Sukuk Defaults in the Kingdom: A Case Study in Saudi Arabia’s Opaque Bankruptcy Process.
Brian Sturgess - March 2013
- The World Bank ranks Saudi Arabia 23rd globally for ease of doing business, but in 123rd position for enforcing contracts and in 90th for the resolution of insolvency.
- A dispute between two Saudi family run business groups that started in 2009 has left international banks owed US$20 billion although Saudi creditors have been largely satisfied after government intervention.
- Corruption, close government links with family run corporations and preferential treatments for domestic creditors in bankruptcy are all hallmarks of crony capitalism.
- Cronyism holds back Saudi Arabia’s ability to attract FDI to fund its infrastructure needs, but the unresolved dispute will also deter bank foreign bank lending and the ability of the Kingdom to raise finance through innovative means of Islamic finance such as sukuk bonds.
Arabia has been ranked 22nd out of 185 countries in the world in
terms of ease of doing business.
This relatively high overall global position is based on an assessment of a
number of indicators and it reflects the economic and commercial reforms the
Kingdom has been carrying out for more than a decade. In sharp contrast, Saudi
Arabia has a very poor reputation for enforcing legal contracts and is currently
ranked in 123rd place by the same high profile survey published annually
by the World Bank. This low ranking will frustrate the Kingdom’s avowed
ambition to attract foreign investment to diversify its economy away from an
overdependence on petroleum.
Bank reports that it takes an average of 635 days to enforce a contract in
Saudi Arabia compared to 370 days in the USA. In cases of insolvency, Saudi
Arabia was also ranked well below its average ranking in 90th position
showing an imbalance in the country’s progress to put in place the judicial
reforms necessary to create a business-friendly environment. The World Bank
found that it took an average of 2.8 years to resolve a bankruptcy (close to
Senegal’s 3 years), but well below the 1.5 years in the United States which
itself was only ranked in 16th position in this category. However,
in terms of recovery rates following insolvency the report stated that
creditors gained an average of 81.5 cents on the dollar in the US compared with
only 28.0 cents in Saudi Arabia. Aside from the statistics Saudi Arabia’s
legal system, particularly in cases of bankruptcy where the assets pledged are
within the Kingdom,, provides a system of commercial justice that is not blind.
Instead in some insolvency cases it gives preferential treatment to domestic over
foreign investors and creditors.
uneven playing-field between Saudi and international creditors in cases of
bankruptcy has been demonstrated in recent years by the failure to resolve an extremely
large case of financial default by a number of interrelated Saudi entities to
the satisfaction of foreign banks. The defaults were consequential on a dispute
between the executives of two high-profile indebted Saudi business groups – Ahmad
Hamad Algosaibi & Brothers (AHAB) and Saad Group. The complicated events in
2009 entangling these two groups has generated a dispute which is now entering
its fifth year, but it has left the global banking system owed a total of US$20
billion with no resolution in sight. There has been a government approved settlement to provide some satisfaction for Saudi Arabian banks and other creditors,
but the inadequacies of the country’s legal system means that foreign creditors
are still fighting for redress in courts outside the country. This dispute between
two Saudi Arabian business families both with close government connections
demonstrates the extent to which crony capitalism is still a prevalent feature
of business life in this autocratic Gulf Kingdom.
events have shown that crony capitalism is alive and well in Saudi Arabia. A
dispute between two of Saudi Arabia’s richest and most prominent families and
their highly indebted conglomerates – Saad Group and Ahmad Hamad Algosaibi
& Brothers (AHAB) - bears all the hallmarks of cronyism with a heady
cocktail of defaults, opaque judicial procedures, government intervention and
preferential treatment of domestic creditors. The dispute, which falls closely
in line with Wei’s definition of crony capitalism, has had far-reaching
consequences for international banks and for the reputation of the Kingdom.
dispute surfaced at the end of May 2009 when the Saudi Arabian Monetary Agency
(SAMA), the Kingdom’s central bank, unexpectedly froze the bank accounts of
Maan al-Sanea, chairman of the Saad Group, and an investment company with
interests ranging from real estate to health care and education, whose group
assets were over US$30 billion at the end of 2008. No reason was given by SAMA,
but the Saad Group’s credit rating was reduced from investment grade and was
subsequently withdrawn. This prompted a liquidity crisis and the company began
selling off its assets.
cause of SAMA’s action anticipated an impending lawsuit filed by a Saudi
leading family, the al-Gosaibis, against al-Sanea for unpaid loans and fraud.
