Banking on Sovereign Wealth
Investment bankers are flocking to the capital-rich Gulf region.
When massive credit losses sent banks scurrying for lifelines late last year, nearly all turned to the world’s richest sovereign wealth funds for infusions of cash. Citigroup was the first to move, selling a 4.9 percent stake to the Abu Dhabi Investment Authority, one of the oldest and most experienced sovereign investors, for $7.5 billion in November 2007. Two months later the Kuwait Investment Authority injected a total of $5 billion into Citigroup and Merrill Lynch, and in June the Qatar Investment Authority shelled out £1.76 billion ($3.5 billion) for 6.4 percent of the British bank Barclays.
Sovereign wealth funds have poured nearly $54 billion into the financial sector since the start of the credit crisis, underscoring their stunning ascendance on the global financial scene. Such funds have existed since the 1950s, but never before have they been as powerful — politically and financially — as they are today. That is especially the case in the Gulf, which boasts the largest concentration of sovereign funds and the most-rapid accumulation of capital, thanks to the recent surge in oil prices. As a result, the world’s big investment banks are flooding the region with senior talent — not to raise cash but to win more business from funds whose appetite for choice investments abroad is rapidly growing.
This year alone more than half a dozen banks have sent key deal makers to the Gulf or announced plans to do so. Since January, Citigroup has moved its co-head of global investment banking to Dubai, Morgan Stanley has established a team of bankers in Dubai to cater specifically to sovereign wealth funds, and HSBC Holdings has named one of its most experienced financiers as co-head of global banking for the Middle East. Lehman Brothers Holdings has tapped one of its top M&A bankers as its first global head of sovereign wealth funds, Merrill Lynch & Co. has hired a veteran Bear, Stearns & Co. executive to work with sovereign funds in the region, and Barclays Capital has recruited a former top regulator and hedge fund executive to spearhead its efforts to win sovereign fund business. Although banks have targeted the Gulf in the past, notably after the first two oil-price shocks in the early and late 1970s, the scale of their investment in the region today is unparalleled.
“Sovereign funds are really moving to the forefront of the markets at a time of crisis,” says Morgan Stanley’s David Law, who moved to Dubai from London in February to take up a new role as chairman of investment banking for the Middle East and North Africa. “They are bringing new sources of capital into play, and I think we will see them become even more active in years ahead as the flow of ideas into the region accelerates.”
The allure of working with sovereign wealth funds is easy to understand. Globally, they now control an estimated $3 trillion in assets — roughly the same amount as the global hedge fund and private equity industries combined. Gulf-based funds account for about half of those assets: roughly $1.5 trillion.
Like many large public pension plans in the U.S. and Europe, these funds are in the midst of diversifying their vast portfolios. Traditionally invested in government bonds and other high-grade credits, asset-backed securities and real estate, they are expanding into equities and alternative assets and making acquisitions of, or taking large stakes in, public companies. Those shifts, although small in percentage terms, are already having an outsize political impact as officials and market regulators in the West question whether government-related investment entities will use their clout to pursue political as well as commercial objectives.
In response to these concerns, the International Monetary Fund and the Organization for Economic Cooperation and Development are leading parallel negotiations that seek to reach agreement on a set of principles governing the behavior of sovereign wealth funds and countries receiving investments from them. The accords are expected to draw heavily on voluntary principles that U.S. Treasury Secretary Henry Paulson Jr. endorsed in March with senior officials from Abu Dhabi and Singapore, which commits sovereign wealth funds to make investments on commercial grounds and to improve disclosure of their strategy and performance and obliges recipient countries to avoid protectionist measures and provide predictable and consistent investment frameworks.
There is little doubt that sovereign wealth funds’ influence on financial markets will grow, given the amount of money at stake. State Street Corp. estimates that if sovereign wealth funds allocated 60 percent of their $3 trillion in assets to the MSCI all-country world index, they would collectively own about 5.5 percent of each company in the index as of March 31, 2008.
