The recent economic crisis that has shaken America to the core has only put forth the many underlying problems major US institutions are confronted with. Last month, prior to the crisis, Abu Dhabi Commercial Bank (ADCB) announced that it had filed a major lawsuit against American financial brand names such as Morgan Stanley, the Bank of New York Mellon and ratings agencies Moody’s and S&P.

The lawsuit, which was filed at the US district court in Manhattan, targeted Cheyne Structured Investment Vehicle (SIV), a complex financial structure previously highly rated. The statement provided by ADCB said that the legal action alleges, amongst other things, that “ADCB was misled about the quality of the underlying mortgages in which the Cheyne SIV would invest.”
In spite of the fact that the Cheyne Finance fund had been selling investments and had enough cash to repay commercial paper due through November, Standard & Poor’s cut Cheyne Finance’s ratings on August 28 by six notches, quoting the deteriorating market value of its assets as a main motivator to its decision.
The scandal stems from a previous valuation on August 15 by Standard and Poor’s, which described the Cheyne notes as one of the highest investment grade. The downgrade seemed to take place at a spiraling speed, with prices deteriorating over a very short period of time. Reports of the downgrade prompted questioning in the financial community regarding the quality of the overall ratings process.
Cheyne Finance is one of dozens of structured investment vehicles, known as SIVs, considered to be playing a pivotal role in the fixed income markets. Such vehicles usually operate by issuing commercial paper, thus borrowing money using short term notes and then investing the money in longer term securities that boast higher returns.
However, the subprime crisis that took over the world and the subsequent liquidity crunch plaguing the markets have weighed heavily on companies that depend on commercial paper. They were thus faced by daunting funding shortages, with investors increasingly wary of advancing any funds in such a volatile context. Many SIVs were rumored to be selling off bank some of their assets in order to reimburse investors.
ADCB said in its statement that “it had also held talks with other banks and investors in the six-member Gulf Cooperation Council about joining its class action and based on these conversations, it expected additional investors to join or support the legal action as required.”
“This is the next step in a process aimed at recouping the losses ADCB has already incurred, and additionally, this is an important step in paving the way for other GCC investors to ensure they are provided an opportunity to recover their own losses. This is the right thing to do and ADCB has taken a proactive early lead to protect itself and other investors,” said Eirvin Knox, ADCB’s CEO.
The bank brought the action on behalf of all investors who bought investment grade Mezzanine Capital Notes which were issued by Cheyne Finance, a wholly owned subsidiary of Cheyne Finance Capital Notes.
ADCB seeks unspecified money damages and class-action or group status on behalf of everyone who invested in the vehicle launched by Cheyne Finance Plc from October 2004 to October 2007.
Bloomberg reported on August 25 that “Cheyne’s structured investment vehicle, premised on short term borrowing to buy higher-yielding assets, collapsed last year. Investors have recovered about 55 percent of the face value of their holdings in an auction of Cheyne’s assets.” It also added that the SIV had owed about $5.7 billion in senior debt, according to its receivers at the accounting firm of Deloitte & Touche.
Also named as defendants in the lawsuit are two units of the New York-based credit ratings firm Moody’s Corp, as well as the Standard & Poor’s Ratings Services, a unit of the McGraw Hill Companies Inc.
ADCB is a full-service commercial bank which offers a wide range of products and services such as retail banking, wealth management, private banking, corporate banking, commercial banking, cash management, investment banking. It is owned to 64.8% by the Abu Dhabi government through Abu Dhabi Investment Council and its shares are traded on the Abu Dhabi Securities Market.
This lawsuit might further impede investors’ confidence of the US market, something that US companies are not in need of in the light of the very unsettling financial context.

Lehman Bros., Merrill Lynch, Fannie Mae, Freddie Mac, Countrywide Financial and Bear Stearns. These are some of Wall Street’s oldest and largest financial firms. They all have one thing in common: they have either been seized or outright gone bankrupt. The credit crunch, which began in the real estate market, has become the biggest global financial crisis in decades for the international business community, negatively affecting all global markets including those of the MENA region.

