The approval for the Federal insolvency and bankruptcy law by the UAE Cabinet on September 4 will have a persuasive and clear impact on the expansion of trade, industry and the banking sector in the UAE.
Whilst we await the publication of the new Federal insolvency and bankruptcy law, this much anticipated legal reform demonstrates that the UAE government understands the need to look at international best practices and align domestic legislation to those ever changing and increasingly sophisticated practices. This evolution and improvement of the insolvency and bankruptcy law is in furtherance of the vision for the UAE to be seen as a jurisdiction which is as (if not more) attractive for investment and business as the more established financial markets of countries such as United Kingdom, United States, Hong Kong and Singapore.
There are two dimensions to the global financial system. On the one hand, there is a domestic market in which domestic banks operate in response to local credit needs. On the other, banks and businesses that are tied inextricably to, and interact daily with, international counterparts. New methods of trade, communication and technology are constantly reshaping how business is done and the markets that businesses operate in. Today, businesses routinely look beyond domestic boundaries to access globally available credit and alternative funding sources. This globalisation of trade and business means that there has to be some commonality and consistency in regulating the relationship between creditors and debtors to maintain market confidence.
Public perception and investor confidence are the key drivers to a healthy and buoyant financial market. Having effective insolvency and creditor rights systems in place is crucial in creating and maintaining the confidence of both domestic and foreign investors. In the absence of sufficient and predictable laws and procedures, foreign creditors tend to extend funds only in return for high premiums. In times of crisis they may withdraw financial support altogether.
All banks have learnt lessons from the global financial crisis. Whether operating in only the domestic markets or cross border, there are now robust credit risk policies in place. This is supported by national central bank requirements to maintain a minimum compliance with risk allocation rules and standards which seek to limit the exposure of such institutions in circumstances where there is a systemic crisis.
What has come from this need for improved regulatory and governance practices is a specific and in depth analysis by banks of what constitutes credit risk and the quantification of “worst case” scenarios. In other words, credit risk goes beyond the basics of the financial health of an individual borrower and takes account of the wider legislative regime in the jurisdiction in which the borrower operates.
This translates to how easy it is to recover debts or realise value in distressed companies and/or support the restructuring of a viable company that faces short-term cash flow issues.
The current legislative environment in the UAE has given little comfort to creditors in relation to the applicability of the insolvency laws to all types of debtors whether they are governmental, quasi-governmental or commercial enterprises. The implementation of a new comprehensive bankruptcy law based on modern legislative and economic principles will translate to enhanced transparency and efficiency in court driven outcomes. This serves as an antidote to the current lack of “workout”, “self-help” or value preserving action available to creditors.
External global factors, both political and economic, can increase the possibility of a borrower facing difficulties — whether due to nonpayment by their own debtors, unpaid contractors, or a need to downsize and operate in a more streamlined and cost effective manner. The reality of banks being in a position where they are more likely to need to rely on unclear, ineffective or unsophisticated laws makes their risk assessment higher and we see a persistent reduction in available credit.
Where a legislative framework does not permit creditors to support businesses in restructuring on a solvent basis or assist in providing protection to debtors who enter into such arrangements with creditors, lending at the entrepreneur level, SME level and in “new” business or industry sectors also stagnates. Simply, it is too risky and too expensive.
If the new legislation is able to bring to the UAE, an insolvency regime which is transparent, efficient, readily accessible and ultimately, enforceable, then undoubtedly we will see a change for the better.
The new legislation, combined with improved corporate governance at the business level, will encourage banks to change the risk that is apportioned to domestic SMEs, trading entities and even larger corporations. With this, in time, will come increased market confidence whether in a buoyant global market or a depressed market and we will see a renewed flow of competitive credit terms across all industry sectors and business sizes.
-- Claire Matheson Kirton is a Local Partner at White & Case LLP.
