china
INDIa
INDONESIa
KOREA
MALAYSIa
UAE
Bank lending goes green
Vodafone victory: Green light for foreign investors
Know your PE pitfalls
Have cash; will buy abroad
Relaxed restrictions bring respite
GCC infrastructure boom creates goldmine for law firms
PAGE 02
PAGE 05
PAGE 08
PAGE 11
PAGE 14
PAGE 18
FOREWORD
REUTERS/Tim Chong Cover: REUTERS/Sukree Sukplang
WELCOME Welcome to Singapore for the 2012 Asia Pacific Legal Executive Briefing. Over the course of the next few days we will be exploring changes to the regional market and legal profession with an eye towards understanding and serving your clients’ evolving needs. This Special Report - prepared specifically for attendees of the 2012 AP LEB – features prevailing changes and trends driving opportunity and risk in China, India, Indonesia, Korea, Malaysia and the United Arab Emirates. For each of these important jurisdictions you will find an insightful article written by a legal journalist from Asian Legal Business (ALB), along with an accompanying report highlighting the key political risks to watch out for written by a colleague from Reuters News. For example, as fund work increases in Indonesia where private equity houses are lining up for a slice of the PE pie, we explore the high degree of importance of personal relationships and advise close attention to the implementation of the new land law and whether the government can use this new regulation to improve infrastructure by attracting investors into private-public partnerships. In Malaysia, Prime Minister Najib
Razak’s New Economic Model is helping develop the domestic financial markets. We explore how it may result in more work flowing through the private banking and wealth management sectors to the legal community, and we highlight signs to watch out for that could strengthen calls for an early election, dampen this gradual reform and derail any opportunity. Over in South Korea, companies are swinging for the fences when it comes to outbound M&A – as highlighted by E-Land Group’s participation in a recent bid for the L.A. Dodgers. We delve into this trend in outbound M&A and shed light on the risks that could weaken this opportunity. I hope this Special Report proves interesting and useful to you and your partners. I’m looking forward to meeting you as we gather for the 2012 Asia Pacific Legal Executive Briefing. Sincerely,
Andrew M. Goldner Managing Director, ALB Thomson Reuters
MANAGING DIRECTOR Andrew Goldner andrew.goldner@thomsonreuters.com JOURNALISTS Ranajit Dam ranajit.dam@thomsonreuters.com Candice Mak candice.mak@thomsonreuters.com Shaheen Pasha shaheen.pasha@thomsonreuters.com Seher Hussain seher.hussain@thomsonreuters.com Zhen Liu zhen.liu@thomsonreuters.com COPY EDITOR Vasundhara Chatterjee DESIGNER John Agra Yvette Chiu
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
1
CHINA Bank lending goes green By Liu Zhen
REUTERS/Reinhard Krause
China has spent the last three decades prioritising the speed of its development, and it is now positioned as the world’s second-largest economy. But this immense and rapid growth has come at a price: that of China earning notoriety as one of the world’s major polluters. To combat this, the Chinese government has stipulated green friendly policies in its last two Five-Year Plans, and implemented a series of measures encouraging environmentally sustainable industries. In fact, it recently took a step further in this direction by introducing an effective and more powerful tool which is expected to support various such green initiatives. On Feb. 24, the China Banking Regulatory Commission (CBRC), the country’s top banking regulator, introduced the Green Credit Guidelines (Guidelines). These are aimed at encouraging commercial lenders to facilitate loans to green friendly enterprises, and also dry out the heavily polluting ones. In the Guidelines, the CBRC urged China’s banks and other financial
2
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
institutions to do three things: first, to provide stronger support to the green, low-carbon and recycling economic sectors; second, to strictly prevent environmental and social risks; and third, to pay attention to and improve the environmental and social responsibility performances of the financial
will also benefit foreign companies with energy saving and emission reduction technologies investing in or transferring to China. “This policy [Guidelines] will have an impact on the allocation of the already tight credit,” says Lin Wei, a Shanghaibased partner at Zhonglun W&D. Given the Guidelines’ expected consequences for the financial services sector and overall economy, it will also affect legal practices, he adds. Lenders are told by the Guidelines to reduce loans to industries with high energy consumption, high pollution rates, and excessive capacity. So-called “two highs and one excessive” industries, such as ferrous metal and non-ferrous metal smelting and processing, cement manufacturing, coking painting, and dyeing have already seen their loans drop by an average of 4.7 percent as of the third quarter of 2011, said CBRC official Ye Yanfei at the press conference that released the Guidelines. He said loans to these polluting industries should be stopped or called in, and “ought to be eliminated eventually”. According to Ye, the Chinese
“[Small enterprises] will be choked by cash shortages and so corporate lawyers could expect more mandates from heavy industry clients on mergers and acquisitions.” - Lin Wei, partner, Zhonglun W&D
organisations themselves. The Guidelines clearly requested that banks evaluate, classify, and rate the clients’ environmental and social risks no less than once every two years, and to use this evaluation to determine the enterprises’ ratings and their access to credit. The policy is also expected to
government is concerned that its emission reduction goals have not been accomplished to satisfaction yet. With the increasingly strict accountability system the government is introducing, the credit risk caused by closure or suspension of the polluter is also growing.
REUTERS/Jianan Yu
Ultimately, the CBRC wants “to cut off the financial supply of the disorderly development and blind expansion of those industries from the beginning, effectively blocking the violators’ funding chain and calming down their impulse to invest,” said Ye. The financial interference is expected to be more effective, in contrast to four previous “national environmental enforcement campaigns” by environmental authorities; none of which achieved the desired result. Current laws and regulations set the maximum fine imposed upon environmental polluters at an embarrassingly low 100,000 yuan ($15,887), and environmental protection agencies do not have the teeth to enforce the fine apart from administrative measures. With the new Guidelines, it is likely that the trend towards industrial
consolidation will increase. As only the larger entities can afford the “greener” technologies that will help them receive a higher environmental assessment and thus receive stronger financial support from the government, it will be the smaller enterprises that suffer. They will be choked by cash shortages, says Lin, and so corporate lawyers could expect more mandates from heavy industry clients on mergers and acquisitions. The green industries, on the other hand, are in desperate demand for cash, being relatively new and underdeveloped. “They used to rely largely on PE investment or equity financing. Now they have more debt financing channels,” says Lin. The Guidelines additionally encourage lenders to “actively create new financial products for green industries”, such as receivable mortgages, Clean Development Mechanism (CDM)
expected return mortgages, and stock rights pledges. As a result, legal practitioners are likely to find opportunities with the banks as they begin to structure these new products. The Guidelines urge lenders to examine their clients’ management of overseas projects and to make sure these projects comply with local energy, pollution, land, healthcare, security, immigration, as well as ecological protection and climate change laws among other requirements. This is expected to foster more due diligence and compliance investigation work for lawyers. It is also important to note that Chinese corporations that have already been operating overseas will be able to claim domestic bank credits citing their environmental contributions in foreign countries.
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
3
KEY POLITICAL RISKS TO WATCH IN
CHINA
By Chris Buckley
BEIJING (Reuters) - China's ruling Communist Party is preparing for a leadership transition while it deals with protests and price rises, but for now economic growth and firm controls are likely to avert serious ructions. SUCCESSION POLITICS Chinese President Hu Jintao and Premier Wen Jiabao are due to give up their main Communist Party posts in late 2012 and their state posts in early 2013, making way for a new leadership generation most likely to be led by current Vice President Xi Jinping. Most other members of the nine-member Standing Committee -- the Party's decisionmaking core -- are likely to retire in late 2012. The politics of determining who will fill those vacancies will increasingly preoccupy decisionmakers, slowing policymaking and deterring the government from grappling with contentious decisions. It will also make the Party even more wary of unrest and external crises. There will be competition for positions in the next phalanx of leaders. Some likely candidates have made little secret of their ambitions, including Bo Xilai, the charismatic Communist Party chief of Chongqing, and Wang Yang, the chief of Guangdong province. Chinese elite politics is largely circumscribed by the norms of conformity and unity around a leader, and the muted competition is unlikely to break out into open feuding or lead to major policy shifts. The growing public prominence of Vice President Xi and Vice Premier Li Keqiang indicates they are increasingly sure of succeeding President Hu and Premier Wen respectively. Xi will visit the White House in February, a trip which will enhance his credentials. One key issue will be whether Hu will remain chairman of the Central Military Commission, which controls the People's Liberation Army. Staying on would give him more sway over his successors. WHAT TO WATCH: Which emerging leaders make substantive policy statements and announcements. That can be a signal of their prospects and likely areas of authority. • Signs of political and ideological rivalry among aspiring leaders. This rivalry is likely to remain constrained, but serious economic problems, political scandals or external shocks could heat up the competition.
