Beyond the IPO: The Strategic Rise of Equity-Linked Bonds in the MENA Region

Introduction: an evolving market of equity-linked bonds

The Middle East and North Africa (MENA) region’s equity capital markets (ECM) have seen a notable increase in activity in recent years. Fuelled by ambitious economic diversification programmes, privatisation initiatives and deep domestic liquidity, primary issuance has surged. In 2023 and 2024, the region solidified its position as a key area of growth in an otherwise subdued global landscape.

Alongside initial public offerings, underwritten secondary offerings are also gaining traction as major pre-IPO shareholders – including state-owned enterprises, sovereign wealth funds and large family offices – strategically monetise mature holdings, and as issuers aim to increase their free float to satisfy the requirements for index inclusion. However, this expansion in straight equity issuance has not been mirrored in the market for equity-linked instruments (hybrid securities that blend the characteristics of debt and equity), which remains comparatively underdeveloped. The MENA region’s contribution to the global market for equity-linked securities has been minimal, pointing to a market that is still developing from both a regulatory and an investor education perspective.

Equity-linked bonds take the form of either convertible bonds (convertible into the issuer’s own shares) or exchangeable bonds (exchangeable for shares owned by the issuer in a different entity). While equity-linked bonds are not yet a mainstream corporate finance tool for public companies in the MENA region, they can function as tactical tools engineered to navigate statutory pre-emption rights afforded to existing shareholders. Concurrently, a handful of landmark transactions have demonstrated their potential as sophisticated corporate finance instruments capable of attracting global institutional capital and achieving strategic objectives, such as stake monetisation and optimised funding costs.

The prevailing macroeconomic environment also shapes the appeal of these instruments. With global interest rates having risen from historic lows, increased conventional debt servicing costs make the lower coupons typical of equity-linked bonds more attractive to issuers. For investors, these instruments offer downside protection through their debt-like features, coupled with upside participation in equity performance through the embedded conversion option.

This article explores the dual identity of equity-linked bonds in the MENA region, analysing their structure and diverse applications, and the critical legal and regulatory considerations across key jurisdictions.

Convertible v exchangeable bonds: a structural comparison

While often grouped together given their equity-linked features, convertible and exchangeable bonds serve fundamentally different strategic functions stemming from the nature of the shares underlying their conversion options. They are, therefore, subject to distinct legal frameworks, particularly in relation to whether shareholder approval is required for their issuance.

Convertible bonds

A convertible bond is a debt instrument that generally grants the holder the right to convert the bond’s principal into a number of newly issued shares of the issuing company based on a pre-determined conversion price. This gives investors the potential to benefit from an appreciation in the issuer’s share price. If the share price exceeds the conversion price, the bond is considered to be “in-the-money”, and holders will likely exercise their conversion right. Conversely, if the share price remains below the conversion price, investors will typically hold the bond as a standard fixed-income instrument. This structure therefore combines a standard corporate bond – with its fixed maturity date and coupon payments – with an embedded equity call option.

The primary attraction for issuers is the reduced funding cost; because investors value the potential for equity upside, they accept a lower coupon than would be demanded for a comparable non-convertible bond. The conversion price is typically set at a significant premium to the issuer’s share price at issuance, meaning conversion allows the issuer to issue equity at a more favourable price than in a conventional follow-on offering. However, this comes at the cost of potential dilution for existing shareholders, as conversion requires the issuer to create new shares. Consequently, issuing convertible bonds requires the issuer to have sufficient corporate authority to allot new shares – a key consideration that brings shareholder approvals and pre-emption rights into focus.

Issuers can structure convertible bonds with various settlement methods, a choice often driven by accounting implications. These options range from full physical settlement, where the issuer delivers only shares upon conversion, to cash settlement or flexible hybrid models like net share settlement, where the principal amount is paid in cash and any excess conversion value can be settled in shares. This structural flexibility, combined with the instrument’s hybrid nature, attracts a diverse investor base. Fundamental investors are typically drawn to the fixed-income characteristics, such as the coupon, alongside the potential for long-term equity upside. In contrast, technical investors, including hedge funds, often engage in arbitrage strategies by hedging the embedded equity option, which usually involves short-selling the issuer’s shares to remain market-neutral.

