Insights Report – UAE’s new Financial Restructuring & Bankruptcy Law Positive Impact & Opportunities

UAE’s new Financial Restructuring & Bankruptcy Law

Positive Impact & Opportunities

24 September 2024

The changes in the nation’s bankruptcy law addresses enormous liquidity gap and opens opportunities, such as private credit, distressed and stressed investing, SMEs, DIP, rescue financing and NPLs, etc.

This law was enacted in India in 2016, leading to a private credit market that has now reached at least $25 billion. This legislation has undoubtedly played a significant role in fostering the growth of small and medium-sized enterprises (SMEs) in India. Similarly, since its introduction in Saudi Arabia in 2018, we can expect to see positive developments as it will be implemented here in 2024.

The hope is that this trend extends to other Gulf Cooperation Council (GCC) countries, especially considering the substantial liquidity gap faced by SMEs. This law could provide downside protection and enhance the attractiveness of investments in this sector.

Expert Speakers:

• Andrew Mortimer, Managing Director, Chief Operating Officer Barclays, Middle East & Africa
• Jody Waugh, Managing Partner, Al Tamimi & Company
• Omar Al Yawer, Partner, Ruya Partners
• Loai Bataineh, Senior Executive Officer, Ominvest Capital
• Moderator: Lara Sif Hrafnkelsdottir, Vikingur Management Consultancies – MENA, Private Funds & Family Offices, Principal & Venture Partner

UAE’s New Bankruptcy Law: A Business Perspective

Lara Sif Hrafnkelsdottir: The United Arab Emirates has strategically upgraded its legal framework with the enactment of the new Financial Restructuring and Bankruptcy Law on May 1st, 2024. This isn’t just a legal update; it’s a deliberate move to strengthen the UAE’s business environment by providing a more robust and efficient mechanism for companies facing financial challenges.

In business terms, this new law is a toolkit designed to help financially distressed companies in the UAE navigate turbulence and emerge stronger. It provides a structured process for restructuring debt and operations, aiming to preserve viable businesses, protect jobs, and ultimately maintain and attract investment.

Jody Waugh: This 2024 legislation builds upon the experience gained from the 2016 bankruptcy law. The earlier law, while valuable, exposed areas for improvement, particularly in facilitating business recovery. The new law addresses these limitations by placing a stronger emphasis on reorganization and restructuring, offering more streamlined and accessible pathways for companies to get back on their feet.

A key refinement is the evolution of “preventative composition” into a more user-friendly “preventative settlement.” Previously, restrictive conditions limited its application. Now, businesses can proactively engage in restructuring while retaining operational control under court oversight, a significant advantage for maintaining business continuity.

While fully operational, the law is still in its implementation phase, with some supporting infrastructure like the bankruptcy register yet to be fully launched. Existing cases continue under the 2016 law, but new restructuring initiatives are already underway based on the 2024 framework. The business community is actively discussing its potential, though the actual number of filed cases is currently moderate, indicating a measured approach to its application.

Lara Sif Hrafnkelsdottir: Could you briefly discuss the concepts of debt financing, exit financing, and rescue financing in the context of restructuring? Are these new opportunities introduced by the new law?

Jody Waugh: Imagine a company undergoing restructuring. It’s often caught in a bind: desperately needing cash to keep operating yet facing reluctance from creditors to increase their exposure. Traditional credit lines may be frozen, hindering the very ability to generate revenue for debt repayment. This was a common scenario under the 2016 law. The new legislation proactively addresses this with the concept of “new money.” This allows financially strained businesses to seek court approval for new capital injections, offering specific protections to those providing these funds.

From a business perspective, this “new money” can take different forms, fitting into the categories you mentioned:

• Debt Financing: This is essentially providing fresh loans to the distressed company to fund its ongoing operations during the restructuring process. This could be working capital loans to cover payroll, inventory, or other immediate needs.
• Exit Financing: This is crucial for successfully concluding the restructuring. It provides the capital needed to repay existing debt under the agreed restructuring plan, effectively allowing the reorganized company to “exit” the restructuring process with a clean slate.
• Rescue Financing: This typically involves a more significant investment, potentially including equity, aimed at fundamentally stabilizing and revitalizing the distressed business. It often comes with a higher risk but also a potentially higher reward for the investor.

While the concept of injecting new capital wasn’t entirely absent before, the new law explicitly recognizes and facilitates these types of financing arrangements with clearer mechanisms and protections. This is a significant opportunity. However, the crucial factor for businesses is speed. As we’ve seen with cases like NMC, securing court approval for “new money” swiftly can be a game-changer. In contrast, Kbow’s experience under the onshore system highlights that the approval process can sometimes be lengthy. So, while the opportunity for debt, exit, and rescue financing is definitely enhanced by the new law, accessing it still requires navigating a court-sanctioned process, where timing is often critical.