•
SOCIAL UNREST -- INFLATION, CORRUPTION AND THE INTERNET
4
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
The Chinese government fears that social unrest could escalate into broader protests and threaten its authority. That was exacerbated in 2011 by the worry of contagion from anti-authoritarian uprisings across the Middle East and North Africa, and the general security tightening is likely to persist, especially with the leadership handover amplifying official jitters. The most widespread sources of rancour are land confiscations and home demolitions for development, persistent prices rises and "corruption", a term that covers the whole spectrum of graft and illicit self-enrichment. Inflation and the slowing pace of economic expansion are also persistent concerns. Some analysts think growth in the first quarter of 2012 will be under the 8 percent seen as sufficient for job creation. Annual inflation in December was 4.1 percent, the lowest in 15 months, though it left the average rate above 5 percent. Most outbursts of unrest are small, local protests by farmers, workers and other disgruntled groups; the chances of mass unrest challenging Party rule soon remain scant. But a protest in Wukan Village in southern China in late 2011 showed that even these local outbursts can attract widespread attention and test the ability of officials to defuse discontent. Public anger, spread and magnified by the Internet, can flare into nationwide controversies that may erode public confidence in the government. Widespread ire over the handling of a deadly high-speed train crash in July underscored public distrust of officialdom, and a collision between two Shanghai subway trains in late September renewed fears about China's aggressive rail building plans. The far western regions of Tibet and Xinjiang also remain tense, experiencing periodic protests and violence by ethnic minorities who call the areas home. In Tibet, there has been a string of self-immolations in protest against Chinese religious controls, and in late January, Chinese troops were reported to have shot at protesting Tibetans, killing one. The Tibetan unrest is most unlikely to trigger sympathy protests in Han Chinese areas of the country -- on the contrary, a Western outcry against Chinese policy could prompt a nationalist backlash -- but with the traditional Tibetan New Year approaching from Feb. 22, government forces could face persistent defiance that spills over into international tensions. Such pressures encourage a mixture of tough security and aversion to policy gambles.
WHAT TO WATCH: Protests and strikes that, while local, put the government on edge. • Flare-ups of ethnic discontent. • Chinese government efforts to contain sources of protest, which could also affect companies, especially Internet and telecoms ones. • International reaction. In November, the United States criticised China for backing away from free market reforms and moving toward more state control of its economy as Beijing approaches the tenth anniversary of its entry into the World Trade Organization.
•
MILITARY EXPANSION AND REGIONAL MARITIME CLAIMS China must not give up on its security presence in Asia in the face of a major U.S. strategic shift into the region, a Chinese newspaper said in early January, although U.S. allies and analysts said China had nothing to fear from the new policy. China is concerned Washington's new posture, as it turns away from wars in Iraq and Afghanistan, is aimed at encircling it and could limit its growing power. One persistent point of tension between China and the United States in Taiwan. China deems the self-ruled island an illegitimate breakaway that must accept eventual reunification. The U.S. says it is obliged by law to help Taiwan defend itself, and U.S. arms sales to Taiwan have long been a key dispute between Washington and Beijing. China's reaction in late September to the White House's latest proposed weapons sales to Taiwan, however, was relatively muted, and Beijing will be relieved that Taiwan's relatively China-friendly president, Ma Ying-jeou, was reelected in January. Also, tensions over rival territorial claims in the South China Sea setting China against Vietnam and the Philippines, have eased and are very unlikely to break out into armed confrontation. China wants the United States to stay out of the dispute, and could be irked by U.S.-Philippines talks about expanding military cooperation. WHAT TO WATCH: Jostling incidents between ships or aircraft in the South China Sea and East China Sea that could escalate into confrontation. • Protests and public pressure in the countries involved, which could force governments to take a harder line. • How China responds to the nascent regime of Kim Jong-un in North Korea. China is the North's key ally, and its influence could shape Pyongyang's regional and global interactions.
•
INDIA Vodafone victory: Green light for foreign investors By Seher Hussain
All eyes were on India in January this year as investors, lawyers and other industry watchers waited with anticipation for the Supreme Court to deliver its decision in what has become a landmark taxation matter for the nation. The highest court in the nation came back with a resounding victory for Vodafone, clearing it of the $2.2 billion in capital gains tax demanded by the Indian revenue department, and bringing good news to foreign investors. The dispute centred around Vodafone’s $11 billion deal to buy Hutchison Whampoa’s Indian-based telecom business in 2007. The tax revenue authorities hit Vodafone with the massive capital gains tax amount, arguing that because the majority of the assets were in India, the deal was liable for tax. Vodafone defended itself by contending that the Indian tax department had no authority to tax a deal between two non-India based companies. It also said that even if tax was due, it should have been paid by the seller and not the buyer. The decision is a bright spot for foreign investors, who have lately been cautiously treading water when it comes to India; a slowdown in the economy (the government expects the economy to grow by 6.9 percent in the current year, the slowest growth in three years, according to Reuters), unseemly corporate scams and policy paralysis have deterred investors from entering the market. However, the Supreme Court judgment is being seen as a clear, positive message to the international market that the perils of doing business in India have been somewhat mitigated. It is a decisive step by the court, and a clear reinforcement of the rule of law. Cross border deals that were in suspended animation can now be revived, given the newly established certainty of the tax environment.
REUTERS/Mukesh Gupta
Rumours abound that the revenue department will not take this defeat lying down. The tax authorities have now been ordered to pay back the $496 million that they had collected from Vodafone as a deposit prior to the ruling; that too with 4 percent interest. These payments have the tax authorities under immense pressure.
tax transactions of this nature, or retroactively overturn their victory, which is Vodafone’s biggest concern. However, industry insiders remain wary but confident that foreign direct investment is more near and dear to the government’s heart than the tax department’s goals. Certainty of the investor environment is crucial to
Cross border deals that were in suspended animation can now be revived, given the newly established certainty of the tax environment.
One especially persistent concern is that the release of the new budget in March 2012 may bring along new tax legislation, legislation that could either set a precedent to tax future indirect
bringing in foreign money, and given that investment proposals in India plunged by 45 percent to a five-year low in 2011, according to Reuters, there is no better time to welcome investors back into the
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
5
REUTERS/Mukesh Gupta
country with a clear green light. Comparing India to other investment hotspots is illuminating in that China, Mexico and Nigeria have all dealt with similar disputes by enacting laws that tax transactions of this nature. In that sense, for the moment, India stands as a lone beacon for investors wanting to enter the market and conduct business free from indirect tax liabilities. Of course, it all depends on how deals are structured going forward. The Supreme Court has set forth six tests to determine whether a deal had been designed simply to avoid tax. These include the concept of participation in investment, the duration of time during which the holding structure exists, the period of business operations in India, the generation of taxable revenues in
6
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
India, the timing of the exit, and the continuity of business in the event of such an exit. Market sources have hailed the clarity and decisiveness of the Supreme Court’s judgment, adding that this is not a static set of tests. Going forward, they will be mutable depending on the situation. The most important take away from the tests, however, is the intent behind the transactions; whether they are motivated by genuine tax planning or by tax evasion. Advice for investors in this brave new world? Beware of smart deal structures with little substance; they will definitely be scrutinised by the tax authorities. Furthermore, the judgment is not a panacea for all inbound investments. Market players, on their part, should
remain cautious in applying the judgment wholesale to their pending deals. Some local sources also advocate a waiting period until after the budget is released in March before taking any significant investment decision. On the whole though, it is a welcome respite for the international community and the Indian marketplace. Foreign investors are predicted to step back into the game, albeit cautiously, as it seems there are no guarantees when it comes to India. For Vodafone at least, it is full steam ahead. Reuters reports that the company plans to launch an IPO of 30 percent of its Indian business later this year, which raise up to $5.26 billion.
