The facts about the imminent restructuring of Dubai World are gradually becoming clearer. Over the past several days , we’ve learned:
1. The amount of debt that Dubai World proposes to restructure is about US$26 billion, less than half what was originally thought. The borrowings are centered around DW’s property subsidiary, Nakheel, and Nakheel’s international property development arm, Limitless World. According to DW, its other activities are on sound financial footing.
2. It appears that about half of DW’s overall obligations are to entities within Dubai. It’s a reasonable working assumption that the same ratio would hold with the debt requiring restructuring. If so, foreigners’ exposure would be $13 billion or so, plus whatever credit default risk they might have taken on through derivatives.
3. The UAE central bank pledged support on Sunday for the federation’s banks through a new liquidity facility, again suggesting that a lot of the direct financial exposure is held internally.
4. The actual restructuring has been underway since at least November 20th, when Dubai fired the head of its International Financial Center, as well as three members of the Investment Corporation of Dubai–including Sultan Ahmed bin Sulayem, the chairman of Dubai World.
5. Yesterday, according to Bloomberg, Dubai’s finance minister, Abdulrahman al-Saleh, clarified the relationship between the government and DW. He said in a TV interview that when DW was set up the government decided that DW’s debt should be secured by its investment projects, not a government guarantee. Further, the government stated in a sukuk prospectus in October that it assumed no obligation to support strategic state-owned enterprises (like DW) financially, although it reserved the right to do so if it chose.
6. Despite the government’s statements, it appears most investors thought that this was similar to what the US government said about Fannie Mae and Freddie Mac–that in the end, despite its protestations, the government would bail DW out. Unlike the US case, this expectation has proved false. It would be doubly interesting if, again unlike the case in the US, a corruption investigation follows.
So the DW debt problems are looking more and more like a tempest in a teapot. Yes, there may be domestic repercussions and emerging markets debt investors may look more askance at countries like Greece, but further fallout appears unlikely.
To me, by no means an expert on sharia-compliant finance, one big surprise is that investors should have so unreflectively assumed that they would be bailed out by the Dubai government.
In a country like the US, where the banking paradigm accepts that the interest of creditors and equity holders are somewhat opposed–that the equity holder is allowed to financially leverage his returns in return for the debt holder being partially insulated from the full consequences of business failure, debt holders would not expect to be fully sheltered from the failure of the debtor’s business. Under a banking paradigm like Dubai’s, however, that, in contrast, brings debt and equity holders together as common participants in the fruits of business success or failure, it’s hard to imagine how a bailout of debt holders could be, even in principle, justified. Go figure.
Also see my original comment from November 29th.