The central bank’s drastic action, taken before any legal hearing, would have
needed the approval of King Abdullah. The connections between the al Saud royal
family and the al-Gosaibi clan are very close and predate the founding of the
modern state. Al-Sanea is related to the al-Gosaibi family by marriage and his
wife is the niece of Sulaiman Hamad
Al Gosaibi, who headed the conglomerate Ahmad Hamad Algosaibi &
Brothers (AHAB) prior to his death in February 2009.
who has his own political connections including the former Emir of the Eastern
Province (EP), Prince Mohammed bin Fahd and Crown Prince Sultan , founded Saad
Group after his marriage and it has expanded rapidly in the last decade from
its basis in real estate and is now a diversified conglomerate involved in
construction, private education, hospitals and banking. In
2007, he acquired a 3.1% stake in HSBC Holding PLC for US$6.6 billion. In 2008 Forbes
had listed him as the 62nd-richest person in the world.
his marriage al-Sanea became a senior executive of an AHAB company - Money
Exchange - but in July 2009 the al-Gosaibi family accused him in a legal action
in New York of fraud with a potential total value of US$10 billion. It was
alleged that he frequently falsified documents to divert funds for his own use.
In a defence against an action by Masreq, a Dubai based bank seeking to recover
debts from AHAB, it was alleged that al-Sanea had overseen 52 transactions
totalling US$4.7 billion between Mashreq and AHAB involving the use of an
account at Bank of America in New York. In 2009, both groups defaulted on loans
made by scores of regional and international banks in the region totalling just
under US$20 billion. The narrative of the dispute in the following years
between the two groups is complex and the Al-Sanea and Al-Gosaibi businesses
are so entangled that it is difficult to establish who is owed what and who is
responsible. The impact of the dispute on the credit position of the
international banks has followed the lines predicted by Wei as one of the
consequences of crony capitalism.
creditors harmed by the dispute have received preferential treatment - another
feature of a crony state. In September 2009 Muhammad al-Jassar, the governor of
SAMA confirmed that the Saad Group had reached an agreement to settle with its
Saudi creditors. Llocal banks owed as much as US$7 billion, agreed to take a
haircut of around 15%. The settlement and subsequent asset transfers demonstrated that SAMA allowed a lift on the asset freeze of Al Sanea and his companies. The dispute had tightened lending across the Gulf, particularly to Saudis.
However, while Saudi creditors appear to be satisfied by the restructuring,
international banks have been forced to seek redress in foreign and Saudi
courts. For example,
in October 2011 French bank Societe Generale won a case in a London court to
force one of Saad Groups subsidiaries to repay a US$50 million loan on which it
had defaulted in July 2009.
case highlights a disturbing element of the external impact of this dispute,
namely the preferential treatment awarded to Saudi over international
creditors. More worryingly, this conduct receives the implicit approval of the
Saudi state. In an early move to resolve the dispute between the two families a
Royal Committee was established in 2009. Its membership included the Saudi attorney general, judges, high-ranking
officials and representatives of the central bank, the Saudi Arabian Monetary
Agency and the financial regulator, the Capital Market Authority. There were
also representatives of the ministries of the interior, commerce and justice.
The deliberations of the committee have never been published, but an indication
of its final recommendations can be gleaned from filings made in Los Angeles by
al Gosaibi lawyers against an American executive of The International Banking
Corporation, a Bahraini bank which collapsed in 2009.
The Royal Committee is reported to have
recommended that the dispute was a private affair between the al-Gosaibi family
and al-Sanea, which must be settled by Saudi law. Al-Sanea was to complete the
restructuring agreed at the end of 2009 with Saudi banks, but no mention was
made of foreign creditors. It is reported that the committee only ‘allows
creditors "operating in the Kingdom" the right to bring legal action
against both parties to get their money back.
who study the economic impact of cronyism would not be surprised by this
dispute and the damage it is causing both to unsatisfied creditors – the
international banks that had extended loans to the two groups – and to the
image of Saudi Arabia itself. Crony capitalism is not only ethically dubious
and anachronistic, it is also inefficient. It has been defined as:
“…an economic system in which the
adjudication of commercial disputes as well as the allocation of resources are
generally made to favour those who have a close relationship with political
leaders or government officials (by blood or by bribes). It is a system in
which connection trumps competence, and money supersedes merit.”
