1 October 2009Presented by: Mustafa Aziz Ata

The role of a Bond Market in an Economy

Aftermath of the crisis - the new world order

Financial integration is deepening, both globally

and regionally, making decoupling effectively

impossible

Despite the coordinated efforts by governments globally to support the international banking system in various forms of liquidity and capital injections, bank lending continue shrinking

– Balance sheet deleveraging, implementation of more conservative risk metrics/policies

– Access to (new) bank capital remains scarce and expensive

Debt capital markets are becoming the main source of liquidity for refinancing / funding gap

– Re-pricing of risk spreads makes corporate bonds an attractive investment proposal for investors

– Despite the higher spread environment, low underlying risk free rates reduces the nominal cost of debt for borrowers

The migration of borrowers from bank lending to debt capital markets seems to be systemic move rather than a temporary deviation from their traditional borrowing mix

– New bond sales volumes, across all market and geographies, have exceeded the historical highs year-to-date 2009

– The new issue supply to remain robust for the remainder of the year although banks show more willingness to lend thanks to recovering macroeconomic environment since March 2009

We have witnessed economies with active local currency bond markets resumed to growth much quicker than economies with a very high share of bank lending (e.g.. Asian economies)

Capitals flow in the wake of the crisis

Financial globalization went into reverse with capital

flows falling by 82 percent

In worst-hit countries, foreign bank credit

contracted by as much as 67%

Total cross-border capital inflows (% of World GDP)

One of the most striking effects of the financial crisis was a steep reduction in cross-border capital flows

Total capital flows as a percentage of the World GDP has dropped to 1.9%, lowest in the last decade

The sudden disruption of capital flows caused severe liquidity crises and shocks to the regional banking systems

The majority of the drop reflects withdrawal of bank lending to non-bank borrowers, particularly in emerging markets

*Source: McKinsey, Global captial markets: Entering a new era, September 2009

MENA Capital Structure

The Middle East lacks balance among various

channels of financial intermediation; although

improving, the region continues to be dominated

by the banking sector

This creates systemic vulnerability during times of crisis; albeit no asset class

has been spared from the recent turmoil

Japan’s “lost decade” provides an excellent

example of the perils of a bank dominated market

And Korea, with an active bond and stock market,

recovered more rapidly than their peers following the

1997 crisis

*IMF Global Financial Stability Report (2004 & 2008), HSBC Analysis

Stock Mkt Cap Debt Securities Bank Assets

2004 2007

MENA

Global

The optimal capital structure, exhibited by the global aggregate, is a balanced distribution

Due to equity market growth, the balance

improved from 2004 to 2007; however, over the past 12 months,

regional stock market capitalizations have

decreased significantly

MENA External Financing Structure

Bond Loan Equity

MENA

Global

UAE

Egypt

2003 2005 2007

Globally the asset class

mixed is balanced

Banks dominate

throughout the MENA

Region

The UAE has improved

dramatically

Egypt remains the most

balanced in the region

According to IIF estimates, the gross foreign assets governments, banks and NBFI’s in the GCC alone

rests at US$1.5 trillion, c. 130% of GDP at June 2008

In addition to its capital structure, the MENA region

needs to diversify its sources of external

financing

*IMF Global Financial Stability Report 2008, HSBC Analysis

-

2,000

4,000

6,000

8,000

10,000

Janu

ary

2009

Feb

ruar

y20

09

Mar

ch20

09

Apr

il 20

09

May

200

9

June

200

9

July

200

9

Aug

ust

2009

Sep

tem

ber

2009

Oct

ober

2009

Nov

embe

r20

09

Dec

embe

r20

09

Financials Corporates Sovereign Sovereign Linked

Regional Issuances and Redemptions

2009 GCC International Redemption Profile*

*GCC Analysis, assuming bullet redemptions and refinancings

US

$m

MENA International Debt Issuance (Country)MENA International Debt Issuance (Product)

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

2000 2001 2002 2003 2004 2005 2006 2007 2008

Conventional Bonds

International Sukuks

Islamic Loans

Conventional Loans

The GCC faces c. US$48.5 billion in redemptions and refinancings over the next

year

Conventional loans have been the main funding

channel for the Middle East

The GCC has been the largest borrower out of the

MENA region

Debt market environment in the GCC

Regional CDS Spreads

0

100

200

300

400

500

600

700

800

900

1000

J ul-08 Sep-08 Nov-08 J an-09 Mar-09 May-09 J ul-09 Sep-09

Abu Dhabi CDS Qatar CDS

Saudi CDS Oman CDS

Bahrain CDS Dubai CDS

Bank appetite for long dated loans—a mainstay of the project finance market—is reduced, the region must evaluate the long dated project bond markets in order to finance the infrastructure requirements of the region

Name lending into family businesses will eventually diminish, these companies will need to enter the capital markets

Spreads for GCC issuers are “normalizing” as Qatar, Saudi and Abu Dhabi CDS levels are back to sub-100 levels

Global investor base is keen to add GCC exposure as oil prices have stabilized around USD 65 per barrel

Looking Forward

Local Currency Markets Development

International institutions can play a important role in establishing local currency

markets

Egypt is an excellent example of a newly

introduced and highly successful primary dealer

system

As international liquidity conditions stay volatile, the region’s government must

foster an active primary and secondary government

securities market

Benefits to the Economy and Markets

MENA Central Banks should develop the local currency bond market by establishing

a risk free yield curve that reflect the opportunity costs of funds at each maturity

This can be achieved through the issuance of the following security types:

– Treasury Bills (T-bills): Issued by the Government short-term financing

requirements.

– Government Bonds (Bonds): Issued by the Government in the 2year, 3year, 5

years and 10 years

– 10year maturity with fixed rate coupons to meet medium to long-term financing

requirements

Many regional banks already invest in Certificated of Deposits issued by the Central

bank to manage liquidity

Development of the Yield

Curve

Significant Government access to local currency funding

Observable/Transparent Government Yield Curve allows corporate risk to be priced

Eventual Development of Non-Government Dept Markets

Enhanced Asset/Liability Management among Financial Institutions

Efficiency in Monetary Policy, better control of Money Supply

Creation of long maturity assets for NBFI’s

Long dated government debt will provide the liability

profile necessary for regional projects

Summary

The MENA region has a healthy and rapidly

developing banking sector; however, access to capital

markets remains key for infrastructure investments

and economic growth

We believe that the development of an efficient Local Currency Debt Capital market is required to ensure a sustainable growth environment for GCC economies

Existence of a full fledged corporate bond market will reduce systemic risk and the probability of a crisis.

A market for direct debt also improves the incentive for banks to remain efficient and innovative.

A well functioning corporate debt disciplines and ultimately strengthens the banking system by providing competition for information-intensive bank loans at the margin.

The absence of a corporate bond market of sufficient size has two principal effects.

– First, the effects of misdirected credit preferences will tend to be magnified.

– Second, the absence of a sizable corporate bond market will aggravate the imperfections present in any financial regulatory system. The associated inferior risk assessment by the over-sized banking system and that system’s other weaknesses will tend to overwhelm, leading to productive over-capacity and non-performing loans