KEY POLITICAL RISKS TO WATCH IN
INDIA
By Frank Jack Daniel
New Delhi (Reuters) - A weak economy exposed to an extended euro zone crisis, growing strain on the government coalition, and looming state elections that mean progress on tough reforms are unlikely are some of the risks to watch in early 2012 in the world’s largest democracy. ECONOMIC MALAISE A feel good rally in Indian markets has given welcome relief to investors after months of gloom that made the currency and the stock market among the world’s worst performing last year, but under the surface the problems afflicting Asia’s third-largest economy remain largely unabated and unaddressed. Inflation is down sharply, but almost entirely because of a drop in volatile food prices. And with the government embroiled in political wrangling over corruption scandals and unreliable coalition partners the prospects seem slim for tricky tax reform or a softening of foreign investment rules that could help deal with infrastructure bottlenecks. The winter session of parliament was an unmitigated disaster from start to finish. As a result of passing no major legislation, the government now has a heavy load of promised reforms to try and push through two fractious houses in the budget session in March. Fickle coalition partners and a disruptive opposition mean the government is often effectively a minority when it tables bills. Prime Minister Manmohan Singh promises to bring in a stalled policy to allow foreign supermarkets into India by March, along with a corruption ombudsman. The first stage of a new tax system is planned for April. On current form, nobody should hold their breath though. In December, Goldman Sachs’ Jim O’Neill called India the most disappointing of the BRICS countries, and warned of a risk of a balance of payments crisis if policymakers were not careful. Asia’s No. 3 economy is sitting on a comfortable cushion of $300 billion in foreign reserves and a confidence-building $15 billion currency swap line with Japan was unveiled in December, so comparisons with India’s 1991 payments crisis are premature. But as ever, India’s dependence on imported, then subsidized energy is a weakness, with high prices adding to pressure both on the current account and fiscal deficits. A drawn out crisis in Europe could exacerbate the capital outflows and further moderate exports. Morgan Stanley wrote in February that the ongoing fiscal and current account deficits will continue to pressure the rupee against the dollar over the long term. As the economy undergoes an extensive dele-
veraging process, we expect Indian equities and credits to underperform against their regional and emerging market peers during 2012,” it said. WHAT TO WATCH: Headline inflation. If price rises show a sustained slowdown, expect the monetary easing India Inc. has been demanding for months. • Moves to accelerate project approvals and implementation. • The global economy and domestic demand.
•
ELECTIONS AND POLITICAL WRANGLING Elections in five states early this year will test support for the ruling Congress party roughly half way through Prime Minister Manmohan Singh’s second term. Elections are hard to predict in India, but opinion polls suggest Congress could do better than a year of corruption scandals and disappointing growth would suggest. A poor result for Congress would compound the feeling that Prime Minister Singh is a lameduck. Already, and even from within the ruling Congress party, anger at Singh’s lackluster performance is on the rise, with growing talk in the Indian media that he could step aside this year to be replaced by a caretaker until elections. That is still unlikely and the government could probably also muster the support to survive a no-confidence vote. The government’s real saving grace may be the lack of appetite in the opposition Bharatiya Janata Party for an general election before 2014. Despite Singh’s woes, it is by no means clear the BJP has won over many voters to its Hindu nationalist cause. The party could win in farming state Punjab, and in the 200 million people strong Uttar Pradesh, any improvement on the 22 seats it currently holds in the 403 seat state assembly would be spun as a victory. Rahul Gandhi, son of current party leader Sonia Gandhi, has staked his political reputation on getting a good result in Uttar Pradesh, which may be a barometer for the national mood ahead of general elections in 2014. Even if the party comes in fourth place but forms a coalition government in the state he will be seen as a success. Party chief Sonia Gandhi, who is at least as influential as the prime minister, has made more public appearances but has shed no light on the illness she is suffering, which some Indian media reports say is cancer.
his mother steps down. The Uttar Pradesh election early next year is a key test. • Election results, which will be announced on March 6. • Political wrangling around the budget for the 2012/13 fiscal year, likely to be announced after the state election results in early March. BETWEEN CHINA AND PAKISTAN India’s foreign policy focus used to be first Pakistan, then China. Now it is more China, then Pakistan. Relations with Islamabad have improved considerably in recent months, with an upgrading of trade ties and an easing of visa regulations helping the thaw. Still, it would only take one armed attack in India bearing the hallmarks of Pakistani-based militants to reverse the advances. Partly in response to its worries about China’s steadily increasing influence among all its neighbours, not least Pakistan, India has forged closer ties with the United States, Australia, Japan and Vietnam. Pakistan’s own perilous political situation could have far reaching fallout for relations between the nuclear armed neighbours. This jostling between China and India is not necessarily dangerous and the risks are offset by growing trade and economic relations, but the rivalry will dominate India’s policy decisions for years to come. India is spending heavily on arms to keep pace with China’s growing military might, and the two countries still have unresolved border issues. India is also stepping up its involvement in Afghanistan, possibly at the behest of Washington, worried about a power vacuum as NATO troops withdraw in the next few years. WHAT TO WATCH: Development of ties with East Asian nations to counter China, not least in the South China Sea. Australia has mentioned the possibility of a tri-lateral security pact with India and the United States. India says this is not on the cards but is stepping up naval cooperation with Australia. • Pakistan’s domestic problems. The fall of the civilian government there could undo the progress made on normalizing ties in the past year.
