With Dubai containing some of the world’s youngest stock exchanges, born in just the first few years of this century, the emirate’s capital markets have lived long in a very short time. After experiencing unprecedented growth in their first years, these markets were then faced with a major global crisis in 2008-09. This saw indexes plummet and international interest wane. Yet since then, there has been much recovery, while certain sections – such as the commodities and precious metals segments – have boomed. The lessons learnt in this financial test have left the emirate’s exchanges and players stronger, with the fundamentals of this vibrant economy returning to bring on a second wave of market activity.

DFM: Dubai initially had two separate exchanges – the Dubai International Financial Exchange, now called NASDAQ Dubai, and the Dubai Financial Market (DFM). In 2007 both were brought under the umbrella of Bourse Dubai (BD), a government-owned holding company, as part of a move to consolidate the financial markets. This is central to the 2015 Dubai Strategic Plan, originally commissioned in 2007 but updated in part, most recently in 2012. This gave the green light for a major focus of the emirate’s development to be on the financial sector.

The DFM was set up in 2000 as a fully Dubai government-owned entity. This ownership structure remained until 2006, when an initial public offering (IPO) was held for 20% of the exchange’s shares – the first such exchange IPO in the region. Nowadays, BD holds a 79.63% stake in the DFM, as well as 33.33% of NASDAQ Dubai, with the remainder of the latter’s shares owned by the DFM. BD also has a 20.64% share of the London Stock Exchange Group, and a 16% stake in the NASDAQ OMX Group, which currently operates some 24 markets worldwide.

STRUCTURE: NASDAQ Dubai operates within the Dubai International Financial Centre (DIFC), the emirate’s free zone for financial services. All entities operating within the DIFC are regulated by the Dubai Financial Services Authority (DFSA), which uses UK law and possesses its own courts of jurisdiction. In contrast, the DFM operates outside the DIFC and is thus subject to the regulations of the Emirates Securities and Commodities Authority (ESCA, usually referred to as the SCA), which operates according to federal law regarding financial markets.

There is a third exchange within the UAE, the Abu Dhabi Securities Exchange (ADX), located in the UAE capital and mainly listing Abu Dhabi-based entities. The SCA has linked the ADX and the DFM together via live market-watch screens to constitute the Emirates Securities Market (ESM), with the ESM index (sometimes referred to as the SCA Index) listing the movements of securities from Abu Dhabi and Dubai. With screens in both emirates, along with others in Sharjah, Ras Al Khaimah and Fujairah, the SCA Index is thus able to offer a UAE-wide platform for traders.

LISTINGS & INDICES: The DFM has a General Index, while listed companies are also grouped into banking, finance and investment, insurance, real estate, transport, industrials, consumer staples, telecommunications and services. As of December 17, 2012 there were 67 companies listed on the DFM, along with eight conventional bonds, six Islamic bonds ( sukuk) and 16 mutual funds.

Over on NASDAQ Dubai, meanwhile, there were a dozen company listings, with 20 derivatives also offered on the FTSE NASDAQ Dubai UAE 20 Index. Since July 2010, NASDAQ Dubai has outsourced its trading, clearing, settlement and custody functions for equities to the DFM. The rationale for this shift was to create a much deeper pool of investors and thus more liquidity, and the move was broadly welcomed by listed companies. NASDAQ Dubai also jointly operates three bond and sukuk indices with HSBC. These include issues from the UAE, as well as the wider region, and comprise the SKBI sukuk index, the MEBI Middle Eastern Conventional Bond Indices and the MEAG Middle Eastern Aggregate Indices.

OTHER FREE ZONE ACTIVITY: The DIFC is also home to the Dubai Mercantile Exchange (DME). The DME currently trades the Oman Crude Oil Futures Contract, the crude oil benchmark for the region. Established up in 2007, the DME is a joint venture between Dubai Holding, the Oman Investment Fund and the CME Group. The latter’s participation means that all trades executed on the DME are guaranteed by NYMEX, a member of the CME Group.