“Their appetite for risk is clearly growing,” says John Nugée, head of State Street’s Official Institutions Group in London and co-author of a recent paper on sovereign funds. “We’re seeing them challenge the market to come up with good ideas, and I expect that we’re going to see sovereign wealth funds facilitate significant financial innovation in the years to come — because if you do have a good idea, they have the means to fund it.”
Those means are growing all the time, especially in the Gulf. According to a recent report by McKinsey Global Institute, the economics research arm of consulting firm McKinsey & Co., Gulf oil exporters’ foreign assets will grow to $10 trillion by 2013 if crude averages $70 a barrel; at $100 a barrel, those assets could reach $12.2 trillion. Gulf countries will be forced to invest more surplus wealth overseas because their domestic economies and capital markets are too small to absorb such a windfall, the report says.
The Gulf’s sovereign wealth funds are already wheeling and dealing like never before. In 2006 they made just ten acquisitions — either whole companies or significant stakes — worth $3 billion, according to market research firm Dealogic. Last year they did 19 deals worth a total of $18.1 billion; in the first six months of this year, they struck another 19, worth $23.1 billion. Globally, sovereign wealth funds made 45 acquisitions in 2007, worth $54.1 billion, and made 40 more, worth $45.1 billion, in the first half of 2008; eight of the ten largest transactions since the beginning of 2007 have been purchases of stakes in beleaguered banks.
Such a surge in activity is all the more noteworthy because it comes against a backdrop of depressed merger volume. The total value of announced global M&A deals was down 27.9 percent in the January–July period from a year earlier, according to Dealogic, largely reflecting a dramatic slowdown in leveraged buyouts by private equity firms because of the credit crisis. As a result, many investment banks are redeploying key players from their financial sponsor teams to the Gulf, where sovereign wealth funds and other potential clients are behaving very much like private equity powerhouses with their vast pools of cash and the ability to move swiftly on major investments.
To date, Lazard leads investment banks in providing M&A advice to sovereign funds, working on two deals worth a total of $17.9 billion in the first half of this year, followed by Goldman, Sachs & Co. with two deals worth a combined $6.2 billion, according to Dealogic. Beyond the investment banks, however, major alternative-asset managers like Blackstone Group and Carlyle Group — which already count sovereign wealth funds among their limited partners and shareholders — are also helping them deploy their newfound wealth.
The Gulf’s sovereign wealth funds are not a homogenous group. The oldest and most established, such as the Abu Dhabi Investment Authority and the Kuwait Investment Authority, are taking advantage of the credit crisis to make opportunistic investments. Those deals represent a modest fraction of their giant portfolios: The ADIA has an estimated $875 billion under management, and the KIA has some $250 billion. State-owned or royally funded asset managers, such as Abu Dhabi’s Mubadala Development Co., Dubai private equity firm Istithmar and asset manager Dubai International Capital, are not sovereign wealth funds per se, but they too are extremely active in the capital markets, and the new wave of Gulf bankers is working to win their business as well.
The key for banks is to match the skills and experience of their bankers to the diverse needs of the Gulf’s deep-pocketed institutional clients. Morgan Stanley, for example, sent a handpicked three-member team from its international financial sponsors group, headed by veteran banker Law, to Dubai. Since he arrived, Law and his team have helped broker a strategic partnership between Mubadala and General Electric Co., in which the Abu Dhabi investment firm will help finance a broad range of GE initiatives on aviation, commercial finance and clean-energy research and development. At Merrill deal flow is also a major focus, but the bank has strong connections to sovereign wealth fund clients through its sales and trading divisions and fund management services (executives believe that the bank’s 49 percent stake in cutting-edge alternative-asset management firm BlackRock gives it an edge). HSBC, which has a long history in Saudi Arabia, wants to play up its experience in Islamic finance and debt issuance. Barclays, whose Barclays Global Investors subsidiary is one of the world’s biggest managers of alternative assets, is playing up its strengths in financing and asset management in its efforts to woo sovereign wealth funds.
