Tuesday, January 26, 2010
Cloak and Dagger, Smoke and Mirrors
As you might imagine there are a lot of conspiracy theories floating around about the Dubai crisis. I want to talk about two in this post one implausible the other completely plausible.
The first theory that has been posted both as a comment and as an email to me is about the Abu Dhabi refusal to back Nakheel and the subsequent debt standstill by Dubai at the end of November. This touched off a global panic for a few days that was not as obvious in the US on account of the Thanksgiving holiday. More immediately it touched off a panic in the Nakheel Sukuk market. The bonds traded down to $0.44 on the dollar, slowly drifted back up to around $0.65. Then in late December Abu Dhabi rode to the rescue and paid off in full.
The theory is that the Abu Dhabi and Dubai planned the whole thing so that they could knock down the price of the bonds and then buy them back more cheaply and then pay them off and avoid default. I think there is zero chance that this is what happened. For one thing, if they were really serious about that then they could have used much harsher rhetoric and threatened an actual default rather than requesting a standstill agreement and that would have driven the bonds much lower. Also if they were so interested in buying back as many bonds as they could get their hands on why did they halt trading on the DIFX? All they did was force the trading to go on in London where, as it turned out, it was easy for hedge funds to get at them. Additionally the increased borrowing costs for all the other Dubai entities that have resulted from the Abu Dhabi bail-out two step are sure to dwarf whatever could have been saved with this clever sleight of hand. No, I don’t think that’s what happened.
No I think what happened was more along the lines of the official narrative. Abu Dhabi got skittish about rescuing the more farfetched of the Dubai property ventures and drew a ring around the things it would save. Nakheel was outside that ring. Abu Dhabi miscalculated however because the very next Nakheel Sukuk to come due had a clause which enabled the bondholders to go after the international assets of Dubai World in event of default. This would have involved massive public humiliation for all involved and so Abu Dhabi paid off.
The other conspiracy theory that has been both posted as a comment and emailed to me, anonymously in both cases but I did some sleuthing and I think the person might actually be connected to one of the parties involved. It has to do with my favourite topic: the Damas heist.
I wrote in an earlier blog post about a curious “unauthorized transaction” in which Damas lent $80 million to a private equity vehicle by the name of Dubai Ventures. Dubai ventures never paid interest on the loan which then accrued to something like $84 million at which point the loan was converted to equity. When the PWC forensic accountants going through the “unauthorized transactions” came upon this vehicle they inquired as to what was in the holding company and were told that what was in the fund were $20 million shares of Damas itself. This is really a mystery and in my original article I theorized that someone must have made off with the missing $64 million, perhaps to buy yachts or Ferraris with it.
Readers of this blog have posited a different and to their eyes a more benign theory. Their theory is that when the book building process was underway for Damas during it’s IPO there was not enough interest to make the offer a success. The Abdullah brothers who control Damas made a call to someone friendly at Dubai Holding who agreed that its private equity subsidiary Dubai Ventures would make a substantial subscription to the IPO on condition that Damas make Dubai Ventures whole. The “loan” and its conversion to equity were Damas keeping up their end of the bargain. The fact that a mere $20 million worth of shares remain in the vehicle is accounted for by the fact that Damas shares have declined substantially since the IPO, not because the funds were stolen outright.
This theory has the ring of truth to me. In the summer of 2008, as the global financial crisis gathered steam it was important for Dubai to not have a failed IPO in the DIFC. The Abdullah brothers were connected and well known and for their IPO to fail would have been particularly difficult. The powers that be probably thought that Dubai Ventures would be able to sell the shares in the aftermarket for a small profit and no one would be the wiser. Unfortunately Damas shares began to sink almost immediately and so there was never a chance for Dubai Ventures to get out but not to worry because the Abdullah brothers made them whole with the money of the other Damas shareholders. Ultimately they rode the shares all the way down until they got their call from PWC.
So what do you think? Was this not a fraud but rather an honest attempt to avoid embarrassment for the brothers Abdullah and more generally the DIFC and Dubai? Their hearts were pure when they put the transaction together but things did not work out as planned and as a result the shareholders are out $60 million? Not to worry though the Abdullah brothers plan to sell a yacht or two and pay it all back. No harm, no foul?
You know my answer to this. The issue is not whether their intentions were noble or not, what matters is whether or not they broke the law. Is there a law against this sort of thing in the DIFC? There sure as hell is. This plan was meant to conceal from the other investors that there was not enough interest in the IPO to justify the price being paid by the non-Dubai Ventures Shareholders. This scheme, if it took place, violated the DIFC Markets Law in several ways. Specifically The DIFC Markets Law, Part 8: Prevention of Market Misconduct, Chapter 1: Market Misconduct: Section 36(a): “contributing a misleading appearance of trading in or price for a security,” Section 38: “engaging in conduct relating to investments that is misleading” and Section 41: “a person in the DIFC shall not induce a person to deal by concealing material facts.”
So what is being done about this? Nothing. The DFSA is monitoring the situation but not conducting its own inquiry. The big international shareholders in Damas are emerging market mutual funds who claim to their investors that they have market knowledge in frontier markets so they will not bring a case because it would undermine their claims to know what they are doing. The inaction of the DIFC and the DFSA is not costless to Dubai. By undermining the integrity of the DIFC, the venue not only for this $80 million fraud but for the $80 billion restructuring of Dubai Inc. Their inaction puts Dubai as a whole at risk in order to spare the Abdullah Brothers and Dubai Holding some embarrassment.