Dubai has another free zone involved in financial services, the Jumeirah Lake Towers, which are home to the Dubai Multi Commodities Centre. Within this is the Dubai Gold and Commodities Exchange, which is taking an increasingly prominent role in this segment, regionally and internationally (see analysis).

PROTECTIVE MEASURES: In June 2012 the DFSA announced two new laws aimed at promoting investor protection within the DIFC. These were the Markets Law 2012 and the Regulatory Amendment Law 2012, which came into force on July 5.

The first of these changes the rules on prospectus disclosure, market misconduct and corporate governance, as well as redefining what activities constitute an offer. The DFSA now has to formally approve a prospectus before it can be used as the basis of an IPO, or for any securities featured in the prospectus to be listed in the DFSA’s official list.

The second new law supports the first, allowing the DFSA powers such as the regulatory oversight of auditors used by DIFC-listed companies. The law also allows further recognition of other trading systems and cross-border functions. Non-DIFC exchanges and clearing houses meeting regulatory requirements can now have access to entities and persons within the DIFC and vice-versa, provided the regulations and standards now enforced are also followed.

This brings the DFSA’s body of regulations up to the latest EU and Organisation for Economic Cooperation and Development standards, with the level of international legislation on financial markets currently increasing. Meanwhile, the SCA has also been upgrading its regulatory framework frequently. The most recent change came in June 2012, when it amended its regulations on disclosure and transparency and securities and commodities listing.

On the disclosure side, this amendment now requires that any person owning 5% or more of a company’s shares, or 10% of the shares of a parent or subsidiary, must disclose this. On the securities and commodities changes, management and employees of listed companies are forbidden from trading in those securities without first disclosing their activities and obtaining market manager approval.

In 2011 the SCA also issued a delivery versus payment regulation, outlining the procedures and time-frames for settlements. That year also saw the SCA’s complete installation of digital infrastructure so that companies could make disclosures via the XBRL system, bringing this into line with International Financial Reporting Standards.

WORKING TOWARD UPGRADE: Indeed, when the Morgan Stanley Capital International (MSCI) team came to assess the UAE’s markets in 2012, they noted that the “UAE Index meets all requirements” for an upgrade from frontier market to emerging market status, except for “specific market accessibility issues related to custody and clearing and settlement”. This was a reference to the prevalence of dual account mechanisms in the ESM – both with the ADX and DFM. This practice – which is common in other Gulf states too – is one in which international institutional investors establish separate custody and trading accounts in order to offset the risk of local brokers having unlimited access to the trading accounts. This risk-management strategy makes for a less efficient market, however, as shares have to be transferred between the dual accounts before any trading can take place.

This issue is being addressed though, and amendments to securities, borrowing and lending regulations are expected to happen in 2013, when the MSCI will take another look at the UAE. An upgrade to “emerging market” would raise the ESM’s global profile, making it more attractive to international investors, some of whom would begin allocating part of their emerging markets funds automatically, and hopes remain high that the upgrade will come soon.

An improved grade would thus likely boost investment flows into the country. Jakob Thomsen, CEO of Saxo Bank, told OBG, “Trading of both major and emerging market currencies in the UAE is growing, and with international trade increasing, the need for currency management will only heighten. Should the UAE achieve emerging market status it will have a positive impact on investment flows and will boost the country’s forex market.”

SECURITIES PERFORMANCE: Prior to the global financial crisis, which impacted Dubai in 2008-09, the emirate had seen some astonishing results in its capital markets. With the economy thriving – mostly on the back of real estate and construction and high oil and gas prices – there were some phenomenal IPOs. The DFM IPO in 2006, for example, was oversubscribed some 300 times, collecting some Dh190bn ($51.7bn) for a Dh1.6bn ($435.5m) offering.

Back then, the emirate was a magnate for investors worldwide, with the capital market also experiencing an influx of funds, including hot money. The crash put paid to most of this in a sudden and brutal fashion. Between year-end 2007 and year-end 2008, the DFM Index fell 72.4%, from 5931.95 points to just 1636.29, while the ADX fell 47%.

