The past 15 years have seen major advances in capital markets activity in Dubai. The financial sector free zone, the Dubai International Financial Centre (DIFC), has gone from idea to reality, and the emirate recently became the world’s largest market for sukuk (Islamic bonds). However, development has been uneven across types of capital markets offerings based on local demand patterns. New equity and bond offerings remain relatively underdeveloped, as most entrepreneurs in the emirate and the region are already well capitalised thanks to wealth accrued over years of oil exporting.
Dubai aims to build on its growing reputation as a regional financial centre, and that has led to continued efforts by the government and major private sector leaders to encourage more breadth and depth in capital markets. It is encouraging equities, initial public offerings (IPOs) and more growth in sukuk sales, and developing trading platforms for commodities and derivatives. The emirate is also establishing itself as the capital of the global Islamic economy, which refers to the suite of products and services tailored to comply with sharia law.
Oil Price Impact
As of mid-2016 one big determinant of capital markets activity in Dubai was crude oil prices. Even though oil production accounts for a small share of Dubai’s GDP, as a regional financial centre the impact has still been felt. Less export income for the region has meant lower demand for the investment opportunities Dubai offers, and equities slumped in 2015 as a result. The market for IPOs has also slowed after a breakout year in 2014. When oil prices revive, in turn boosting securities demand, Dubai’s two stock exchanges aim to capture business not only domestically but also from across the region.
Low oil prices, however, are expected to be an opportunity as well as a challenge. The need for financing could bring government entities to the market for sukuk sales, for example. Bank loans have been a main method for financing large-scale projects, but there are signs that oil prices are affecting banks as well, leaving them with less capital available for lending and highlighting capital markets as an attractive alternative to meet financing needs.
Size & Scope
Dubai has multiple securities exchanges, which mostly focus on specific areas. The Dubai Financial Market (DFM), created by the government in 2000, is the primary equities bourse and is considered the first option for domestic companies looking to list. Nasdaq Dubai, housed in the DIFC, is designed for listings of companies doing business predominantly in the region as well as in the domestic market. It is also the emirate’s primary home of bond and sukuk listings. The DFM offers 60 stocks and five bonds, and Nasdaq Dubai, which was licensed in 2005, offers trading in eight equities, 50 sukuk and 18 bonds as of May 2016.
There are also regulated platforms for trading in derivatives – the Dubai Gold and Commodities Exchange (DGCX) and the Dubai Mercantile Exchange. The former is marked by activity in Indian rupee-US dollar futures, while the latter is focused on crude oil futures. Dubai Multi Commodities Centre (DMCC) is a majority shareholder as well as home to the DGCX and more than 12,000 companies that have access to its infrastructure, products and services that also help facilitate trade of commodities such as gold, diamonds, pearls and tea (see analysis).
According to Gaurang Desai, the CEO of DGCX, interest in DGCX is increasing from Europe and Asia, which is a factor of macroeconomic adjustment in the market. “There are not so many opportunities in the European market now so traders from Europe start to look for global opportunities, with Dubai providing these types of opportunities,” Desai told OBG. “The emirate will remain the regional centre for commodity trading thanks to the ease of doing business, location and quality of infrastructure it offers.”
The securities regulator is a federal body, the Emirates Securities and Commodities Authority (SCA), and its jurisdiction includes everything in Dubai except for activities within the DIFC, where Nasdaq Dubai and the Dubai Mercantile Exchange are located. There, the Dubai Financial Services Authority (DFSA) supervises and regulates, and the free zone has its own bespoke legal framework based on English common law.
Dubai continued to attract new entrants in the financial services sector in 2015, with the SCA listing 125 regulated firms, of which 111 are local and 14 foreign. In the DIFC the number of active companies grew by 11%, and overall the free zone grew from 19 firms and 75 employees in its inaugural year of 2004, to 1445 and 19,808, respectively, by the end of 2015.
