Challenges facing cross-border M&A in the GCC region in 2021.

The compliance of Islamic law in M&A

It is essential that foreign companies willing to do business with the Islamic ones reflect their commitment by
showing the utmost respect for Shariah laws and principles.

There are challenges in regards to business dealings between Islamic companies and non-islamic
companies which comes down to difference in cultures. For example, taking up
loans on interest to expand their businesses. This may limit the capability of investors to expand their
businesses through M&A activity with Western firms through cross border M&A.

Financial instruments such as bonds, swaps, futures, and forwards are not allowed by Shariah in their
conventional form and would need restructuring, where possible, to comply with the Shariah principles. For
example, Sukuk (Islamic bonds), where the bond is backed by real assets and the r
eturn is a fixed share of profit, is always Halal, as opposed to the return being in the form of interest, which is
Haram, noting that not everything is explicitly prohibited by the Shariah and that there is room for interpretation

Furthermore, in regards to the the investment culture in the middle east region, particularly the wealthy GCC
states, there are no investment culture. Locals with an increasing amount of wealth that they have acquired from
their relations and families are investing on truth-based ideas and interest-free loans. This means that they may
be willing to limit their amount of investments based on their decision on the capability of businesses to repay
the loans.

It must nevertheless be conceded that Shariah compliance may be a barrier in dealing with non-Islamic
companies. Noted that restructuring an Islamic company to accommodate the capital structure of the target
company could be cumbersome, time-consuming and costly. In some cases restructuring may fail which could
lead to the breakdown or delay in M&A transactions process. The Accounting and Auditing Organization for
the Islamic Financial Institutions (AAOIFI) provides guidance standards that the Islamic companies can
follow in ensuring that they are in compliance. Some organizations completely follow these standards, while
others use them as a reference to guide in particular decisions.

Finally, conflict of interest must be avoided to improve the rate of M&As in the identified countries. Per the
AAOIFI guidelines, SSB appointed members should not hold any shares in the company for which they work
for. This is because in doing so, they may be tempeted to engagein misinterpreting the Shariah principles for the
company’s benefit rather than ensuring interest-free, halal principles, and working towards socio-economic
justice are in line. Hence, by adhering to those rules, there may be success in cross-Border M&A.

Key obstacles to the success of cross-border M&As between the Islamic and the non-Islamic
companies such as the need for Shariah compliance (prohibition of Riba or interest, obligation of
Zakat or an obligatory contribution based on earnings/wealth and the Islamic inheritance law), weak
systems of disclosure, the lack of independence, corruption in compliance, having family members
on the Board, weakened communication with external auditors, different interpretations of
Shariah by different scholars and a lack of alternative Islamic financial instruments.

Activity in M&A going forward post-pandemic.

Total deal volume in first quarter of 2020 in MENA was 109 deals,
which was slightly lower than 115 deals in the first quarter of 2019.
However, 62% of MENA executieves remain optimistic that the
global M&A market will improve in the next year.

the pandemic and lower oil prices are expected to accelerate

consolidation across sectors and sale of non-core businesses held by
merchant families [people who own retail shops].

Some MENA companies will use M&A to strengthen their resilience

and position for recovery through bolt-on acquisitions (45%) and
transformative deals (30%) that could fundamentally reshape their
business (https://www.ey.com/en_ae/ccb/mena-mergers-
acquisitions).

 In the UAE, intentions are actually higher, with 56% looking to make deals in

the next year, vs. 45% in October 2019.

 Conversely, in KSA, intentions are down from 63% six months ago to 57% in

this survey.

 In Egypt, although it would appear executives have lowered their expectations,

deal intentions remain higher than the long-term average of 39%, with 49%

expecting to be active in the M&A market.

The gulf region has been hit by economic challenges from the
pandemic and the oil price crash. A by-product of these two
crises happening at the same time is that there may be a
second wave of Mergers and Acquisitions. This was the case
in 2014 when there was an oil price crash, and a number of GCC
banks turned to M&A to enhance resilience.

