Equities are lightly traded across the region, and initial public offerings (IPOs) have been few and far between. In Dubai, however, a capital markets culture that has relied on private wealth and bank debt seems ripe for change. The emirate has four regulated trading platforms, and plans to encourage more activity on them are under way. In 2014 the first equity capital raising since 2009 was completed, but the year’s highlight was the upgrade of the UAE and Qatar from frontier to emerging market status by MSCI, the US-based provider of indexes and other market tools. Inclusion in MSCI’s Emerging Markets Index is a major accomplishment that has brought more liquidity and international attention, and that is one reason for companies’ increased interest in listing. However, a closer look reveals that the demand has been there for a longer period of time, and the proof is in the number of companies from Dubai and the wider region that have listed elsewhere. According to the London Stock Exchange, for example, there are 42 companies from the Middle East and North Africa (MENA) region listed there, with a total market capitalisation of $92bn as of early 2014. For Dubai, the conclusion is that if it can offer liquid markets and an easier and cheaper trading platform, it can compete, not only for Emirati companies, but for regional ones.
For equities, the story starts with the emirate’s banks and government-related entities (GREs). Bank lending to the latter was a chief cause of Dubai’s troubles when the impact of the global financial crisis hit the emirate, and the governments of Dubai and the UAE are working to head off future bubbles and crashes through diversification. One of the main policy proposals are regulations that forbid banks from too much concentration risk in lending to corporations with full or partial government ownership. The GREs will have to look elsewhere for financing, and with the emirate hosting Expo 2020, there will be a need to pay for new infrastructure development and real estate projects. As a result, IPOs and secondary capital raisings are expected to be a large part of a more diverse financing mix.
Islamic Growth
Another Dubai government policy is driving growth in sukuk (Islamic bonds). The emirate announced in 2013 an ambition to crown itself as the capital of the global Islamic economy. For now sukuk investors mostly keep the assets until they mature, but in the months after this announcement a number of sukuk were listed on NASDAQ Dubai, one of the two multi-asset exchanges in the emirate. Secondary trading of sukuk remains a small share of overall Islamic-finance activity, but the exchange is the third-largest for sukuk in terms of market capitalisation, trailing Bursa Malaysia and Saudi Arabia’s Tadawul.
In a broader sense, government policies such as these, which create incentives for more securitisation and secondary trading, are also helpful in meeting Dubai’s ongoing ambition to be a regional financial hub. The emirate offers deep pools of capital, a financial services free zone that has attracted some of the world’s largest names in financial services, and proximity to the Gulf region’s oil wealth. It has also emerged as a safe haven for financial assets in the wake of regional instability in the last three years. Continuing on with shallow and illiquid securities platforms does not fit with that narrative. As it is, the perception-based surveys that rank international financial centres perceive Dubai’s offering as significant. For the second year in a row The Banker ranked Dubai sixth worldwide on its annual list, behind London, New York, Singapore, Hong Kong and Frankfurt. Another ranking from the London-based consulting firm Z/Yen, which is sponsored by the Qatar Financial Centre, considers Dubai as the leading financial centre in the region, placing it 21st worldwide in its most recent survey.
Size & Scope
Dubai’s primary securities exchange, the Dubai Financial Market (DFM), was created as a government-owned entity in 2000. It was converted into a publicly traded company in 2006, when a minority stake was floated in an IPO. The majority owner is Borse Dubai, a government body that holds 79.63% of shares, according to its web site. There are 56 equities trading on the platform, and the DFM website also lists 11 mutual funds, nine government bonds, three commercial bonds and eight sukuk, although some of these debt securities have matured and trading activity is not available. The DFM is regulated by the Emirates Securities and Commodities Authority, a federal-level body more commonly known as the SCA.
Nasdaq Dubai
The second securities exchange was introduced in 2005 and was initially called the Dubai International Financial Exchange but is now called NASDAQ Dubai. This platform was created within the Dubai International Financial Centre (DIFC), a financial services free zone in which companies are generally focused on regional markets rather than the domestic one, and which has its own purpose-designed legal framework. The laws are based on English common law. Activity in the DIFC falls outside the jurisdiction of the SCA. The regulator for NASDAQ Dubai and all other DIFC activity is the Dubai Financial Services Authority (DFSA), which was created for the purpose due to the DIFC’s nature as a free zone. There are 11 equities traded on NASDAQ Dubai, three government bonds, eight commercial bonds and 30 sukuk.
