GCC bonds – growing activity and how Bahrain is poised to capitalise

June 2014 | EXPERT BRIEFING | CAPITAL MARKETS

financierworldwide.com

Over the last year GCC markets have witnessed growing interest in capital markets transactions which is expected to increase over the coming years. With the recent launch of the OFS Module of the CBB Rulebook, the Central Bank of Bahrain is well positioned to take advantage.

The Bank of England was famously founded in 1694 with the express intention of providing the government of William and Mary with the means to raise money for war with the French. The bank raised £1.2m by importing the pioneering Dutch system of national public debt, funded through a stock exchange, where long-term bonds could be easily bought and sold. The issuance of bonds was a revelation for England’s antiquated financial system. They allowed the government to borrow at reduced rates, which in turn made large-scale projects (such as wars) much easier to afford. From 1715 onwards the Bank of England was regularly raising money for the government by the issuance of government bonds.

Fast-forward to the 21st century and the practice of issuing medium- to long-term instruments (by governments or private institutions) as a reliable method of raising capital is now commonplace. The emergence of Sukuk as a legitimate, Shari’ah compliant, method of raising capital on a large scale has had a dramatic effect on capital markets in the Middle East. The global Sukuk market started to develop a decade ago, was knocked by global turmoil in 2008 and then rocketed for four years, leading to US$140bn of issuance worldwide in 2012. According to Kuwait Financial Centre (Markaz), total Sukuk issuance in 2013 amounted to US$97.7bn, a figure which, although down on the previous year was still substantial. Predicted growth in 2014 is still widely perceived as falling far short of investor demand.

Capital markets and the GCC region

Public expenditure across the Gulf Cooperation Council (GCC) countries has risen over the last two years, with policy makers responding to social pressures by increasing wages and boosting employment in the public sector. These measures, together with increased public subsidies, have resulted in higher fiscal deficits and (in oil importing countries) public debt. Moves towards economic diversification have led to increased spending on infrastructure and a need for private debt.

We are already beginning to see increased capital markets activity in the GCC region as a result. The UAE, which has the largest portfolio of outstanding debt securities in the GCC, has recently issued new rules for the issuance and trading of covered bonds. It is widely accepted that Qatar has large ambitions to develop its domestic capital markets and build a world-class asset management industry. Oman’s first Sukuk issuance, by Tilal Development Company, took place in 2013, and it is widely anticipated that at least one private Omani Sukuk issuance will soon be launched. It also seems likely that a sovereign Sukuk issue will follow at some point in 2014. In Saudi Arabia the recent 30-year, US$2.5bn landmark Sukuk issuance by Saudi Electric Company was a particular highlight of a positive start to the year.

Bahrain as a regional securities hub

In anticipation of growing regional demand, the Central Bank of Bahrain (CBB) has not rested on its laurels. In December 2013 the CBB announced the launch of the Regulatory and Supervisory Module on Issuing and Offering of Securities and Shari’ah Compliant Sukuk (OFS Module) of the CBB Rulebook. The OFS Module, which officially came into force on 1 January 2014, contains the CBB’s new rules on the offering of securities in Bahrain and provides comprehensive regulatory guidance for the sector.

The main purpose of the OFS Module is to regulate the issuing, offering, floating and subscription of securities, whether conventional or Shari’ah compliant.

The module is divided into nine sections covering: functions; procedures; roles and responsibilities; documentation; legal and other requirements; and rights of issuers and investors.

Detailed guidance on the application process is included as well as prospectus templates for various forms of securities and specific criteria for service provider appointments. The provisions were developed in accordance with international standards and best practices, as advised by the International Organisation of Securities Commission.

The guidance should dramatically shorten the timeframe required to approve offering of securities applications. At a press conference to mark the launch, a CBB representative confirmed that the OFS Module seeks to bring Bahrain in line with global-standard best practice with regard to transparency and investor’s rights.

CBB Governor Rasheed al Maraj also highlighted the CBB’s decision to accept all applications submitted by GCC issuers prepared in accordance with the Unified Standards issued by the GCC as particularly significant. It is hoped this move should facilitate the integration of GCC securities markets.

The first test of the new regime came in December 2013 when Bahrain Commercial Facilities Company B.S.C. issued an unsecured, privately placed BHD20m (approx. US$53m) conventional bond. Coming before the official launch, this was the first issuance in Bahrain to comply with the new regulatory and disclosure framework and was successfully delivered within a particularly challenging timeframe.

Fortunately the days of kings and queens issuing bonds to raise money for foreign wars appear to be behind us. However, in the midst of a tentative global economic recovery the requirement for a stable, efficient regulatory framework to facilitate the raising of capital remains.

There are encouraging signs that 2014 will be a bumper year for bond issuances in the GCC. With the timely introduction of the OFS Module, the regulatory authorities in Bahrain have made a huge effort to position the country as a regional hub for securities activity.

Niall McMorrow is a senior associate at Trowers & Hamlins. He can be contacted on +973 17 515 609 or by email: nmcmorrow@trowers.com.

Niall McMorrow

Trowers & Hamlins