The United Arab Emirates is planning to print its debut dollar bond this week. This note of around $3bn is special because it takes the smaller emirates — some of which have previously accessed the international bond markets on their own — one step closer to an explicit guarantee from their bigger, stronger brother, Abu Dhabi.
As a borrowing entity with the backing of Abu Dhabi, the UAE will likely issue at yields only slightly higher than Abu Dhabi. That means, first of all, savings on funding costs for the smaller emirates.
But perhaps equally importantly, mutualised debt is another tie between the emirates. While many investors always felt that Abu Dhabi would step in to help out its fellow emirates, as it did in 2009 when it gave $10bn to Dubai to pay its debts, the support was always very much implicit rather than formalised.
Following the issuance of bonds at the level of the UAE, with Abu Dhabi likely on the hook for the joint Emirati deals, it would have one more reason to extend its protection to its neighbours if they were to approach default. The spreads of these smaller emirates look likely to slam tighter as a result.
A close parallel could be seen in the European Union.
Unlike the EU, which is rated in line with the Germany at AAA, the UAE bond will be rated one notch lower than its strongest member, Abu Dhabi. But the mechanics should be broadly the same.
When the EU announced its Next Generation EU Covid recovery programme last year, in the middle of the pandemic, the spreads of its weaker members, such as Italy, came tumbling down long before any money was borrowed or lent. The mere existence of a vehicle for shared funding was a huge comfort to investors.
There is an argument the same will happen for the weaker emirates.
The volumes of debt that these smaller monarchies print could also fall if they are at least partly funding themselves via the UAE entity, which would mean that their outstanding paper gains rarity value. That too could pull the spreads of the likes of Sharjah and Ras Al Khaimah tighter, though the effect may be offset by a decline in liquidity.
What then will happen to Abu Dhabi spreads? The jury is out. The investor base for the UAE bond looks likely to be similar to that for the Abu Dhabi bonds. The risk is roughly the same, the yields will likely be roughly the same — perhaps a little more generous. So Abu Dhabi’s standalone bonds will face new competition.
But the extent to which Abu Dhabi bond trading comes under pressure will depend on how much the market is already undersupplied with Abu Dhabi risk. Syndicate officials say investors have plenty of room for more and are nowhere near their limits.
The UAE bond is a luxury for the emirates, which were managing to issue just fine on their own. But only a fool would pay more for something they can buy cheaper under a different name. The funding officials of these states know they are stronger as a pack. They are no fools.