Exchangeable bonds

An exchangeable bond is a debt security exchangeable for existing shares of a company other than the issuer, typically a publicly listed subsidiary or affiliate in which the issuer holds a significant stake. Like a convertible bond, an exchangeable bond offers a lower coupon by embedding an equity option. However, the key difference lies in its settlement. Upon exchange, the issuer delivers existing shares held by it in a subsidiary or a portfolio company; no new shares of the issuer are created.

This has two key implications:

• first, the issuance does not dilute the issuer’s own shareholder base; and
• second, it allows the issuer to monetise its holding in another company in a phased manner, raising immediate funds while deferring the disposal of shares.

The 2021 transaction by Abu Dhabi National Oil Company (ADNOC), which issued USD1.195 billion in bonds exchangeable into shares of ADNOC Distribution, is a quintessential example. The structure allowed ADNOC to raise funds at an attractive cost while retaining flexibility. When the bonds matured in June 2024, ADNOC settled its obligation in cash, retaining its strategic shareholding and demonstrating the flexibility an exchangeable structure affords.

In essence, convertible bonds are settled with newly issued shares, resulting in dilution and requiring corporate authority to allot new capital, while exchangeable bonds are settled with existing shares of a third party, thereby avoiding dilution and functioning as an asset transfer. This distinction shapes the strategic purpose of each type of security: convertible bonds are primarily a capital-raising tool, whereas exchangeable bonds serve as a hybrid stake monetisation and financing instrument.

The multifaceted role of convertible instruments in the MENA region

Beyond large-cap public offerings, convertible instruments serve a wide array of strategic purposes across the MENA region, reflecting their inherent flexibility.

For example, simple convertible instruments are central to early-stage financing for start-up companies across the region. Convertible loan notes and agreements like Simple Agreements for Future Equity (SAFEs) function as crucial bridging tools. A SAFE is an investment contract that allows a start-up to obtain capital without issuing debt or equity immediately; instead, investors receive the right to purchase shares in a future equity financing round at an agreed discount, enabling the start-up to secure funding quickly while postponing complex and often premature valuation discussions.

Separately, convertible bonds are also used by the banking sector across the MENA region to build up their regulatory capital requirements in the form of Additional Tier 1 (AT1) capital to meet Basel III regulatory requirements. These instruments act as a buffer to absorb losses, as demonstrated in June 2024 when the National Bank of Fujairah PJSC converted USD275 million of AT1 securities into ordinary shares to strengthen its capital base.

Convertible bonds can also serve as a tactical instrument to facilitate non-preemptive capital increases, particularly in jurisdictions where disapplying pre-emption rights for a direct share issuance is legally or practically challenging. In such scenarios, an issuer can issue short-maturity convertible bonds to a specific investor. Upon maturity, these bonds convert into the issuer’s shares (a process that typically falls outside the scope of statutory pre-emption rights), effectively achieving a targeted equity placement.

Convertible bonds also serve as a flexible currency in mergers and acquisitions. For instance, Gulf Navigation Holding PJSC funded its acquisition of the Brooge Target Group in part by issuing more than AED2.3 billion in mandatory convertible bonds (MCBs) to the seller, aligning the interests of both parties.

Navigating the regulatory maze: pre-emption rights and shareholder approvals

The decision to issue equity-linked securities in the MENA region is heavily influenced by varied legal and regulatory requirements, particularly concerning statutory pre-emption rights. The principle of pre-emption gives existing shareholders a “right of first refusal” to subscribe to new shares, protecting them from dilution. The applicability of these rights dictates whether a convertible bond issuance can be executed rapidly or if it requires a more protracted approval process.

