Key fact

First Gulf Bank announced in November it was raising the ceiling on foreigners’ share holding to 25 per cent

Source: MEED

Speculation over the pace of capital market liberalisation in the UAE continues as investors wait for final approval of a new companies law that could permit foreign investors taking majority control of local businesses outside free zones for the first time.

Confirmation of the new regime would provide a welcome boost to the Abu Dhabi Securities Exchange and the Dubai Financial Market, which both endured a sluggish 2011.

An influx of international money, managed with risk-taking panache, would liven up an investment culture notable for its conservatism, putting listed businesses under greater pressure to perform and creating new opportunities for local and international share-buyers.

Breakthrough measure

The anticipated lifting of the ban on non-Emirati corporate control of firms outside free trade zones is just one element of a wider reform process that has been gradually transforming the UAE’s capital markets over the past few years.

Abu Dhabi securities exchange stock ownership
Company name Foreign ownership permitted Limit for GCC (%) Limit for foreigners (%) Minimum for nationals (%)
Abu Dhabi Commercial Bank Yes 49 49 51
Abu Dhabi Islamic Bank No 0 0 75
Aldar Properties Yes 40 40 60
Bank of Sharjah Yes 30 30 70
Dana Gas Yes 100 49 51
Etisalat No 0 0 100
First Gulf Bank Yes 25 25 75
Sorouh Real Estate Yes 15 15 85
Waha Capital Yes 49 49 51
Source: Abu Dhabi Securities Exchange

But it could prove to be one of the breakthrough measures that at last enables the UAE to secure the prized status of emerging market under the non-official but highly influential grading system devised by Morgan Stanley Capital International (MSCI).

That status would help the country attract a wider range of international portfolio investors, rather than limiting it to those willing to buy into frontier markets – the heading under which the UAE is currently categorised.

Uncertainty hangs over the timetable for the new companies law. In early December, the state news agency, Wam, informed local media that it had been approved by the cabinet. But even after approval by the Federal National Council – the UAE’s national parliament – the measure still has to secure the endorsement of the Supreme Council of emirate rulers, before signature by the president, Sheikh Khalifa Bin Zayed al-Nahyan.

Foreign portfolio investors would inject fresh liquidity into the exchanges

Some sources believe the law could come in to force as soon as March or April. But others say there will be no rush to push it through because its natural partner in the structure of business regulation is a planned new bankruptcy law, which is at an earlier stage of preparation.

Even after the main law has come into effect, the practical impact on investment conditions will depend on decisions the government subsequently takes about individual sectors.

“The full details have not yet been released,” says Hardeep Plahe, counsel at law firm Linklaters in Dubai. “However, I expect the companies law to say that foreigners will continue to be limited to owning 49 per cent or less of all UAE incorporated companies, except in those cases where the cabinet decides otherwise.

“With the main law in place, the cabinet would then be able to use its new powers to specify certain sectors where foreign ownership of up to 100 per cent will be allowed.”

Plahe tells MEED that it seems likely (but is not confirmed) that different levels of maximum foreign ownership will be set for different sectors, depending on national interests.

For the Emirati federal authorities, the relaxation of ownership rules is not so much a question of ideology as of pragmatism. They have to balance the need to attract international capital against ensuring a continued central role for UAE citizens in their own national economy.

There are certain activities that will not be seen as strategic and where the authorities will take a relaxed view of foreigners taking full control of businesses. And there are other sectors, such as the oil industry, where the prospect of allowing international investors to take majority stakes seems remote.

There are also some sectors that are not fundamentally strategic, but where the government will want to ensure local businesses retain a major share of the wealth. “They still have a protectionist mentality,” says one observer of UAE regulatory issues.

The most notable example is the importation and distribution of major brands. The UAE’s agency law specifies that registered commercial agents must be nationals or companies that are 100 per cent Emirati owned. This rule protects the position of the leading business families within the local economy. It also serves a useful purpose for the suppliers of major brands, by guarding against the inflow of ‘grey’ imports.