•
WHAT TO WATCH: The Gandhi dynasty. Rahul Gandhi has yet to prove himself as an effective politician, raising concerns he will struggle to lead the party if
•
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
7
Indonesia Know your PE pitfalls By Ranajit Dam
REUTERS/Enny Nuraheni
With a population of almost 250 million, Indonesia is the largest economy in Southeast Asia, and offers an attractive alternative to the increasingly crowded Indian and Chinese markets. According to Thomson Reuters data, the country’s revised GDP growth for the 12 months ending Feb. 6, 2012 was 6.2 percent. The government has also shown signs of stability after a very long time - evidence of which are two recent peaceful elections. What is particularly enticing is the growing group of consumers within the country. More than half of the population is under the age of 30, and there is a fast-expanding middle class as well; domestic consumption has accounted for almost 60 percent of GDP in recent years. Funds have been flowing into the
8
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
country, according to media reports. Foreign direct investment (FDI) totaled $13.3 billion in 2010, and is expected to reach $20 billion in 2011, and there’s no surprise why. Growth is set to become exponential in consumer goods and services, such as food and beverages, retail, telecommunications, healthcare, and insurance. Additionally, the high level of activity in Indonesia’s mining sector is expected to continue; not just in coal but in other minerals such as nickel, gold and copper as well. Also, with its Master Plan for the Acceleration and Expansion of Indonesian Economic Growth (MP3EI), the Indonesian government is actively encouraging private sector participation in infrastructure. Not unexpectedly, private equity
houses are lining up for a slice of the action. Last year, the standout story was the $820 million raised by the PE house Northstar Pacific for its third fund - an impressive amount for an Indonesiafocused PE fund. In November, Chad Holm, a former investment banker with the Bank of America, announced plans to raise $1 billion in a new private equity fund to invest in the country. Holm’s fund, which is backed by Indonesian businessmen, will be primarily focused on financial resources and infrastructure investment opportunities in Indonesia. Funds like Saratoga Capital, Ancora Capital, and Falcon House Partners are also planning to raise private equity funds targeting Indonesia, with fund sizes varying between $300 million and $400 million. With Indonesia-
“[Personal relationships are] probably the main reason why a large number of global PE houses have been unable to succeed [in Indonesia] so far.” - Chad Holm, Yawadwipa Group of Companies (raising a $1 billion private equity fund to invest in Indonesia)
focused private equity firms increasing fundraising substantially from 2010, and big guns like KKR and Carlyle scouring the country for deals, there is no doubt that this is Indonesia’s time. But scratch the surface, and the picture doesn’t look as perfect as the hype claims it to be. Despite the relentless bluster of the past year or two, the private equity industry manages assets of less than $5 billion, say Indonesian authorities, compared with a stock market value upwards of $400 billion. Additionally, for all the talk about its potential, Indonesia remains a notoriously complex place to do business in. Suffice to say that while spotting a deal might be relatively simple, getting an accurate valuation of the deal, and concluding it within a reasonable time might be much harder. Finally, foreign PE investors must prepare for a number of potential issues ranging from complex tax regimes and restrictions on exit options to local politics, legal issues and a paucity of reliable partners. Another important trend that sets Indonesia apart from other emerging markets like China is that many of the assets available in the market have been owned by family conglomerates for a number of decades now. Most of these conglomerates are run by a matriarch or patriarch of fairly advanced age, who has a sentimental attachment to the asset in question, and thus is unwilling to let it go at a reasonable price. Owners of assets are happy not to sell until they are offered an extremely high price, and that makes it very difficult for PE investors, who are out looking for deals. After Indonesia was burnt by the 1997 Asian financial crisis, the country had an anti-private equity stand for a long time. There was a lot of opposition to the leveraged buyout model of private equity investing the subsequent surrendering of control. In recent years, while the market has grown to be much more receptive to private equity investment, the method of
acquiring a stake is different from other markets in the sense that deals don’t follow the typical LBO structure. Instead, investors often enter into joint-venture arrangements by owning minority, noncontrolling stakes. This is in part due to Indonesia’s so-called “negative list,” which restricts the percentage of foreign ownership in certain industries, giving PE investors no choice but to find local partners. Needless to say, due diligence is absolutely crucial in Indonesia. Lawyers say that when it comes to carrying out an investigation of a local partner, no avenue should be left unexplored, including tax avoidance, corruption, illicit payments that are in violation of international anti-corruption laws, the keeping of multiple sets of accounts and lax corporate governance, among others. The level of detail is also different when one compares it to Singapore or other developed markets. Additionally, the introduction of the UK Bribery Act and the increased awareness of the Foreign Corrupt Practices Act (FCPA) are leading to more requests from American and European investors to conduct anticorruption due diligence exercises prior to acquisitions. The way around a lot of risks for PE investors in Indonesia is to establish solid relationships with local entities – local government, well connected families and business organisations. But this, in many cases, requires a lot of hard work. Holm, who is looking to invest $1 billion in Indonesia through his Yawadwipa Group of Companies, talks about the importance of relationships with the big families, as well as other people on the ground. “Personal relationships have to be a priority,” he says. “It’s probably the main reason why a large number of global PE houses have been unable to succeed here so far.” Holm points out that many businesses have been operating in Indonesia over decades, and have been built their
reputations on a history of trust; outsiders would find it difficult to break in. He adds that it is only when an investor in the market and active in raising their profile, can they begin to be taken seriously. Finally, he stresses on the importance of communication. “You will never make any headway unless you initiate a dialog,” he says. “You need to communicate and understand how things work; how people think.” Sensitivity to the country’s culture and other issues of doing business in Indonesia is also critical. For one, terms of the deal such as pricing and so on can change very quickly even as talks are underway. It is up to investors to ensure the deal, including the due diligence, does not take too long, because it is possible that the same deal is being discussed in parallel with other parties. Crucially, the general partner (GP)– limited partner (LP) relationship, vital as a rule in private equity, is more so in Indonesia. At some point of time, PE houses will realise that they cannot rely on legal documents alone.
REUTERS/Enny Nuraheni
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
9
KEY POLITICAL RISKS TO WATCH IN
Indonesia JAKARTA (Reuters) - Indonesia’s economy expanded faster in 2011 than at any other time in the past 15 years, a rare case of Asian strength in the face of Europe’s debt crisis. The country has been rewarded with two recent credit rating upgrades to investment grade, decisions which will draw more money to southeast Asia’s biggest economy. Still, President Susilo Bambang Yudhoyono has no room for complacency. He reshuffled his cabinet in October in an effort to freshen his appeal, ditching some ministers who were seen as underperforming, and bringing in political allies. ECONOMIC GROWTH, POLICY AND INFLATION Indonesia’s economy expanded 6.5 percent in 2011, its highest since 1996, and annual inflation fell to a 22-month low in January, leading the central bank to cut rates this month to a record low of 5.75 percent as it sought to maintain the strong growth. The central bank, which generally supports lower interest rates, had already slashed its policy rate by 75 basis points in October and
By Neil Chatterjee
steep rate hikes that pushed investors to sell rupiah assets. WHAT TO WATCH: Policy statements by the central bank. Progress on the government’s plans to limit subsidized fuel and power use, which would spur inflation. • Retail sales data, exports and core inflation data.
• •
HAVE REFORM DRIVES STALLED? When President Yudhoyono was re-elected with a strengthened mandate in 2009, many Indonesians hoped the former general would use his second and final term to fight corruption, and shore up his legacy as a progressive reformer. In his cabinet reshuffle he said ending graft remained a priority, but he did not remove two ministers linked to corruption scandals. The country’s parliament in December demoted the chief of the country’s anti-graft body, who had been critical of lawmakers’
WHAT TO WATCH: The implementation of the new land law, and whether the government can use it to improve infrastructure by attracting investors into private-public partnerships. It has won state investment and loans from Japan and China, but delayed corporate bidding for some projects. • Progress on the anti-graft body’s case to prosecute the former treasurer of Yudhoyono’s own Democrat Party for graft, after the body’s leadership shake-up. • To what extent the opponents of reform, including those within Yudhoyono’s ruling coalition, manage to block other pro-investment policies.
•
SECURITY AND STRIKES Miners returned to work in January at Freeport McMoRan’s giant Grasberg copper and gold mine after a three-month strike in late 2011, though their deal for a 40 percent pay hike could spur further industrial action as workers seek a greater share of profits from economic growth. The strike was marked by worker clashes with police, attacks on employees and unexplained sabotage to company facilities, showing disputes over resource wealth and wages may turn violent. Workers on the island of Batam near Singapore went on the rampage in November to demand wage hikes, leading the military to guard industrial estates. Added to that, there were signs of increasing militancy and religious intolerance last year, with attacks on the minority Islamic Ahmadi sect, the burning of a church in Java and a series of unexplained parcel bomb attacks in the capital. The risk of a large-scale attack like the ones on two luxury hotels in Jakarta in 2009 has been reduced by the arrest or killing of senior figures in militant network Jemaah Islamiah, though security has been tightened at some Jakarta buildings. WHAT TO WATCH: Ability of militants to regroup and launch more attacks. Indonesia’s markets have proven highly resilient to attacks and unless there is a sustained deterioration in security, any sell-off could be limited and brief. • Protests and public pressure in the countries involved, which could force governments to take a harder line. • More arrests, and possible trials, of suspected militants. • Whether further labour strikes turn violent or are successful in winning hefty pay rises for workers.