With the DFM aimed at the domestic market and Nasdaq Dubai more internationally oriented, both are likely to identify foreign bourses as their primary competition, rather than each other. Although companies are currently likely to seek a local listing presence first, in the past local listings have gone elsewhere, such as the London Stock Exchange, on account of companies looking for a market that offers sufficient liquidity – a volume of activity sufficient to make trading fast and easy, without gaps between bid and offer prices.
Both bourses fall under the same ownership group, the government-owned Borse Dubai. Although both trading and custody platforms remain under different legal and regulatory regimes, there is a degree of integration between the DFM and Nasdaq Dubai, with securities from both being traded on the DFM IT systems, and trading, clearing and settling also handled together. The DFM website contains data for Nasdaq Dubai securities as well as its own.
Now that the UAE has been given formal emerging market status by MSCI – the US-based provider of indexes and other market tools – some of its shares can be included in the company’s benchmark MSCI Emerging Markets Index, and the liquidity problem that so many developing-country bourses face is becoming less of a challenge.
Net foreign investment through the three exchanges amounted to Dh8.5bn ($2.3bn) in 2014, double the total of 2013, according to the latest available annual report published by the SCA in 2014. Trading peaked in April and May 2014 as index funds bought shares in the nine UAE-based stocks made eligible for the index. Index funds are those that are not controlled by a fund manager’s decisions, but instead hold shares in proportions that mimic a particular index. The nine companies that are in the global benchmark are Abu Dhabi Commercial Bank, Aldar Properties, Arabtec, DP World, Dubai Financial Market, Dubai Islamic Bank, Emaar Properties, First Gulf Bank and National Bank of Abu Dhabi.
Achieving emerging market status has helped to create additional liquidity. However, the rush to purchase shares also pushed up prices on the markets. When that wave was over it was followed by a sell-off, as price-to-earnings ratios fell and some stocks looked expensive in comparison to before the rally.
Another reason for the slump in prices in 2016 was the UAE dirham. The UAE’s currency is pegged to the dollar, which has gained against most major currencies in recent trading. For investors using currencies other than the dirham to buy UAE shares, the drop in their currency’s value against the dirham has reinforced their gains.
“If you made an investment three or four years ago and you’re not in dollars, you’ve made 30% on foreign currency alone,” Nabil Al Rantisi, managing director of Menacorp, told OBG. “You might as well sell and take your profits. It made sense for people to start exiting in this environment.”
The main index tracking DFM shares is the DFM General Index, which rose 12% in 2014, the third consecutive year it had gained. However, by the end of 2015 the index had slumped 16.5%, according to the DFM’s annual report. Market capitalisation rose by 24.3% to Dh322.6bn ($87.8bn) in 2014, before falling by 4.5% to Dh308.1bn ($83.7bn) at the end of 2015. That compares with Dh259.6bn ($70.5bn) at the end of 2013. The value of shares traded also decreased by 60.3%, from some Dh381.5bn ($103.8bn) in 2014 to Dh151.4bn ($41.2bn) in 2015, along with the number of shares traded, which dropped 38.8% from 160.5bn in 2014 to 98.2bn in 2015.
As of March 2016 there were 48 brokers, with the leaders by trading volume including Menacorp Financial Services, NBAD Securities and ADIB Securities. The DFM is largely composed of real estate and construction stocks, followed by banking stocks. By market capitalisation they account for 51.9% and 26.3% of the board, respectively.
The market remains heavily influenced by retail investors, as institutional traders accounted for 27.4% of total traded value with Dh41.5bn ($11.3bn) worth of stocks bought in 2015, down from Dh106.7bn ($29bn) and 28% in 2014, according to the DFM’s annual report. The geographic split favours locals over foreigners, though the latter are catching up, accounting for 48.6% of the total traded value in 2015, up from 43.8% in 2014.
Foreign investors also made up the majority of new investors on the DFM, with 76% of the total. Of the Dh73.6bn ($20bn) in stocks bought by international investors in 2015, the largest share was purchased by Arab investors outside the Gulf, at Dh33.1bn ($9bn), with the GCC accounting for Dh13.2bn ($3.6bn) and those from elsewhere for Dh27.2bn ($7.4bn).