The great unknown, of course, is whether there will be enough deal flow in the Middle East to keep all these newly deployed bankers busy.
David Law, Morgan Stanley
Morgan Stanley has had great success in advising sovereign wealth funds on mergers and acquisitions, and the British-born Law is one of the main reasons why. While running the firm’s international financial sponsors group from London in recent years, the 40-year-old banker developed close relationships with a number of sovereign funds and state-owned investment firms, including Dubai International Capital and Abu Dhabi’s powerful Mubadala. Since February, when Law moved to Dubai to become Morgan Stanley’s chairman of investment banking for the Middle East and North Africa, he has been spending two thirds of his time advising sovereign wealth fund clients.
“People who aren’t on the ground tend to talk about sovereign wealth funds in the Gulf as though they’re one generic group, but there are tremendous differences between them,” he says. “I do think it takes living and working here — and having these funds as part of as your day-to-day focus — before you can begin to understand those nuances.”
Morgan Stanley was a relatively early mover, setting up a full-service investment operation in the Middle East in 2006, the same year as Citigroup. The firm now has 70 investment bankers in the region, 40 of whom are based in Dubai, and has opened offices in Egypt, Qatar and Saudi Arabia.
The bank is making its presence felt. In 2006 and 2007, Morgan Stanley led all banks in sovereign wealth fund M&A, advising on half a dozen deals worth a combined $13 billion, including working with Singapore’s Temasek Holdings on its $4.39 billion acquisition of Hong Kong–based Hutchison Port Holdings. It also helped Mubadala, arguably more of a state-owned business development company than a sovereign wealth fund, on its $622 million purchase of an 8.1 percent stake in Advanced Micro Devices, a Sunnyvale, California–based computer chip maker.
Law, who reports to Georges Makhoul, Morgan Stanley’s president for the MENA region, will have plenty of help in trying to keep the bank at the top of the league tables. Since April, Morgan has sent three bankers to join Law, including Dennis Cornell, previously a senior banker in the financial sponsors group in New York; Hugo Parson, who worked with the leveraged and acquisition finance division in London; and Hani Ramadan, an expert in the Middle East who was poached from UBS’s financial sponsors group.
Law says the team sees strong similarities between sovereign funds and private equity firms like Kohlberg Kravis Roberts & Co. and Apax Partners because of the funds’ increasing willingness to invest directly in companies and infrastructure projects as general partners rather than through established private equity funds. To do this, the funds are looking for banks to do more than simply broker introductions and structure deals; they also need access to products and services, from asset management and banking to sales and trading.
“These clients require a lot of cross-divisional work across the entire firm,” Law says. “Sovereign wealth funds are not just focused on what investment banking can do for them — they want to know what we provide across our entire range of our products and services, from sales and trading to asset management.”
Makram Azar, Lehman Brothers Holdings
A veteran banker who rose to become head of Lehman’s media, consumer and retail sector coverage in 2007, Makram Azar has carved impressive notches on his deal maker’s belt, including advising on the €5.6 billion ($8.11 billion) takeover of Munich, Germany–based ProsiebenSat.1 Media by Kohlberg Kravis Roberts and Permira in late 2006. But Azar’s people skills as much as his banking credentials explain his appointment in April to a newly created role as Lehman’s Dubai-based global head of sovereign wealth funds.
Born in Lebanon and educated in France, the 41-year-old Azar moves nimbly among cultures. Fluent in Arabic, French and English, he can talk as easily to a Gulf sheikh or sovereign wealth fund manager as to the CEO of a major U.S. or European company, and — when he meets with clients — has the full range of Lehman’s product capabilities at his disposal. “This is an umbrella role,” says Azar, “because the business I head spans all of our divisions and geographies.”
