airport will be completed in mid-2016, with a further year needed to test equipment before a 2017 opening.

Saudia is strengthening its presence in Egypt and has decided that women will be employed in administrative jobs. Jasser in late October also said the privatisation of Saudia’s catering company had “reached its final stages now, and will be put on the stock market for public subscription shortly”. He was also quoted saying the privatisation of ground services had reached its final stages.

Judging from the headlines, the region’s aviation industry is planning a bright future. However, the lack of detailed financial results issuing from many airlines makes it impossible to judge the viability of their strategies. Data included in GSN’s graphic may be the best available, but still subject to discrepancies.

Load factors, where they are published, generally look healthy enough, running at 79-80% for Etihad and Emirates and 81% for Sharjah-based Air Arabia (chaired by UAE-based Qatari businessman Abdullah Bin Mohammed Bin Ali Bin Abdullah Al-Thani). Oman Air is slightly lower at 74%.

A few issues are holding back growth. Deregulation of the Saudi domestic aviation industry appears to have stalled and, across the region as a whole, the rapid growth in traffic has highlighted the shortage of airspace open to commercial jets. As flydubai chief executive Gaith Al-Gaith has observed (see box), airlines are finding it difficult to break into new markets. The big three have been met by a wall of opposition from US carriers, while gaining further access to some European markets is also proving tricky.

On the plus side, Iran’s imminent opening up could offer an attractive nearby market to exploit. And low oil prices mean low fuel prices, at least for those airlines that did not order too much fuel when prices were high. Emirates says fuel made up 35% of its operating costs in 2014-15, compared to 39-40% in the previous three financial years.

Overall, barring any sudden shift in corporate strategies, a revival in aircraft orders is likely to happen before long. The big three Gulf carriers have some 876 aircraft on order, so there is still plenty of work for Boeing and Airbus. Add in the smaller airlines and the regional order book swells to 1,200. Airbus thinks the Middle East region will buy 2,460 more aircraft over the next 20 years, with 1,890 as a result of fleet expansion and 570 to replace aging planes. Boeing says it expects the region to need 3,180 new planes over the same period, worth an estimated $730bn.

Investors target London property market with Shariah-compliant funds

Published on Salaam Gateway, 14 November 2015

Interest in Shariah-compliant investment in the UK property market is showing signs of strong growth, with several hundred million pounds of investment potentially on the way into the market over the next year.

Among those currently raising money for investment is London Central Portfolio (LCP), which has been running an investor roadshow in Southeast Asia in recent weeks, holding meetings with local banks around the region. It is seeking to raise £100 million by the end of March for its London Central Apartments III fund, which will invest in the private rented sector in the UK capital.

Naomi Heaton, CEO of LCP, says the combination of a Shariah-compliant fund and the reputation of the London property market is proving to be a compelling one. “We’ve spoken to a wide variety of banks in Malaysia, Singapore and Hong Kong. A lot of them will come on board,” she says.

In the coming weeks, Heaton is due to travel to the Gulf region to talk to potential investors there. One Qatari bank, Masraf al Rayan, has already signed up as an investor.


London property has been a popular option for international investors for many years, including those from the Middle East and Southeast Asia. However, the growth of Shariah-compliant investment vehicles is providing a new route to the market and adding to the dynamism in the sector.

“We have seen strong demand for cash-generative Shariah-compliant real estate investments for a number of years,” says Chris Coombs, head of product development at Gatehouse Bank, a boutique finance house in Kuwait that has invested heavily in the UK real estate market. “Investor demand for real estate developments structured in accordance with Shariah has increased. We have made a big push into the residential private rented sector in the UK.”

As Coombs notes, from an Islamic finance perspective, the fact that property investment involves a physical asset makes it a more straightforward option than many others. “Relative to other alternative investments, real estate is a natural fit with Shariah, provided that care is taken with respect to the uses of the assets,” he says.


The market is not just being tapped by high net-worth individuals and institutional investors. The House Crowd launched in March 2012 and styles itself as the UK’s first Shariah-compliant, crowd-funding property platform. With a minimum investment of £1,000, it is more accessible than many of the larger funds. In comparison, the minimum subscription for private investors in the new LCP fund is £25,000.

Frazer Fearnhead, CEO of The House Crowd, says it has financed the purchase of more than 150 properties to date, usually holding them for between three and five years. The company has ambitious plans for the year ahead.

“In the next financial year we anticipate raising £100 million’, he says. ‘Over the course of the next few years, we intend to grow significantly beyond that and be in a situation where we are managing several hundred million pounds worth of property.

