We have long been hearing about the need for developing a domestic bond market, but unfortunately it has not happened yet. With banks slowly backing out from the lending scenes, more so after the recession for reasons other than risk aversion, governments and large corporations will be forced to look for alternative fund sources in the future. Speaking to CL Jose of Business Benchmark, Stuart Anderson , Managing Director, Regional Head, Middle East , Standard & Poor's, underscored the importance of developing a local bond market, which could play a much important role than just raising funds. On the prospects of Dubai being rated by any of the top agencies, in the future, Anderson said, "We'd love to rate Dubai ." BUSINESS BENCHMARK: There was considerable criticism against rating agencies with regards to the rating of certain instruments prior to the sub-prime crisis. How do you respond to them? All the criticism was levied particularly at what happened in the US around sub- prime. I think we've been open to saying that the performance of many highly rated sub-prime bonds was disappointing. But we relied on the same mortgage data as the rest of the market did. One of the biggest criticisms was that we failed to foresee the US mortgage crisis. But no one foresaw the sheer extent of the US mortgage meltdown. And that includes not just the ratings agencies, but also the Federal Reserve and the US Treasury. If you look at our ratings, apart from the structured financial products, the sovereigns, banks, corporates and insurers rated by us, have performed exceptionally well, over a long period of time. Since 1981, less than 1 per cent of investment grade names rated by us have defaulted. After the recession, did you bring in any changes in the rating methodologies? We've certainly tightened our criteria. We've looked at the rating methodologies not just of the structured products, but the entire spectrum -- sovereigns, banks, and corporates. We now have a much stronger compliance framework and risk culture. You must remember that rating agencies historically were never regulated. Now we are also in a regulated environment. Who regulates the rating agencies? Our primary regulator in this region is ESMA, the European Securities and Markets Authority. ESMA has comprehensive regulation around the rating process and methodology. Though this has been developing over the last five years, it really took effect only this year in a meaningful way. We are now regulated in the DIFC jurisdiction by the DFSA, which also looks at the rating process. The DFSA coordinates with ESMA as our lead regulator. There have been many high-profile UAE corporates that have withdrawn their ratings. Isn't it obvious that you stand the risk of losing clients when you tighten the rating criteria? Our business is growing and that's the interesting part. We have added clients much faster than we have lost them. We believe that S&P is really the leading ratings agency in terms of analytical rigour. In some quarters, we're seen as much tougher and that's what actually good investors demand. There are a lot of major international institutional investors who demand an S&P rating. How many clients does S&P have in the region? In this region, we have almost 140 public ratings. On top of that, we have confidential and private ratings. A confidential rating is purely between us and the corporate. Many public ratings start off as confidential and at some point they may want to go public. We will not disclose a confidential rating. The corporates can of course disclose it to anyone they like. Not surprisingly, confidential ratings represent a growing business for us in this region. Can you please compare the benefits of ratings versus costs? Ratings ensure that risk is priced correctly. The cost of ratings is a very small part of the cost of the issuance process. There are third party studies from in- vestment banks, which say that on average a rated bond can be anywhere between 50 and 100 basis points better priced than unrated bonds. From a broader regional perspective, ratings have a vital part to play in creating deeper and more liquid capital markets. Without ratings, capital market investors and lenders would be less inclined to provide capital to borrowers. They can contribute significantly to development and diversification, to the benefit of investors, intermediaries and issuers. This will be critical for funding the next phase of growth for Gulf corporations and for the region's infrastructure. Ratings also play a key role in sup- porting the flow of international finance to the region by enabling international banks to make decisions on risk participation here. Something that is less known is the fact that many major inter- national banks, which don't have a presence here, have exposures to this region and they use ratings to help set counter- party limits for overall country limits and bank limits. Ratings also guide their exposure to large GREs and corporates. This helps to enable the flow of routine bank transactions including trade finance and foreign exchange. How do you see the role of a regional rating agency? Don't you think they can rate regional companies better? This is not true. We have local analysts who are based on the ground. We have a team based in the DIFC. These analysts have spent many years in the region. They have strong regional and local knowledge and expertise. However, we do also have a regional rating scale for the GCC. Most of the 140 ratings that I talked about - about 95 per cent - are made on a global scale, which means that they provide an idea of credit quality at a global level. We also do provide a rating assessment based on the regional GCC scale. But 95 per cent of issuers we rate choose not to publish that. They prefer the global rating scale. What sort of growth do you see in S&P's ratings business in the coming three to four years? I think we could comfortably achieve double digit growth in the GCC region. We have seen substantial growth in regions like Europe . Issuances among sub-investment-grade corporates (i.e. below BBB), in Europe grew 75 per cent compared to last year. This is astonishing. Most of these new issuances are from corporates who have traditionally relied on banks for their funding. This whole process, called disinter- mediation, has been happening over a long period of time and it's now accelerating. Banks are seeing their roles as intermediaries being gradually reduced. Do you think more regional corporates are increasingly viewing bonds as attractive compared with loans? Corporates have for long happily existed on unsecured uncommitted short secured medium term, which means the term lending, which for a bank is won- derful. But there hasn't traditionally been a great understanding among the corporates of what this really means. They've been funding long term capital expenditure on short-term borrowings for