Azar sees an advantage in being based in Dubai, which in addition to affording proximity to the Gulf’s massive sovereign wealth funds is roughly equidistant from other big sovereign investors, such as Norway’s oil-financed Government Pension Fund - Global, with $400 billion in assets, and $200 billion-in-assets China Investment Corp. His goal in building his team is not to replicate Lehman’s efforts across all of its divisions but to vet investment ideas coming up from each of those areas and present the best of them to the bank’s sovereign clients.
Gulf-based funds are particularly eager to look at investment opportunities in asset classes and countries where valuations are depressed, such as the troubled U.S. real estate market, he says. These funds are also becoming much more active in alternative strategies, like private equity and hedge funds; increasingly, they want to become involved in deals as general partners.
That trend could open up new opportunities for Lehman. In November the firm co-led the $1.15 billion IPO of New York–based hedge fund firm Och-Ziff Capital Management Group, whose founder and CEO, Daniel Och, struck a pre-IPO deal with Dubai International Capital to sell it a 9.9 percent stake in the firm as part of a strategic partnership. DIC is not, strictly speaking, a sovereign wealth fund. But as an active international investment firm owned by Dubai Holding, which is controlled by Dubai’s ruler, Sheikh Mohammed bin Rashid Al Maktoum, it is very much a target client of Azar and other bankers.
“Some sovereign wealth funds, like the ADIA and the KIA, have been around for decades, but up until recently, they had fairly plain-vanilla investments in fixed income and listed equities,” Azar says, “Now, however, many of them have decided to go into more aggressive, higher-performing strategies and asset classes.” Azar and Lehman will be only too happy to help them.
Gay Huey Evans, Barclays Capital
Unlike most of its big rivals, Barclays Capital, the investment banking arm of the U.K.’s Barclays, is not a player in global M&A. But that shortcoming isn’t restraining the British bank’s ambitions in the sovereign wealth fund space. Barclays aims to exploit its strengths in asset management and fixed-income financing to build closer relationships with sovereign clients. Indeed, the bank has sought to turn a weakness to its own advantage, raising capital last year by selling stakes to Singapore’s Temasek and to China Development Bank with the express aim of developing business opportunities with both of those entities.
To spearhead its efforts, Barclays recently hired 53-year-old Gay Huey Evans, a former U.K. capital markets regulator and hedge fund executive (most recently, she was head of governance for Citi Alternative Investments), to fill a newly created role as vice chairman of investment banking and investment management.
Evans sees herself as operating like an old-fashioned personal banker — albeit to some of the wealthiest investment funds in the world. She got to know many of them when she headed the International Swaps and Derivatives Association from 1994 through 1998. She is working across Barclays’s divisions — including Barclays Global Investors, one of the world’s biggest asset managers and hedge fund managers — to help sovereign wealth fund clients get whatever they need to diversify their portfolios, from advice on asset allocation to inflation-protected securities for their fixed-income holdings.
“Sovereign funds are following an evolutionary process that revolves around the adoption of modern portfolio theory as it has been practiced by major U.S. endowment funds,” Evans says. “They are diversifying from plain financial instruments, such as equities and fixed income, and investing in hedge funds, private equity, commodities and inflation-linked assets.”
The American-born Londoner, a dual U.S. and U.K. citizen, is not moving to the Gulf. She will be based in London, where she will work closely with Roger Jenkins, chief executive of Barclays’s private equity, principal investments and structured capital markets group, who was recently named executive chairman of investment banking and investment management for the Middle East.
Barclays’s ambitions in the Gulf extend beyond sovereign funds. The bank is keen to emphasize its expertise in Islamic finance to drum up business with a range of state-funded financial institutions and corporates. Since establishing offices in Dubai and Qatar in 2004, Barclays has developed a strong track record in underwriting sukuk, the Islamic equivalent of bonds. In Dubai the bank helped issue $1.5 billion in sukuk for ports operator DP World, $3.52 billion in a pre-IPO sukuk for Dubai real estate development company Nakheel, and $2.53 billion in convertible sukuk for commercial developer Aldar Properties.
