Alternative financing options for the GCC

Traditional financing options, such as bank funding, continue to rule the roost in the Gulf region.

Rising oil exports led to large government revenues, which usually ended up as deposits in the region’s banking system and constituted a significant source of low-cost funds. However, the current lower oil price environment and the resulting budgetary deficits have forced market participants to look at alternative sources of funding, such as private equity, venture capital, peer-to-peer lending, crowdfunding, and project bonds among others.

In the GCC, banks constitute the lion’s share of financing – not only for corporates, but also for government project financing. Recently, however, funding by banks has lost steam due to a host of factors, such as a liquidity squeeze, regulatory constraints and the need to support government bond programmes.

Interest rates have increased during the past year across the region – more so in the major economies of the UAE and Saudi Arabia – and are likely to rise in tandem with a hike in US Federal Reserve rates to facilitate the maintenance of currency pegs.

Consequently, the interbank rates, a key benchmark used for pricing loans, have continually increased in the past 12 months. Increasing fund raising activities of the government to pay back debt and to bridge burgeoning deficits have squeezed domestic liquidity, thereby crowding out the private sector.

According to Marmore’s report on financing options in the GCC, large corporates in the region have taken a clue from the government issuances and started to tap bond markets – local as well as international.

However, GCC markets lack an active secondary market for bond issues, which acts as a constraint for investors. And while there is demand for sovereign issuances, corporate issuances have faced withdrawals after liquidity dried up in the primary markets. Add the fact S&P credit rating agencies downgraded the ratings of Saudi Arabia, Oman and Bahrain, citing pressures created by drop in oil prices on their finances, and you can expect fiscal and external balances to weaken further. This will increase the cost of funds for corporates.

Besides having access to bank loans at competitive rates, issuance of corporate bonds (including sukuks) in the GCC are also largely restricted to the bigger companies.

Credit default swap (CDS) spreads have widened in the recent past, which also reflects the deteriorating credit outlook for GCC sovereigns. In the past two years, the CDS spreads of Oman, Qatar and Bahrain have doubled while those of Saudi Arabia have tripled. Bond investors are demanding wider spreads, which implies significant deterioration of the liquidity in the banking sector and adversely affects the loan market. The uncertain outlook for GCC economies has resulted in volatile equity markets. And this in turn has led to increased equity premium for GCC markets.

Since the highs witnessed in 2014, the initial public offering (IPO) market has remain muted owing to

poor investor participation following subdued valuations and depressed market sentiment.

Last year saw only six IPOs, compared to 16 in 2014, and the decline in investor confidence has led to the cancellation of many listings.

Instead, the rights issue of shares has gained popularity in the region, with 97 rights issues that were either closed or listed during 2010-15, raising close to $20.7bn. Whereas, preference shares in the region have not been able to achieve critical mass owing to two major factors – regulations and long lock-in periods.
Most GCC countries allow the issuing of preference shares only through the form of private placements, which combined with lock-in periods of up to three years discourages investor interest.

In the GCC, private equity (PE) is still at a nascent stage, and has been subdued with single digit fund closures in the last five years – barring 2014 – which witnessed the closure of 11 PE funds. In 2015, PE funds raised in the region declined by 78 per cent, and the number of issues fell by 81 per cent. Marmore estimates more activity in the private equity space as an alternative form of financing going forward.

In 2016, it was estimated that there was close to a $26bn gap in small and medium enterprise (SME) funding, at a time when SMEs in the region are increasingly pessimistic about the outlook for growth, as oil prices remain unusually low.

Credit penetration to SMEs in the GCC, as measured in the form of bank loans, is among the world’s lowest and hovers around 2 per cent, compared to 26 per cent in Organisation for Economic Co-operation and Development countries. Banks in the region demand higher collateral, stricter documentation and shorter tenors from the smaller players.

SME exchange is a relatively new concept in the GCC region, with simpler listing laws than the main exchange, which not only facilitates SMEs to access alternative sources of funding but also improves corporate governance among SMEs. It also provides an option to move onto the main stock exchange – when minimum requirements are met – without an IPO.

Saudi Arabia is working to finalise rules for a new SME stock exchange, which it could launch by early 2017. The new exchange is expected to have lower minimum capital requirements in the single digits, as opposed to the main Tadawul exchange. In the UAE, to facilitate bond issuance by SMEs, the minimum issue size of bonds has been decreased from $13.5m to $2.7m, which could increase SME participation in the bond markets.

Alternative financing forms such as project bonds and IOUs have gained prominence in the past two years as lower oil prices have altered the financing landscape in the GCC region.

In addition, crowdfunding and peer-to-peer lending have also caught the region’s fancy, with an increasing number of technology start-ups relying on crowdsourcing to start their business or to expand their operations.

New lending platforms are set to transform credit evaluation and loan origination, as well as open up consumer lending to non-traditional sources of capital. This will intensify competition in the financial services sector and narrow spreads between deposits and loans, thereby affecting the profitability of financial institutions.