Foreign investors pulled out, in response to the global liquidity crunch, while the index’s heavy weighting in favour of real estate and construction companies and banks also acted against it, as these two sectors took the brunt of the downturn. Local banks found their access to international liquidity strongly curtailed, while this drying up of funds also obliged some local investors to liquidate their securities positions in order to free up cash. The market capitalisation (mcap) of the DFM’s listed companies fell 53.6%, year-on-year (y-o-y), from Dh499.7bn ($136bn) at year-end 2007 to Dh231.7bn ($63.1bn) at year-end 2008, according to the DFM’s 2008 Annual Report. “Everyone was involved before,” Tarek Lotfy, the managing director of Arqaam Capital in Dubai, told OBG. “This has changed. The size of the individual players has shrunk, as has their number.”

Since then, securities markets globally have suffered from risk aversion, with Dubai being no exception. With the emirate a high beta market, the DFM and NASDAQ Dubai have both had to contend with cautious and conservative strategies from international investors as the global economy has sputtered, with slow recovery in the US, the Asian slowdown, the eurozone crisis and the conflicts of the Arab Spring. In 2009, however, after starting out at the year-end 2008 low, the DFM General Index fell further, until a turn around came in February. This upwards trend continued until October that year, when the index reached 2373.37 points, a climb that placed the DFM back amongst the top five performing global indexes. Then, however, there was a gradual decline again. Over the year, the index rose some 10.2%, settling at 1804 points by year-end 2009. Mcap continued to fall over the year, ending at Dh213.4bn ($58.1bn). Breaking this figure down, the banks were the largest segment by mcap, accounting for 25.4% of the total, followed by real estate at 20.1%, finance and investments at 17.3%, and transportation at 12.1%.

On NASDAQ Dubai, equities volumes rose over the year by some 30% to 3.1bn shares. The year was also the first full year of equities derivatives trading for the exchange, with volumes reaching 129,000 contracts, worth a total of some $7.23m. The FTSE NASDAQ Dubai UAE 20 Index had a good year – rising 48% to stand at 1851 points by the year’s end.

VOLATILITY: However, into 2010, the DFM General Index fell by 9.6% over the year, ending at 1630.5 points. The year was marked by high volatility, with swings of minus 20.7% in the second quarter of 2010, followed by plus 15.2% in the third quarter. Indeed, in September 2010, the index was the highest-performing Arab exchange. The year therefore saw the introduction of some important rule changes on the index aimed at minimising volatility. These included a limit of 20% free float for the least-traded companies, while the maximum weight of any single company on the index was reduced from 25% to 20%.

These changes meant that when the exchange reopened for business during 2011, there were 30 companies listed, with 15 of these classed as most traded; these 15 most traded had a total weight of 81%. The margin for daily fluctuations in price for all shares was also set at 15% up and 10% down, while traders were also allowed to price trades down to fractions of a fils (Dh1 = 100 fils).

Mcap, meanwhile, continued to decrease, dropping to Dh199.1bn ($54.2bn) by the end of 2010, down 6.6% y-o-y. Overall, the DFM came fourth in terms of traded value amongst Arab stock markets (the GCC plus Egypt and Jordan).

NASDAQ Dubai had a better year, however, with the value of equities trading there rising 22%, from $1.07bn in 2009 to $1.31bn – even whilst volume declined 15%. This was a unique result among GCC exchanges, all of which saw trading value decline. NASDAQ Dubai’s two most heavily traded companies, DP World and Depa, were also both in the top five gainers for UAE stocks over the year.

Into 2011 the DFM General Index continued its downwards path. Over the year, the index fell 17%, reaching 1353 points. This was despite an upwards surge from February to April, when the index approached 1650. The year was characterised by regional and global uncertainty, with the effect of the Arab Spring, plus the continuing eurozone crisis, impacting global risk appetite very strongly.

This could be seen in the dramatic decline in foreign trading activity on the exchange. In 2010, total purchases by non-UAE nationals and entities stood at Dh30.8bn, ($8.4bn) with total sales of Dh30.6bn ($8.3bn). In 2011, the respective figures were Dh15.27bn ($4.2bn) and Dh15.1bn ($4.1bn).