In 2010 DFM acquired NASDAQ Dubai. With the two platforms under the same ownership group a degree of integration was introduced: NASDAQ Dubai stocks can also be traded on the DFM platform, and trading, clearing and settling are handled together for both. Both also offer trading in debt and sharia-compliant securities, and information on the securities traded for both can be found on the DFM’s website. DFM currently owns 66.67% of NASDAQ Dubai, and Borse Dubai owns the balance, according to Borse Dubai’s website. The agency also owns 17.4% of the London Stock Exchange Group and 17% of the NASDAQ OMX Group. Brokers typically offer investors access to both markets. The most active is EFG-Hermes, which accounted for 33.88% of activity on NASDAQ Dubai in 2013, according to the bourse’s annual report. Arqaam Securities was second with 23.82% of market share, and Deutsche Bank third at 20.75%, according to the exchange. No other brokers had more than a 10% share.
Merger
In recent years officials from Dubai and neighbouring emirate Abu Dhabi have considered merging the DFM with the Abu Dhabi Securities Exchange (ADX), the only equities platform in the UAE outside Dubai.
The multiplicity of stock exchanges in the UAE results, to some extend, in a dilution of the liquidity pool. Thus, a merger has been proposed by officials from both Dubai and Abu Dhabi. In late 2013 it was reported that the two had hired outside advisors to help with the process, but further progress has not been reported. Abu Dhabi’s decision to build a financial free zone of its own, similar to the DIFC, led to speculation that it was no longer likely to happen. However, in October 2014 Mohammed Al Shaibani, CEO of Dubai’s main state-owned holding company, the Investment Corporation of Dubai, told the press that the proposal to merge the markets was still up for consideration.
“In terms of strategy it’s a no brainer,’’ Al Shaibani told Bloomberg. “There should be one stock exchange.”
Indices
Portfolio investors track several equities indices. The DFM General Index tracks 30 DFM stocks, and rose 107.7% in 2013. Seven of nine sector groupings climbed on the year, with the exceptions being consumer staples and insurance, where drops of 9.9% and 7.2%, respectively, were recorded, according to the DFM’s 2013 annual report. The biggest gains were financial and investment services (169.2%) and banking (120.6%). The FTSE NASDAQ Dubai UAE 20 index includes the 20 largest stocks by market capitalisation in the UAE, including on Dubai’s two exchanges as well as the ADX. It gained 86.7% in 2013.
The largest publicly traded equity in Dubai is Emaar Properties, the emirate’s main property developer and owner of the Burj Khalifa, the world’s tallest building. It accounts for 21.9% of the DFM General Index, according to Bloomberg data. Next is Dubai Islamic Bank, at 16.3%, the construction company Arabtec at 9.7%, Dubai Investments at 8.8% and Emirates National Bank of Dubai at 7.7%. All others have a weighting below 5%.
The index that has meant the most to Dubai recently is the MSCI Emerging Markets Index. MSCI, the New York-based provider of indices and investment analytical tools, upgraded both the UAE and Qatar from frontier to emerging market status, and that has brought increased international attention, both from passive investors who seek to mimic the contents of an index as well as active fund managers. The payoff was immediate: investments by exchange-traded funds and mutual funds in UAE listings surged four-fold from 2012 to mid-2014, according to the IMF. A total of nine stocks were added to the MSCI Emerging Markets Index on May 14, including Arabtec, DP World, Dubai Financial Market, Dubai Islamic Bank, Emaar Properties and First Gulf Bank. Many investors bought UAE shares ahead of the formal upgrade date of May 14 – the DFM General Index’s value was at its highest in the first nine months of the year on May 6. A plunge in the following months came in part because of market confusion over the ownership structure of Arabtec. MSCI reviews the index twice annually. In October 2014, research from the investment firm EFG Hermes predicted the UAE’s weighting in the overall index to climb from 0.57% to 0.77% after the November review.
Representation
One area left to address for index-based investing is that none of the available measures are able to closely track the overall economy, because it is highly correlated to oil and there is a lack of listed companies in the energy sector. The structure of the upstream energy industry in the region, led by national oil companies that are not publicly traded, however, makes this an issue in Dubai and elsewhere in the Gulf.
There is still not an index that provides a more accurate benchmark for the underlying fundamentals of the UAE economy, which means that introducing derivatives products like an index futures contract remains premature. However, the Dubai Gold and Commodities Exchange (DGCX), could be a potential trading platform for those types of products. In addition to Borse Dubai’s trading platforms there are also two exchanges focused on commodities. The Dubai Mercantile Exchange is the site of trading for the DME Oman Crude Oil futures contract, diamonds are traded via the Dubai Diamond Exchange, and all other commodities on the DGCX. Common contracts include currency, and precious and base metals. The DGCX is also home to trading in hydrocarbons and equities futures.