Notwithstanding the recent run of mergers in the UAE,

with 48 banks operating in the country – made up of 27
foreign and 21 domestic institutions – the country is
still overbanked, and is likely to see further
consolidation.

Banks looking to merge at a national level have benefitted from having the same
laws and requirements – and often the same shareholders – as prospective
partners, while international deals have been seen as risky and complicated.
While most analysts do not expect too much cross-border activity in the near term,
some institutions could consider such mergers as a way of pooling resources and
improving efficiency. [https://oxfordbusinessgroup.com/news/will-covid-19-spur-
mas-gcc-banking-sector]

Gulf policymakers are also keen to consolidate the number of banks. They are keen to create
national champions which will dominate lending in their home countries as well as
participate in larger cross border transactions. Fewer local banks, provides more space
for international financial institutions to operate as well as leads to more foreign capital
and investment. Inward foreign direct investment and capital is a key goal of all GCC economic
diversification plans. But in consolidating banks, there much be significant cost-saving synergies
present.

Over the past few years, UAE authorities have consolidated the number of players in their
banking sector. Last year, Union National Bank and Al Hilal merged with Abu Dhabi Commercial
Bank. In 2017, First Gulf Bank and National Bank of Abu Dhabi joined together to create First
Abu Dhabi Bank. More mergers in the UAE are likely to take place over the next few years.
This will likely take place in individual emirates. Smaller lenders like Abu Dhabi Islamic
Bank or Commercial Bank of Dubai may also seek mergers or being acquired as they
struggle to compete larger rivals. [https://www.quorumcentre.com/merger-mania-infects-
gulf-banks/]
 Activity in M&A IN 2020 [https://thelawreviews.co.uk//digital_assets/7dc3139b-6b6b-4798-b303-
6ad687ba7c4b/The-Mergers-and-Acquisitions-Review---14th-edition.pdf].
Transactions in the UAE continue to be driven by government and public sector
entities, and by strategic objectives such as food security and supply chain
integrity, which have become significantly expensive.

A noteworthy transaction undertakn in UAE this year was by ADNOC for the sale of a
minority interest in its pipeline assets. This demonstrates the continued interest of foreign
investors in high quality assets in the oil and gas industries despite the continued depressed
demand for petroleum. This is expected to be a continuing trend in the short-term.

Parties to M&A transactions should take note of the fact that the FTA are actively enforcing
the collection and payment of VAT and has brought an increasing level of tax litigation.
Parties in an M&A transaction should agree appropriate provisions in transaction
documentation to ensure an appropriate allocation of risk between parties with respect to
tax matters such as tax warranties and negotiation of an appropriate tax covenant.

A particular interest during the pandemic have been industries and business that
are involved in advanced health and therapeutic processes and businesses that
assist the government in its aim to improve food security and supply chain
integrity for key supplies required by the population.

External financing for acquisiitions continue to be less prevalent in the UAE in

comparison to other jurisdiction, and a large majority of acquisitions continue to
be financed in cash. In regards to acquisition finance, it is usually structured as a
long-term loan, which is secured by personal or corporate guarantees, including
securities over target assets.

Although most acquisitions that are finance are funded through conventional finance,
various other Islamic finance structures are used as well such as MURABAHAH,
MUSHARAKAH, MUDARABAH, and IJARAH structures. These financial covenants are
more difficult that conventional financing.

In the UAE, there might be a continued public sector activity in areas of strategic interest
( E.G. business involved in advanced agricultural processes and those that enable the
government to protect food security and supply chain integrity for vital products). Private
Equity investments may continue to be directed at sectors such as food and beverages and
healthcare, with a renewed focus on those businesses pursuing hi-tech advancements in
these sectors.

There is expected to be a heightened public sector investment and activity in

M&A concerning strategic sectors. There may be business offering access to
sectors of interest such as logistics, agricultural and advanced therapeutics.
These sectors may received special interest and may also be able to obtain better
valuations.