Chairman: James Gavin, Global Investor/ISF
Ziad Aba al-Khail, managing director and CEO, Aljariza Capital
Arindam Das, head of HSBC securities services, MENA
K Hammad Izz-e-Hamid, head of securities services, MENA, Deutsche Bank institutional cash and securities services
Osman Gunsel Topbas, director, cluster head MENA and Turkey, Citibank
Shehryar Salam, vice-president, client coverage, MSCI Eric Salomons, director, head of markets, Dubai Financial Services Authority
How will the liberalisation of the Saudi Arabian market two months ago transform the wider region?
Arindam Das: It’s a very positive development because suddenly the investable space in the Middle East has almost doubled in size. Apart from size in terms of market cap or depth in terms of liquidity, Saudi also has a diversified market in terms of sectors, which makes it interesting for investors.
I believe the opening of Saudi will put the GCC on the map of international investors who, in the past, found the region sub-scale. And everybody will benefit from the effect of spillover – whether it’s the UAE, Qatar, Kuwait or Oman.
Gunsel Topbas: It comes at just the right time. With the MSCI index upgrade there’s been a particular focus on Qatar and the UAE. Coupled with the Saudi market opening up to foreign investors, the spill over effect will be significant and will attract more interest into the region.
In a sense it resembles a bazaar or a souk; you line up the merchants selling similar products. Now that the biggest merchant in the region is opening up shop, it will have a positive overall impact.
Do you think that will lead to greater competition between ‘merchants’? Or is there a prospect of greater collaboration, perhaps leading to more integration?
Eric Salomons: It is still early to draw conclusions, but we at the Dubai Financial Services Authority (DFSA) see more connectivity. For example, there are now a number of Saudi firms active in the Dubai International Financial Centre (DIFC), that have been set up to arrange entry to the Saudi market. And we have listed a sukuk by Dar al Arkan, which has its shares listed on the Saudi Tadawul but chose to list its sukuk on Dubai Nasdaq, which is an interesting development.
The connectivity between MENA markets needs to be driven by market participants in first instance. Regulators then need to consider how to approach the specific risks of cross-boundary issues. For instance, is the sharing of information possible, are market conduct standards in the other jurisdiction equivalent?
Topbas: We may never see integration at all – but this kind of cooperation can enable more efficiency, which is always a benefit. The Saudi opening will also help diversification – enabling exposure to sectors such as chemicals which are largely missing from the rest of the GCC exchanges. It presents the GCC as a far more holistic opportunity.
Hammad Izz-e-Hamid: There is a healthy mix of competition and collaboration that is in play here. The steps undertaken by the UAE and Qatar towards regulatory and infrastructure development have been noticeable, as has the impact of this on MSCI Emerging Markets Indexation is known to all.
The learning’s of one market’s evolution may well be easily replicated and or modified by another. The inclusion of Saudi Arabia in the MSCI EM Index will be complementary to the Middle East as a whole. With the inclusion of Saudi Arabia, the combined weighting of the GCC is estimated to go up from 1.6% currently to 3.3% – attracting increased attention from both active and passive investors. The benefits of growth and diversification will accrue to all.
Once the weighting gets close to or above 4%, does it serve as a kind of ‘global calling card’ for the wider region?
Shehryar Salam: Any increase in weight to around 3%-4% may mean that asset owners will be attracted to the market, or at least that they can no longer ignore it. That said, MSCI indexes follow and do not lead markets, so a 3%-4% weightage may mean that there already have been fund inflows into the market.
Typically it is the active managers who are generally the first movers because they are often not restricted to sticking to benchmarks – they can be benchmark agnostic as well. That may be the case with Saudi Arabia as well and will be a function of cost and timing.
What conversations is MSCI having with the Saudi authorities?
Salam: As part of MSCI’s standard business operation, we have relationships with the vast majority of asset owners, managers, broker dealers, exchanges, regulators and central banks. We get feedback from them on a regular basis. Since MSCI is not actually trading itself, this feedback is vital in our understanding of the practical applications of how regulations work.
This feedback is passed onto the local stakeholders and in the kingdom these would be the CMA and the Tadawul. Please also note that MSCI announced in June 2015 that it would be conducting a formal consultation with international institutional investors who have applied for QFI quotas in Saudi Arabia on their end-investor experience in the kingdom.
Aba Al-Khail: Regarding the T+0 issue, the authorities are very keen on doing things that project the right image. T+0 works fantastically for us. The issue is being studied by the regulators. The authorities recognize how outside entities deal with settlement and since these are QFIs with $5bn-plus under management, they have issued regulations to facilitate the funding for the settlement of their trades.
Salam: Both regulations and the QFI process will evolve over time. They might look very different after a year.