Equities
Dubai’s capital markets is a tale of two bourses. The DFM is a domestic market with a high degree of retail participation, whereas NASDAQ Dubai is focused on its role in the global economy. Of the DFM’s total of Dh159.88trn ($43.5trn) in turnover in 2013, individuals accounted for 76% of activity and institutions 24%. According to the DFM’s 2013 annual report, domestic investors accounted for 56.9% of trading activity; GCC investors, 7.5%; those from other Arab countries, 21.8%; and those from beyond the region, 13.8%. The most active sectors were the real estate and construction group, accounting for 44.3% of trades, according to the DFM, followed by banking at 19.8%, and financial and investment services at 17.1%. Market capitalisation for the DFM’s shares jumped 42.7% in 2013, from Dh181.9bn ($49.5bn) to Dh259.6bn ($70.7bn).
At NASDAQ Dubai, liquidity notched forward in 2014 as the value of trades rose 118% from $633m in 2013 to $1.45bn in 2014, and the volume of equities traded in 2014 reached 280.3m shares, up 41% over 198.9m shares in 2013. In 2014 the Emirates Real Estate Investment Trust (REIT) ended a five-year IPO drought when it listed in April, reversing a trend in which UAE and regional companies mostly listed on regional exchanges instead of domestic ones (see analysis). Those companies have proven, however, that demand exists for a broader, deeper and more dynamic equities market. Dubai is determined to capture it, with both direct and indirect methods likely to be used.
In the former category, the UAE’s status update from MSCI has added liquidity and visibility, helping to make the case for IPOs. Regulations are also a part of that effort, as rules for listing have been relaxed. At the federal level the Ministry of Economy has said the companies law will be changed so that companies are no longer required to list a minimum 55% of their value on UAE exchanges, reducing that number to 30%, and it is not mandatory for fresh equity capital to be raised in the process. Owners will be allowed to sell on exchanges from existing company shares when taking a company public. The DFM falls under the SCA’s regulations and these changes will bring requirements closer to that of NASDAQ Dubai, where the minimum offer can be 25% of company value. DFM’s chairman, Essa Kazim, said in October that exceptions to the rules could be made and would be evaluated on a-case-by-case basis for IPOs considered to be of strategic value.
Other rules that have discouraged listing on the DFM include a lock-up period of two years before founding shareholders can sell in the open market, and a requirement that IPOs must be priced at a par value of Dh1 ($0.27). That is a great deal for investors, because prices cannot rise with demand at the IPO stage, but it does limit the amount of capital a company can raise, therefore making a listing less desirable. The alternative to this option would be the bookbuilding method, in which underwriters suggest a price range and investors respond with the number of shares they are willing to buy at a certain price.
For NASDAQ Dubai, its regulator DFSA has already approved some other changes to encourage listings, such as dropping the minimum market capitalisation for an IPO from $50m to $10m. This rule is expected to help draw interest from small and medium-sized enterprises. NASDAQ Dubai is also working with free zones in the emirate to generate new listings, such as an agreement with Jebel Ali Free Zone, the industrial area that hosts roughly 7300 companies, to facilitate their participation. This has eliminated any legal confusion about whether companies in zones can list in Dubai, and the bourse plans to copy the model with others.
New Rules
These new listing rules are to a large extent aimed at private sector firms. These and some additional changes in the UAE’s regulatory environment will likely induce listings from public sector entities, including the GREs that have been central to Dubai’s economic story in the past decade. They helped to build Dubai during its growth period before the global financial crisis, but debt financing left them requiring assistance when the impacts of the crisis spread. While creditors have come from around the world, UAE banks were a major source of financing, and debt restructurings are still ongoing. It is unlikely that the GREs will enjoy the same access to domestic bank credit in the future because the country’s central bank has introduced a large exposures regulation to limit how much credit lenders can extend to them. The rule, introduced in late 2013, prevents any bank from extending more than a quarter of its capital to any one entity, either in the form of credit or other vehicles. There is a specific stipulation for GREs that count them all as one entity, meaning no bank can lend more than a quarter of its capital to all of them as a group.
There are two important exceptions to this rule that are relevant for Dubai’s prospects as an IPO market as well as for debt securities. The first is that GREs that are profitable, rated BBB- or higher by the ratings agencies, and can service their debts on their own will not be grouped in with others in the 25% cap for all GREs. The second exception is that banks can invest in bonds and sukuk if these are rated at AA- or higher by any of the top three global ratings agencies, Standard & Poor’s, Moody’s and Fitch, without these investments counting toward the 25% cap. Enforcement of the regulation as written would therefore encourage GREs to increase their reliance on bonds and sukuk, which would potentially mean more debt securities available for trade on the DFM and NASDAQ Dubai. The latter in particular has become a global focal point for sukuk.