Yet the level of foreign net investment fell significantly less – down from Dh180.3bn ($49.1bn) to Dh164.25bn ($44.7bn), while in 2011, institutional investors recorded a net positive in their trades – purchases minus sales – at Dh265.5m ($72.3bn). Mcap continued to decline, however, by 9.5%, to stand at Dh180.1bn ($49bn) by the end of the year 2011.

Meanwhile, the NASDAQ Dubai also saw its equities trading decrease in both volume and value terms during the year as a consequence of global risk aversion. The former totalled 602m by the end of 2011, while the latter came in at $675m, from 16,378 trades, down from 22,435 the year before. Adding to the changes seen during 2011, the exchange’s most heavily traded stock, DP World, issued a one-for-20 stock consolidation, while also launching a listing on the London Stock Exchange.

There was also evidence of the soundness of the move to outsource to the DFM, completed in 2010, with a rise in the number of individual traders participating – 5.8% of all trades came from this group, around twice the number recorded in 2010. On the bond front, however, there was good news in that the number of sukuk holdings kept in the exchange’s custody rose 36% over the year.

INDEX CLIMBS & THEN DECLINES: Into 2012, however, the Dubai capital markets experienced a change of fortunes in the first seven months. The DFM General Index rose through January and February, reaching a first half-2012 high of 1777.75 on March 5. This was followed by a gradual decline, picking up again towards the end of the first half and into July, when the index reached 1516.53, on July 16. Interestingly, the best-performing stocks were in the real estate sector, which saw a 2.37% rise between January 1 and that date. Finance and investment, and transport also saw slight rises over the period, which was year-to-date at the time of writing.

Real estate received a particular fillip with the success of Emaar’s $500m sukuk offering in July (see analysis). The offering gave investors more confidence, with a Bloomberg poll at the time suggesting that Emaar’s profits stood to double between the first quarter of 2012 and the second quarter of the year. The company’s shares had climbed 23% since the start of the year by mid-July.

Over at NASDAQ Dubai, the year followed a similar pattern to begin with, with a rise in the first quarter in the value of equities traded, month-on-month – up 25% in January to $35m, then a further 8% in February to $37.9m, and again up 8% in March to reach $41m. Following this the value began to drift down, by 10% in April, up 4% in May, then down 39% in June, to reach $23.4m. Quarter-on-quarter, the value of equities traded in the second quarter of 2012 was 53% down on the second quarter of 2011. Damas International also delisted, following a takeover by the Qatari-Egyptian BIDCO. The FTSE NASDAQ Dubai UAE 20, however, had a better year-to-date, ending June around 13% higher than at year-end 2011. IPOs: In such an environment of global uncertainty, IPOs have been scarce internationally in 2012, with few headline-grabbers except Facebook and Malaysia’s FELDA. Dubai has been no exception to this, with the last listing being Drake & Skull in March 2009. Next door in Abu Dhabi, for example, the ADX has seen only minor IPOs recently, the largest (Dh825m, $224.6m) being Eshraq Properties in 2011.

This may be about to change, however, with news in June 2012 that investment management company Daman Investment was pursuing plans for an IPO, though it has since put them on hold. This followed a private placement by the company, active in asset management, of a 22.7% stake. No timeline was given by the company, but the news suggested that a turnaround may be in the offing for some of Dubai’s investment management outfits, as well as for IPOs.

Indeed, the asset management segment was particularly badly impacted by the 2008-09 downturn. As an example, Daman itself was valued at around Dh850m ($231.4m) in 2009, while the valuation in 2012 accompanying the private placement was around Dh440m ($119.8m).

PRIVATE EQUITY: Private equity (PE) funds have indeed been victims of recent caution in the region as a result of the Arab Spring and global uncertainty. The 2011 annual report of the Middle East and North Africa (MENA) Private Equity Association, released in June 2012, showed that the year had seen the industry raise less than half the funds in 2011 it had in 2010 – $700m as opposed to $1.5bn.