However, despite slowing global growth and the meltdown in US markets, Saudi Arabia, the Middle East’s largest economy and the world’s biggest oil producer, continues to register a respectable amount of IPO announcements. In September four new IPOs saw the light with a total estimated value of $1.5 billion. Meanwhile in Kuwait, the region’s largest telecom company, Zain Group has recorded the largest ever capital increase in the country’s history, raising $4.49 billion with over 1.4 billion subscriptions.
Al-Ittefaq Steel Products, Saudi Arabia’s third largest steel producer, said it will offer a 30% stake in an IPO in the last quarter of 2008. The company did not disclose the amount it would like to raise, but the company’s CEO, Shabir Rafiqi, told the press that “after the valuation the company will decide whether to go for a capital increase or sell only existing shares.” In the transportation sector, the Saudi- based National Air Services, or NAS, will launch an IPO in late September or early October to sell around 30% of its shares. The executive jet charter firm is seeking to raise $600 million. The proceeds are expected to be used to purchase several new aircraft. NAS is also expected to start new flights to Egypt, Jordan, Syria, Lebanon, India and Pakistan.
Saudi-based Al Tayyar Travel Group said it’s seeking the approval of the market regulator to launch its initial public offering in the last quarter of 2008. The company will be offering 30% of its share seeking to raise around $320 million. Sources close to the company say the IPO might take place in early October. Also in Saudi Arabia, Coast Cement or Al Sahel Cement Co., plans to sell 50% of its shares in an IPO and the other 50% in a private placement in the last quarter of 2008. The shares will be offered at SAR10 ($2.67).
Moving to the region’s hottest economy, two announcements came out of the UAE last month. The consumer goods company, Aswaaq, said it plans to offer 55% of its shares in an IPO in October. The company did not disclose the amount it seeks to raise but said it has plans to build and run 35 outlets in Dubai over the next seven years. In the precarious real estate sector, Al Benaa Real Estate Investment said it plans to launch and IPO in the fourth quarter of 2008. Although the company did not reveal the amount it wants to raise or the stake it will offer, analyst say the company will probably offer 50% of its share to the public.
Although analysts’ opinions vary on the consequences the collapse of Lehman Bros and Merrill Lynch will have on the region’s markets, they do agree that whatever happens it will be a short term blurb. The question on the lips of pundits in the US is “Who’s next? ” The consensus among US analysts is not whether the turmoil will continue, but rather for how long, with how many more casualties, and at what cost? But the economies of the region continue to weather the storm in the global financial markets and local experts say the downturn in US markets and high oil prices will only drive investors into emerging markets in record numbers.

High oil and gas prices in recent years have brought windfall profits to companies and natural resource-rich states alike. With a large concentration of two extremely valuable commodities, the Middle East has enjoyed the benefits of its riches but has managed its oil wealth in smarter fashion than in prior oil booms. Based on the precedent set by the Kuwait Investment Authority (KIA), other oil states in the region have created sovereign wealth funds (SWFs) to ensure that oil price downturns do not dry the liquidity available.

Luckily, unmatched price rises in the barrel have added to the coffers of several other regional SWFs, including those controlled by other authorities in the Gulf Cooperation Council (GCC) as well as Algeria and Libya. With extensive pools of capital, SWFs are actively maintaining and building relationships with asset managers who can put their money — estimated at over $1.6 billion for 15 of the 17 ‘official’ SWFs — to work. Some have even speculated that SWFs will replace banks or overtake Wall Street during a US slowdown by providing the debt necessary to finance firms with operations stuck in the turmoil of the credit crunch.
Enter private equity. An excessive capital base of these SWFs has generated the need for financial intermediaries and new asset classes to diversify ownership among several sectors and regions. The appeal of private equity is based in the nature of the asset class as extremely relationship- driven and without regional or sector boundaries. With PE funds offering a bounty of target portfolios, from pan- emerging markets to US-specific funds to pan-industry or industry-specific funds, the available choices are immense and allow limited partners (LPs) to weigh in during fundraising.
Private equity fund managers are, in turn, attracted to the opportunity to work with SWFs as their investment philosophies — to maximize returns and add value to assets to be exited in a few years over an investment with a longer time horizon — are parsimonious with their own views. In what has blossomed to be a complementary relationship, sovereign wealth has become a strong limited partner for private equity funds.
The less-concrete drivers behind this style of partnership between governments and fund managers are illustrated well in a Norton Rose survey of professionals in the industry. Increased activity between SWFs and private equity firms is likely to be through co-investments in deals, by SWFs taking stakes in established private equity managers, and because SWFs will invest directly in private equity funds. With both entities driven towards convergence, PE funds are attracted to SWFs because the latter’s lack of exit pressure allows longer-term investment strategies, which is useful when restructuring a buy can take several years. Additionally, the large blocks of capital in the pockets of SWFs managed under minimally-imposed controls gives SWFs the sort of financial capacity and autonomy needed to build relationships with private equity managers.