• REUTERS/Beawiharta Beawiharta
November to shield the economy from the euro area debt crisis. Some analysts reckon the central bank has overreacted given the economy is not showing major signs of stress, unlike some of its exportreliant neighbours, and worry the rate cuts will spur inflationary pressures later this year that could force Bank Indonesia into a policy U-turn. The central bank, however, says there is still room for further rate cuts. Previous bouts of high inflation have led to
10
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
“hedonistic” lifestyles, replacing him with a little known lawyer, casting further doubt on the anti-corruption effort. Parliament passed few bills last year, and the government’s ineffectiveness at passing laws threatens the pace of reform. Still, in mid-December, parliament approved a longawaited land acquisition bill that investors hope will speed the implementation of infrastructure projects.
Korea Have cash; will buy abroad By Ranajit Dam
The recent announcement that E-Land Group, Korea’s top fashion retailer, was part of a consortium looking to buy storied baseball team, the Los Angeles Dodgers, out of bankruptcy provided a literal illustration of a well-worn metaphor: Korean companies are now swinging for the fences when it comes to outbound M&As. Local media sources say that E-Land will take a 15 percent share, worth 150 to 200 billion won ($133 to $177 million) in the Dodgers; and if it does, it will be part of a trend of cash-rich Korean companies snapping up assets worldwide with a passion. From January to October 2011, the country was the 10th largest acquirer in the cross border mergers and acquisitions markets, acquiring foreign targets equivalent to $11.2 billion in combined asset value. The acquisition spree leapfrogged Korea ahead of more traditional economic powerhouses such as Germany and France, and made the 2008 global financial crisis seem like a blip in the distant past. In 2009, the nation’s outbound figure dropped to $6.8 billion, but recovered to $11.9 billion by 2010 and hasn’t looked back since. A more telling trend is how rapidly Korean companies have turned from hunted to hunters in the span of just a few years. In 2005, Korea recorded only about $190 million in net M&A purchases (outbound M&As less inbound M&As); in 2010, the figure was $9.9 billion, a 51-fold increase in five years, according to the United Nations Conference on Trade and Development (UNCTAD). Some of this has been sparked by persistent turmoil in the eurozone, and continuing economic stagnation in the U.S., which has led to many U.S. and European companies being put up for sale. At their end, Korean companies today are flush with cash and keen on making buys as they seek to tap new markets.
REUTERS/Lee Jae Won
With China being an option now seemingly exhausted by Korean companies, Southeast Asia is looking like one of the most favoured destinations, and retail, natural resources, consumer goods, entertainment and pharmaceuticals are set to be the most popular sectors. Korean companies have shown particular interest in targets that have strong technological capabilities, apart from providing a springboard into untapped markets. An example has been steel producer POSCO, which took over Thailand’s Thainox, Southeast Asia’s largest stainless steel producer, for an undisclosed amount in September 2011 as it sought to gain a foothold in markets like Thailand and Vietnam. In
the 12 months preceding this acquisition, POSCO had also taken over Asia Stainless Corp in Vietnam and Taihan ST Corp in Korea. A number of Korean companies are partnering with private equity firms and pension funds in order to share the risk, apart from bringing more cash to the table. In May last year, Fila Korea teamed up with Mirae Asset Private Equity, the National Pension Service (NPS) of Korea, and the Korea Development Bank to acquire U.S. golf equipment manufacturer Acushnet Company for $1.225 billion. Pension funds and sovereign wealth funds are set to team up with acquiring companies in a far greater way in 2012, as commercial banks remain restricted
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
11
Korean companies have shown particular interest in targets that have strong technological capabilities, apart from providing a springboard into untapped markets. REUTERS/Jo Yong hak
by a number of regulations. In early February, the NPS, the world’s fourthlargest pension fund, announced that it would be making the first investment from the 8 trillion won ($7.13 billion) fund it had set aside just for this purpose. It proposes to do so by funding half of GS Engineering & Construction’s $300 million purchase of Spanish desalination company Inima. It is also set to fund Korea Telecom’s stake in South Africa’s Telkom for an estimated $600 million. Also, expect Korean companies to carry out a plethora of small to mid cap deals in the coming 12 months or so. Part of this is that the value of assets is likely to be generally smaller, particularly in Southeast Asia, where the majority of deals tend to fall in the $10 to $99 million category, and also in the sub-$10 million category. Then, there are also the generally volatile markets in the West, and investors - even the larger conglomerates - will be keen to hedge their risk and aim for smaller deal amounts. Smart investing has been a trademark of the Korean wave of outbound M&As, and it is no different for E-Land, as it queues up for a shot at the Los Angeles Dodgers. With a total of six World Series titles, 21 National League pennants, and ten Cy Young awards, the Dodgers are among the most successful Major League Baseball franchises in history. But its influence goes well beyond trophies. “The Dodgers are not just a baseball team, but a symbol of Los Angeles,” an E-Land spokesperson was quoted in media reports as saying. “If we succeed in acquiring the club, the company would have more opportunities to introduce our fashion and leisure businesses to the world.” For E-Land and its outboundhungry peers then, it’s game on.
12
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
KEY POLITICAL RISKS TO WATCH IN
KOREA
By Jeremy Laurence and Jack Kim
SEOUL (Reuters) - The outside world is warily watching North Korea for any signs of instability following the death of iron-fisted ruler Kim Jong-il and the emergence of his young and untested son as the secretive state’s new leader. Kim, who died of a heart attack on Dec. 17, was the driving force behind the North’s nuclear weapons and missile programmes, spending most of the country’s meagre finances on the military even as millions went hungry. He ruled for 17 years. The “Dear Leader” had a succession plan in place for a number of years, promoting his youngest son Kim Jong-un to prominent positions in the military and ruling party to ensure a third generation of dynastic rule. The young Kim is being aided by his uncle, Jang Song-thaek, and powerful elements in the military, in what is seen as a collective rule. Little is known about Kim Jong-un: only that he is believed to be in his late 20s and that he was educated in Switzerland for about two years. He has moved quickly to try to build a hardline image by visiting military sites around the country. The North has said it will carry on with the same policies, indicating it will continue to try build a nuclear weapon. It has twice tested a nuclear device. China, the North’s closest ally, has expressed its support for the new leadership, while Seoul and Washington have both said they wish to see a stable transfer of power. So far, they say, the transition appears to be going smoothly. Despite the change in leadership in Pyongyang, the North has not featured on the domestic political scene in the South, although both the ruling party’s new chief and the opposition say Seoul should be more accommodating to Pyongyang. This year, for the first time in two decades, the South will hold a parliamentary and presidential election in the same year. The main issues are the economy, jobs and the growing wealth divide. SOUTH KOREA: DIFFICULTIES FOR RULING PARTY The struggling ruling conservatives have changed their party’s name in a bid to revamp their image. The new name, Saenuri Party or “new world”, was ridiculed by some who had trouble hiding their dismay that this was best the party could offer as a sign of reform. Park Geun-hye has taken over as interim leader of the party as President Lee Myung-bak continues to slide into a ‘lame duck’ period with one year left in office. Park is finding it tough to breathe life into the party, and it is not clear whether she will succeed in averting a landslide
defeat in the April parliamentary election. The party has also been hit by a string of corruption cases. The main opposition party has completed a merger with a minority leftist party and picked a new leader, well on the way in preparations to contest the general election. A lawyer who was chief of staff to late President Roh Moo-hyun, Moon Jae-in, has emerged as a frontrunner for president in polls after playing a catalytic role in unifying the liberal groups in the coalition. Latest polls show him pipping Park. A liberal victory in this year’s elections will mean a shift toward more welfare initiatives, and possibly closer engagement with North Korea. Such a result could also impinge on Seoul’s close ties with Washington. WHAT TO WATCH: Conservative interim leader Park Geun-hye will oversee the nomination of candidates for the April election and will face the biggest challenge so far of dealing with people who do not get the nod. It could lead to further discord. • Popular software mogul turned professor Ahn Cheol-soo has not ruled entering politics. If he does join the political fray, the political landscape will change dramatically. • Democratic United Party’s Moon Jae-in may take on a greater role, possibly putting him in direct line to declare candidacy for president. It would put him at the top of the so far very weak field of left-leaning candidates.
