Malaysia’s 1MDB and Abu Dhabi Feud Over Coming Bond Payment

Wall Street Journal
April 18, 2016

Officials worry that a default could further undermine investor confidence in Malaysia

A dispute between sovereign-wealth funds from Malaysia and Abu Dhabi over missing billions of dollars is coming to a head and could roil currency and bond markets this week.

The funds are feuding over who must make a $50 million bond payment due Monday. Each is saying the other failed to meet its obligations and is refusing to pay, potentially setting off a chain reaction leading to billions of dollars of bond defaults.

The dispute is the latest chapter in the scandal involving 1Malaysia Development Bhd., known as 1MDB, which is under investigation in seven countries, including Malaysia. The Swiss Attorney General said he was investigating possible misappropriations of about $4 billion.

The 1MDB fund denies wrongdoing.

The Abu Dhabi fund, International Petroleum Investment Corp., or IPIC, guaranteed $3.5 billion of 1MDB’s bonds when they were issued in 2012. Last year as 1MDB grew short on cash, IPIC also agreed to give an emergency billion-dollar loan and to make interest payments on the same bonds. In return for IPIC taking over the debt, 1MDB agreed to transfer assets to the Abu Dhabi fund.

But negotiations have broken down recently. Last week, IPIC officially said that money sent by 1MDB to the Abu Dhabi fund as payment for the bond guarantee was never received. The money was sent to an offshore shell-company that was controlled by the same two people who ran IPIC and one of its investment companies, according to documents reviewed by The Wall Street Journal and people familiar with the matter.

The 1MDB fund last week sent a memo to Malaysia’s Ministry of Finance, which owns the fund, laying out the situation. The memo, reviewed by the Journal, said that IPIC had informally told 1MDB it wouldn’t be making an interest payment to bondholders of about $50 million on Monday. Malaysia could make the payment but, the memo argued, doing so would harm its negotiating position with IPIC. Attempts to reach 1MDB for comment on Monday were unsuccessful. Attempts to reach IPIC weren’t successful.

The negotiations have high stakes: Under IPIC’s interpretation of their deal, 1MDB and Malaysia’s Ministry of Finance owe about $6.5 billion to lenders, which includes the $3.5 billion principal of the bonds, interest and other payments, said the memo.

Officials at 1MDB told the Ministry of Finance that if a default comes to pass it could cause investors to sell Malaysia’s currency and bonds and damage the country’s reputation in global financial markets. Malaysia is currently marketing a government bond to be denominated in U.S. dollars, the memo said.

Cross-default clauses in other 1MDB agreements would also likely be triggered, putting the fund in default on several billion dollars more of debt, according to the memo viewed by the Journal. The Malaysian finance ministry owns 1MDB and the fund’s debts are considered quasi-sovereign bonds, meaning investors treated them as if they had the same risk as Malaysian government debt.

IPIC could also face difficulties with its own bonds, according to a person familiar with the matter.

The 1MDB fund said in the memo it has fulfilled its obligations and IPIC is required to make the payment. IPIC’s decision to publicly say it didn’t receive money from 1MDB for the bond guarantees means the debt agreement between 1MDB and IPIC is no longer feasible, the memo added.

The memo said that IPIC also believes the Malaysian fund still hasn’t given it the assets it promised in exchange for IPIC to make the bond payments.

It is still unclear whether IPIC or 1MDB will ultimately make the payment, but 1MDB is preparing for a default, according to the memo reviewed by the Journal. It has already hired a law firm and investigative firm to assist it with a restructuring, the memo shows. 1MDB last week sought permission from the Ministry of Finance and the Prime Minister to decide what to do on Monday, the memo added.

The dispute marks a further unraveling of a close relationship between Malaysia and the United Arab Emirates, both Muslim countries. Besides guaranteeing the 1MDB bonds, Abu Dhabi, which is the capital of the U.A.E., agreed to pay for half of a $6 billion real-estate development project in the Malaysian capital led by 1MDB. That project never got off the ground and Abu Dhabi never sent any money.

Malaysia, like many emerging-market countries that are dependent on commodity exports, has struggled after prices of oil and other natural resources collapsed. Investors have pulled cash from these economies and sent currencies down. The Malaysian ringgit lost more than half its strength between July 2011 and September 2015, but since then has rallied about 12%.

The dispute between the two funds has been brewing for months as the 1MDB scandal grew. Abu Dhabi has been trying to get a handle on what happened and on its exposure to 1MDB, according to the person familiar with the matter. Last year, the government removed from office the two men who ran IPIC and its investment companies.

IPIC said in a statement to the London Stock Exchange last week that it was aware of media reports that 1MDB had sent money to a company called “Aabar Investments PJS Ltd.” IPIC said in the statement that it has a subsidiary called Aabar Investments PJS, but that the similarly named company “was not an entity within either corporate group.”

The Wall Street Journal, citing people familiar with the matter and bank-transfer documents, earlier reported how the 1MDB fund sent $2.4 billion to the imitation Aabar, which was set up in the British Virgin Islands and later closed.

A report released last week by a Malaysian parliamentary committee inquiry into 1MDB put the amount transferred to the imitation Aabar at $3.5 billion. About $681 million of this money later flowed via a circuitous route into the private account of Najib Razak, the Malaysian prime minister, the Journal has also reported, citing people familiar with the investigations.

Mr. Najib has denied wrongdoing or taking money for personal gain.

Malaysia’s attorney general said the money that entered his account was a legal donation from Saudi Arabia’s royal family and that most of it was returned, and he cleared Mr. Najib of wrongdoing.

The 1MDB fund says it never sent money to Mr. Najib’s accounts.

The standoff with Abu Dhabi puts a spotlight on Mr. Najib’s role in 1MDB and in the government. He founded the fund and is chairman of its board of advisers. He is also finance minister, meaning he will ultimately decide whether the payments are made or not.

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