from the lack of transparency of its legal system in cases of insolvency noted
in the World Bank’s Doing Business league table further evidence of the
existence of crony capitalism is suggested by the Kingdom’s international
position in terms of perceptions of corruption. Transparency International
ranked Saudi Arabia in 66th position in the world out of 176
countries surveyed. Shang-Jin Wei carried out an in-depth multinational empirical
study of crony capitalism with data from 103 countries over a twenty year
period and suggested that the existence of cronyism and corruption are highly
“…crony capitalism almost always implies a
widespread corruption as private firms and citizens in such an environment
would find compelled to pay bribes to government officials in order to achieve
also found that cronyism has a negative impact on sustained and balanced
development since it discourages long-term and productive direct foreign
investment. He also found, however, that there was a positive correlation
between cronyism and international bank lending implying that the companies and
citizens of more corrupt countries tend to finance investment more through bank
debt than other forms of funding. This can affect the composition of the
capital stock in ways that are not favourable to a country and the money
borrowed is often used either channelled abroad or used for speculative
investments in real estate and commodity trading.
Saudi Arabia perceived cronyism holds back the country’s economic development
hampering attempts to diversify the economy away from its overreliance on the
petroleum sector. Although the country had a GDP per capita of US$21,200 in
2011, petroleum activities still accounted for around 80% of government income,
45% of GDP and 90% of export earnings. This imbalance is being imperfectly
addressed as long as the country does not treat foreign creditors fairly. Indeed,
there is also evidence that crony capitalism discourages the influx of foreign investment
that will be needed in Saudi Arabia to create employment in the medium-term.
Arabia has been undertaking reforms for more than a decade to move the country
towards having a more open, market-focused economy. The Saudi Arabian General
Investment Authority (SAGIA) was established in April 2000 to provide services
and facilities to promote investment and economic development in the Kingdom. The
pattern of FDI shown in Chart 1 demonstrates the success of Saudi Arabia in
attracting FDI after the creation of SAGIA, but continuing uncertainty about
Saudi Arabia’s commercial judicial system appears to be counteracting the
initial successes. Although Foreign Direct Investment (FDI) in Saudi Arabia
rose strongly from 2005 onwards the most recent report from SAGIA shows that
annual inward FDI declined from a peak of US$38.2 billion in 2008 falling to
US$28.1 billion in 2010. More recent data from the United Nations Conference on
Trade and Development estimates that FDI into Saudi Arabia fell sharply by 42%
to reach US$16. 4 billion in 2011 According to Saudi sources in 2010, the
largest single country source of investment was the USA with 14.7% of the total
followed by France and Kuwait accounting for 13.6% and 8.7% respectively.
is the imbalance of inward capital into a country which is weighted towards
bank loans necessarily favourable to the lenders themselves who may be chasing
short-term business since as Wei argues:
“…there is a limit on
how much international arbitration or court proceedings can help to recover the
assets, as there is a limit on how much collateral the foreign creditors …can
seize as compensation.7
is exactly what has happened in the Saad Group- AHAB case. A significant aggregate
value in loans has been extended by international banks to the two Saudi based
family run conglomerates, but after their default whereas the claims of some
domestic creditors have been addressed following government intervention, not a
judicial ruling those of non-Saudi creditors have been completely ignored. This
is an unsatisfactory situation. A country wishing to take advantage of the
benefits of belonging to multinational organisations like the WTO must meet its
obligations. Furthermore, if international banks are holding back from
extending credit to Saudi companies as a result of the financial mess following
the defaults, this is providing an opportunity for domestic lenders who are
assured a greater level of security by the Saudi legal system. Data published
by SAMA, the Saudi central bank, show that total bank credit extended to the
private sector in local currency has soared from 701.7 billion riyals in 2009
to 951.0 billion (US$253.6 billion) by the end of 2012.
It has been
estimated that Saudi Arabia will need to spend around US$400 billion on
infrastructure over a five year period and the government’s officials have been
looking for foreign partners to provide funding.
of the WTO was also seen as part of a programme to attract foreign investment.
As part of this initiative six
"economic cities" were established as focal points in different
regions of the country. On the country’s accession to the WTO the Saudi
Arabian Minister for Commerce and Industry, Mr Hashim Yamani, stressed the
importance of the WTO in the context of a reform programme instituted to
improve the business climate for foreign and domestic business. He said:
“This is a high point in the programme of
economic and structural reform that Saudi Arabia undertook…The accession will enhance
the business environment in Saudi Arabia by adding more transparency and
predictability. This we expect to lead to more investment and job creation."
government’s reforms have been aimed at job creation for Saudi nationals,
mainly for reasons of political stability. If the official statistics are to be
believed while nearly 8 million foreign nationals provide an essential role in
the Saudi economy, unemployment among Saudi nationals (males only) was 10.5%
last year, but unofficial estimates place the figure higher at nearly 25%, what
is more unemployment among young people is likely to be higher.