Not all of this will come from people concerned about whether the fund meets the requirements of the Muslim faith. As with other areas of the Islamic economy, being Shariah-compliant means that funds can appeal to investors in the Islamic world but also to people beyond it.

“We want our funds to be globally available,” says Heaton. “They’re just as attractive to conventional investors as Islamic investors because the model of targeting the private rental sector in central London is one that appeals to everyone globally. And the cost of funds and the cost of structuring it in an Islamic way is no greater than doing it in a conventional way.”

London property dispute draws in Kuwaiti sheikhas and UAE real estate giant

Published in Gulf States News, 12 November 2015

A complex legal dispute over a property deal in central London could be heading to mediation or a future trial.

Another complex dispute over property involving wellheeled Gulfis has come to the High Court of Justice in London, where Sheikha Hind Bint Salim Hamud Al- Jaber Al-Sabah and two other claimants are pursuing a legal action involving six defendants, including the Kuwaiti royal’s sister Sheikha Salem Hamud Al-Jaber Al-Sabah and Iraqi- Emirati businessman Hussain Sajwani, chairman of UAE-based developer Damac Properties.

The sheikhas’ father was Sheikh Salim Hamud Al-Sabah, described in court documents as a high-ranking professional soldier who was head of the Emiri Guard for 25 years. A grandson of Emir Sheikh Jaber I (who ruled from 1915 to 1917), Sheikh Salim died on 10 June 2003 without leaving a will; he left 15 heirs, including the two sisters. His estate included two adjoining flats, numbers 61 and 62, at 3-8 Porchester Gate, on the north side of Hyde Park in central London. The two flats had been converted into a single property and were registered in the names of two Gibraltar companies, Rosork Holdings and Fairlann Trading.

In June 2009, the combined property was bought for a documented price of £1.9m ($2.9m today) by British Virgin Islands-incorporated Gulf Heritage Properties Company Ltd, controlled by Sajwani. The transaction was arranged by agent Tareq Al Baho, a Kuwaiti national. At the centre of the disputeare Sheikha Hind’s claims that the property was undervalued at £1.9m and that a ‘bribe’ was paid to secure the property at a below-market rate. She contends that the property’s true value is £2.5m-3m.

In the particulars of a claim submitted to the High Court in July, Sheikha Hind said that, on top of the £1.9m, further payment of “not less than £600,000” was paid by or on behalf of Sajwani to Al Baho or Andrew Pinnell, a solicitor appointed under a power of attorney in 2008 to represent 12 of the 15 heirs and Sheikh Salim’s estate. The £600,000 figure is based in part on a claim that Al Baho told Foxtons estate agency that the property had been sold for £2.5m – in other words £0.6m above the £1.9m figure. The property had been marketed through Foxtons for a time, although the sale was agreed separately.

Two other claimants in the proceedings, property agents Asad Meerza and Mohsen Mehra, claim they are owed a £300,000 commission from Al Baho and Sheikha Salem for their role in introducing Sajwani to Al Baho.

In their defence, Sajwani and Gulf Heritage say they paid £2.2m, comprising £1.9m for the property and an agent’s fee of £300,000; these sums were paid to the benefit of Rosork Holdings and Fairlann Trading. The £300,000 was paid via two bankers drafts made out in UAE dirhams. Gulf Heritage and Sajwani say no payment was made to anyone other than the two vendor companies and deny that the £300,000 constituted a ‘bribe’. They also deny that a sum of “not less than £600,000” was paid in connection with the property purchase.

In a further twist, Sheikha Hind claims that Al Baho obtained the £300,000 by lodging the two bankers drafts in accounts held by two ‘clone companies’ that he had set up in the UK and which had identical names to the two Gibraltar companies, Rosork Holdings Ltd and Fairlann Trading Ltd.

In a two-day hearing in the High Court’s chancery division, Justice Peter Smith noted that Al Baho had not served a defence nor filed any evidence. On 3 November, he made judgements that Sheikha Hind could claim a number of interim payments from Al Baho and BC Penthouse Ltd, a company wholly- or partly-owned by Al Baho, for the benefit of the estate.

According to the defence, substantial sums have been spent on the Porchester Gate property since the transaction went through, including £1.89m to renovate and extend it. The property is used by Sajwani as his personal residence when in London.

A lawyer for the three claimants, Matthew Jenkins at Hughmans Solicitors, told GSN that mediation efforts have been proposed and are due to take place before Christmas. If they do not go ahead, or prove unsuccessful, the matter is expected to proceed to trial in early 2017. A spokesman at FTI for Sajwani declined to comment on the proceedings. Lawyer Richard Barca at Wilson Barca, for Al Baho, Pinnell and Sheikha Salem, did not respond to a request for comment.