Topbas: Expectations will change as we move forward. The Saudi market was expected to open up to foreign investors, but now the question is when will it become part of the MSCI Emerging Market index?
Das: The Saudi regulators have been quite progressive in terms of coming up with regulations and also very responsive in receiving feedback. However making changes in regulations or the systems infrastructure takes time – and I think people understand that, but equally one wants to see steps being taken to improve the infrastructure on an ongoing basis to feel reassured that things are moving in the right direction. The concerns on T+0 are not always fully understood by everybody locally – the T+0 point is not just a prefunding issue.
People think that by making credit available the prefunding issue, and hence the T+0 issue, is resolved. From the custodian perspective the main issue with T+0 is that the matching between the broker’s allegement and the global custodian’s instruction is not possible. That fundamental point of matching and settling, where the discretion to settle lies with the custodian, is not in place yet in the kingdom. And that represents a major asset safety risk for all international investors.
Das: These are practical technical issues that are coming to fore now but hopefully, as we provide feedback to the regulator, they will be addressed in an iterative process.
So how far away is Saudi eligibility for the MSCI EM Index?
Izz-e-Hamid: Analyst reports suggest the earliest that Saudi Arabia may be eligible to form part of the MSCI EM Index is 2017. In order to make the cut, Saudi Arabia will need to meet the eligibility criteria and tick all the assessment boxes. The capital markets authorities are surely making efforts to arrive at an optimal operating model that meets the needs of domestic and international investors.
How are regulatory moves affecting MENA markets?
Das: There’s lots going on across the region in the regulatory spectrum. In the UAE, there are conversations around the Central Bank becoming more involved in the clearing mechanism. The CSD will become involved in distribution of dividends. In general, everything is aimed towards risk mitigation and improving efficiency. If we look at the case of the UAE, it’s aiming to achieve developed market status in a few years. That would entail a number of changes.
But we also need to prioritise these changes and focus on the most important ones. For example, there are lot of discussions underway about creating CCPs. However, in the current pre-validated trading and settlement model, with centralized clearing at the country’s central infrastructural utility, is the case for a CCP that acute?
Salomons: The MSCI upgrade last year was a milestone for the UAE capital market and a reflection of the standards against which they operate. What I am conscious of are the introduction of regulation not just because of the MSCI upgrade but in support of developing the capital markets in general. For example, one of the things we are very keen on is to continue the axes of the Europe-US-Asia based trading nexus into the DIFC.
This provides us with a challenging situation in that we must clearly understand the regulation coming out of the European Union (EU) and the US as well. Various EU directives are therefore high on the DFSA’s radar.
Just because a jurisdiction follows international standards does not necessarily grant that jurisdiction access across the threshold of offering exchange or clearing house services into the EU or US.
Furthermore, the MENA region may not always be a priority for regulators in developed markets. This can cause delays in obtaining the necessary approvals or recognitions. For example, I understand from market stakeholders that clearing members are keen to connect from London into the UAE.
However, those clearing members are also cautious because of the regulatory uncertainty. They are holding back from connecting to clearing houses in Dubai until there is clarity from a European perspective.
What international best practices have yet to be applied in the region and how might investors reduce risk further?
Das: Firstly, while we should look at international best practices, we must make them fit for purpose for the markets we are operating in. For example, omnibus accounts may be the norm in developed markets and they are very convenient, but that concept is coming under more regulatory scrutiny, and may not be ideal for the Middle East where we have pre-validation of trades and foreign ownership limits.
But equally we should look at what has worked elsewhere and see if we should apply it here. For example stock lending has been introduced in some markets here, but with a very restricted end use. Stock lending can only be used for market making and settlement of failed trades.
Restriction to those uses will not give it enough scale to take off. That is a shame because there are strategic investors sitting on piles of stocks and the only return they are getting is dividends. They could very productively lend the stock into the market and get an income stream, while improving the liquidity of the market.
What is the quality of the local regulators?
Aba Al-Khail: In Saudi Arabia the CMA is very strong institution and the caliber of its staff is extremely high. It is corporate friendly yet it vigorously monitors the market and is constantly developing its rules and regulations.
Salomons: One issue is that funding for regulatory bodies is limited. They are also challenged by the wide array of capital market competences that you need to have in areas like corporate finance, derivatives, structured products, and so on.
These days you are competing for talent across the world. At the DFSA we have gone from being a predominantly expat organisation in the early days to one whose biggest nationality is now Emirati. That is the result of a commitment to a two-year management training programme which has been very successful.
What new products and asset classes do you see emerging in MENA? Is it too soon to speak about ETFs and derivatives?
Topbas: We can talk about sukuk emerging as a product with huge potential and that is evident in the multiplier effect in terms of sukuk markets. But I’m a bit less optimistic on the ETF side. Yes, it’s very promising, but when it comes to reality, from a trading and liquidity perspective I wouldn’t categorise ETFs in the same bracket.
