The Gulf Co-operation Council (GCC) countries are creating some of the world’s most powerful entities, led by the sovereign wealth funds that are now repeatedly coming to the rescue of some of the world’s largest investment banks, recently including Citibank and Merrill Lynch.

Charles Roxborough, who leads management consultancy McKinsey & Company’s global corporate and investment banking practice, estimates that by 2020 sovereign wealth funds, of which some of the richest are located in the Middle East and north Africa (MENA) region, will have invested a staggering $7000bn in capital markets. “They’re reshaping strategies at banks and intermediaries,” he says. He believes that hedge funds, Asian central banks and sovereign wealth funds have tripled their market position since 2000 and now make about 5% of global investments.

Powerful players

The Gulf’s petro-dollar-fuelled cash boost has allowed it to create powerful and impressive new investment banking players, such as Dubai newcomer Noor Islamic Bank, all of which have aggressive ambitions to become global players. Given their government backing and focus on Islamic finance, which has become key to banking in the Gulf, these banks stand to rival the traditional global investment houses of the US and Europe.

Although there will always be a place for bulge-bracket players such as HSBC, Goldman Sachs and Morgan Stanley, given their international footprint, expertise and access to capital, the new Gulf banks have put the pace of investment banking in the region into a higher gear.

Dubai’s new darling, Noor Islamic Bank, is emerging as a key player for 2008 as it aims to create the world’s largest Islamic bank within five years, spending between $500m and $1bn on individual acquisitions in countries as far apart as Indonesia, Egypt and the UK. Noor intends to make its first purchase this year, and is targeting Islamic banks as well as conventional lenders that can be converted into operations that comply with sharia law.

Testimony to the growing importance of sharia-compliant financing, Islamic banks controlled assets worth about $750bn at the end of 2006, a figure that may rise above $1000bn by 2010 as the industry expands, according to McKinsey.

Hussein al-Qemzi, Noor’s chief executive, says the bank might consider expansion into Kuwait and Saudi Arabia, although he notes that there “are limited opportunities in the Gulf”, hinting at intense competition in the regional market.

Noor began operations last month with a share capital of $860m. Two Dubai government-owned bodies, Dubai Holding and its Dubai Investment Group subsidiary, hold a 50% stake in the new bank; the rest is said to be held by 15 investors, including Noor chairman Sheikh Ahmed bin Saeed al-Maktoum. Given that Noor is backed by some of the biggest players in Dubai, its management team is unsurprisingly of high calibre with a distinct Citibank flavour.

Rivalling Noor is Abu Dhabi’s Al-Hilal Bank, which was established by the Abu Dhabi Investment Council in October 2007 with capital of about $1bn but which has yet to announce a launch date.

Globalisation

Continuing the globalisation trend, Qatar’s Doha Bank plans to form a joint venture investment bank with a major global bank by mid-2008. Chief executive Raghavan Seetharaman says that Doha Bank will open offices in the United Arab Emirates (UAE), Kuwait, China and elsewhere. He says he expects a significant proportion of Doha Bank’s expansion to revolve around the sukuk (Islamic bond) market, which is growing at about 200% a year. An enthusiast for ‘green’ banking, Mr Seetharaman also aims to sell a $1bn sukuk this year to finance investment in renewable energy.

Some regional players are teaming up. Kuwait’s Global Investment House and UAE investment firm Al-Qudra Holding, for example, announced in January that they planned to set up an investment bank in Abu Dhabi. Al-Qudra chairman Salah Salem al-Shamsi insists that the market is not saturated, arguing that “there are lots of opportunities for such a bank in the UAE and we also see opportunities in the region”.

Local presence

Citigroup is keen to return to the Saudi market after selling its 20% stake in Samba Financial Group in 2004. Citigroup head of investment banking for the Middle East and Africa, Julian Mylchreest, says: “We want to be back in Saudi and are working hard to be so. However, our Saudi position is a case in point in terms of what matters and what makes you successful in the region. I think the fact that we don’t have a presence on the ground has held us back certainly in terms of the equity capital markets.

