From a distance, the gleaming glass-clad office blocks and condominium towers spearing skyward from Dubai's flat desert plains are an astounding sight. They're the physical manifestation of an audacious 20-year plan to transform an arid enclave into a modern metropolis (including the world's tallest skyscraper, just-opened), an upscale tourist playground and the financial heart of the Middle East.
When night falls, a quite different reality intrudes. Light is sparse, the mood turns slightly sinister. Many buildings are nearly vacant, while others are simply hollow shells on which construction has suddenly stalled. All form a backdrop, literal and symbolic, for the unraveling of Dubai's great ambitions.
Faltering from the start of the financial crisis, those ambitions came crashing down in late November, when the Dubai government announced that Dubai World, a state-owned investment conglomerate whose property subsidiaries built many of the towers, could not meet its debt obligations.
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As the emirate now struggles to regroup -- hastily cobbling together rules to govern debt restructuring, writing new laws that draw heavily, if not exclusively, on British and American legal structures, meeting with creditors -- global investors closely follow the unfolding drama.
Insolvency regulation was long thought unnecessary in a country in which the state was implicitly assumed to stand behind everything from builders to port operators. But on Nov. 25, when the government said Dubai World would need a six-month debt standstill and the restructuring of about $26 billion in debt (much of it carried by two developer subsidiaries, Nakheel PJSC and Limitless LLC), the news sent a shudder through still-fragile global markets. Suddenly, the implicit state backing was nowhere to be found.
Attention quickly focused on the absence of regulation capable of dealing with large-scale and complex restructuring and the murky accounts of a company that remains as much a mystery as it is now a concern.
The government of Dubai, led by hereditary ruler Sheikh Mohammed bin Rashid Al Maktoum, rushed to at least partially fill the void. On Dec. 13 it established a tribunal code in order to "decide the disputes related to the settlement of the financial position of Dubai World and its subsidiaries."
The new rules have been almost universally, if cautiously, welcomed. They provide some certainty to a situation in which many key issues -- the company structure, the amount of debt, the role of the government and, most of all, the outcome of the restructuring -- are very much in play.
"We are confident that a solution will be found," says a source at one of Dubai World's largest creditors. "Every single party at the table has too much to lose from the alternative."
To Dubai's credit, the new regulations have gone some way toward calming creditor nerves. The laws have a great attraction -- familiarity.
"The decree has borrowed from the U.K. [company voluntary agreement] and Scheme of Arrangement processes to create a framework and bolted on some of the best bits of the Chapter 11 regime," says Adam Gallagher, a partner at Freshfields Bruckhaus Deringer LLP. "While this looks good on paper, it remains to be seen how it works in practice, given that Dubai doesn't have a history of dealing with these kinds of issues, and because there may be a potential conflict between the decree and legal systems governing certain of Dubai World's subsidiaries."
The United Arab Emirates does have bankruptcy laws, but they have rarely, if ever, been used by international firms and have certainly never been applied to a business of the scale or complexity of Dubai World.
They are also far from investor-friendly. According to a study by the World Bank, it takes an average 5.1 years to recoup money from a closing business and even then investors should expect only 10.2 cents on the dollar. That gives the UAE the second-lowest ranking in the Middle East and North Africa on both measures.
Thankfully for Dubai World's creditors, the new restructuring decree has little to do with those laws. Instead it builds on a basic CVA concept and winding-up regime already in place under laws applicable to Dubai's financial and business hub, the Dubai International Financial Centre. DIFC, as it is commonly known, has its own courts and laws, separate from those of Dubai in all matters except criminal law.
The Dubai World decree added to those existing rules a cramdown mechanism that enables the tribunal to approve the CVA if one impaired class votes in favor; a mechanism for accepting or rejecting executory contracts; and an absolute priority provision. All of these will be familiar to those versed in Chapter 11.
The decree also introduces a three-man tribunal that will rule, on a majority basis, on claims against Dubai World. On the panel sit two Brits, Sir Anthony Evans, a former England and Wales High Court judge and currently chief justice of the DIFC courts, and Sir John Murray Chadwick, a DIFC court judge and former judge of the Court of Appeal of England and Wales, and a Singaporean, Michael Hwang, a former commissioner of the Supreme Court of Singapore and deputy chief justice of the DFIC courts.
"The appointment of some highly credible individuals to sit on the tribunal should provide some confidence in the process and likely application of the principles underlying the new decree," says Gallagher.
On Dec. 30 the government established a second three-person panel to handle creditor claims on struggling mortgage lenders Amlak Finance PJSC and Tamweel PJSC, which are due to merge in 2010.
The relief with which the new restructuring decree has been welcomed does beg the question: Why were so many sophisticated investors and lenders so readily willing to finance a company without first ensuring that there was an exit route in the event of default?
The answer is that, until the shock of the November announcement, such concerns were thought to be immaterial. It was widely assumed that Dubai's state-owned companies came with implicit state guarantees.
Dubai's rulers at best did little to discourage this notion. At worst, they actively encouraged it, not least because it lowered the cost of borrowing for companies that were by most measures hugely overstretched.
"During the boom years, as the emirate built this model of foreign direct investment, the crown prince, who is now the ruler, was dropping very strong hints that Dubai Inc. would enjoy sovereign backing," says Christopher Davidson, a senior lecturer in the school of government and international affairs at England's Durham University and the author of several books on the UAE. "The mood was that if something went wrong, the government would step in to make it right."