Omar Al Yawer: The Rise of Private Credit in the Middle East

The private credit sector is thriving, particularly in the Middle East, due to the limited participation of regional banks in small and medium enterprise (SME) lending. Banks in developed markets allocate 28% of their loan portfolio to the SME segment, while Middle Eastern banks dedicate less than 2% – the lowest globally. This gap presents an opportunity for private credit providers, like the speaker’s company, to step in and address the financing needs of regional SMEs.

Traditionally, SMEs in the Middle East rely on friends, family, or equity sales for growth, which can be costly and restrictive. However, the emergence of private credit, backed by regional sovereign wealth funds, has facilitated growth for these businesses. Over the past five years, private credit has grown rapidly, with an increasing number of allocators investing in the sector.

Despite no defaults in the previous 15 years of regional investments, potential investors may still have reservations about the risks associated with investing in the Middle East. Addressing these concerns, the speaker highlights recent improvements in regional laws aligning with global standards, attracting international investment managers to the region. Goldman Sachs and JP Morgan, for instance, have recently invested in Tamara and Tabby, respectively.

The influx of international managers and structured finance solutions encourages growth for regional businesses, advisors, families, entrepreneurs, and family offices. Although the concept of debt was initially viewed negatively in the Middle East, societies are starting to accept the importance of debt financing.

The growth of private credit in the region can be attributed to Saudi Vision 2030 and Vision 2040, alongside the regulatory changes and increased influx of foreign businesses post-Covid. While the sector is growing during the current cycle, the speaker predicts a significant uptick in demand for private credit when the economy faces challenges, ensuring that the necessary regulations and support structures are in place.

Omar Al Yawer: A Catalyst for SME Growth and a Differentiated Opportunity for Investors

The landscape of lending in the Middle East and North Africa (MENA) region is poised for significant transformation with the burgeoning private credit market. This shift as a pivotal opportunity for Small and Medium Enterprises (SMEs), a sector historically underserved by traditional banking institutions, receiving less than 2% of bank lending. This emerging market represents a crucial step towards fostering a more dynamic environment for private credit, attracting not only distressed and stressed asset investors but also substantial interest from large foreign asset management firms.

There is a critical distinction regarding the nature of distressed and stressed debt within the MENA region compared to Western markets. The challenges faced by companies in the region often stem from poorly structured loan agreements, frequently involving informal lending from family members. These businesses, while facing immediate liquidity pressures due to these personal obligations, often possess fundamentally sound operations and growth potential. This contrasts sharply with the Western understanding of distressed debt, where businesses typically struggle due to inherent operational difficulties despite access to traditional bank financing. This nuanced understanding is key to demystifying the region’s potential for international managers. The attractive returns generated by regional private credit are not necessarily a reflection of higher risk, but rather a consequence of investing in fundamentally healthy businesses that have been historically constrained by limited access to conventional financing. Consequently, these companies often exhibit lower leverage compared to their Western counterparts, not by choice, but by necessity due to the limited appetite of banks in the region.

This lack of traditional bank lending has forced growing businesses to consider selling equity to fuel expansion, leading to the consolidation of wealth within established families and hindering the growth of independent entrepreneurship – a trend now showing signs of change in the UAE and Saudi Arabia.

Impact of recent bankruptcy law adoptions in the UAE (2020) and Saudi Arabia (2018) on the trading of non-performing loans (NPLs) within the GCC region.

Legal frameworks provide a strong foundation for increased trading activity in NPLs. Highlighting the substantial NPL balances within GCC banks, exceeding $50 billion, what opportunity does this presents for banks, particularly in the UAE where the NPL ratio stands at a significant 5%. There is a compelling opportunity for banks to offload these assets and for investors to acquire them with perceived downside protection, potentially fostering a more developed market.

Andrew Mortimer: While Barclays’ focus in the UAE excludes retail and SME banking, the overall sector’s performance is notable. UAE banks are experiencing record profits, supported by exceptionally strong capital positions (around 1,920% versus a 13% requirement) and high liquidity (over $200 billion in liquid assets).

This financial strength allows large onshore banks with retail and SME exposure to strategically address non-performing loan portfolios. Now is arguably the optimal time for them to absorb potential losses.

The current approach to NPLs is driven more by these favourable financial conditions than by the bankruptcy law itself. Crucially, the social stigma associated with bankruptcy in the UAE has diminished considerably, aligning with the banks’ capacity to manage these situations and offering a viable option for individuals facing financial distress.