Private equity consolidation
An additional component to the relationship is the much- anticipated private equity industry consolidation in the over the next five years. While private equity style investments are not new to the region, which has long experienced the presence of large holding companies with PE-like strategies, the slew of private equity houses that developed in the region over the past decade have driven the idea of the asset class to become more active investment in the investment landscape and future of regional economies.
Unfortunately, the hubris under which the asset class grew and the burgeoning institutions created to foster it contributed to the current industry snapshot: too many firms and not enough performance. Closed funds have had successes and deals and exits information has revealed that the Middle East has some of the most under-valued potential in the developing world, but the lack of exits and lengthy fundraising periods have signaled that something in the industry of efficiency is amiss. Experts attribute this to the overwhelming growth in private equity firms, many of which have made only modest debuts. For regional private equity shops, building and maintaining a rapport with one or several SWFs is essential for long term survival.
Without open balance sheets, one can only speculate on the extent to which private equity firms are partnering with SWFs, but new funds are only likely to deepen relationships between SWF managers and those of private equity funds. Bahrain’s Mumtalakat Holding Co. recently launched a $10 billion fund for overseas investment. In an interview with local press Talal Al Zain, the firm’s chief executive, noted that “Mumtalakat has so far concentrated 98% of its investments in Bahrain, in aviation, industrial and communications assets in the Persian Gulf,” but the fund plans to switch its portfolio allocation to 50% in overseas assets outside of the Middle East with annual growth targets of 15%.
In order to channel capital for Western buyouts, Mumtalakat will doubtlessly seek the aid of firm’s with already large presences in the Middle East and North Africa (MENA) region, including The Carlyle Group, Kohlberg Kravis Roberts (KKR), Investcorp, and others. Every week relationships of this nature are mentioned in the financial pages with Oman, Qatar, Saudi Arabia, the United Arab Emirates (UAE), Kuwait and others establishing relationships with local and foreign money managers and holding companies which are in fact conducting private equity-style investments but maintain opportunistic strategies, leaving their firms with less direct names than their more established counterparts.
Deals over the past two years have targeted celebrity investments aimed not only at the underlying value in the assets acquired but the branding associated with some of the biggest names in their respective industries. Dubai’s Istithmar holding company purchased Barneys, a retailer, for $942.3 million in 2007, Dubai World made a $5 billion investment in MGM Mirage, a Las Vegas casino operator, while Kuwait’s own SWFs have purchased stakes in Daimler-Benz, British Petroleum, and other firms
Other opportunities to take direct stakes in Western private equity shops are apparent when Abu Dhabi’s Mubadala Development Corporation spent $1.3 billion on a stake in The Carlyle Group while the Abu Dhabi Investment Authority (ADIA) took a stake in another US private equity firm, Walden Capital.
Although some Western institutional partners have looked to open their exposure to Middle Eastern private equity, the majority of institutional money comes from regional institutions based on the region’s oil wealth. In any Gulf country where the 90% or more of the economy is based on its state-owned natural resource wealth, institutions are essentially sovereign wealth investors, even if their do not carry the grander titles afforded to SWF flagships in the region such as Abu Dhabi Investment Council, SAMA Foreign Holdings, or the Qatar Investment Authority. In a group of six member states in the Gulf Cooperation Council (GCC), there are in fact 13 official SWFs, according to Norton Rose’s survey, with Dubai alone accounting for three, including Dubai International Capital, Istithmar World, and the Investment Corporation of Dubai — with the first two SWFs having estimated assets of $25 billion.

