Market Reform - A larger role for capital markets

30 December 2010

Along with market consolidation, the next decade will see some radical changes made to the Gulf’s exchanges in a bid to draw in more international investors and boost liquidity

Gulf stock markets have been among the worst-performing in the world over the past five years in pricing terms. Today, the markets continue to suffer from negative sentiment and low turnover, with shares of many companies infrequently traded.

The Dubai Financial Market (DFM) recorded the sharpest drop as a result of the emirate’s well-publicised debt crisis. Trading volumes fell by 68 per cent between March 2009 and the end of October 2010.

The GCC states have generated just $1.91bn from initial public offerings (IPO) so far this year, down from $2.27bn in 2009, as investors continue to shy away from the markets.

Market mergers in the Gulf

Against this backdrop, it is not surprising that calls for consolidation have increased, and market reform is set to be a major feature of the next decade. Industry observers argue that the Gulf region, with a population of less than 40 million, is too small to support nine stock markets, and this argument has gained credibility of late.

In July, the first GCC stock market merger between the DFM and Nasdaq Dubai was completed in a bid to improve liquidity. It has already produced positive results, with an upturn in both trading volumes and value. The Abu Dhabi Securities Exchange (ADX) is now in talks to merge with the DFM and the deal is expected to be completed in 2011.

Capital markets require scale to be successful and it is clear that the merging of liquidity pools will rank much higher on Gulf countries’ agendas over the next decade. It is also clear that the products traded on regional markets will be considerably more sophisticated by 2020.

Both the ADX and the Saudi Arabian Stock Exchange (Tadawul), are working to introduce derivatives and short-selling, while Nasdaq Dubai is also in favour of introducing short-selling, which would enable investors to profit from a fall in the value of shares.

Gulf markets have woken up to the fact that they need international institutional investment if they are going to generate proper liquidity. But until it is possible to hedge against market volatility, such investors will not be willing to buy into regional shares. “One of the main weaknesses of the GCC is you can only make money when there is a bull market,” says Jeff Singer, chief executive of Nasdaq Dubai.

Gulf markets, especially the UAE, are also making other notable changes to boost trading. The UAE is in talks to relax its foreign ownership laws, as well as to reduce the minimum size stake that a company has to float from 55 per cent to 25-30 per cent.

A stronger regulatory framework will also be a hallmark of the Gulf markets in the future. GCC market regulators are currently working on a raft of new legislation to ensure the development of the exchanges. 

For this reason, analysts are confident GCC exchanges will gradually be upgraded over the next decade to ‘emerging’ market status, from their current ‘frontier’ classification by index provider MSCI – the conventional performance benchmark for large-scale emerging market investors. This will translate into an increase in overseas and institutional investment that will lead to greater market stability.

The nascent bond and sukuk (Islamic bond) market will also play a much larger role in the years ahead. Middle East and North Africa bond issuance is forecast to hit $30bn by the end of 2010, with the UK’s HSBC predicting it will record 25 per cent growth in 2011.

Mena bond issuances, 2010*
Abu Dhabi2,533
Saudi Arabia2,133
*=Year to date. Mena=Middle East and North Africa. Sources: HSBC; Bloomberg 

Governments in the region are fast realising the significance of the debt capital markets as a source of liquidity for the huge public infrastructure projects being carried out, and bonds hold immense potential in a region that has largely been supported by bank lending to date.

State initiatives aimed at diversification are likely to be a key driver of IPOs in the future, meaning sectors such as transport and industry will see increased issuance. This should help lead to a more balanced sector representation. At present, most exchanges are skewed towards construction, real-estate and finance companies.

Privatisation plans for Gulf firms

Gulf countries will also be increasingly open to the idea of privatising public sector firms, but it is likely they will want to restrict these IPOs to their own nationals. The Dubai government is mulling a stake sale in its most prized asset – Emirates airline. The state-backed carrier reported a 351.2 per cent year-on-year increase in net profit in the first half of 2010 to $926m.

Currently, the regional exchanges lag behind their counterparts in other emerging markets by a wide margin in terms of overall liquidity. Combined revenues of the companies listed on the GCC stock markets stood at $175bn at the end of 2009, compared with $590bn in India and $1.2 trillion in China.

But the GCC is expected to post robust growth over the next decade, both in terms of population and gross domestic product (GDP). By 2020, the GCC population is forecast to reach 53.5 million, a 30 per cent rise over 2000, while real GDP is expected to grow by 56 per cent.

To service the growing needs of this expanding population, the corporate sector will need improved access to capital. This should spur the growth of both the IPO and debt markets. Certainly, the markets will be more liquid and mature by 2020. But differentiation is also crucial, and the question of how the varying exchanges will competitively position themselves will be key to how the markets develop.

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