How attractive are low oil prices and the liberalising Middle East to foreign investors?

There has been much coverage of the recent fall in oil prices with Brent crude dropping below US$30 per barrel this year.

This is in stark contrast to the highs of US$110 per barrel between 2011 and 2014.

Oil dependent Middle Eastern economies therefore have to deal with unfamiliar budget deficits where government spending has been a key driver of economic growth.

However, we believe this creates opportunities for foreign investors looking to emerging markets for future growth with assets becoming available and governments liberalising their foreign investment regimes.

Investing in the Middle East

The Middle East has always been an attractive market for foreign investors for a number of reasons. Its location between the East and the West makes it a favourable pathway for trade and it is increasingly used as a platform for investors (notably from Asia) to invest in Africa given its proximity to the continent.

Economic growth in the GCC (Gulf Cooperation Council states) has largely remained positive mainly due to the region’s vast oil reserves and favourable demographics, with almost half the population being under 25. The generally low-tax environment and transport infrastructure have also been welcoming factors for foreign workers moving from high-tax countries.

However, like many other developing regions of the world, the Middle East has not fully implemented legal, regulatory and business reforms meaning that foreign domestic investment has been lower than it could be. The Middle East harbours many nuances that can be a concern for foreign investors wishing to enter the market.

Most countries in the GCC have restrictions on foreign ownership in many sectors. In the UAE for example, foreign investors are not allowed to own more than 49 per cent of a company incorporated onshore (that is, outside of a specially designated free zone) and in certain sectors such as insurance and real estate, this threshold is often much less.

Such restrictions mean that investors typically invest in the Middle East with a local partner or partners, and consequently any new money investment or acquisition is commonly in the form of a joint venture or consortium where the investor takes a minority position.

This then puts the focus on co-investment and joint venture issues such as personal relationships, control (including reserved matters, veto rights and board appointment rights), transfer rights, access to information and arrangements around the day-to-day operation of the company.

Foreign ownership restrictions are also relevant in the context of enforcement of assets. For example, restrictions on foreign ownership of land and shares in UAE companies make enforcement by a foreign lender potentially difficult where the secured assets may only be able to be transferred to a local investor.

On a similar vein, many remedies that are often negotiated in case of a breach of a shareholders’ agreement may be ineffective if the foreign shareholder cannot exercise its rights to purchase directly the local shareholders’ shares in the UAE company.

Another challenge for foreign investors, who often come from well-developed common law backgrounds, is coming to grips with the developing legal and judicial systems in the Middle East.

Any court proceedings are likely to be Arabic and can take a long time. In many countries, it is impossible to know definitively whether there may be legislation in existence covering a particular topic because there is no requirement to publish a law that is passed.

Contrast this with developed economies where transparency and publication (often in a gazette) is a fundamental pillar of the rule of law. Similarly, there is often no equivalent of a Companies House and therefore no publically searchable register disclosing key information on a company, such as its constitutional documents, the identity of its directors and its shareholding structure. Often, this type of information can only be sourced from the company itself.

Many of these concerns are addressed to some extent by the initiatives taken by some Middle Eastern governments to develop designated areas called “free zones” which “disapply” certain laws and regulations for those businesses established within the zone’s boundaries.

Probably the most successful of these free zones is the Dubai International Financial Centre (DIFC) which permits 100 per cent foreign ownership, has its own common law courts system and a legal framework based on English law which applies to the almost complete exclusion of onshore UAE and Emirate laws.

Qatar has launched the Qatar Financial Centre (QFC) and Abu Dhabi has recently launched Abu Dhabi Global Market. Such zones however, are not a complete solution when it comes to enforcement. If the free zone has its own courts system, unless the assets of a party to a dispute are located within the zone there is no established precedent in many Middle Eastern countries of enforcing judgments against a party’s assets which may be located elsewhere in that country. To address these concerns precedent has developed in respect of DIFC court disputes where Dubai courts have enforced DIFC money judgments.

Opportunities

As oil revenues diminish, Middle Eastern governments and businesses are giving careful thought to future sources of revenue and funding. Although discussed for a long time, it is expected that VAT will be introduced in the GCC in 2018.

A number of Middle Eastern countries and government related entities have sold international assets, mostly stocks and bonds but also illiquid assets, or sought access to the public and private debt markets to borrow money.

