Gulf Capital and Islamic Finance

GULF CAPITAL AND ISLAMIC FINANCE – Book Sample

Introducing the New Global Players

The world of finance is being transformed before our eyes. Many of the long-established “rules” of capital markets face fundamental questions and rapid change. Long-revered multinational banks have been deeply shaken by a global financial crisis, in which Wall Street giants like Citigroup and Goldman Sachs participated in massive “troubled asset” programs.

 Recognizing the regulatory lapses that contributed to the financial crisis, regulators around the world have taken more activist positions and increased their intervention in capital markets. At the height of a credit crunch fueled by the spread of misrated and opaque “toxic paper,” money markets in the United States faced unprecedented pressure—in an extreme episode, even money market funds briefly slipped into negative returns.

This transformation of financial markets—which was still under- way at the time of this writing—reflects the changing topography of the global economy. Large, developed economies such as the United States and the United Kingdom have taken on unprecedented levels of public debt to stimulate their domestic economies and stabilize key economic sectors. These measures, which were considered essential for economic recovery, have set the stage for long and protracted deficits.

 Companies and individuals in the world’s leading economies find themselves facing a painful process of “deleveraging,” seeking to recover from the burdens of high debt levels in recent years. For many economies, generating fresh capital for investment may be a multi- year challenge.

At the same time, in contrast, a number of economies, mainly in emerging markets, are continuing to grow. A handful of countries (a fortunate few) enjoy large capital reserves, continue to generate budget surpluses, and act as next exporters of capital. As many economies are slipping deeper into debt, others are busily accumulat- ing savings. Our long-held belief that capital naturally flows from developed economies to emerging markets no longer holds—today, saver nations in the developing world provide much-needed capital to the world’s largest economies. This shift in topography is funda- mentally changing global markets.

In the evolving financial topography, the economies of the Gulf region—the six countries that make up the Gulf Cooperation Council (GCC)—are new and increasingly important peaks. Individually and in aggregate, the member states of the GCC—Saudi Arabia, the United Arab Emirates (UAE), Qatar, Kuwait, Bahrain, and Oman— are playing an increasingly pivotal role in global markets. At the same time, Islamic finance, a phenomenon that is distinct from but deeply linked to the rise of the Gulf, has evolved from a niche, regional sector to an increasingly integral part of the world’s financial system.

ON THE WORLD STAGE

When General Electric (GE), one of the world’s most admired compa- nies and a titan of US business, resolved to sell its plastics business in 2007, the most attractive buyer was not a midwestern chemical com- pany or even a European conglomerate. It was the Saudi Basic Industries Corporation (SABIC), a leading industrial conglomerate. SABIC, by the way, had once reached a market capitalization of $135 billion—a shade under those of Google and Honda, and greater than that of Coca-Cola.¹

As Citigroup—at the time, the world’s largest bank—began to buckle under the pressure of the credit crisis in 2008, the first waves of relief did not come from Wall Street or from Washington. They came from the Abu Dhabi Investment Authority (ADIA, a Gulf sovereign wealth fund) and Prince Alwaleed Bin Talal (a Gulf-based private

investor). ADIA, typically discreet in its investment activities, is widely viewed as one of the world’s largest institutional investors. Prince Alwaleed, individually or through his firm Kingdom Holding Company, is also a major shareholder in Apple, the Four Seasons Hotels, and a host of other multinational firms whose total customer base worldwide is in the hundreds of millions.

When Ford sold off its business line Aston Martin—world- famous as James Bond’s preferred vehicle—the principal buyers were two investment companies not from Detroit or Tokyo, but from Kuwait. Further, the transaction was an Islamic one, structured to conform to the guidelines of Shariah to meet the preferences of Aston Martin’s new owners.

The Aston Martin transaction was by no means the first Islamic acquisition of a prominent US firm; for example, Caribou Coffee (America’s second-largest coffeehouse chain) is owned by a Bahrain-based Islamic investment firm.

Such high-profile investments by Gulf-based and Islamic institu- tions are not surprising when one considers the following facts:

• Collectively, the Gulf states control over 40 percent of the world’s known oil reserves and nearly a quarter of global natural gas reserves.²
• By the end of 2006, the GCC states’ foreign assets reached an estimated $1.9 trillion.³ No doubt, these grew substantially in 2007 and early 2008 before suffering losses in the subsequent financial crisis.
• Gulf-based investors either currently hold or historically have held major stakes in prominent global companies. Both

Gucci and Tiffany & Co., for example, have been owned by Bahrain-based Investcorp in the past.⁴

• In 2006 alone, the net capital outflows from the Gulf were above $200 billion—a figure surpassed only by China.⁵
• In the same year, GDP per capita in the GCC reached

$19,000—nearly three times that of China and more than five times that of India.⁶

• In the auto industry alone, Gulf investors hold major stakes in Daimler, Ferrari, and (as mentioned previously) Aston Martin.⁷
• The GDP per capita of Qatar is astonishing—it was nearly

$86,000 in 2008. That’s 1.8 times the US figure of about

$47,000, 2.6 times the figure for the EU, a whopping 14 time that of China, and 31 times that of India.⁸ Some are forecasting that by 2011, the small, resource-rich Gulf state will have the highest GDP per capita in the world.⁹

• According to the McKinsey Global Institute, the Gulf’s total foreign wealth could reach $8.3 trillion by 2020. This would correspond to about $270,000 per GCC citizen at that time.¹⁰
• Nearly all leading global financial institutions, including HSBC, Citigroup, Standard Chartered, and Deutsche Bank, among others, now offer Islamic financial services and view Islamic finance as a significant opportunity.
• In 2008, the Harvard Business Review featured a piece on the rise of Islamic finance as a new global player in its issue on “Breakthrough Ideas” for the year.¹¹

The global financial crisis and economic recession—which are still underway at the time of this writing—have deeply affected the Gulf region and its investment activity. The credit crisis and the subsequent global fall in investor confidence rocked GCC stock markets, wiping away billions of dollars of market capitalization in 2008 alone. The drying up of global debt markets has brought many capital projects— especially a number of Dubai real estate initiatives—to a screeching halt. Perhaps most fundamental, however, has been the steep decline in oil prices as a result of the global recession. Trading at around $150 per barrel at its peak in 2008, oil fell more than two-thirds in value before settling again at around the $50 per barrel mark.

This fall in oil prices slashed government surpluses in the Gulf and severely reduced the supply of new surplus capital available for investment. Some observers, therefore, have questioned whether Gulf capital will remain as important to global markets as it has been in recent years.

In assessing the ongoing importance of Gulf capital despite the

dip in oil prices, consider the following four facts:

1. If no additional surpluses were generated in the Gulf, the region would nonetheless still have substantial reserves that have been built up over the past years. According to a McKinsey forecast, the returns on GCC foreign assets would exceed $1.6 trillion over a 14-year period even “if the GCC never invested another penny.”¹²
2. Gulf-based investors, like institutional investors worldwide, have no doubt suffered losses as a result of the financial

 crisis and global recession. Unlike many other institutions,

however, Gulf investors (especially in the UAE, Qatar, and Kuwait) can expect fresh infusions of capital as a result of their ongoing budget surpluses.

• Even at modest oil prices, key Gulf economies will accumulate new capital. Assuming an oil price of $50, GCC economies would gather $4.7 trillion between now and 2020.¹³
• Gulf investors enjoy sizable reserves and “dry powder” for acquisitions in an environment of lower asset values worldwide. In an increasingly capital-constrained world,

Gulf investors are a rare source of liquidity. Thus, they could