DUBAI SOVEREIGN VERSUS COMMERCIAL DEBT

C O N F I D E N T I A L SECTION 01 OF 03 DUBAI 000530

SENSITIVE
SIPDIS

DEPARTMENT FOR NEA/FO; NEA/ARP/BMCGOVERN; TREASURY FOR NATASHA
ZAMECNIK

E.O. 12958: DECL: 12/10/2019
TAGS: ETRD KIPR EFIN ECON PREL AE
SUBJECT: DUBAI SOVEREIGN VERSUS COMMERCIAL DEBT

REF: A. A) ABU DHABI 1114

B. B) DUBAI 516

C. C) DUBAI 491

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CLASSIFIED BY: Justin Siberell, Consul General.
REASON: 1.4 (b),(d)
1.(C) SUMMARY: In the aftermath of the November 25 Dubai World
debt restructuring announcement (Ref A),Government of Dubai
officials have sought to differentiate sovereign debt - those
guaranteed by the Emirate - from commercial debt subject to
market terms. In so doing, the Dubai government is determined
to preserve sovereign assets by distancing the government from
any obligation to repay debts incurred by Dubai's
government-related "private" companies, like Dubai World. The
government is also determined to ensure that Nakheel "sukuk"
holders, particularly foreign hedge funds, understand that the
December sukuk (Islamic bond) is tied to a particular asset
(land). Default, therefore, should it occur, would not entitle
holders of the sukuk, which matures December 14, to lay claim to
other more-valuable Dubai World assets. Negotiations with
creditors to extend debt maturity deadlines are proceeding
favorably for Dubai World, according to senior government
officials. They continue to stress their active interest in
helping Dubai World manage its difficult restructuring effort,
in part because of the Dubai government's role as a significant
shareholder and also out of recognition that an orderly
restructuring of Dubai World is in the best long-term interest
of Dubai and the UAE. END SUMMARY.



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DUBAI GOVERNMENT NOT LIABLE FOR DUBAI WORLD
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2. (C) Dubai government officials have been publicly explaining
Dubai World's unexpected November 25 announcement seeking a
standstill on payments on its USD 26 billion debt by
differentiating "commercial" debt from Dubai's sovereign (and
therefore guaranteed) obligations (Ref B). This effort seeks to
disabuse investors of any notion that the Dubai government had
ever been a guarantor of these debts as many investors had
believed. (Note: According to a recent Barclays report, Dubai
sovereign and quasi sovereign debts that are publicly guaranteed
total USD 17.6 billion. The remaining USD 69.5 billion is
thought not to be guaranteed by sovereign pledges and includes a
substantial albeit undisclosed portion of Dubai World debts.
End Note) The list of sovereign and quasi-sovereign assets that
the government would presumably guarantee include Emirates
Airlines, Dubai Civil Aviation Authority, Dubai Electric and
Water Authority, Dubai Aluminum Company, Dubai Ports World and
Dubai Holding, Dubai Ruler Sheikh Mohammed Bin Rashid Al
Maktoum's stable of personally owned assets.




3. (C) In a December 8 meeting with Ambassador and Consul
General, Mohamed Shaibani, Chief of the Dubai Ruler's Court, and
the individual at the center of the government's attempts to
deal with the debt crisis, said that the priority of the Dubai
government was to "protect sovereign assets". A clear line
would be drawn between assets owned/backed by the government and
those of the private, government-associated companies like Dubai
World. Similarly, Dubai Department of Finance Director General
Abdul Rahman Al Saleh and Director of Funds Management Marwan
Abedin told the Consul General and Econoff on December 6 that
the government would continue to take an active interest in
helping Dubai World manage its restructuring effort, but would
not be liable for its debts. In this regard, and in a possible
foreshadowing of government intent, Shaibani pointed to USG
support for companies viewed as critical to the long-term health
of the U.S. economy, noting specifically the auto manufacturers.
Saleh held that investors "did not do their homework" to
properly assess the risk of investing in Dubai World and
Nakheel, despite the presence of explicit disclaimers in
Nakheel's sukuk prospectus, he said.



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GOVERNMENT WILL MEET ITS DEBT OBLIGATIONS

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4. (C) At the same time, Al Saleh emphasized that the Dubai
Government will honor its sovereign debts and has taken

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necessary steps to ensure it is in a position to meet all future
obligations. (Note: The Government of Dubai successfully sold
USD 1.9 billion in five year Islamic Sukuk bonds in November as
part of a USD 6.5 billion bond program (Ref B). The bond sale,
although it preceded the Dubai World debt standstill
announcement, was the biggest Sukuk sale from the Gulf region
this year End Note.) Saleh insisted that all publicly
guaranteed Dubai Government entities such as Dubai Civil
Aviation Authority and Dubai Electric and Water Authority have
the full protection of the Emirate's sovereign guarantee and
that the government has sufficient revenue to meet those needs.
Al Saleh did concede that in the short-term the Dubai Government
will face difficulty in raising funds through capital markets,
but remained optimistic about long-term fund-raising prospects
(Comment: Saleh is exceedingly optimistic on this point in our
view End Comment.)