Finding employment for its relatively young population, the
median age is only 25.7 years ,
is a government priority in Saudi Arabia... Many young Saudis lack the
education and technical skills the private sector needs, so the government has
substantially boosted spending on job training and education. At present since
nearly 90% of Saudis in employment work for the government, an expansion of the
private sector is essential to absorb those trained without leading to social
disaffection. A similar trend can be witnessed in Abu Dhabi which has achieved
some success in diversifying its economy (See Boyfield (2012).
source of finance is to tap into the growing market in Islamic finance
particularly sukuk debt securities. In January, 2012 the General Authority of
Civil Aviation (GACA) in the Kingdom raised US$4 billion sukuk in sovereign
debt, although Saudi banks have been selling sukuk securities through Saudi
British Bank for some years. The GCC sukuk and a number of smaller issues
allowed the Kingdom to take second place after Malaysia in terms of global
sukuk issues in the first half of 2012 as shown in Chart 2.
bonds are a relatively new form of financial security. The Islamic Fiqh Academy
at a conference meeting in February, 1988, legitimized the concept of a sukuk,
by ruling that subject to proper legal documentation:
‘.. any collection
of assets can be represented in a written note or bond; and that this bond or
note can be sold at a market price provided that the composition of the group
of assets, represented by the security, consists of a majority of physical
assets and financial rights, with only a minority being cash and interpersonal
The first Sukuk originated
from a non-Islamic company, Shell MDS, although it raised RM 125 million in
Malaysia. From its small beginnings
in 1990 the sukuk sovereign and corporate debt market now stands at a market
value of well over US$100 billion. Since then the sukuk market has grown
rapidly after shaking off a downturn associated with the global financial
crisis. In 2001, US$1,172 million of sovereign and corporate sukuk were issued
according to the Islamic International Financial Market. In fact, the value of sukuk issues grew to US$48.8 billion in 2007 before
falling to US$18.6 billion in 2008. Growth in the market returned strongly in
2009, with a 38’% increase in issuance to US$25.7 billion. By 2012 new issues
in the market were estimated to have topped US$121 billion as shown in Chart 3.
The market’s revival was led by Malaysian
domestic issues, accounting for 72% of sukuk issuance by value by 2011 with the
remainder split between Sudan, Pakistan, Indonesia, Brunei, Bahrain, the UAE
and Saudi Arabia. However, despite
the robust growth in this market and the Saudi state’s ability to tap into it
relatively successfully, investor appetite, particularly from non-Saudi’s for corporate
sukuk’s may well be limited as a result of the opaque Saudi legal system in
cases of insolvency and its preferential treatment of foreign creditors. The
uncertainties arise from a US$650 million sukuk default in 2009 which stems from
the same dispute between Saad Group and AHAB that has left international banks
with a US$20 billion deficit in their balance sheets.
question of the nature of relevant assets is essential to Islamic finance.
Sukuk securities are based on shari’ah compliant
structures which avoid the payment of a coupon or interest which is forbidden.
Furthermore, pure financial instruments cannot be traded under shari’ah,
so sukuk securities have relevant assets of either real
estate, capital equipment or a commodity which are held in a Special Purpose
Vehicle (SPV) which issues the debt securities. The asset must be specified in
the contractual documentation so that when investors buy and sell sukuk securities
in a secondary market they are, in effect, trading their rights to receive
income from a real underlying assets and not a stream of income specified by
the coupon. There is, therefore, a subtle difference between conventional bonds
which may be asset backed with the assets as collateral and sukuk, where the
bond holder has a right to a share of the services provided by the asset. Over
the full term to maturity sukuk securities can effectively mimic the
main characteristics of similar length conventional bonds and price comparisons
can be made with yields reflecting for both types of security the risk
weighting of the issuer based on the probability of default. However, it is in
the actual eventuality of default that significant differences occur.