SWF strategies
In an interview with Christopher Balding, an academic who recently published A Portfolio Analysis of Sovereign Wealth Funds as well as a congressional candidate in next month’s US elections, he outlined that SWF strategies are both well-balanced and profit-maximizing, not unlike most investments. According to Balding, “MENA SWFs resemble well-balanced portfolios divided between debt, equity, and alternative investments,” with a similarly diverse geographical reach spanning both developed and emerging markets. Understanding this dynamic makes the argument SWF investments are based on politics utterly impossible to demonstrate. For SWFs and the private equity funds which manage their capital, a buyout in Manhattan or London is based on a desire to control Western assets, but only to the extent that fund managers can exit the asset in an approximate time of five years for a profit.
In an effort to move away from becoming tools of a rentier form of economic patronage, MENA SWFs have diversified “into liquid financial instruments overseas,” according to Balding. However, MENA SWFs have also invested domestically in non-oil sectors in an attempt to diversify their economies in the long run by stimulating infant industries. In Balding’s view, some of the activity has “created some national champion that has moved beyond their domestic environment, but only time will tell whether they can compete beyond their home economy.”
While evidence might point to symmetries in investment style, the majority of sovereign wealth is invested in more stable assets, while SWFs allocate a small percentage to riskier asset classes like private equity in order to diversify geographic and sector locale. “Growth investment does not appear to be a primary concern for MENA SWFs. Judging by their investments, MENA SWFs seem more concerned with capital preservation, diversification, and economic diversification,” said Balding.
Lauded as one of the most influential sovereign wealth funds and certainly the largest, ADIA plays a large role globally as a limited partner, allocating the minimum $200 million buy-in entrusted with fund managers. However, its portfolio reveals a more diversified investment structure with only 10-15% allotted to emerging markets, and even less for private equity (2-8%). By itself, a portfolio snapshot reveals that ADIA is still largely focused on dollar- or Euro-backed investments and economies. A report by the International Monetary Fund (IMF) explains that “most SWFs actively use external managers either to match index returns or to create active risk-adjusted return.” Private equity funds are relishing the partnership opportunities.

As the first major actuarial practice to establish itself in the Middle East, PricewaterhouseCoopers (PwC) offers the region its unmatched expertise in Islamic insurance products and risk management programs. Executive sat down for an exclusive interview with Bryan Joseph, PwC partner and global actuarial leader, and Camille C. Sifri, PwC country senior partner in Lebanon.

E Could you describe the recently launched actuarial services?
CS: Six months ago we set up an insurance advisory unit — an important element of which is the actuarial practice, which is something unique in Lebanon and in the Middle East. This unit has three partners, who are doing regional projects covering both the insurance and the banking industry. One of the things we’re doing as part of this unit is covering risk management projects, i.e. assisting financial institutions with their risk management systems, policies, and procedures. Other services we provide comprise undertaking due diligence, business valuations and assistance with the establishment of insurance companies in the region.

E How will this affect Lebanese consumers?
CS: This practice is directed primarily at the banking and insurance sectors. Both sectors are under tremendous pressure — maybe more so the banks — to install proper systems of risk management and controls. This is part of the drive to implement Basel II, which is now being required by both the central bank and the banking control commission. Banks are now forced to install proper systems of risk management, and this is where we believe our role comes in — to try to support this sector and give them whatever they need by way of consulting advice on proper structures to strengthen their control environment.

E Why did Lebanese banks not have such evaluation systems before?
CS: Lebanese banks have always had conventional systems of internal controls. Obviously the banks cannot survive without having a minimum, sound internal control system. What is new, and what is being driven by Basel II — globally, not just in Lebanon — is the importance risk management concepts have acquired in the day to day management of banks.
BJ: I think that one of the things that you are seeing globally is products have become more complicated, relationships between financial institutions became more complicated, and banks have become more global. Those three things mean that systems which may have worked in the past, may not be necessarily be fit for purpose in the future. So what’s happening here in Lebanon and globally, is an attempt to bring standards which are fit for purpose for the future years.