Lara Sif Hrafnkelsdottir: To effectively encourage banks to offload non-performing loans (NPLs) from their balance sheets, providing a compelling incentive is crucial. The ability to sell these assets at a discounted price serves as a primary motivator, aligning with the investment strategies of certain market participants. Specifically, investors specializing in distressed and stressed assets are actively seeking such opportunities, recognizing the potential value inherent in these portfolios.

This dynamic is evident in the recent emergence of portfolio NPL transactions. Significantly, earlier this year, Abu Dhabi Commercial Bank (ADCB) successfully divested 1.1 billion in NPLs to a hedge fund. This portfolio comprised loans from 44 Small and Medium-sized Enterprises (SMEs), illustrating a concrete example of this trend. This transaction, along with others that have occurred, highlights a growing appetite from investors for these types of assets.

Andrew Mortimer: Banks are particularly mindful of their reputation and strive to maintain a positive image. Therefore, in the marketplace lending (MPL) sector, when a bank intends to sell a portfolio, it must be sold to a suitable buyer. This is to prevent the buyer from jeopardizing the bank’s reputation by engaging in overly aggressive enforcement tactics to recover funding.

The market continues to mature, more professional and experienced hedge funds are entering the MPL space. These sophisticated investors view the market as a viable opportunity and are confident in their ability to operate within it. This market maturity has led to a growing confidence in local regulatory, legal frameworks, and structures, enabling a greater flow of transactions.

In summary, banks prioritize their reputation and are cautious in selecting buyers for their MPL portfolios. As the MPL market matures, more professional hedge funds are entering the space, leading to an increase in transactions and confidence in local regulatory and legal regimes.

Jody Waugh: Navigating the Complex Terrain of Non-Performing Loan Recovery

In the past, the approach to non-performing loans (NPLs) has predominantly focused on straightforward recovery. The assets and clients involved in these transactions were primarily seen as opportunities to recoup value. Consequently, the most effective strategy for dealing with NPLs often depends on the specific composition of the portfolio in question.

Currently, there is a notable increase in activity within the simple distressed debt market, especially concerning individual assets, projects, or clients. This segment is attracting significant interest from private credit and private equity firms, suggesting that it could be a promising avenue for value recovery when assessing NPLs. The key considerations in such cases are whether legal mechanisms can be effectively utilized and whether the underlying business remains viable. If both conditions are met, investors can potentially capitalize on the situation through restructuring and subsequent business turnaround.

However, the central bank plays a crucial role in NPL transactions. Although they have allowed foreign funds to acquire assets in two instances, this was primarily due to the perception that these transactions were recovery-focused and did not involve performing loans. The central bank closely examines the data related to these portfolios, including their composition, the entities involved, the collection strategies, and the projected recovery rates. This thorough scrutiny highlights the central bank’s deep understanding and concern regarding the risks associated with NPLs.

In the context of bankruptcy law, the feasibility of restructuring or settlement as recovery tools is fundamentally determined by the structure of the debt and its current stage. These factors will ultimately decide whether restructuring or settlement can provide a viable and effective pathway to successful recovery.

Loai Bataineh: Private Investment Offices and Family Offices: Awareness of Bankruptcy Law

 

Tycoon Families: These families possess significant wealth and impact, often operating with implicit government oversight. They are aware of bankruptcy law and may face government intervention to manage their affairs.

Financially Savvy Families: These families have the resources and expertise to navigate the business environment and utilize legal and financial mechanisms, including securitization. 

Smaller Family Businesses: These entities have limited influence and rely on guidance from banks. 

Evolving Sophistication: There is a significant shift in the sophistication of family businesses in the region. Younger generations are highly educated and possess a deep understanding of business practices. They are often involved in succession planning and demonstrate a commitment to financial responsibility. 

Reputation and Data-Driven Decision-Making: In the past, the reputation and personal guarantee of the family patriarch were crucial for loan agreements. Today, families present data-driven business plans and expect banks to make decisions based on financial performance. This shift reflects the increasing focus on cash flow and sound business practices. 

Cross-Selling Capabilities of Banks: Banks play a vital role in monitoring the financial health of family businesses through cross-selling capabilities. Loan facilities can be tied to cash flow channelled through the lending institution, allowing for sophisticated oversight. 

Conclusion: There is growing awareness of bankruptcy law among family offices and investment firms in the Middle East. The increasing sophistication and expertise within these businesses, has led to a data-driven approach to decision-making and a focus on financial stability.

Loai Bataineh: The Evolving Landscape of Oman’s Financial Sector

Despite its experience in the real estate market, Oman’s financial landscape has faced significant challenges in recent years. While its non-performing loan (NPL) ratio remains elevated at 4.8%, an increase attributed to the decline in oil prices, restructuring efforts and legal reforms are underway to address these issues.

