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Abraaj's dispute with Gates Foundation has huge fallout for Middle East

Scandal severely damages region's reputation; fundraising has come to a halt

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"The region does have an issue with transparency. But hopefully this case will highlight the need for better governance and disclosure." Meziane Lasfer, professor of finance at Cass Business School of City University of London

IT'S troubling for any asset manager, but this dispute has the potential to damage a region.

Allegations that one of the biggest and oldest private equity firms in the Middle East misused client money - including from the Bill & Melinda Gates Foundation and the World Bank - have sent shock waves through the ranks of local dealmakers. The firm, Dubai's Abraaj Group, has shaken up its top ranks, cut dozens of jobs and hired outside help to probe the matter and patch up relations with clients, but the fallout may just start to ripple through.

Since the allegations surfaced in February, private equity deals and fundraising in the region, which had already been slowing, have come to a halt, according to interviews with about a dozen financial industry executives. The issue has hurt the region's reputation and threatens to bring back concerns about a lack of transparency that had kept some investors away, they said, asking for anonymity because the matter is sensitive.

"The true impact of the Abraaj situation is one of reputational capital," said Karim Souaid, managing partner of Growthgate Capital, a private investment firm operating in the region. It "will impact the appetite of fund investors to commit, and the capabilities of fund managers to raise capital".

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At the heart of the contention is how Abraaj used some client money in a US$1 billion health-care fund. The Middle East's largest buyout firm says everything is properly accounted for and that some unused capital from the fund - it didn't say how much - was returned to investors. It said a discrepancy between money it collected from investors and the amounts it invested was due to delays in projects, and that the agreement with clients allowed it to hold on to the cash until it could be put to use.

"At Abraaj, our focus remains on working collaboratively with our investors, completing the re-organisation of the firm to ensure long-term growth, and partnering closely with our partner companies to create value," the company said. "We are confident of the long-term resilience of the economies we operate in, which are supported by a thriving regional eco-system, a mature private equity industry, and the long-term interests of global investors who continue to view growth markets as attractive investment destinations."

Even if no rules were broken, the fact that such large, renowned investors see a reason to be leery of their money manager - and hire their own accountant to probe the matter - is severely damaging for a business that at its core depends on the trust of clients.

Since the questions were asked of Abraaj, the company has suspended new investments, undertaken a review of its corporate structure and put the fund unit up for sale. The firm is in talks to sell a majority stake in the division to Colony NorthStar Inc to help stabilise the business and raise cash, people with knowledge of the matter said this week.

Abraaj is considered as one of the developing world's most influential investors. The firm manages almost US$14 billion for institutions and supranational agencies from the US, UK and other countries. Its founder Arif Naqvi had become a regular at the World Economic Forum in Davos.

That's precisely why the allegations are so damaging for the broader industry, said one top dealmaker in the region. Abraaj is a blue chip company among the private equity firms in the Middle East, so the impact extends far beyond the firm. The concerns have already affected investor appetite more broadly as well as dealmaking, this person said.

Data provided by Preqin Ltd showed that since the start of the year, only one Middle East-based private equity-backed buyout deal occurred. The figure doesn't include venture capital transactions and compares with seven deals last year. Deals had been slowing for three straight years as the region's economy grappled with the impact of low oil prices.

Fundraising by Middle East-focused private equity has come to a halt, with no funds closing in the first four months of the year, according to Preqin. Last year, a total of six funds closed, though the aggregate amount raised was only around US$144 million. Fundraising peaked in 2012, when investors committed US$2.9 billion in total.

One industry executive who is currently seeking to raise a venture capital fund said those plans have been impacted by the Abraaj issue simply because Abraaj is so large. Another person, an executive at a regional private equity firm that has looked at co-investing with Abraaj, said investors already had very small allocations to the region and this will make things worse. That person and others say they have received calls from investors in Europe and the US asking questions about how the company is run in the wake of the Abraaj troubles.

Private equity, which lets big institutions and wealthy individuals invest in companies and assets that aren't publicly traded, is still a nascent industry in the region, but one with the potential to bring large amounts of capital needed to help transform economies that are still reliant on oil. Worldwide, private-equity firms oversee about US$3 trillion for clients such as pension funds, endowments and sovereign investors. Less than US$18 billion of that is run by firms based in the Middle East, according to Preqin.

The industry in the region has been stunted by significant gaps in the region's legal and regulatory frameworks, particularly in areas of investor protection and corporate governance. Bankruptcy laws are also still just developing, making it tricky to deal with situations where portfolio companies fail. The business landscape in the Middle East is also primarily relationship-based, which does not facilitate the transparency that global investors seek.

"The region does have an issue with transparency," said Meziane Lasfer, a professor of finance at Cass Business School of City University of London. "But hopefully this case will highlight the need for better governance and disclosure."

The risk is that the Abraaj dispute deepens investor perceptions, particularly among institutions, that such issues are widespread in the region, which could impact fundraising, said several executives. While most regional funds have raised enough commitments in recent years to keep going for now, investors will be doing a lot more due diligence and paying more attention how Mideast firms operate, said one top official.

Abraaj has hired investment bank Houlihan Lokey Inc for assistance in negotiations with investors, and held talks last month with some of them.

"What they did seems to be allowed by the limited partnership agreement, and their's seems standard," said Ludovic Phalippou, author of Private Equity Laid Bare and a faculty member of the Said Business School at the University of Oxford. "Still, given that Abraaj is an ambassador of private equity in the Middle East, it will negatively impact the other firms in the region." BLOOMBERG

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