The stand-off between the Malaysian government and Abu Dhabi over disputes at 1Malaysia Development Berhad (1MDB) is set to present both governments with challenges sure to rattle financial markets in the coming weeks.
For Malaysian Prime Minister Najib Razak's government, the immediate worry is that the dispute with Abu Dhabi over billions of dollars in payments, which the Gulf emirate's state-owned entities claim they did not receive from 1MDB, could trigger cross-defaults on borrowings amounting to roughly US$5.1 billion (S$6.9 billion).
In faraway Abu Dhabi, public disclosures about how its state-owned entities led by the International Petroleum Investment Company (IPIC) entered complex financial arrangements with 1MDB are set to lift the lid on the often opaque business dealings in the rich Gulf Arab state, according to financial executives tracking the unfolding saga.
IPIC is Abu Dhabi's second-largest wealth fund and is chaired by Sheikh Mansour bin Zayed Al Nahyan, a high-profile businessman who owns the Manchester City football club and is the brother of Sheikh Khalifa bin Zayed Al Nahyan, the ruler of Abu Dhabi and President of the United Arab Emirates.
Financial executives who have close business dealings with Abu Dhabi and IPIC say Sheikh Khalifa ordered an internal due diligence on the workings of the kingdom's numerous state-owned entities. The IPIC audit tossed up a number of irregularities, including the fund's dealings with 1MDB and the obligations covered under the guarantee of 1MDB's 2012 bond issue.
Under the May 2012 agreement, the London-listed IPIC guaranteed 1MDB bonds valued at US$3.5 billion. In return, 1MDB agreed to make payments as collateral to IPIC's subsidiary, Aabar.
A cross-default situation could result in demands for early repayment from creditors. 1MDB's other debt obligations that could get affected:
• US$3 billion (S$4.1 billion) bond expiring in 2023
• RM5 billion (S$1.7 billion) Sukuk bond expiring in 2039
• RM800 million loan from state-owned pension fund due in 2022
• Internal bonds of RM2.4 billion
The saga so far
1MDB subsidiaries 1MDB Energy Ltd and 1MDB Energy (Langat) Ltd issue bonds totalling US$3.5 billion (S$4.75 billion), which are guaranteed by Abu Dhabi's IPIC. In return for the guarantee, 1MDB provides US$1.4 billion to Aabar BVI as collateral for the IPIC exposure and grants Aabar BVI the right to purchase a 49 per cent interest in 1MDB's energy business.
1MDB, which is proposing to list its energy business, pays Aabar BVI US$993 million to terminate Aabar BVI's option to acquire 49 per cent of 1MDB's energy business. In addition, 1MDB pays US$1.15 billion to avoid the penalty of losing the original collateral of US$1.4 billion because 1MDB did not comply fully with the bond agreement with IPIC. 1MDB eventually sells its entire energy business to China General Nuclear Power Corp for US$2.52 billion in November last year.
1MDB, Malaysia's Finance Ministry, IPIC and Aabar enter into an agreement in which IPIC makes a US$1 billion advance payment to 1MDB to help the latter settle a loan owed to Deutsche Bank. IPIC also agrees to assume all interest and principal payments of the bonds issued in May 2012 under a complex debt-for-asset swop agreement.
OCTOBER TO NOVEMBER 2015
IPIC pays the interest due on the bonds, totalling US$100 million.
APRIL 11, 2016
IPIC issues a statement to the London Stock Exchange denying that it or its subsidiary Aabar PJS owns Aabar BVI. It also says neither entity benefited from any of the US$3.54 billion paid by 1MDB. It is unclear why it took the London-listed IPIC and Aabar more than three years to make this statement. IPIC also says it will not make any further bond interest payments.
1MDB president Arul Kanda Kandasamy briefs Prime Minister Najib Razak on the IPIC-Aabar issues. The KL government insists it has dealt only with the top management of IPIC and Aabar and that they must remain responsible for any fraud.
Interest payment of roughly US$50 million on 1MDB energy bonds falls due. Failure to settle this would put the entire US$3.5 billion bond issue in default and trigger potential cross-defaults on roughly US$5.1 billion in other related 1MDB bonds.
In April last year, IPIC announced that long-time chief executive Khadem al-Qubaisi had left. Mr Qubaisi, a close associate of Sheikh Mansour, was the chief point man who negotiated all the deals with 1MDB. IPIC has not provided any reasons for his departure, but there is widespread speculation that Abu Dhabi officials are trying to distance IPIC from the deals entered into by Mr Qubaisi, including the arrangements surrounding the guarantees for the 1MDB bond issue.
Last month, Mr Qubaisi's longstanding corporate sidekick, Mr Mohamed al-Husseiny, the chief executive at Aabar, also stepped down without any explanation. Like Mr Qubaisi, he was deeply involved in the many transactions that the Abu Dhabi entities entered into with 1MDB.
"From the look of things, there is an internal clean-up that is ongoing and the IPIC-1MDB deals are casualties," said a Malaysian financial executive closely involved in negotiations with the Abu Dhabi entities.
At the centre of the dispute are over US$3.54 billion in payments that 1MDB says it made to units of IPIC in 2012. But IPIC maintains it never received those monies. Last week, it informed 1MDB that the latter was in default of the 2012 bond agreement, according to Malaysian government officials and financial executives close to the situation. The monies are part of payments under that agreement.
Negotiations between the two entities to settle the dispute over the past month failed and the row became public last week when IPIC informed the London Stock Exchange that it had not received the billions that 1MDB says it made.
IPIC said it was aware of media reports that 1MDB had sent money to a company called Aabar Investment PJS in the British Virgin Islands, but that the company was not in its corporate stable.
The face-off will come up against a crucial test with tomorrow's deadline of a US$50 million interest payment on the 2012 bond issue. Under the bond agreement, IPIC must make the interest payments, following a complex debt-for-assets swap.
Malaysian government officials say that IPIC has informally advised 1MDB that it has no intention of honouring the interest payment because of the alleged default of the bond agreement. The Najib government has also taken the position that it, too, will not step in to cover the interest payment because it has done nothing wrong.
"Settling the interest (payment) is not an option because that would be seen as acknowledging IPIC's position," said a Malaysian government official involved in negotiations in the dispute with IPIC.
But Malaysia's strategy comes with huge risks and the Najib administration has been presented with several worst-case scenarios in the event that the 2012 bond agreement is declared in default. They include the prospect of cross-defaults that may be triggered on other 1MDB debts, and potential legal suits from bondholders and IPIC against the Malaysian government.
The default situation could also present complications to government-linked agencies other than 1MDB in their efforts to raise funding, dim the country's sovereign ratings, and put intense selling pressure on the ringgit and local stock market, financial executives and bankers say.
"The big challenge will be to send the message that this is a specific problem (with IPIC) and not something that is systemic," said one government official.