Investors are taking a new look at government-related entity debt in the UAE, but broad reforms are needed as well as competitive pricing to develop the secondary market.
"The (Dubai World) crisis has resulted in investors re-pricing their investments taking into account the different meanings of implicit or explicit (support guarantees)," said Nish Popat, head of fixed income at ING Investment Management.
"The market has adjusted re-rating issues based upon their belief of support. Going forward, with the Dubai World issue appearing as if this is resolved, is only the first step in the structural changes that are happening in the region."
Nine months on, spreads between bonds issued by government-related entities (GREs) and UAE sovereign debt are stabilising within ranges more likely to coax investors to buy credits offering fair value and a decent yield, albeit on a more critical creditworthiness basis.
"The widening of quasi-sovereign spreads (versus the sovereign) has been more pronounced for those entities with relatively weaker stand-alone profiles and/or weaker association with the government," said Nafees Akbarali, regional head of fixed income trading at Standard Chartered.
Yield spreads of Dubai Holding's 2014 bond versus Dubai's sovereign maturing in 2014 stood at around 900 basis points (bps) on August 16 after peaking at over 2100 bps on December 10. The Abu Dhabi GREs have also witnessed repricing of risk.
The individual credit profiles of state investment vehicle Mubadala or Tourism Development and Investment Company (TDIC) have led to spreads widening to a level investors think more realistically reflects the risk since the end of last year.
In Abu Dhabi, yield spreads of TDIC Sukuk versus the 2014 sovereign peaked at 207 basis points in March as Moody's downgraded seven leading GREs in the emirate including Mubadala, but they have since stabilised at around 170 points.
Following the Moody's downgrades in March, the Abu Dhabi government countered it had the fiscal position and reserves to meet its commitments to the firms concerned.
Yet, regional markets are very much driven by investor perceptions. Even without explicit support, a default on an Abu Dhabi state-linked credit is highly unlikely but issuers must still deal with the premiums the market demands.
Market participants say a resolution of the Dubai World restructuring and continued falling of spreads globally, combined with more primary issuance from the region, are likely to be key factors determining the direction and pace of growth the secondary market takes.
"We need the primary market to start flowing again in earnest. If we get a few more deals during the second half, Q3-Q4 that would certainly help," National Bank of Abu Dhabi's head of credit research, Chavan Bhogaita said.
Bhogaita added that international investors need to participate in the secondary market to drive volumes and liquidity.
Although current spread levels are likely to be a consideration for investors, the long-term development of the market will depend on other criteria.
"In times of differentiation, transparency, governance and liquidity will be key in attracting flows into any market. Attractive spread levels could lead to some interest, but longer-term trends in the development of the secondary market should be more important," Akbarali said.
Although market sentiment is improving, bonds of equal-rated credits in Dubai and Abu Dhabi are valued differently by investors, as reflected in trading patterns and pricing.
"The crisis has highlighted the greater need for transparency, and, combined with the lack of a yield curve, the growth of the secondary market remains at a slower pace than initially expected," Popat said.