many years. But the fact is these facilities are repayable on demand. And with better corporate governance, many of the larger corporates are starting to upgrade the quality of their financial management. They're now realising that the corporates are highly exposed to the goodwill of banks. Typically 75 per cent of bank borrowing is short term and is uncommitted, which is a big risk, and the other 25 per cent is possibly unsecured medium term, which means the bank may want to reduce that type of lending because it's going to be expensive in capital terms under Basel III. So our mantra is, 'Diversify your funding base' - why wouldn't you have 30-40 per cent of your long term borrowings on a five year bond? You have a guaranteed coupon, you don't have to think about the risks of repayment at a sooner date. And you also get to diversify. Also, there are PR spinoffs for a lot of these groups as they tell the story of their company. Can you elaborate? Look at Majid Al Futtaim (MAF). They went through a wonderful transitional process of better corporate governance, bringing professional management and raising transparency standards. This went hand in hand with a prudent and sustainable business strategy, which balanced expansion with solid risk management. MAF has been able to obtain an in- vestment-grade rating on the strength of its senior management team and gov- ernance standards, among other things. This, in turn, has allowed it to diversify its funding sources, access longer-tenor debt, and reduce its overall funding cost. It successfully issued a $400 million five- year sukuk priced at 5.85 per cent in Feb- ruary 2012, followed by a $500 million seven-year bond priced at 5.25 per cent in July the same year. In October 2013 , it issued a $500 million hybrid perpetual bond priced at 7.125 per cent, the first rated corporate hybrid from a Gulf-based issuer. These sukuk have set benchmarks for corporates in the region, and many others will aspire to do that. How do you view the Central Bank Regulations on Large Exposure Limits? It makes a lot of sense. For some banks, it presents a challenge. But we think on a holistic basis, it makes a lot of sense. The big secondary benefit is that we will see a lot of high quality GREs issuing paper into the domestic bond market, which has huge spin-offs because ultimately, it's in the Central Bank's interests. This is not just a UAE story; it's equally a big story in Saudi. Establishing deep and liquid bond markets and thus a domestic yield curve supports the Central Bank's economic role in implement- ing and managing an effective monetary policy. What will be the impact of the with- drawal of European banks from lending markets in the region? There were several groups of European banks lending locally. We know the role of HSBC , Standard Chartered , Barclays etc very well. They were doing a lot of the high profile deals. But there were also provincial banks that never even visited the region, but had a substantial participation in deals originated by the big banks. Small banks in Austria and Scandinavia, for example, had expo- sures here. This was the plain vanilla stuff, whether it's bilateral term loans or performance bonds. These smaller banks, which occupied the base of the pyramid, are completely gone. They liked the Middle East , they liked the ex- posure, they never lost money here, but strategically, they are focusing on their home market because they are now cap- ital constrained. What will be the impact of the with- drawal of these European banks? We're seeing East Asian banks coming into the regional markets - from Korea Exim Bank to credit-linked Japanese state agencies. But undoubtedly, you're going to see the large regional banks, and local banks play a larger role in the upcoming projects. We see a big portion of the trillion plus funding needs also being funded by project bonds, whether it's sukuk or conventional. We think this is really an important door that needs to open. And it will also al- low international investors to come in and contribute as well. Bonds are yet to find a secondary market. How do you view this? Some of the bonds issued by the bigger names like the large UAE GREs are relatively liquid. But are the secondary markets in the region optimally liquid? No, but that's a huge opportunity. When the Gulf eventually implements expatriate pension programmes on a large scale, it will be another big driver of debt capital market growth. At the moment, you have this whole unfunded liability - the gratuity schemes. If that was actually funded and invested into fixed income, you would get a positive funding flow into the private sector. That's a major opportunity. I'm sure it will come. How would you view UAE and Dubai if you had rated them? Though we don't rate them, we have an internal view on Dubai and the UAE . We rate Abu Dhabi AA/Stable. Abu Dhabi forms a big part of the UAE , so you may understand our position on the UAE from this assessment. For Dubai , you can look at rating assessments for GREs like DEWA, that's all I can say. We recently rated Dubai Investments . It was not investment grade but they may achieve investment grade pricing. Do you think GCC sovereigns are poised for higher ratings? In this region, S&P has four AA ratings for sovereigns - Saudi Arabia rated AA-/ Positive and Kuwait , Qatar and Abu Dha - bi, all rated AA/Stable. Several AAA and AA rated sovereigns have slipped after the crisis and these four AA ratings in the GCC are much stronger today, relatively speaking, than three years ago. You see the benefits of that flowing into the GREs. One good example is Saudi Electric , which takes the same AA- ratings as the Saudi sovereign. When they go to inter- national capital markets for a bond issue, they can now achieve much better pricing than their international peer group. Do you think Dubai should go for a rating? Well yes, we'd love to rate Dubai ... of course. We've based our regional headquarters in Dubai for many good reasons. BB 75% TYPICALLY 75% OF BANK BORROWING IS SHORT TERM AND IS UNCOMMITTED, WHICH IS A BIG RIS GROWTH DRIVER Stuart Anderson , Regional Manager for Standard & Poor's in the Middle East . Anderson has more than 20 years of experience in business development, risk management and governance functions in the financial services sector, mostly in markets throughout Asia and the Middle East . Recently he was Chief Risk Officer at Standard Chartered in Bahrain and over the last four years has been responsible for managing the bank's wholesale risk management function while based in Abu Dhabi . Anderson is responsible for driving the next phase of growth and development of Standard & Poor's portfolio of businesses across the Middle East , which spans credit research and ratings, investment indices, equity and fund research, market data, valuation and risk management services.
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