Debt financing has in general not been a focal point for capital markets in the past in the UAE because the government is well capitalised thanks to oil revenue and does not need to borrow money. And because in capital markets worldwide government debt has typically served as a reference point for the pricing of commercial debt, its absence has led to sluggish growth in this market. However, with the rise of sukuk as a sharia-compliant alternative to bonds in the past decade, and with the need for finance in Dubai growing, interest in developing the debt markets in the UAE is on the rise. The emirates themselves have issued debt, but the UAE has yet to do so. An important reform that would allow that to happen is a public debt law, which would let the federal government to issue bonds and establish debt management offices in its individual emirates. There is a draft law in place, and such a step has been in discussion for several years, but a final decision has not been made. “Developing the debt market would reduce the reliance of governments, GREs and private companies on external funding and bank lending,’’ according to an IMF assessment from July 2014.
Commodities
Dubai’s energy trading platform, the Dubai Mercantile Exchange (DME), was established in 2007 as a joint venture. Major shareholders are the CME Group, owner of the Chicago Mercantile Exchange, with a 50% stake, Dubai Holding at 9%, and the Oman Investment Fund with 29%, according to the DME website. The DME is situated in the DIFC and regulated by DFSA. Clearing for the contract is handled by the CME’s US operations, and regulated by Washington’s Commodity Futures Trading Commission. The venture was formed as an attempt to create a price benchmark for crude oil in Asian markets using Oman Crude, a medium-sour grade that is generally purchased for use in markets east of the Suez Canal. China is the ultimate market for 50% of the crude traded on the DME, but accounts for under 10% of trading activity, according to the bourse.
The DME Oman Crude contract averaged a daily volume of 9143 lots per day in the first half of 2014, up 52% from 5993 lots in the first half of 2013. Trading in the period surpassed 1m contracts for the first time, with a total of 1.13m changing hands over the exchange, according to DME data. A key goal, according to CME Group, would be to establish a consistent daily volume of at least 10,000 lots traded, as at that threshold major oil producers would be more likely to use the contract’s pricing as a benchmark for their own sales, adding legitimacy and importance to the contract as a pricediscovery mechanism. The DGCX, the region’s largest and fastest-growing derivatives exchange is majority owned by the Dubai Multi Commodities Centre (DMCC). DCGX lists a large portfolio of futures contracts in precious and base metals (gold, silver and copper), plastics, crude oil (West Texas Intermediate) and currency futures. The exchange lists all major currency pairs versus the dollar, and its flagship Indian rupees futures contract is a global market leader. DGCX lists Bombay Stock Exchange Sensex index contracts and has plans to launch new products in 2015, including a spot gold deliverable contract. All contracts traded on the exchange are cleared by the Dubai Commodities Clearing Corporation. “With Dubai continuing to solidify its position as a major player in global gold and precious metals trading, its bullion trade touched some $75bn in 2013, new initiatives such as the introduction of a spot gold contract by the DGCX will ensure the sector continues to go from strength to strength,” said Ahmed Sultan bin Sulayem, executive chairman of DMCC.
Dubai’s metals refining sector is expected to grow at a rate of 5% to 6% annually and requires substantial investment to expand capacity to a fuller range of metals, including silver, platinum and rare earth elements, explained William McKeag, chairman and CEO of Gulf Gold Refinery. “Dubai needs much more investment in refining capacity to be able to gain ground as a globally recognised hub for metal trading,’’ he told OBG.
Mohammed Adnan Younis, sales and business development director of Gold Holding, told OBG, “Dubai’s emergence as a gold trading hub is reflective of the commodity’s shift in demand from west to east; however, for Dubai’s gold trade to reach its full potential the capacity for gold refining needs to develop further.”
The exchange’s strategy has been to seek areas of the Dubai economy where exchange-based trades can complement physical activity in the real economy, in particular by building infrastructure where it is lacking, and offering it as a service to traders while also building trade activity on the exchange. This has resulted in a strong opportunity for Dubai to begin developing derivatives products that leverage the niche physical goods that travel through the country in large volumes.
Gautam Sashittal, the CEO of DMCC, said in July 2014 that more agricultural commodities were under consideration for similar treatment, such as black pepper, sugar and pulses. Outside commodities, plastics futures began trading in February 2014, based on a contract of 5 metric tonnes of raffia-grade polypropylene.
Outlook
While work is ongoing across asset classes to boost trading options, the Dubai government’s policy priorities make prospects for equities and sukuk look particularly bright. Questions for the near-term future that could determine the speed at which an IPO pipeline is built include the flexibility of revised listing rules, the buoyancy in prices on the stock markets, and when GREs get started on preparation for Expo 2020.
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