•
NORTH KOREA: WHAT NEXT? Since his Kim Jong-il’s death, the North has bestowed a string of titles including “great successor”, “supreme commander” and “great leader” on Kim Jong-un as part of plan to build a personality cult around him. Unlike his father who disappeared from public view for 100 days after the death of the state’s founder Kim Il-sung in 1994, Kim Jong-un has embarked on a charm offensive by staging more than 15 “field inspections” in the past six weeks. Analysts say Kim’s visits, mostly to military sites, are designed to shore up his support within the army, and to prove his credentials as a “prepared leader”. The North has vowed it will continue with Kim Jong-il’s songun, or military-first, policy and has called on its people to rally behind the young Kim. But it has also acknowledged the “burning issue” of food shortages and the need to fix its moribund economy.
Analysts say there is no evidence to suggest succession is veering off track, but say it is still early days. Seoul has stated the change in leadership signals a possible “turning point” for interKorean relations and called for a return to dialogue. South Korea maintains the North must suspend all nuclear activities before it can agree to a resumption of regional aid-fordisarmament talks. Pyongyang quit the forum in 2009. The United States has also said it is willing to return to talks with the North, but insists relations between the two Koreas must improve first. WHAT TO WATCH: Signs that the transition is going badly, and that there might be a coup attempt. Such signs could include unexplained disappearances of the elite, overt challenges to Kim Jong-un’s authority, military-party friction, unusual military activity inside the country or on the Chinese side of the border. • Talks between the two Koreas, and possibly the United States. • The North allowing the return of international nuclear inspectors. This would be seen as sign of the North’s sincerity at wanting to rejoin the six-party forum. • For either Seoul or Pyongyang to make a concession which could end a three-year rift over the joint Mount Kumgang tourist resort in the North. • The possible resumption of food aid. The United States reportedly was close to agreeing to resuming food aid only days before Kim Jong-il’s death. • Third nuclear test. South Korean media reports have said the North was at work on a tunnel at its known nuclear test site, and that progress indicates it is ready to conduct a test. • Long-range missile test at a new site. The site near the North’s border with China is believed to be more sophisticated than its first facility. It could be used to test the so-called Taepodong-2 missile with an estimated range of 6,700 km (4,200 miles).
•
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
13
Malaysia Relaxed restrictions bring respite By Seher Hussain
The beginning of 2012 saw Bank Negara Malaysia issue a statement announcing several progressive measures aimed squarely at developing the domestic
REUTERS/Bazuki Muhammad
14
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
financial markets. With the nation consumed by election fever, these liberalisation measures tie into national sentiment by closely adhering to Prime
Minister Najib Razak’s New Economic Model, which aims to turn Malaysia into a developed country by 2020. Specifically speaking, restrictions have been relaxed on interest rate derivatives, as well as debt and foreign exchange trading. Asian economies across the board are expected to slow down in 2012 but avoid a slump, according to Reuters reports which also predicts GDP growth at 3.8 percent, down from 4.9 percent last year, for Malaysia. As such, there is a strong argument to move up the 2013 election date, and swiftly dispel any uncertainty that currently surrounds the business environment given that investors are prone to withhold crucial investment at the mere sniff of political insecurity. It is clear that the central bank’s announcement could not have come at a better time for the Southeast Asian nation. Undoubtedly one of the most significant measures with regard to foreign exchange is that from now on, licensed foreign banks will be permitted to trade one foreign currency against another. Some caveats do apply, such as the bank must be a licensed onshore bank, and that trading will be only allowed between a foreign currency and another foreign currency, not against the ringgit. Further rules have also been relaxed on domestic interest rate derivatives, with licensed banks now being allowed to offer ringgit-dominated interest rate derivatives to a nonresident. The take-away for the business world is that investors and companies will be able to manage their foreign exchange costs more efficiently, while financial institutions will have increased flexibility to include ringgit-based assets in their portfolios. For the legal practitioner, there is a definite knock-on effect. As more Malaysian banks start offering a greater range of financial products and services
As more Malaysian banks start offering a greater range of financial products and services to investors, more work is expected to flow through the private banking and wealth management sectors to the legal community.
REUTERS/Bazuki Muhammad
to investors, more work is expected to flow from the private banking and wealth management sectors to the legal community. These measures are part and parcel of Malaysia’s gradual liberalisation, of which one of the most closely watched facets has been the opening up of the market to foreign banks. The newest
entrant to the market is Japan’s Mizuho Corporate Bank. Combine that with other announcements that allow foreigners to hold up to 30 percent shares in banks, and Malaysia will have succeeded in drawing the interest of foreign investors. Local sources reveal that some international clients still hold archaic notions surrounding capital controls,
first established in 1988. If anything, this relaxation of restrictions will prove to the global community that that there are no capitals controls left in Malaysia, apart from the yet-to-be internationalised ringgit. As the global economy slows down, all eyes are on the Islamic finance market, a shining light amidst the gloom.
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
15
REUTERS/Bazuki Muhammad
As a trend, Malaysian transactional lawyers continue to see a robust amount of inbound investment and heightened international interest in the purchase of Malaysian assets.
16
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
According to Thomson Reuters data, Islamic bond issuance globally rose from $13.9 billion in 2010 to $23.3 billion last year. Malaysia is strategically positioning itself as an Islamic financing hub; recent stand out matters include one of the largest toll expressway companies, Plus Berhad, announcing that it plans to issue $9.7 billion in Islamic bonds in what will be the world’s largest sukuk offering. Taking an aggressive tack on two fronts, the government is not just limiting itself to “soft” measures to attract the international community. Brick-andmortar examples of its dedication to liberalise the economy are visible in two places - the Kuala Lumpur International Financial District, and the development of the special economic zone of Iskandar. The former covers more than 70 acres of land adjacent to the central business district, and aims to bring together myriad international and domestic financial institutions under one roof. The second is being developed in the
southern Johor area, and is modeled after the Pearl River Delta Economic Zone in China. As a trend, Malaysian transactional lawyers continue to see a robust amount of inbound investment and heightened international interest in the purchase of Malaysian assets. Leaving aside the banking and financial services sectors, other significant sectors of foreign interest include the real estate, healthcare, oil and gas/petrochemicals sectors. So what lies ahead? In a nutshell, the new rules should improve cross border investment and allow domestic banks to expand their product offering and cater to different investor appetites, while deepening their franchise base and enhancing their regional influence. Wider implications include the further liberalisation of the market for foreign investors, safeguarding the country’s economy in these times of turmoil.