The sukuk market, because of its relative youth,
is particularly vulnerable to information shocks: the limited number of
defaults so far and the immaturity of rating systems means that cases where
investors are treated unfairly will have a magnified impact on the future
growth in the market. So far, there is no global standardized contract and
documentation process relevant for this product, consequently there is no
consensus of countries abiding by one set of rules and this is causing
uncertainty. While Malaysia’s legal system provides protection to sukuk
investors a series of high
profile sukuk defaults in the Gulf such as Investment Dar, Saad Group (Golden Belt) and Dubai World’s
Nakheel Sukuk in 2009, as well a s the
East Cameron Sukuk in the US provoked a debate on investors’ protection and rights. In
Saudi Arabia, the subsequent history of the Saad Group default illustrates
another example of the impact of crony capitalism in Saudi Arabia where legal
uncertainty could damage the sukuk market.
Golden Belt 1 case will prove a test case of the impact of a default event (a
dissolution event in a sukuk trust) on a sukuk security within the Kingdom. In
May 2007, a subsidiary of Saad Group raised US$650 million through the sale of
Islamic securities which were subsequently traded on the Bahrain Stock
Exchange. The notes were structured
around real estate in Saudi Arabia that was leased to the Bahrain-based Golden
Belt 1 Sukuk Co,. a special purpose vehicle, with a Declaration of Trust over
the leased assets made on 15 May. In turn, the leased assets were parcels of
land in Saudi Arabia all under the unencumbered legal ownership of Mr Mann Al
Sanea, the chairman of Saad Group. A series of Promissory Notes were signed by al-Sanea as chairman of Saad Group at the time of the issue in order to guarantee the rental payments from the parcels of real estate. Although it was noted that the calculation of the payable rental amounts were not directly linked to the value of the land parcels and that this involved a risk that the amount of the payments could be challenged in a Saudi courts apply the principles of equity, this risk is mitigated by the existence of the Promissory Note. Finally, the issue document stated that although the security was issued in Bahrain that The Promissory Note will be governed by the laws of Saudi Arabia and that the Negotiable Committee of Saudi Arabia has jurisdiction to hear all disputes relating to the Promissory Notes. These assets were vulnerable
to the asset freeze resulting from the dispute with AHAB. Saad Group was rated at
BBB+ by Standard & Poor’s and baa1 by Moody’s rating agencies and the bond
certificates received the same ratings.
A lack of resolution for international creditors in the Saad and Al Gosaibi dispute would be extremely harmful
to the country’s proclaimed investor-friendly image and set back the progress
achieved by those reforms already enabled.
The broader dispute and the outstanding
sums still owed to international banks shows that Saudi Arabia’s domestic
economy has been effectively captured by rent seeking individuals and families
who are nurtured by the autocratic political system. This creates an impasse
because in the short-term real reform which would create a level playing field
internationally is hampered by the need to keep these groups in business
instead of facing the employment consequences of a real default and a seizure
of their assets. In the longer-term, the resultant cronyism hampers the ability
of Saudi Arabia to attract the investment necessary to address its severe and
growing social problems.
The existence of family
dominated business conglomerates based on concessions, government and corporate
patronage and corruption reduce competition in the Kingdom and hold back the
creation of a dynamic private sector. It has been noted that unemployment among
Saudis is high and probably higher than revealed by official figures. An
indication of this is provided by estimates of the incidence of poverty in the
Kingdom where the lack of accurate
figures and official statistics makes it a controversial issue. According to recent
statistics, the government announced that the social security services have helped
around 800,000 cases where a case is a unit indicating one Saudi family, with
the average family size in Saudi Arabia being between six to eight people. The
Ministry of Social Affairs announced later on that its services would include
families of up to 15 persons. This means that the number of poor people in
Saudi Arabia exceeds six million out of an estimated population of 20 million.
The sukuk market and international lending could be an important means
of helping to fund the over US$219 billion of announced 2013 expenditures on
social welfare and infrastructure projects the Saudi state estimates to be
Financial Market (IIFM), (2011), Sukuk Report (second Edition)
Wei, Shang-Jin (2001)
Domestic Crony Capitalism and International Fickle Capital: Is There a
Connection? International Finance, 4:1 pp 15-45.
Doing Business (2013), Smarter
Regulations for Small and Medium-Sized Enterprises, World Bank, http://www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual-Reports/English/DB13-full-report.pdf
Wilson, R (2004) Overview of
the Sukuk Market’ in Adam, N.J. and Thomas A Your Guide
to Issuing, Structuring and Investing in Sukuk, Euromoney.
Rate in Saudi Arabia is reported by the Central Department of Statistics and
Information. Historically, from 1999 until 2010, Saudi Arabia Unemployment Rate
averaged 10.1% reaching an all time high of 12.0 Percent in December 2006 and a
record low of 8.1% in December of 1999. The unemployment rate measures the
number of people actively looking for a job as a percentage of the labour