Yet Dubai continues to be home to some of the most powerful PE firms in the region, including Abraaj Capital – ranked the largest PE firm in emerging markets in 2011 by Private Equity International – Al Masah Capital and Eastgate Capital, in addition to Daman. Complementing these, Dubai Islamic Bank also has a PE and venture capital arm.

There is also some cautious optimism in the sector that a revival may come about soon, with the association report suggesting that while only around 25% of MENA PE firms said they had made investments in 2011, around 50% said they intended to do so in 2012, with some $5bn in capital held by these funds still waiting for an opportunity to be used. SMEs: Another strategy being developed to assist the IPO pipeline, as well as broaden and deepen the existing capital markets, is to encourage small and medium-sized enterprises (SMEs) to list. SMEs employ 61% of Dubai’s workforce, according to the government agency, Dubai SME, with around half of the UAE’s SMEs headquartered in Dubai.

This is potentially a major source of listings, yet historically, SMEs have shied away from the capital markets, relying on traditional sources such as family, reinvested profits and loans from outside the financial mainstream for funding. There are many reasons for this (see Banking chapter), with SMEs often preferring to keep a low public profile. They may be unwilling to open their books to inspection by banks, exchanges and other potential financing sources.

NASDAQ Dubai, in cooperation with Dubai SME, is aiming to change this, however. “We’re actively looking at the SME market,” Hamed Ali, the acting CEO of NASDAQ Dubai, said. “Using the local market to back your firm is the next stage of SME development, with an SME-specific business model now required.”

The exchange has been going out to meet SME associations and groups and educating them on the possibilities provided by listing – an activity few had previously considered. Meanwhile, Dubai SME has assembled a ranking index of the top 100 Dubai SMEs, an exercise which started many businesses thinking about the kind of provisions they would have to make if they were to begin the process of listing, particularly when it comes to disclosure rules.

In a tax-free environment, many SMEs are not set up to provide the kind of public information that a listing would require. “We found many of the top SMEs were already investment grade,” Alexander Williams, the director of the strategy and policy division of Dubai SME, told OBG. “We are now talking seriously to 10-15 companies about developing them for the capital markets.”

This would be a welcome boost to the IPO pipeline and to the exchanges. The current indexes, many investors remarked to OBG, have long been dominated by the same companies and sectors – namely, real estate and construction and banking – with investors looking for something new to invest in. SMEs could be this new sector, boosting the available free float for trade and market activity, as well as getting the financing necessary for the next stage of their growth.

Making this happen requires a strong focus for now on boosting the corporate governance of the top SMEs, though, with Dubai SME helping directly in this, along with NASDAQ Dubai. Indeed, Dubai SME has invited the International Finance Corporation in to help provide SME training as part of this.

OUTLOOK: Recent times have been characterised by cautious recovery in Dubai’s equity markets, while debt and commodities have continued to do well (see analyses). The emirate’s exchanges have suffered both from globally negative sentiment and local challenges, as legacy issues from the 2008-09 crisis continue to work through the financial system.

The international outlook in 2012 does not seem bright either, with this likely continuing to have a dampening effect on recovery. Yet there is now a more optimistic mood than in 2011 in Dubai’s capital markets, with a feeling that a recovery in “Dubai Inc.” is under way, as evidenced by continued bond and sukuk market support, successful debt restructuring by the government-related entities and growth in sectors such as tourism and retail.

In addition, Dubai possesses the advantage of being the most developed financial market in the region, with its exchanges internationally linked and the technological infrastructure in place to meet global requirements. There is a critical mass of capital market players in the emirate, with the DIFC clearly outstripping regional rivals in size and influence.

Using these advantages to build deeper and stronger local bourse is the aim for the present moment, with a sizeable number of efforts under way to bring more companies to the market, Encouraging those already listed to increase operations in the emirate is also likely to bear fruit in coming year. “We all want to see Dubai succeed,” Ali said. “We just need to work to keep the liquidity here, and that’s it.”