Saudi Arabia last year resumed issuing domestic bonds for the first time since 2007 and other members in the GCC (including individual Emirates in the UAE such as Sharjah and Ras Al-Khaimah) have looked to the foreign bond markets to help cover their deficits.

Cost of borrowing may increase as GCC borrowers no longer have the oil to support their budgets and their sovereign ratings, which may make the capital markets more attractive for international investors.

Governments will also want foreign investors (such as large international private equity funds and multi-national strategics) to invest in their countries contributing both financial resources and intellectual capital, and this encourages legal and market reforms to create a favourable and attractive environment for them. We are already seeing such reforms to a certain extent in many countries in the region.

There are reports that Saudi Arabia is considering allowing foreigners to own 100 per cent of a company in at least four unspecified industries. This is in addition to other reforms which have taken place prior to the oil price fall, including laws which allow 100 per cent foreign ownership in the retail sector and its stock exchange (which is the Arab world’s largest) allowing direct foreign investments.

Qatar’s largest free zone, the QFC, has broadened the scope of businesses allowed to operate in the free zone by adding architecture, engineering, urban planning and media representation to its list, among others.

Most recently, Oman’s new foreign capital investment law which is in its final approval stages, will permit 100 per cent foreign ownership in certain sectors and remove the minimum capital requirement in order to open up the market.

Such reforms may encourage more foreign investment, particularly from the private equity sector and we are seeing increased interest from international investors. For example, last year we saw a consortium of Asian and GCC investors, led by Standard Chartered Private Equity, invest in FINE Hygienic in Jordan.

Diversification is also a key focus for many GCC countries, with a desire to reduce their reliance on hydrocarbon. The increased emphasis and continued government spending on the non-oil sector such as infrastructure, tourism, trade and financial services may present interesting investment opportunities.

Large government-sponsored events such as Expo 2020 Dubai and the Qatar World Cup encourage this and are further cemented by regulatory reforms.

For example, last year Dubai passed a new law governing public-private partnerships to encourage greater participation and investment by private establishments and companies in development projects in Dubai.

Kuwait similarly passed a new law which establishes the regulatory framework for public–private partnership projects in Kuwait, creating a greater degree of certainty, reliability and flexibility for foreign contractors, investors and lenders that participate in such projects.

We have witnessed increased investment (greenfield and brownfield) in the education and healthcare sectors, driven by regulatory reform and a government desire to encourage investment. However demographics have also supported sector activity. The recent reverse takeover of London listed UAE business Al Noor Hospitals Group is an example of this.

Historically, state owned enterprises in the Middle East have rarely been privatised and if they have, they have often only been minority stakes that are listed on the local stock exchanges.

In Bahrain a proposed amendment to the Private Companies Law, if approved by Parliament will permit the full privatisation of some of the country’s biggest non-oil and gas companies in which the government has a stake, including Gulf Air, Alba, Bahrain Airport Company, Batelco and the National Bank of Bahrain.

In the Kingdom of Saudi Arabia, Saudi Aramco (the Saudi Arabian Oil Company) has released statements that it is looking at listing a percentage of the company’s shares or a bundle of its downstream subsidiaries. Saudi Aramco is estimated to be valued between US$1.5 and 5 trillion, and a listing would probably create the most valuable listed company in the world. Furthermore we may see certain non-core assets being privately auctioned. These prized publicly held assets could prove to be attractive investment propositions for foreign financial and strategic investors in the future.

Challenges ahead

Despite these opportunities, competition is significant as many investors are still seeking to spend unallocated funds accumulated previously. There are signs of slow down, shelving or delays of major projects and consequential cost reductions. But this is the rainy day that the Middle East has been preparing for, where diversification, reform and investment, will no longer be catch phrases used by governments in implementing their policies: they will hopefully be testaments to the resilience of the region.

David Martin, Partner, Linklaters LLP, UAE

David Martin is a corporate partner in the UAE, Head of Linklater’s Middle East desk and responsible for the firm’s Qatari client base. He is primarily engaged in public and private M&A, equity capital markets, joint ventures, strategic investments, restructurings and general corporate advice, often with a cross-border element. Mr Martin regularly advises Middle Eastern clients on their international investments and he has a particular focus on the firm’s SWF clients, co-heading the firm’s SWF sector team. For more information about Linklaters go to www.linklaters.com. For more information about Mr Martin click here.

To contact David Martin email david.martin@linklaters.com

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