Oman’s NPL Ratio: Oman’s NPL ratio is higher than that of other GCC countries, although Qatar’s ratio is slightly higher at 3.9%. This increase has been driven by the country’s reliance on oil and gas revenues, budget deficits, and the transition following the passing of the late Sultan Qaboos.

Restructuring and Law: To address the NPL problem, the government has taken measures to restructure the economy, move away from its dependence on oil and gas, and improve its fiscal discipline. The Central Bank of Oman has also adopted a more conservative definition of NPLs.

Challenges for SMEs: Small and medium-sized enterprises (SMEs) face particular challenges in Oman. Despite a mandate from the Central Bank of Oman that banks allocate 10% of their loan portfolios to SMEs, many banks are hesitant due to concerns about management and structural integrity.

Recent Improvements: Despite the challenges, Oman’s financial landscape has shown signs of improvement in recent years. Rising oil prices and successful restructuring efforts have reduced the budget deficit and the debt-to-GDP ratio. The government has also explored innovative financial instruments such as securitization.

New Opportunities in Restructuring: The increased focus on restructuring has created new opportunities for senior bankers in Oman. Many have pivoted to restructuring consulting, providing much-needed expertise to the financial sector.

In conclusion, Oman’s financial landscape remains challenging, but restructuring efforts and legal reforms are underway to address the NPL problem. The government’s commitment to economic diversification and fiscal discipline, combined with the rise of restructuring consulting, offers hope for the future of Oman’s financial sector.

Andrew Mortimer: Banking Regulations and the SME Sector

Regarding SMEs, it’s evident that there’s a significant opportunity in the private credit market for SMEs, given the substantial liquidity gap. The 2% of bank lending is SMEs very low. How can banks change their risk profiling?

In my role at Barclays and as the chair of the British Chamber of Commerce for Dubai, which has over a thousand member firms, many of which are SMEs and entrepreneurs, I’ve heard firsthand the frustrations these businesses face, even in basic matters like opening bank accounts. The challenge for banks, however, lies in what I term the ‘cost to serve.’ As a bank, you must consider the cost of servicing a customer against the revenue generated from that customer, along with the associated risks. In the SME sector, the cost to serve is relatively high, while the risks are also significant.

This context is important, especially considering the recent history of the UAE. A couple of years ago, the country was placed on the Financial Action Task Force’s (FATF) grey list due to concerns over financial crime. The UAE has since worked diligently to address these issues and was successfully removed from the grey list earlier this year. The country is keen to maintain this status, and the regulatory environment has become increasingly stringent. The Central Bank of the UAE, the primary regulator of the onshore banking system, has implemented a robust supervisory regime that subjects banks to intense scrutiny. This regulatory pressure adds to the cost to serve, making it commercially challenging for banks to justify lending to SMEs when considering the potential revenue and the regulatory costs involved.

However, the UAE leadership has ambitious plans, such as the Dubai 33 initiative, which aims to double the size of the economy over the next decade. For this to succeed, the SME and entrepreneurial segments must play a crucial role. The recent improvements in bankruptcy laws, for instance, are a positive step toward building a stronger and more supportive platform for these businesses. Nevertheless, there are still significant challenges to overcome. The tension between regulatory pressures and the need to support SME growth is a critical issue that needs addressing.

Omar Al Yawer: The Evolving Middle Eastern Market – A Magnet for Foreign Investment

A compelling illustration of this trend is the recent acquisition of National Bank of Kuwait Capital (NBK Capital), a prominent private credit fund in the Middle East, by Janus Henderson, a US-based asset manager overseeing trillions of dollars in assets. This acquisition signifies more than just a strategic move for Janus Henderson to access Middle Eastern capital. Crucially, it reflects a deliberate decision to actively invest within the region. Credit markets in the region offer the potential for significant returns without the need for excessive leverage, outperforming comparable markets in the West.

This influx of major asset managers is not a coincidence. It is a direct consequence of regulatory reforms and the visionary economic plans being implemented by countries like the UAE and Saudi Arabia. Large entities are relocating entire teams to the region, signifying a deeper commitment to active investment. This trend extends beyond traditional asset management, encompassing hedge funds and private equity firms from the UK and the US.

This growing interest is even influencing personal career decisions. Globally, developed nations are grappling with concerns regarding safety and security. In contrast, the Middle East offers a compelling combination of financial opportunity and a robust security environment. The ability for families to live and raise children without the pervasive anxieties of gun violence or petty crime adds a significant layer of appeal, creating a “perfect storm” – a confluence of factors driving business growth.

This confluence of factors points towards a potential “golden era” for the Middle East. While the longevity of this advantageous period remains uncertain, the current trajectory suggests significant potential for at least the next decade.