5. (C) Al Saleh identified the government's recent payment of a
USD 1 billion Dubai Civil Aviation Authority bond as proof that
the Emirate was fiscally sound and on track to meeting its
sovereign debt obligations. Abedin noted that once the Dubai
Government completed critical infrastructure projects such as
the metro rail, government funds committed to this effort would
be freed up and eventually would generate sufficient funds to
help meet future debts and to fund future investment. In
response to the question where Dubai might find additional
revenue to help service government obligations, Saleh said that
Dubai would continue to advocate for a federal Value Added Tax
(VAT) system. Implementation of a UAE VAT was being discussed
at senior levels of government, he said, but would hinge also on
whether the UAE was prepared to move forward alone or only as
part of a GCC-wide decision.



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LOOMING DISPUTE OVER SUKUK TERMS?

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6. (C) Shaibani told Ambassador and Consul General that Dubai
World was having some success negotiating a restructuring of
Nakheel's sukuk obligations with bank holders of that debt, in
particular the Dubai-based banks most exposed to Dubai World
debt. (Note: Numerous sources claim that roughly 75 percent of
Dubai World's debt is held by UAE banks. End note.) Dubai
World faced an aggressive community of sukuk holders within the
hedge fund community, however, who were pushing for default in
order to lay claim to Dubai World assets, he said. Shaibani
held that in this regard, the Nakheel sukuk was being confused
by the hedge funds as an ordinary bond, when actually the terms
of the sukuk were quite different. The sukuk issuance was, by
nature of its Islamic structure backed by an asset, in this case
land (Nakheel's proposed Dubai Waterfront mega development near
Jebel Ali port). In the case of non-payment, holders could lay
claim to the specific asset that backed the sukuk, but not other
Dubai World or Nakheel assets (e.g., hotels or other property in
the U.S.) (Comment: ForeQ ownership of land is highly
contentious in the UAE. It is hard to imagine the Dubai or UAE
Federal governments allowing a hedge fund or other international
beneficiaries of a Nakheel default, to actually take control of
this particular asset End Comment.)


7. (C) Director of Funds Management Abedin claimed in the
December 6 conversation with Consul General and Econoff that the
sukuks issued by Nakheel were originally intended for a domestic
investor class and not for foreign based investors. Foreign
investors "erroneously" assumed Dubai World's commercial debts
would be backed by a sovereign guarantee rather than the
specified assets that by definition underpin a sukuk issuance.
(Comment: Clearly, when Nakheel conceived of its sukuks, it did
not plan for or expect to begin dealing with the hedge funds,
and Dubai authorities continue to struggle to understand how to
deal with that community. Local fears have been stoked by press
reports that hedge fund holders of the Nakheel sukuk are pushing
for a default on the December 2009 sukuk in order to lay claim
to assets spread throughout the Dubai, Inc. firmament. One
senior Emirati banker told Consul General that the "coup de
grace" in terms of shame for Dubai would be a U.S.-based
creditor successfully seizing an Emirates airlines plane or
other recognizable Dubai asset as part of a Nakheel default End
Comment.)



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MIGHT DUBAI WORLD PAY ON TIME AFTER ALL?

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8. (C) Accompanying the statements from Dubai officials
differentiating between sovereign and private debt have been
several hints that Dubai World may not go into technical default
on its December USD 3.52 billion sukuk re-payment. Shaibani
indicated that Dubai World's negotiations with banks were
proceeding well. This was echoed in a December 9 conversation
with Dubai Financial Market Executive Chairman Essa Kazim who
told CG and Pol/Econ chief that international banks were
reportedly coming to the table with Dubai World due to
longer-term confidence in Dubai not shared or seen as relevant
by the hedge fund-holders of short term paper. Those with
longer-term expectations in Dubai had an interest to help the
companies restructure and renegotiate repayment terms, while the
short-term holders had a greater interest in default in order to
lay claim to assets, he said. Finally, Finance Chief Al Saleh
emphasized to CG and Econoff December 6 that the Dubai
government would "support" Dubai World as it went through its
restructuring. DFM's Kazim sketched out a scenario whereby
Dubai World successfully renegotiates extended terms on its
large debt obligations with the local banks that reportedly hold
75 percent of its debt, with the Dubai government later stepping
in to cover the costs associated with buying up the short-term
notes from the hedge fund community, possibly using the USD 5
billion raised from Abu Dhabi in the days prior to the Dubai
World standstill announcement.



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COMMENT

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9. (C) The Dubai government is determined to protect its
sovereign holdings and those of the ruling Maktoum family.
Second, it seeks to "ring fence" prized assets within the Dubai
World and other government related entities portfolios while
simultaneously seeking to renegotiate and extend debt maturity
dates with the local and international banking community.
Whether these steps will succeed in seeing the Emirate through
the coming period without significant assistance from Abu Dhabi
remains to be seen. We still lack clear data on the
government's ability to meet its own obligations, despite the
assurances from its senior financial managers. Certainly,
markets are not yet convinced, as evidenced in significant
market drops in the past several days of Dubai trading, and the
credit downgrades of government bodies like the Dubai Water and
Electricity Authority. The recent appointment of outside
restructuring experts is hoped to bring credibility to the
restructuring of Dubai World, but still does not address the
broader, and quite confused, mix of government and private
liabilities. The coming weeks should provide a clear signal of
the success of the government's current strategy, once the
Nakheel sukuk repayment deadline passes (December 14, but with a
two-week grace built in). END COMMENT
SIBERELL