On Nasdaq Dubai, trading volume jumped from 199m shares in 2013 to 280m in 2014, before dropping to 219m in 2015. The value of shares traded went from $633m in 2013 to $1.45bn in 2014, before falling to $1.37bn in 2015. Despite the slight dip in value for 2015 the number of trades surged from 11,910 to 24,698 to 30,637 over the three years. There is not a major index that exclusively tracks the stocks on this bourse, however, the FTSE Nasdaq Dubai UAE 20 Index tracks 20 liquid shares from it as well as from the DFM and the Abu Dhabi Securities Exchange. The index climbed 11.2% in 2014, gaining for the third year in a row, before declining 19% in 2015.
Broking in 2015 was dominated by Egypt’s EFG Hermes with a 51.26% market share. Two others had over 10%, Mubasher Financial Services at 12.56% and Arqaam Securities at 12.3%. In August 2015 Nasdaq Dubai announced a deal with Egypt’s Beltone Financial Holding to provide market-making services – offering simultaneous bids and offers on specific securities in order to increase liquidity. Beltone said it would focus initially on equities. Nasdaq Dubai saw the only IPO in Dubai in 2015, Egypt’s Orascom Construction. That, in addition to Beltone’s new relationship and EFG Hermes market share, has helped to cement Egyptian-Dubai ties in capital markets. “It has accentuated the development of a pathway between the Egyptian and Dubai markets by also allowing direct exchange access to the DIFC,” Eric Salomons, director and head of markets at the DFSA, told OBG.
While Dubai saw five IPOs in 2014, that represents a departure from the norm in recent years: The March 2014 sale of shares in Emirates REIT ended a five-year drought. Hopes for building on the momentum of activity in 2014, including new equities and also debt instruments, were dashed by external factors, such as the decline in crude oil prices and speculation about when benchmark interest rates may be boosted in the US. “There was a lot of talk in the sukuk market in 2014 about getting sales done before the US Federal Reserve raised rates, but the emerging markets volatility is making issuance more difficult,” Khalid Howladar, global head of Islamic finance for credit ratings agency Moody’s, told OBG.
Authorities have tweaked market regulations to in some cases, such as the requirement that a minimum of 55% of a company’s value must be offered in an IPO. The rush of new sales in 2014 included some that were allowed to offer less. Now Nasdaq Dubai’s minimum capital threshold is 25% of a company’s value, and the DFM’s has been lowered to 35%.
Bonds & Sukuk
There were 25 new bond, equity and sukuk listings on the Nasdaq Dubai in 2015, together worth close to $16bn. This added liquidity made Dubai the largest market for sukuk listings worldwide at $36.7bn in July 2015, nudging it past other key centres for Islamic bonds such as Malaysia, Ireland and London, which stood at $26.6bn, $25.5bn and $25bn, respectively.
Chinese issuers as a group raised their profile in 2014, as the government of Hong Kong as well as several Chinese banks were among the sellers of both asset classes. Hong Kong was joined by Dubai’s neighbour, the emirate of Sharjah, in issuing sukuk, but corporate issues were also more prominent. “One thing that has changed in the Islamic finance market over the last two years is the strong increase of corporate sukuk listings in Dubai,’’ Salomons said. “This is particularly true for Chinese banks.”
The first to market from China was the Agricultural Bank of China, the country’s third-largest lender by assets. Its RMB1bn ($163m) issue in September 2014 was the first debt listing in the MENA region by a Chinese issuer, according to Nasdaq Dubai.
Listing Vs. Lending
Future growth for sukuk may to some extent depend on underwriters’ ability to compete with bank lending to secure the lowest cost of funds for issuers. For many large-scale borrowers in Dubai – such as the government-related entities (GREs) playing pivotal roles in the real estate and hospitality sectors – bank lending has been the first choice in the past. However, the Central Bank of the UAE, which regulates the banking sector, has implemented rules for lending to GREs that could present an opportunity for investment banks hoping to underwrite more sukuk. The regulations cap the total proportion of banks’ lending capital that can be extended to GREs at 25%, with a deadline for compliance set for 2018 (see Banking chapter).