Wider trend

In other non-strategic sectors, the course towards a gradual liberalisation of ownership rules is now set. This is partly because of wider trends across the GCC, where competitor economies are also moving towards a relaxation of controls on foreigner shareholdings.

There are reports in Saudi Arabia that the authorities are finally close to permitting direct investment in the stockmarket, albeit only by large international portfolio investors and only up to maximum share stakes of 5 per cent. Qatar is also understood to have held talks with individual firms about raising ownership limits.

Once the companies law is in place, the main remaining barriers to increased foreign ownership will be sector regulation and the constitutions of individual companies. Neither the Abu Dhabi Securities Exchange nor the Dubai Financial Market impose any percentage ownership ceiling, so they will be able to adapt to the new regime with ease.

But there are sector laws that impose limits: “In commercial agency, the law permits no foreign ownership, while in insurance, foreign shareholdings are limited to 25 per cent,” Plahe says. “The articles of association of some individual entities set higher foreign ownership limits. For example, Emirates NBD limits foreign ownership to 5 per cent and it is not alone in this. Of course, some businesses may decide that it is in their interest to relax these rules.”

In November, First Gulf Bank announced it was raising the ceiling on foreigners’ share ownership to 25 per cent. With non-Emiratis holding 14.03 per cent of the stock (including 9.05 per cent held by non-Arabs), the bank’s former 15 per cent ceiling risked deterring would-be new shareholders.

Clear signals

As one of the Gulf’s most dynamic and diverse economies, the UAE has a reasonable chance of attracting significant foreign investor interest once the rules have been reformed.

But if investors are to come, the government needs to signal clearly that liberalisation is definitive and the new rules are here to stay. As the law firm Baker Botts suggests in a recent briefing, uncertainty would be unhelpful: “It is unknown whether, once the threshold has been increased, it can be lowered again and, if so, what is the mechanism for doing so. If the threshold can be easily lowered, this would adversely affect the effectiveness of the new law and therefore the willingness of companies to rely on it to increase their investments in the UAE.”

Confirmation would help the country’s stock exchanges, which have struggled to maintain momentum over the past two years, yet continue to resist pressure to merge.

At present, the purchase of listed share stock is dominated by local retail investors who tend to buy shares for the long term to supplement their salaries or pensions with a flow of dividend income. They are able to acquire shares at bargain prices in initial public offerings (IPOs) priced to promote indigenous share ownership.

Because the companies tend to be good businesses, generating solid profits and therefore strong dividends, there is no incentive for small retail investors to sell their shares later on. Instead, they wait for the chance to increase their holdings when rights issues crop up.

While this provides a useful supplementary income for the UAE middle class, it makes for a highly illiquid market, with limited movement in share prices and little risk taking.

Consequently, exchange activity has stagnated. In December, Shuaa Capital, a leading UAE investment bank, shut down most of its equity research operations. Its analysts had been producing reports on listed companies, yet hardly anyone was buying the stock.

Many brokerages have ceased operations and are now listed by the UAE Securities and Commodities Authority (SCA) as ‘not active’.

Increased activity

“Foreign portfolio investors would inject fresh liquidity into the exchanges, creating a more dynamic and flexible market for stock,” says Plahe. “In their search for attractive returns, they should take a more calculated approach to risk and reward than retail stockholders and buy and sell shares more actively.

“This could encourage an environment in which retail investors could manage their holdings more actively because they would know that there was a market for stock they wanted to sell and regular opportunities to buy shares when others wanted to sell.”

The SCA has taken other steps to bolster the standing of the UAE capital market and improve its prospects of securing emerging market status. The authority has tightened corporate governance rules. It reports that in the third quarter of 2011, some 98.2 per cent of local listed companies met its information disclosure requirements: 119 out of 127 companies submitted their financial reports on time and 106 out of 108 local public joint stock companies disclosed third quarter results as required.

The SCA has recently published draft rules on market-making and short-selling, and it has reformed market rules to provide bookbuilding for IPOs. Last year, the UAE exchanges dealt with a key concern of the MSCI by shifting to the delivery versus payment settlement system.

The regulators want the market to be taken seriously by foreign investors and the new companies law should help them achieve that.