After a period in which the country’s bond market was negatively affected by the global economic crisis, signs of growth were returning at the turn of the year: Consumer credit firm Commercial Facilities Company announced the successful completion of its KD50m ($180m) local bond in December 2011, which was followed by Kuwait Projects Company’s (KIPCO) KD80m ($288.4m) local currency bond issue in January 2012. The GCC debt market, which includes conventional bond issues and their sharia-compliant equivalent, sukuks, cooled as a result of the global economic crisis of 2008 and its economic aftershocks before showing renewed growth in 2009 and, to a lesser extent, 2010. However, while Kuwait has traditionally been a leading participant in the region’s growing bond and sukuk arena, the supply of locally originated debt did not show a similar return to form in 2011. A changing local economic environment and a far-reaching process of regulatory reforms are creating the conditions by which Kuwait might reclaim its prominent place in the GCC debt market.
REGIONAL SLOWDOWN: Prior to the financial crisis, the GCC debt market had enjoyed a period of expansion as governments, mindful of the importance of diversifying the sources of funding that underpinned their expanding economies, took steps to encourage the growth of both bonds and sukuks within their jurisdictions. They did this by enhancing regulatory regimes to eradicate the negative effects of a lack of transparency and inadequate legal frameworks, and by issuing their own sovereign bonds to establish yield curves and thereby ease the passage of corporate issues to the market. While the development of the GCC region’s bonds and sukuks was still in its early stages at the time of the economic downturn (many jurisdictions, including Kuwait, have yet to develop a secondary bond market), the rise of debt instruments as a means of financing appeared to be inexorable. However, this growth trend – which saw the total value of GCC debt securities, both conventional and Islamic, rise from $25.2bn in 2005 to $48bn in 2007 – took a downward turn in 2008 to reach just $22.7bn.
Since then, the regional debt market has proven more volatile. In 2009 the market staged a recovery that was driven by conventional sovereign issues from the Qatari government and Dubai Department of Finance to reach a total of $72.8bn, according to Capital Standards Rating, a research firm that focuses on MENA economies and industries. In 2010, however, bond and sukuk issues in the GCC region declined year-on-year by nearly 30%, despite an increase in the number of issuances from 37 to 42, thanks to a renewed interest among UAE corporations.
UPTICK: The recoveries of regional economies raised hopes that 2011 would see a significant uptick in corporate bond issuances across the Gulf, but in spite of improving macroeconomic conditions, the uncertainty arising from political unrest across the MENA region stifled the anticipated bond expansion.
In the first half of 2011, aggregate bond issuances (conventional bonds and sukuks combined) had reached $43.87bn, according to Markaz Research, around $30bn of which originated with central banks. Despite issuances from high-profile companies in the first half of the year, such as Emirates Airlines, the preponderance of sovereign issues and private sector reticence regarding debt markets have dampened the prospects of a significant uptick in private sector bond growth in the short term.
MARKET HISTORY: The Kuwaiti government, eager to establish new channels of capital with which to fulfil its long-term goal of economic diversification, was an early adopter of fixed-income instruments. Despite the regular surpluses provided by its hydrocarbons wealth, a steady stream of government bond issues over the last decade helped to establish the country as a leading issuer of both conventional and sharia-compliant debt. From 2003 to 2009 issuances originating in Kuwait amounted to $99.7bn, according to Markaz Research, or 40% of the GCC total for that period. The vast majority, 92.9%, were issued by the Central Bank of Kuwait (CBK), the dominant role of which was to define the fundamental characteristics of the nation’s expanding debt market for the first decade of the new century. Conventional bonds accounted for 97.9% of the aggregate market, while the Kuwaiti dinar became the currency of choice, being used for 94.3% of issuances during the 2003-09 period.
However, while the treasury bills, central bank bonds and treasury bonds flowing from the CBK were the driving force behind Kuwait’s emergence at the forefront of the regional debt market, the yield curve established by its regular sovereign issuances was enabling an important expansion in corporate issuances. Some 65 corporate issuances took place between 2003 and 2009 – a sustained period of growth which reached its zenith in 2006 (with 11 issuances for the year) and raised a total of $7.1bn. While conventional issuances accounted for the majority of this corporate debt expansion (70.3%), the first sharia-compliant fixed-income offering by a Kuwaiti corporation in 2005 marked the beginning of a period of rapid growth which saw 15 sukuk issuances by 2009, raising a total of $2.1bn (see Islamic Financial Services chapter).
POST-CRISIS: As with the wider GCC market, the global economic crisis brought an end to fixed-income growth, and there has only been a moderate recovery in Kuwait and the whole Gulf region. The country saw just two notable bond issuances in 2010: the $500m issued by KIPCO under its $2bn Euro Medium Term Note (EMTN) programme and the KD40m ($144.2m) issuance by United Real Estate. While both issuances were important – KIPCO’s bond was the first dollar offering from a Kuwaiti firm since 2009 while United Real Estate’s was the first local-currency-denominated issue since 2008 – less than $1bn of conventional bonds originated in the country for the year, representing 3.5% of the GCC total. The sukuk market, meanwhile, remained dormant. The $190m issue by Gulf Holding Company in May 2008 is the most recent sukuk to emerge from Kuwait, and will mature in 2013 – by which time all of Kuwait’s current sukuks will have completed their tenors.
POTENTIAL FOR GROWTH: The trickle of issues in 2010 did bring some solace, however. The oversubscription of the KIPCO offering by 3.6 times revealed that there remained a demand for highly rated debt.
This set the scene for the KD80m ($288.4m) bond issuance that KIPCO offered in late 2011. Originally assigned a provisional rating of BBB+ (later raised to A+) by Capital Standards Rating (CSR). Announcing the rating in July 2011, CSR noted that the KIPCO issue offered good credit quality “compared to other local issues”. This perceived gap between highly rated fixed income offerings and those that have difficulty interesting investors touches on one of the main concerns regarding the future growth of Kuwait’s debt market: regulation. However, the first local bond issuance after 18 months, and the first to be approved and supervised by the Capital Markets Authority (CMA), was Commercial Facilities Company’s completion of a KD50m ($180.3m) local bond issuance in December 2011. A month later, KIPCO closed its four-year local currency bond issue worth KD80m ($288.4m), making it Kuwait’s first local currency transaction in 2012.
Many in the financial sector believe that with proven demand and increasing interest on the part of potential issuers as a result of reduced liquidity offered by the banking sector, debt issuances have been primarily held back by a weak regulatory environment that has been unable to provide the levels of corporate governance and transparency required by both the supply and demand sides of the debt market equation.
For this reason, the promulgation of the Capital Markets Law in 2010 and the commencement of the newly established CMA’s operations in 2011 are together seen as a crucial step towards the revitalisation of the bond and sukuk market.
The new regulatory framework being assembled will allow for the development of a secondary market for debt securities, which will boost the avenues of liquidity available for an already substantial pipeline of infrastructure projects, create more channels of financing for corporate investors and provide a more comprehensive yield curve for differing maturities. These steps will in turn lead to better bond pricing, introduce a greater number and variety of debt instruments, such as mortgage bonds, and increase investors’ awareness of the debt market in general.
ISSUANCE OVERSIGHT: The CMA has already exercised its authority over the debt issuance process with a requirement in second-quarter 2011 that firms get its approval before asking their shareholders to back measures such as bond sales and capital increases or reductions. The government, meanwhile, is reviewing new sukuk and trust legislation to bring oversight to the issuance of sharia-compliant debt. Both developments represent significant elements of a long-term process that will bring a new degree of compliance and transparency to the nation’s fixed-income market – changes that have been greeted largely optimistically.