The regulatory approach varies significantly across the region. The financial free zones of the Abu Dhabi Global Market (ADGM) and the Dubai International Financial Centre (DIFC), operating under English common law principles akin to the UK Companies Act 2006, provide the most flexibility. In these jurisdictions, the issuance of convertible bonds triggers statutory pre-emption rights – or the need for a special resolution to disapply them – only when the issuance is for cash consideration. This creates an opportunity to use financing structures like the Jersey cash box, where an issuer allots new shares in exchange for shares in a newly formed Jersey-based subsidiary holding the cash proceeds from investors. Because the issuer’s shares are issued for non-cash consideration, the transaction falls outside the scope of statutory pre-emption rights.

In contrast, the “onshore” regimes in the UAE and Saudi Arabia mandate shareholder approval for any issuance of convertible notes regardless of whether the bonds are for cash or non-cash consideration or whether the bonds convert into new or existing treasury shares. Consequently, structures like the Jersey cash box are relevant almost exclusively for ADGM and DIFC issuers seeking to align with international market practices, but are of little or no practical use for “onshore” issuers where the statutory requirement for shareholder approval cannot be circumvented.

For exchangeable bonds, which do not dilute the issuer’s share capital, shareholder approval is not required in any of these jurisdictions, making them a structurally simpler instrument. Issuers should be mindful, however, of whether the issuance will result in the divestment of a major part of their business, which may require specific corporate approvals.

Key considerations for issuers

A successful equity-linked issuance demands careful strategic planning that extends beyond regulatory approvals. Because these securities combine features of equity and debt, the disclosure provided to investors must present both a compelling equity story and a robust credit story. This dual narrative is essential to satisfy investors analysing both the potential for share price appreciation and the creditworthiness underpinning the instrument’s downside protection.

For exchangeable bonds, this consideration becomes more complex, as the issuer’s ability to provide comprehensive disclosure on the underlying company is directly tied to its level of control and insight. This is more easily managed where the underlying securities are issued by a controlled subsidiary, but presents challenges when the holding is a minority stake in a company listed on a separate exchange. In such cases, the issuer must rely on the public disclosure made by that entity, making the quality of that market’s continuous disclosure regime a critical factor.

While a financial adviser is best placed to assess whether an equity-linked security meets an issuer’s strategic and financial needs compared to traditional debt, equity or a straight asset sale, this analysis cannot be conducted in a vacuum. The legal and regulatory considerations, particularly those concerning shareholder approvals and pre-emption rights, must be integrated into that assessment from the outset to ensure a holistic and successful execution of the transaction.

Furthermore, unlike straight equity or conventional bonds, hybrid instruments such as convertible or exchangeable bonds are often classified as “complex securities” for the purpose of securities offerings. This classification can subject their distribution to more stringent rules in certain jurisdictions, potentially limiting the eligible investor base or imposing additional suitability assessments on distributors.

Conclusion and outlook

The market for equity-linked bonds in the MENA region has two distinct sides. On the one hand, these instruments are employed as tactical tools, particularly short-dated convertibles engineered to navigate the rigid pre-emption rights frameworks in certain onshore jurisdictions. On the other, they function as sophisticated, globally oriented instruments of corporate finance, exemplified by landmark exchangeable offerings designed for strategic stake monetisation. This bifurcation is a direct consequence of the region’s fragmented regulatory landscape (particularly in the United Arab Emirates), which contrasts the stringent requirements of onshore corporate laws with the flexible, common law-based regimes of the financial free zones.

Looking ahead, the evolution of this market will be driven by the increasing complexity of the region’s financing needs. As national economic transformation programmes demand more diverse and efficient funding sources, the strategic appeal of hybrid instruments is set to grow. For equity-linked bonds to transition from a niche product to an integral component of the MENA financing toolkit, issuers and investors will require greater familiarity with their structural nuances and a clearer understanding of the varied regulatory pathways. The precedents set by major sovereign and corporate issuers have laid the groundwork for this shift, demonstrating the product’s versatility.

Ultimately, the future of equity-linked bonds in the region hinges on their ability to bridge the gap between tactical workarounds and strategic, mainstream corporate finance.