“That said, despite the fact that we are not on the ground again yet, because of our global footprint, our ideas and our industry dialogue, we have still managed to put ourselves in a position where we are acting for some of the biggest deals out of Saudi, and for that we are very grateful.”

Financiers agree that having a presence in the target market is key to securing deals in the region. “They look for a real relationship… that’s why you need to have people on the ground that can connect locally and be regular faces for them,” says Mr Mylchreest.

International rescue

The region’s sovereign wealth funds are having a substantial impact on global investment trends and have emerged from the subprime crisis as arguably the most interesting clients for investment banks. They have also been investment banks’ rescuers, having stepped in lately with cash injections to help bulge-bracket banks recover from losses accrued from the crisis in the US high-risk mortgage market. Kuwait Investment Authority has been the most recent fund to step forward, as an investor in Merrill Lynch.

In late November, Citigroup was the first to benefit from this trend, receiving a $7.5bn loan to boost its balance sheet from the Abu Dhabi Investment Authority (Adia), the Gulf’s largest sovereign wealth fund with total assets estimated at $875bn. The loan is convertible to shares in 2010, making Adia the single largest investor in the bank, with a 4.9% stake.

Together with Saudi tycoon Prince Alwaleed bin Talal al-Saud, who recently participated in a further injection of $12.5bn of convertible shares into Citigroup, Gulf investors now own nearly 10% of one the world’s largest banks. The size of Prince Alwaleed’s investment is said to be less than the 4.9% ownership threshold. It is the second time he has gone to Citigroup’s aid; the first investment was made in 1991.

Such deals demonstrate Gulf investors’ spending power and their appetite for megadeals beyond their borders. More Gulf players could come to the fore as big US banks and brokers are expected to reveal up to $40bn in further write-downs related to subprime mortgages.

Hajir Naghdy, executive director of global real estate investment banking and advisory firm Macquarie Capital, describes the region’s sovereign wealth funds as “a huge phenomenon”, but says that tracing their behaviour is not so easy. “If you’re in banking, you don’t know which way it’s going to go,” he says.

Financiers are adamant that the current wave of investment by Gulf sovereign wealth funds in investment banks will not change the nature of their relationship. According to one international banker: “Gulf players are only going to keep giving you business if you are giving them good ideas and demonstrate that you are thinking of them.”

With competition being so fierce among banks and the region’s funds, including the Qatar Investment Authority and smaller funds emerging out of Saudi Arabia and even Libya, relationship management will remain the key to investment banking success.

IN FOCUS:

SAUDI ARABIA'S TADAWUL GEARS UP FOR CHANGE

Although Saudi Arabia represents one of the most lucrative markets for investment banks, which are eager to tap the Tadawul stock exchange’s $500bn capitalisation and other opportunities, the kingdom is still largely restricted to Saudi and Gulf residents and institutions. This is set to change, however.

Abdulrahman al-Tuwaijri, head of the Saudi stock market regulator, the Capital Markets Authority (CMA), recently said that he was studying the option of launching exchange-traded funds, which would offer a basket of traded equities and would be accessible directly to external investors. This will help the oft-heard complaint that Saudi lacks institutional investors – so far, foreign access to the Tadawul has been limited to a few Saudi mutual funds.

“Institutional investors comprise only about 5% of the market, including Saudi equity mutual funds and institutional portfolios,” says head of finance and investment research at Riyadh-based Bakheet Investment Group Hisham Tuffaha.

The Tadawul’s 2006 slump, which spread across the region, was blamed in large part on the dominance of retail investors, many of whom were making investment decisions based on rumours. To bring more discipline to the market, the CMA is licensing a large number of investment banks, and issued a law in 2003 stipulating that all banks must move their investment banking services to separate institutions. In 2007, 42 investment banking licences were issued, including two eye-popping licences to Bear Stearns and Goldman Sachs, which are forming tie-ups with local institutions.