The central bank has allowed two exceptions to this rule; the first is that credit extended to GREs with a track record of profitability and a credit rating of “BBB-” or higher from major ratings agencies will not count against the cap. The second exception is that the bonds and sukuk of GREs rated at “AA-” or higher can also be invested in by a bank without including it within that 25% allocation. “Transactions are spreading from the biggest banks to the next-biggest,” Anver Jalaldeen, senior vice-president and head of investment banking for Sharjah Islamic Bank, told OBG. “We will see more GREs going to the market, but it’s a lot of syndicated loans.”
In the UAE it is common in the financial services sector to see delays in implementing changes such as these, but enforcing them by 2018 would suggest an increased incentive for GREs to raise money through sukuk or bonds. The government’s “Dubai: the Capital of Islamic Economy” initiative has also increased the incentive to sell sukuk, in order to strengthen the emirate’s reputation as a centre for Islamic finance. For now market reactions to the rules appear to suggest that underwriters of sukuk will still have to compete with bank loans – albeit from different banks.
“On the sukuk side, and within a few weeks of the launch of ‘Dubai: the Capital of Islamic Economy’ initiative, we launched the ‘Dubai: the Global Sukuk Centre’, as the first plan under this initiative,” Essa Kazim, chairman of the DFM, said. “It gained momentum soon afterwards, attracting issuers from the UAE and beyond, lifting the nominal value of sukuk listings on Dubai’s capital market to $42.61bn, compared to $9bn prior to the launch of the initiative in early 2013. This has earned Dubai the top ranking amongst international sukuk centres. Listings from foreign institutions represent 44% of all listings in a clear indication of their high level of confidence in Dubai’s regulatory framework and business environment.”
The UAE government at the federal level intends to further support debt markets in the emirate with a programme of dirham-denominated bonds and sukuk in a variety of maturities and sizes, which will serve several goals. One thing that regular public issuance can do is develop a yield curve – a graph which shows the various yields of government debt securities at various maturities.
Investors typically use a yield curve when pricing private sector debts, as it is generally assumed that they will always offer a higher yield than a government bond of the same term. Having more outstanding government debt, and in various maturities, offers more points of comparison and therefore makes it easier to price corporate securities.
Selling more sukuk, in particular, will also help the country’s banks, which could invest in these as a way to manage their liquidity over short periods. It does this by offering them an asset that gives a return on their investment, but which can also be sold quickly in case the bank needs to repurpose that capital.
As the authorities look to develop capital markets, growth in traditional asset classes, such as equities, debt and commodities, has proceeded at different paces and is aligned to the needs of investors in the market – sukuk has grown because of the need for debt financing and reflects the religious values of many investors, for example.
At the two commodities exchanges, higher trading volume is the result of activity in the real economy, such as the demand for foreign exchange tools from Indian traders converting rupees into foreign currencies, or the rise in gold futures alongside Dubai’s increasing prominence as a trading centre for the precious metal. The end-users of Oman crude in China find the tradable benchmark offered by DME a reliable and transparent pricing source and increasingly trade on the exchange (see analysis).
Markets are also developing to fund small and medium-sized enterprises and family businesses, many of which have not perceived equities markets as suitable sources in their early stages of development. Thus, crowdfunding and peer-to-peer lending platforms are emerging as potential areas for growth. Beehive – a Dubai-based peer-to-peer lending platform – has been deemed sharia compliant by the Bahrain-based Shariyah Review Bureau, which could expand its potential customer base.
A new specialist debt provider in this category is Tawreeq Holdings, which began operations in 2015 as a sharia-compliant financier of specific supply chains. By September of that year it reported a $55m loan portfolio of small and medium businesses.
For the traditional platforms global conditions are likely to remain a factor in pushing up asset prices or subduing them. Emerging markets for foreign direct investment are mostly based on domestic conditions, but for foreign portfolio investment the main determinants of financial flows are global conditions and expectations of performance in the US economy.
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