Declan Hegarty, HSBC Holdings
When Declan Hegarty first moved to Dubai at the end of 1999 to help launch the bank’s debt origination business in the Gulf, the price of oil was about $25 a barrel and the now-glittering skyline was only a dream in the mind of the emirate’s rulers. Since then, oil prices have surged more than fourfold and the 36-year-old Hegarty — who helped set up HSBC’s office in Saudi Arabia in 2003 before returning to Dubai in 2006 — has witnessed an unparalleled period of expansion across the Gulf, as well as the rise of the region’s sovereign wealth funds to global prominence.
“This is really the third oil boom,” says Hegarty, who was named co-head of coverage for global banking in the Middle East and North Africa in June. “The first couple of times it happened, I don’t think the resulting resources were used as efficiently as many sovereign wealth funds might have hoped. This time around they have a clear desire to invest in industries and services that can bring a lasting benefit to the Middle East.”
Hegarty, who has essentially spent his career working with HSBC’s sovereign wealth fund clients, sees their current appetite for cross-border acquisitions as much more than a means to diversify their investment portfolios. Countries whose economies and wealth are fueled by hydrocarbons — primarily Kuwait, Saudi Arabia and the United Arab Emirates — are eager to leverage their abundant reserves of cheap energy to move up the value chain and develop other industries, such as aluminum smelting and aviation. Dubai Aluminum Co. churns out 950,000 metric tons of aluminum annually for clients in more than 40 countries; Abu Dhabi Aircraft Technologies, which is owned by Mubadala, recently agreed to make parts for Airbus Industries’ giant A380 aircraft after Etihad Airways, the U.A.E.’s fast-growing airline, placed an order for Airbus planes worth as much as $43 billion.
“Sovereign wealth funds see this as a once-in-a-lifetime opportunity to buy into the processes, technology and know-how that they might never be able to develop locally,” Hegarty says. “The advantages are twofold: First, you have a return on a given investment; and second, you have a means of developing a productive industry base that can help generate jobs for these growing populations.”
Within HSBC, Hegarty is one of the key experts in the region because of the depth of his relationships and his experience in Islamic finance, which is now integral to the bank’s businesses in the Middle East and Asia. HSBC, which launched its Islamic finance initiative in late 1998, has dominated sukuk issuance in the Middle East over the past decade. It has also gained a head start over rivals in Saudi Arabia, where Hegarty spent three years setting up the bank’s debt business in Riyadh as part of an investment banking joint venture between HSBC and SABB (formerly known as the Saudi British Bank). Thanks in large part to the Saudi team’s efforts, HSBC has since played a crucial role in underwriting a number of major public offerings over the past couple of years, including the $1.2 billion listing of Saudi oil company Petro Rabigh and the $1.8 billion listing of Saudi Kayan Petrochemical Co. Back in Dubai, Hegarty personally took the lead in advising Dubai Holdings on its massive $2.5 billion bond issue — the first multicurrency, multitranche bond to come out of the Middle East.
For Hegarty, who has watched sovereign wealth funds gain critical mass over the past ten years, nothing can rival the opportunity to assist them as they look to make more cross-border investments in basic industries. “They’re not doing as much in markets where they have been active for the past 30 or 40 years, like the U.S. and Europe,” he says. “They’re looking at investing in emerging markets, like Latin America and Asia — areas of the world that might not have registered with them before now but are increasingly important.”
Julian Mylchreest, Citigroup
Julian Mylchreest has been earning his air miles for the past three years, commuting between London and the Gulf as Citigroup’s head of investment banking for Central and Eastern Europe, the Middle East and Africa. Now the 39-year-old rising star is getting some serious help on the ground. In the past six months, Citigroup has almost tripled its Dubai-based investment banking team, from seven to 20, and in May it announced that Alberto Verme, co-head of global investment banking, would move to Dubai to facilitate the flow of ideas in and out of the region.