Salomons: Regarding sukuk, in the DIFC we have seen close to $12.7bn to date this year of issuance which is already close to the level that we saw in the whole of last year. That is a major achievement but it brings other challenges to the forefront and we need to start thinking about standardisation and market transparency. ETFs have certainly been on the cards for a while but no ETFs have actually come to list until date. The first REIT however listed successfully last year.
Aba Al-Khail: ETFs exist in Saudi Arabia but have not taken off yet. As the market continues to develop so will ETFs and derivatives.
Looking beyond the Gulf, do you see Egypt figuring on investor radars more prominently? Is there a genuine prospect of a cross border corridor of issuance between Cairo and the Gulf?
Salomons: Egypt is a very interesting development. We have seen the first duallisting of Orascom Construction Limited earlier this year, closer co-operation with the Egyptian regulator following that transaction; a link between the Nasdaq Dubai and the Egyptian central securities depositories, and other issuers with Egyptian assets coming to the DIFC market. We recently registered Egypt’s Beltone Market Maker as a recognised member to the DIFCD markets, thus offering remote access to Egyptian investors into the DIFC markets for the first time. Whether we call this a corridor or not – this development has been picking up pace this year.
Aba Al-Khail: There is pent up demand for the Egyptian market. The problem with the Egyptian market is getting your money out. We’ve not got that problem ourselves, but the risk is always there.
Topbas: The Egyptian economy is slowly returning to health and confidence is rising. When this is looked at from the perspective of capital market infrastructure, it lends itself to being a robust market that will attract new growth.
As this dynamic accelerates, it is more crucial than ever for local regulation to keep pace with new market requirements in order to remain competitive. Clarity and timeliness of regulatory updates are essential in this regard.
As UAE and Qatar move to EM space, is there room for new MENA frontier entrants? And will any of the Frontier markets move to emerging status?
Salam: MCSI’s market classification looks at both quantitative and qualitative criteria with size, liquidity and foreign ownership the areas we are most asked about. For MSCI Emerging Market classification we also need to see at least three stocks that meet these criteria.
Not surprisingly a number of GCC markets already meet the size criteria but have lower than required levels of liquidity and foreign ownership limits. So whilst a number qualify based on size, it is not size alone with governs an MSCI classification.
In terms of MENA asset management, asset and product classes are vanilla, with markets dominated by equities. But are any changes in the pipeline? For example, is fund passporting now a genuine prospect?
Das: Regulators should actively consider allowing passporting. It will generate scale and reduce costs. After all it has been very successful in Europe and Asia is also doing it now. There is one school of thought that that western markets should lead such innovation, followed by Asia, and then the ME will follow suit.
I don’t agree with that. In a number of fields, including construction, tourism and hospitality, some of the Middle East countries especially UAE have set standards for the rest of the world to emulate. There is no reason why we need to lag behind other regions when it comes to capital markets. In fact, I would argue that concepts like fund passporting are more critical in the GCC than in Asia, because the GCC countries (excluding Saudi) have a scale constraint, which many Asian countries do not.
Market infrastructure is another area where change is underway. Sub-custody and clearing services are becoming more sophisticated. What are the big issues facing the securities services industry in the MENA region?
Das: In Saudi Arabia, the launch of the QFI regulations and the introduction of the Independent Custody Model are significant changes to the market infrastructure. Similarly in the UAE and Qatar, they have implemented the DVP model that led them to attain Emerging Market status last year. Oman and Kuwait are also planning similar changes. Overall I think that the pace of change in the post trade operating infrastructure in the ME is really commendable.
However, it is also our collective responsibility to educate investors and international intermediaries about the benefits of these changes. For example, despite the improvements taking place, UAE and Qatar we still see investors keeping shares in custody accounts and going through a rigorous process of moving them from the custody to the trading account, all of which increases the cost of operating in these markets.
Do you see the evolution of an Islamic fund market as a likelihood? Are sharia investment instruments to have more impact in MENA in future?
Salomons: It is certainly growing, but sharia-based funds are still a small area of our regulatory work in the DIFC. We do see the facilitation of murabaha transfers and the murabaha platform developed by Nasdaq Dubai through its custody service. And we have made a conscious decision to operate as a sharia systems regulator.
This means that we rely on the sharia boards of companies or issuers to determine whether or not they have the appropriate structure: we do not get involved in testing the fatwas (sharia pronunciations) – but we do make sure that the prospectus does disclose as to why a particular security is deemed to be a sharia-compliant security.
This is different from other jurisdictions like Malaysia where there is a centralised model. I have heard of the idea of establishing a centralised model in the UAE, which may be a conduit to more standardisation of sharia products and documentation, but we feel comfortable with the regulatory framework in place at the moment.