KEY POLITICAL RISKS TO WATCH IN
Malaysia KUALA LUMPUR (Reuters) - Malaysian Prime Minister Najib Razak is widely expected to call national elections in the first half of 2012, aiming to win a fresh mandate while economic growth remains relatively strong and before a looming global slowdown jeopardises his chances. The election promises to be the most fiercely fought in Malaysia’s history, and January acquittal January of charismatic opposition leader Anwar Ibrahim of sodomy charges has added to the unpredictability of the outcome. The polls will be a test of whether Najib’s gradual efforts to reform the state-heavy economy and its race-based political system are enough to restore the ruling coalition’s prized two-thirds majority in parliament. Najib is widely expected to win the election, but further gains by the opposition would undermine his standing within the dominant United Malays National Organization (UMNO) party and could prompt a leadership challenge from a more conservative, less reform-minded candidate. Najib has maintained that the economy will grow by around 5 percent in 2012, but many economists have been scaling back their forecasts to below 4 percent as global uncertainties mount. The central bank has kept its benchmark interest rate on hold at 3 percent since May, although its latest policy statement highlighted growing concern at the worsening global outlook and many economists expect it to cut the rate soon. The budget deficit was expected to hit 5.4 percent in 2011 and the government expects it to fall to 4.7 percent this year. That target could be jeopardised by ramped-up election spending and a worse-than-expected global slump. POLITICAL TENSION The surprise high court acquittal of former deputy prime minister Anwar in January has given the opposition a formidable campaigner and eloquent critic of the government in what is likely to be an election year. But the impact of his freedom is not clear-cut -- some analysts say it could help Najib by undermining the opposition’s claims that the judiciary is controlled by the government. Najib has tried to claim the reformist mantle as UMNO struggles to retain support among young, urban voters but he faces resistance from conservative elements within UMNO who are loathe to give up affirmative action benefits for ethnic Malays. Najib pledged to repeal two notorious security laws last year, following the government’s heavyhanded response to street protests demanding electoral reform in July, but he has yet to replace them with new legislation. A new bill that bans street protests has cast serious doubt on his
By Stuart Grudgings
reformist credentials. A crucial gauge of his ability to reform the political system will be proposed changes to the electoral system that the opposition says is weighted in favor of the government. The three-party opposition alliance says it aims to campaign more strongly among ethnic Malays in rural areas, where support for UMNO remains strong, and to focus on recent corruption allegations against government officials. Religious tensions are also a concern. In late October, about 2,000 Malaysian Muslims gathered near the capital to denounce alleged Christian attempts to convert Muslims, widening a religious rift that could cost Najib minority votes. Political uncertainty has weighed on foreign investment since 2008 but speculative inflows in search of higher-yielding markets have boosted the ringgit currency. WHAT TO WATCH: Clues about the timing of the election, which must be called by March 2013. Signs that the global economy is deteriorating more rapidly could prompt Najib to rush to the polls before Malaysians feel the pain from a slowdown. Another reason for calling the election earlier would be to get in ahead of UMNO’s internal elections which will are likely to be held in the second half of 2012. • The risk of more protests, and government response to them, as well as racial and religious relations. Najib is trying to reach out to non-Muslim minorities who make up about 40 percent of the population. Last year, he set up diplomatic ties with the Vatican in a bid to win Christian support. • Resistance to reform. Najib’s promise to repeal the Internal Security Act and Emergency Ordinance as well as to reform other laws to promote civil liberties has been questioned by Perkasa, an influential conservative group backed by some members of UMNO.
•
REUTERS/Mukesh Gupta
Model” to promote greater competition. But the prime minister has since softened his stance on reforming the policy for fear of alienating conservatives among the majority ethnic Malays who make up about 60 percent of the electorate. Investors and the political opposition complain that the race-based policy has been widely abused, fostering “cronyism” and resulting in an economy run on patronage. The government is implementing a $444 billion initiative, called the Economic Transformation Program, that is aimed at propelling the country to developed nation status by 2020. WHAT TO WATCH: How the global slowdown affects the Malaysian economy, and how this affects development spending. • A possible rise in Malaysia’s budget deficit if the economy slows and the government ramps up spending in an election year.
•
ECONOMIC REFORM Najib pledged in 2010 to reform a decadesold affirmative action policy favouring ethnic Malays and replace it with a “New Economic
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
17
United Arab Emirates GCC infrastructure boom creates goldmine for law firms By Shaheen Pasha
The Middle East is likely to see a spending of more than $1 trillion in construction projects and infrastructure over the next decade. But the fallout from the global financial crisis may put a damper on traditional financing prospects. For law firms, especially those with expertise in areas such as Islamic finance, the infrastructure boom is a goldmine, which is creating opportunities for growth on the capital markets front as well as in project development. A number of local and international law firms in the Gulf have gone on a hiring spree in recent months to address the expected flood of business. Firms such as Eversheds and Vinson & Elkins have sought to enhance their infrastructure practices with high-profile recruits. Clyde & Co, which named projects veteran Adrian Creed of Trowers & Hamlin as partner earlier this year, says it is strengthening its project finance capabilities in the region. By doing so, the firm plans to support the burgeoning number of infrastructure projects that are planned and are currently underway across the Middle East, particularly in the Kingdom of Saudi Arabia and Qatar. “The projects market in the Middle East is not just important, but rather it’s critical,” says Jawad Ali, managing partner of King & Spalding’s Middle East offices. “The region is in need of some serious infrastructure investment to allow the populations of these countries to grow in the quality of life. I think the next five years will be the most critical in the development of the Middle East.” Regional governments are the main drivers of this push to spend billions on infrastructure. Ali says that financing for projects has traditionally come through government funds and syndicated loans from a mixture of local and international banks. But international banks are struggling with mounting global economic fears as well as their own balance sheet woes, thus making
18
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
lending less attractive. Local banks also do not have the same level of funding to facilitate large-scale projects and tend to only finance those developments implemented within their own borders. This creates an opportunity for capital markets in the form of Islamic bonds, or sukuk, to become an increasingly important potential source of funds. Saudi Arabia, with projects worth $623 billion currently underway, according to the economic weekly MEED, is expected to lead the charge in the Gulf. Saudi Arabia’s General Authority for Civil Aviation (GACA), meanwhile, is funding the building of the 27 billion riyal ($7.2 billion) King Abdulaziz International Airport in Jeddah through a series of Islamic bonds that are fully guaranteed by the Saudi Ministry of Finance. Saudi Arabia’s Al-Jadaan & Partners has joined global law firm Clifford Chance in advising on the deal. Legal experts say that project sukuk has not caught on rapidly due to the perception that they can be time consuming and more costly, and that it involves the creation of a special purpose vehicle which uses the sukuk proceeds to pay a contractor to build a future project. Also, there is no standardised documentation for a sukuk structure. But there is more willingness now to gain familiarity with the sukuk as an alternative, and that is creating more business for legal entities in the Gulf. “Project bonds have long been heralded as the future, and the jury is still out to a large extent,” says Dominic Harvey, Abu Dhabi-based partner at Vinson & Elkins. “As a refinancing strategy to take out short-term debt, there is certainly more support and I would expect this to be more prevalent.” Recent project sukuk, such as the $1 billion Saudi Aramco Total Refining and Petrochemical Co (Satorp) issue, are expected to help pave the way for future issuance as sponsors become
more comfortable with the structure and process, legal experts say. Allen & Overy, in association with Abdulaziz AlGasim Law Firm as well as Linklaters and Hourani & Associates in affiliation with Meshal Al-Akeel Law Firm, were the
legal advisers to the deal. Harvey says the project finance practice is considered a major growth area, prompting Vinson & Elkins to expand with a Saudi Arabia office to further target project finance work.
Social infrastructure such as power, water and wastewater projects will be key, while transportation infrastructure, alternative energy and more metals and petrochemical facilities will keep law firms busy in days to come.