“Alberto’s presence really reaffirms the importance of the Middle East to us,” says Mylchreest, who has lately been spending three days a week in one of Citigroup’s offices in the region. “His arrival is a statement of intent and a reflection of a new reality: Clients in the Middle East — and sovereign wealth funds in particular — have become major global powers in their own right and critical facilitators in a capital-short world.”
Citi should know: It received a $7.5 billion cash infusion from the ADIA last fall after losses in the mortgage market wiped out almost half its market value. Besides Citi’s own example, Mylchreest points to Dow Chemical Co.’s $18.8 billion acquisition of specialty chemicals producer Rohm and Haas Co. as the kind of transaction in which Gulf funds are playing a growing role. When Dow announced the deal in July, it disclosed that Warren Buffett’s Berkshire Hathaway was providing $3 billion in equity financing and that the Kuwait Investment Authority was investing an additional $1 billion. Citigroup, Morgan Stanley and Merrill Lynch advised on the deal.
“This is a classic example of a company wanting to close a great deal and drawing on Middle East relationships and capital to make it happen,” Mylchreest says. “There will be many more such deals to follow.”
Since Mylchreest has been overseeing business in the Middle East, Citigroup has topped the charts among the bulge-bracket firms in generating investment banking fees; it earned an estimated $99 million in the region last year, according to Dealogic. Still, it has not yet had as much global success as its peers in advising sovereign wealth funds on M&A transactions. For 2006 and 2007, Citigroup ranked sixth on Dealogic’s list of the top ten sovereign wealth fund M&A advisers, consulting on deals valued at $5.19 billion. No matter. Mylchreest and Verme aspire to compete more closely in the years ahead — and see opportunity, given the sovereign wealth funds’ interest in working their way up the value chain of commodities-based industries. Mylchreest also sees potential in serving state-owned conglomerates. Citigroup advised Saudi Arabian Basic Industries on its $11.6 billion acquisition of GE Plastics last year.
“Up until three years ago, the focus that banks had on the Middle East region was totally, inappropriately low,” Mylchreest says. “Now it is finally where it should be — right up there in the spotlight, and that is not going to change.”
Fares Noujaim, Merrill Lynch
Merrill Lynch’s new man in the Middle East, Fares Noujaim, can’t abide the way sovereign wealth funds are often described in the media.
“The press has done a good job of vilifying these guys, and yet they have done nothing but add economic value throughout the world,” says Noujaim, who was named president of Merrill Lynch Middle East and North Africa and global head of sovereign wealth funds in June. “Frankly, I can’t imagine where the finance industry would be now without the involvement of sovereign wealth funds over the past eight months.”
Certainly Merrill Lynch would be in worse shape. The bank has been the recipient of no less than three investments from sovereign wealth funds — Singapore’s Temasek, Korea Investment Corp. and the Kuwait Investment Authority — since December. What Merrill has not had, however, is a global head of sovereign wealth funds to focus on those relationships. To fill that role, the firm in June recruited Noujaim, a 45-year-old former vice chairman of Bear Stearns who was one of that firm’s most senior investment bankers.
Noujaim is now looking for a house for his family in Dubai, and his move will be a regional homecoming. The banker was born in Kuwait and raised in Lebanon and holds dual citizenship in Lebanon and the U.S., where he has spent nearly all of his career.
Merrill hopes his cultural and deal-making skills will raise the bank’s already impressive profile in the region. The firm advised on $9 billion in global sovereign wealth fund M&As in 2006 and 2007, good for fourth place on Dealogic’s ranking; Merrill just advised on the $2.6 billion July acquisition of French technology and systems installation company Cegelec Group by Qatari Diar Real Estate Investment Co., which is owned by the Qatar Investment Authority.
Noujaim advised on mergers valued at more than $300 billion during his 21 years at Bear Stearns, most recently working with Thomson on its $17 billion acquisition of Reuters. Sovereign wealth funds “don’t mind paying fees, but they want real partners,” says Noujaim. “I think the most successful bankers will be those who not only bring them ideas but who are also able to approach everything they do with them as a partnership.”