E You are working on risk assessment, but even some of the best financial institutions in the world have failed with their risk assessment; how is this different?
BJ: The how and why are different. The risk management systems in the past have attempted to vaguely link capital to risk, under new systems there is now an explicit link between risk and capital. It’s actually asking the directors and management teams to take charge of understanding their risks fully and explaining them to their regulators and ensuring that appropriate levels of capital are in place to support those risks. What has happened around the world is that companies did not necessarily always understand the risk that they were taking and indeed how those risks were being passed from bank to bank. Prior processes were not transparent; it meant that banks were left with more risk than they thought they originally had. Hence, once a lack of trust and the conflagration developed, the financial system was placed under pressure which led to further difficulties for institutions as trust decreased. The result for any company is inevitable once it has lost the trust of the public and its peers.

E After the crash of the US financial market, what is the impact on the Lebanese financial market?
CS: So far I would say that the central bank and the banking control commission have done a good job at sheltering the Lebanese banks and financial institutions from this crisis, by putting strict limits on what sort of trade such institutions could enter into. The supervision has been quite effective, and has protected the Lebanese sector from these international crises. So far we do not seem to have any major exposures. However, to the extent that the Lebanese market is not isolated from the rest of the world, and that banks are trading international products, I think it’s going to be critical for banks to have good early warning systems, good risk management, risk detection, and risk prevention measures to make sure that any such risks are mitigated.

E What are the trends in insurance practices in Lebanon and the region?
CS: I believe insurance companies in Lebanon are somewhat less exposed to fluctuations in the market value of real estate in terms of their insurance products than the banking sector. This is because such conventional insurance products are typically life or property insurance that do not expose the insurers to credit risk on mortgage loans held by banks. However, some insurers have invested part of their funds in real estate and have not so far experienced any significant losses resulting from adverse fluctuations in real estate prices.
BJ: Mortgages are just another asset class. Traditionally, mortgages have been looked at as a sound asset class, and insurance companies have held them as part of their asset portfolios. What you will find regionally as the global real estate market readjusts its new paradigm, is that companies will have to look quite carefully as to what assets they are holding on their balance sheets and making sure that they are properly valued; also making sure that the risk of loss is taken into account — and that goes for banks, insurance companies and for any entity holding mortgages as an asset class. Companies need to take into account that there is a risk that asset values decline as well as increase, which is something easily forgotten when asset values seem to be always on the way up.

E Where is the risk in the Lebanese market? Does it in any way resemble the US model?
CS: The Lebanese market is quite peculiar and does not necessarily follow the same pattern as the US model, especially in terms of the real estate market. Real estate constitutes an important part of the collateralized debts carried by commercial banks. Banks are therefore potentially susceptible to fluctuations in the price of real estate. However, the real estate market has withstood political pressures of the last three years pretty well and the financial sector has therefore not been adversely affected by the local situation.

E How can we learn from the fallout of Lehman Brothers and AIG?
CS: I think we’re back to a proper understanding of risk, proper identification of risk, proper management of risk, and proper evaluation of risk. I think the auditing profession has a major role to play in that, as well as the actuarial profession. Also, there is a major role for boards of directors, whose responsibility it is in the first place to have proper, solid, and robust structures to face the risks which such institutions face in their normal day-to-day business. I think it’s their prime responsibility, and they need to have the proper structures in place to be able to mitigate these risks.

E Do you think the Lebanese will efficiently absorb the proper notion of risk management?
CS: I think there is a major learning curve, through which everybody is going at the moment. The larger banks are making major efforts to get up to speed with international developments in risk management. The smaller institutions may be having some difficulty in keeping up with the pace of change. I believe there is plenty of room for an investment in learning, training and development in that area.

E What would you say are the most essential factors in successful risk management?
BJ: The first one, I would say, is the tone from the top. The board of directors has to set proper governance procedures and framework around risk and how it is managed and reported. Boards need access to the internal tools of risk reporting — via the chief risk officer and the internal audit process — to tell them what risks are being taken and how they are being managed. By setting the correct tone from the top, which says that ‘the sound management of risk is integral to our business’, that permeates down through to how the individual managers or underwriters look at risk and how they report risk upwards. So it is about the tone from the top; having the correct framework, having the correct governance procedures in place, and then having the correct tools to evaluate risk, to quantify it and to define their company’s risk mitigation strategy. And when all else fails, having a contingency plan in place, which will help your organization when things which are outside of ‘normal’ experience go wrong. With all that in place, then banks and indeed financial institutions themselves are more robust.