Few publicly questioned that assumption, even as the finances of Dubai, with its $89 billion of sovereign and quasi-sovereign corporate debt, could evidently no longer underwrite a large-scale bailout. Dubai's creditors mostly kept the faith, believing that Dubai's wealthier neighbor, Abu Dhabi, the big brother of the UAE and home to about 90% of the UAE's huge oil reserves, would step in should the worst come to pass.
That belief was lent substance by past action. In February, the Central Bank of the United Arab Emirates, in which Abu Dhabi is the largest stakeholder, bought $10 billion of bonds from Dubai. The move came after the cost of insuring Dubai's sovereign debt, as measured by the spread on the credit-default swap market, broke the 1,000-basis-point barrier, putting it on par with Iceland, the highest-profile sovereign victim of the credit crisis.
The money was eventually funneled into the Dubai Financial Support Fund, a bailout fund launched in July, and given the task of raising $20 billion to "provide loans on a commercial basis to government and government-related entities engaged in projects deemed to be of strategic and developmental importance to the Emirate of Dubai."
It remains unclear where the money went, according to one analyst, or what criteria the support fund would use to make decisions on how to disburse money. What happened to a $5 billion loan that two Abu Dhabi commercial banks extended to Dubai in November? That's another unanswered question.
The assumption that Dubai World's debt would be backed by the governments imploded in late November and early December, when first Dubai and then Abu Dhabi distanced themselves from Dubai World. Dubai insisted that the company had the means to save itself so long as creditors agreed to a restructuring. Banks were naive to assume that Dubai World was guaranteed by the emirates, the Dubai government added.
That statement may itself have been naive in failing to anticipate the swift investor flight that soon followed, sending Dubai and Abu Dhabi's stock markets sharply lower. In the month after the Dubai World restructuring was announced, Dubai's key Dubai Financial Market General Index, or DFMGI, lost about 17% of its value.
The extent of the retreat ultimately spurred Abu Dhabi into action. The emirate on Dec. 14 provided a further $10 billion to Dubai's government, allowing Dubai World to repay $4.1 billion due the same day to holders of a "sukuk," or Islamic bond, issued by Dubai World property developer Nakheel.
"The credibility of Abu Dhabi and the region would have been shot through" had it not stepped in to protect a business that while technically a standalone entity was politically tied to the government, says a lawyer whose firm is involved with the restructuring.
The intervention calmed local markets, even if values continue to drift lower. But the move further muddied the already opaque relationship between Dubai Inc., the collective name given to the emirate's state-owned enterprises, and the government.
That lack of transparency continues to pervade and bedevil almost all aspects of the Dubai World affair, as well as any assessment of the state of the rest of Dubai Inc. and the emirate's finances.
A very few things can be stated with any real certainty: The government of Dubai has created three holding companies -- Dubai World, the Investment Corp. of Dubai and Dubai Holding -- which manage separate pockets of money for the emirate.
Dubai World's units include the real estate investment companies Nakheel, Istithmar World and Limitless. Infinity World, the company involved in the Las Vegas CityCenter, a joint venture with MGM Mirage, is part of the conglomerate as well. Also part of the larger company are port operators DP World and Drydocks World; natural resources investor Dubai Natural Resources World; commodities exchange operator Dubai Multi Commodities Centre; Economic Zones World, which develops infrastructure and logistics for industrial parks; and Leisurecorp LLC, which develops and runs golf courses.
But this is about as clear as it gets.
Take the question of liability. Dubai has distinguished between assets directly owned by the government and the government-related entities, or GREs, classified as commercial enterprises. An October bond prospectus issued when Dubai launched a $6.5 billion borrowing program to shore up GRE finances said that the government was "under no obligation to extend support to any GRE."
The fact that Dubai World is 100% government owned, with Morgan Stanley calling the holding company "a wholly-owned entity of the Dubai government," seemed not to have mattered in October. However, as events of the last few weeks have proven, neither Dubai's ruler nor the United Arab Emirates as a whole could simply walk away from liabilities held by GREs. How then do lenders asses the risk of extending credit to these entities?
What complicates matters even further is the question of exactly how much is owed by these entities. Dubai World has officially released a $59.3 billion debt figure as of the end of 2008, but that number isn't taken at face value by financial experts.
Deutsche Bank AG, for example, says that the figure included more than just financial debt, including equity, and payments due to suppliers. Discounting the nonfinancial debt led the German bank to estimate Dubai World's financial external debt at $24.27 billion.
Morgan Stanley has its own estimate of the liabilities, taking a disclosed $26.2 billion number from Dubai and then adding another 30% to that to account for a presumed undisclosed amount, putting Dubai World's debt at a seemingly arbitrary $34.1 billion.
Even if a figure could be agreed on, it remains to be seen how much debt the Dubai government slates for restructuring. Dubai has said that Dubai World's stronger subsidiaries, including the port operations, are excluded from the current operation.
The amount of debt to be included in the restructuring should become clearer as the process progresses. A first meeting of creditors and Dubai World's management was held on Dec. 21, though bankers who attended say there was little useful information to be gleaned from a presentation and question-and-answer session.
Dubai is under pressure to move quickly to clear up uncertainties. According to one source, Dubai World creditors are already effectively operating under an informal standstill, which they will not long tolerate.
But the emirate must also move ahead carefully. Its continued growth as a financial center, and the ultimate fate of Dubai Inc., will rely on the fickle support of global capital and its gatekeepers. The currency for their support is stability and the maintenance of a regime that is at least as business-friendly as regional rivals, including Abu Dhabi and nearby Qatar.
Dubai's actions since late November have seriously damaged its credibility. Another misstep could prove fatal, in which case those empty, unfinished buildings could very well become a permanent monument to the failed ambitions of the emirate.
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