Dubai World default a lesson on foreign investing

I do not have any exposure to equities or debt outside of Canada and the USA, but I have been watching with fascination the fallout with respect to the default of Dubai World. Although most of Dubai’s investor base is European, it should have a small ripple effect around the world in absolute terms, but in psychological terms should reinforce that unmitigated speculation in real estate properties in might have adverse consequences in the future.

The parallel analogies between China (which one could argue has sufficient economic growth to warrant such capital investment) and Vancouver (which continues to mystify almost anybody that tries to perform a rational valuation on most properties) is obvious. However, even Vancouver does not have the excesses that Dubai did, mainly valuing waterfront properties so highly that they are to be reclaimed from the sea (or here). Looking at these projects makes me wonder what the monthly “strata fee” would be for one of these strips of land – just the costs to make sure that your island is not reclaimed by the Persian Gulf must be huge.

Financially, what is more complicated for investors is the lack of any idea of how subordinated their debt is, and what guarantees, if any, are embedded in the debt financing that was used to build such structures. The closest governmental analogy is that Dubai is a municipal government, while Dubai is one of seven divisions of the senior government, the United Arab Emirates (UAE). That said, the UAE (and the government of Dubai) made it quite clear that they will not be guaranteeing any debt of Dubai World, which means investors are hooped and can only claim whatever embedded asset value there is in the properties. This is even assuming the corporation follows whatever legal rules that are available to foreign investors in the UAE or Dubai.

It is these legislative nightmares that keep me clear away from foreign investments. In order to have a true grasp of the risk that one takes while investing, one needs to know the legal framework of the jurisdiction in question. Good luck trying to figure out Dubai World.

That said, China has gotten to the point where one might wish to more intensively study how their corporate legal structures work – from what I can tell, signed contracts and written documents are guidelines, opposed to binding, which makes analyzing social frameworks a much more relevant avenue than here in North America.