Eye on Qatar The tiny Gulf Arab state of Qatar, the world’s top liquefied natural gas exporter, is also on the radar of law firms in the region. The country has allocated 40 percent of its budget between now REUTERS/Morteza Nikoubazl
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
19
and 2016 to infrastructure projects. State-owned property developers Barwa Real Estate and Qatar Diar, for instance, are set to spend 100 billion riyals ($27.5 billion) over the next five years to 2016 on commercial and residential projects, according to a national development strategy unveiled last March for the country of 1.7 million people . The government is backing that with promised public investment worth $95 billion during the period, over $65 billion of which is expected to be on infrastructure. Much of Qatar’s development boom is in anticipation of the 2022 soccer World Cup. There are plans to spend $11 billion on a new international airport, $5.5 billion on a deep-water seaport, and $1 billion on a transport corridor in Doha. An additional $20 billion will be spent on roads. Among its ambitious projects, Qatar plans to implement a $41 billion rail project. In October last year, Qatar Railways had stated that it had received bids from around 60 consortiums with at least two contractors each for the same. The project will include four rail lines, and will link stadiums that will be used to host the various matches of the 2022 soccer World Cup. The rail project is also expected to have an underground component in the centre of the capital city of Doha. “Qatar will be an increasingly important part of the landscape in the region,” says Muneer Khan, Middle East partner at Simmons & Simmons. “They have a hard deadline for development. I think we will see more Islamic financial institutions in Qatar, and the wider region being called upon to invest heavily in that.” Khan adds that Islamic finance is likely to play a larger role in
20
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
REUTERS/Anwar Mirza
infrastructure development, through traditional project financing structures, sukuk or securitisations, in Qatar and markets such as Saudi Arabia and the UAE. As a result, there will be an increased need for law firms to bolster their Islamic finance practices with lawyers who have genuine practical experience in structuring and executing such transactions in the region. UAE looks towards alternatives The United Arab Emirates is also aggressively pursuing its infrastructure strategy, while keeping an eye on alternative financing methods, including Islamic finance. “Dubai has been a symbol for region,” says Khan. “I have often heard from clients in markets, such as Kuwait and Saudi Arabia, that they would like to develop their infrastructure in the same way as Dubai.” Last year, Dubai raised $800 million by securitising road toll receipts, and plans to use the proceeds to fund infrastructure projects in the Gulf emirate. The emirate’s Roads and Transport Authority, which operates the electronic toll collection system Salik, was projected to contribute about 3.4 billion dirhams ($925.7 million), or 11.5 percent of the 2010 budget income. The
actual Salik contribution has not been made public. Both Dubai and Abu Dhabi have also set their sights on building infrastructure for renewable energy. In Abu Dhabi, Masdar plans to invest $15 billion in renewable energy projects such as the world’s flagship carbon-free city. Neighbouring emirate Dubai, likewise, announced plans to launch a $3.27 billion solar park by the end of 2013 which will be aimed at generating electricity. Capital markets work is not the only area of opportunity for law firms. Ali says his firm is advising a number of infrastructure funds that raise equity for the sole purpose of investing in projects. As the private sector becomes increasingly involved in the projects market, there is also increasing work for infrastructure related M&A transactions and project development work such as land contracts. “Projects and project-related work is becoming more and more important,” says King & Spalding’s Ali. “You’ll find now that if you don’t play a part in the projects market, the other work is just not of sufficient size to justify your existence and growth in the region.”
KEY POLITICAL RISKS TO WATCH IN
United Arab Emirates DUBAI (Reuters) - The United Arab Emirates is vulnerable to any fallout from tension over Iran’s nuclear programme, which has escalated after Tehran threatened to shut the Strait of Hormuz and stop the flow of the bulk of the region’s oil. On the domestic front, the UAE has escaped the upheaval that has shaken the Arab world, but the case of five activists convicted of insulting the country’s rulers suggests the oil producing state is not immune to calls for reform. UAE President Sheikh Khalifa bin Zayed alNahayan pardoned the five, a day after a state security court sentenced them to prison terms ranging from two to three years. The case had been seen as a gauge of how the oil-producing Gulf Arab state, which allows no political parties, responds to hints of dissent after uprisings toppled other Arab leaders. The UAE has also shown little tolerance towards Islamists. It stripped six nationals suspected of links to an Islamist group of their citizenship late last year. The emirate of Dubai, which built itself into a finance and trade hub only for its real estate bubble to burst in 2008-09, faces possible debt refinance and investor flight risks. Below are some of the risks facing the UAE: DOMESTIC UNREST Chances of protests in the UAE are widely considered lower than in other Arab states due to the small indigenous population and huge oil wealth, especially in the emirates of Dubai and Abu Dhabi, where the federal capital is located. But Emirati activists have been calling on the Internet for a greater say in government, legislative powers for the 40-member Federal National Council (FNC) and less censorship. In December last year, the UAE revoked the citizenship of six nationals whom it said posed a threat to national security. The men, affiliated with an Islamic organisation, said they were being punished for demanding political reform. Observers suggested that besides Iran, the UAE’s top security concern was a potential rise of political Islam. Islamist parties won parliamentary elections in Egypt, Tunisia and Morocco and are expected to play a major role in Libya. Any unrest would likely emerge in one of the five northern emirates, whose citizens have benefited less from Abu Dhabi’s vast oil wealth or Dubai’s trade - and property-fuelled development. Northern emirate Ras al-Khaimah has seen small protests, quickly crushed by security forces. But even there, Abu Dhabi is spending billions of dollars to improve the living conditions in these less developed emirates.
WHAT TO WATCH: Whether the government will grant the FNC more powers. • Increased public debates over political reform. • Widespread arrests that could trigger local protests. • More moves against Islamist activists.
•
DUBAI DEBT AND FINANCIAL WOES The UAE economy is expected to grow by around 3.1 percent in 2012, according to a Reuters poll in December, down from last year, but higher than the 1.4 percent in 2010 when Dubai struggled to restructure its debts. Dubai’s finances remain a concern after the global financial crisis burst its property bubble, shelving multi-billion dollar projects and leading to thousands of job cuts in 2008-09. The property sector is still suffering from oversupply, but the economy has picked up. Abu Dhabi, home to most of the UAE federation’s oil wealth, lent Dubai $10 billion, helping avert default on a bond issued by Nakheel. Dubai World and Nakheel have both reached agreements to restructure about $41 billion in debt. A year-end rally in Dubai-related bonds sends a positive signal for 2012, suggesting more investors are becoming convinced the emirate can arrange smooth refinancing for state-owned firms next year. But there are still major doubts Government-related entities in Dubai have bonds worth $3.8 billion maturing in 2012. With the real estate market still sagging, the stock market moribund and many banks reluctant to lend because of global financial instability, investors have worried that some of those bonds might be restructured, with changes to repayment terms that disadvantage creditors. The crisis has strained relations with the wealthier but more staid Abu Dhabi, which is itself tightening the purse in its territory and shelving non-essential projects. WHAT TO WATCH: Will Dubai’s government-linked firms be able to make their debt repayments? • Will Abu Dhabi have to intervene again to meet any Dubai debt obligations?
•
REGIONAL ISLAMIST MILITANCY The UAE has so far been spared any attack by al Qaeda. But Dubai, a business and tourism centre that attracts many Westerners, could make an attractive target for Islamist militants. In 2009, al Qaeda’s Yemeni and Saudi branches merged into a regional arm. They
By Jeremy Laurence and Jack Kim
claimed responsibility for a failed plot in October 2010 to send two parcel bombs to the United States that were intercepted in Britain and Dubai. Al Qaeda in the Arabian Peninsula (AQAP) has threatened to attack Westerners in the region and has said it sees the UAE as its fourth target after the United States, Saudi Arabia and Britain. UAE’s tight security may have helped it prevent attacks. WHAT TO WATCH: Any expansion of al Qaeda attacks in the region could put other Gulf countries, including the UAE, at risk.
•
IRAN ESCALATION, SANCTIONS The strategic Gulf Arab region could be affected if the dispute between Iran and Western powers over Tehran’s nuclear programme escalates into armed conflict. A U.N. nuclear watchdog’s report suggested Iran’s nuclear programme could have a military nature. Tehran denies this. Following the report, Britain and the United States introduced tougher sanctions on Iran. The UAE’s foreign minister said on Nov. 30 that his country only supported U.N.-imposed sanctions and it was up to private sector companies to choose whether to abide by other sanctions. Dubai has strong trade links with Iran. A leaked U.S. diplomatic cable said leaders of the UAE regarded Iran as “its primary external threat, and one that is existential in nature”. The same cable portrayed Abu Dhabi’s crown prince, one of the most powerful figures in the UAE, as holding the view that “the logic of war” dominates in the Gulf Arab region when it comes to dealing with the Iranian challenge. A recent New York Times article described in detail how the crown prince recruited Blackwater founder Erik Prince to build up an 800-member battalion of troops for the UAE. The UAE’s extensive purchases of U.S. arms, and facilities it offers to the U.S. military, could make it a potential target for revenge if the nuclear dispute spirals into military conflict. WHAT TO WATCH: Any signs the Iran nuclear dispute could turn into a military conflict. • More sanctions on Iran, a major Dubai trade partner, could affect a recovering UAE economy.
•
2012 ASIA PACIFIC LEGAL EXECUTIVE BRIEFING
21