Market regulators must toughen up

03 July 2014

The sharp fall in UAE contractor Arabtec’s share price has led to calls for tougher regulation

The spectacular collapse in the share price of UAE contractor Arabtec Holding over the past four weeks could not have come at a worse time for those responsible for managing the UAE’s capital markets.

The reclassification in May of the UAE to emerging market status by US-based index compiler MSCI had been heralded as a stamp of approval from the international investor community. But failures exposed by the Arabtec falls have raised concerns that key aspects of the UAE’s capital market culture, particularly around the increased requirement for transparency, have yet to match the upgrade.

Arabtec’s stock plunged to AED6 ($1.6) in the first week of May from a high of nearly AED10 at the start of the week. One month later, on 18 June, Arabtec managing director and CEO Hasan Ismaik resigned. Ismaik’s departure contributed to the sell-off, and by 3 July, the firm’s share price had fallen to AED3 a share.

Regulator effectiveness

The Dubai-listed firm’s devaluation revealed a lack of transparency that characterises many of the worst habits of the region’s stock markets. And it has led investors to question the effectiveness of the country’s Securities & Commodities Authority (SCA), which is responsible for regulating the UAE’s capital markets.

Arabtec’s share price collapse comes four years after concerns were first raised about the lack of transparency surrounding the ownership of Abu-Dhabi-backed Aabar Investments, a major shareholder of Arabtec. Clarification was not provided until mid-June this year, when the DFM disclosed that Ismaik owned not 21.4 per cent, but 28.9 per cent of the firm, while Aabar was first shown as owning 21.5 per cent, then 14.3 per cent, before finally putting the actual figure at 18.9 per cent. The confusion triggered panic among investors amid concerns that Aabar was selling off its holdings.

“The authorities are under a lot of pressure to provide more transparency following the MSCI upgrade,” says a Dubai-based investor. “That includes showing exactly who is in control of what, even if, say, an individual owns more shares under other people’s names. The information should have been disclosed much sooner, at the time ownership changed. It looks like they have now decided to correct previous mistakes, although questions remain.”

The plunge in Arabtec’s share price followed a four-month climb between January and May. The sudden surge in price coincided with a stream of positive reports in the media about actual or potential construction awards, which sparked speculation among investors that the firm, or people close to it, may have been leaking tips to the market to try and drive up the stock.

As investor excitement around the contractor intensified, the company seized the moment to announce aggressive plans about future projects and possible acquisitions in Kuwait and the UAE. Under Ismaik, the company announced it would be targeting an acquisition in Europe, plans to go public with several of its subsidiaries, a $6bn deal with Aabar to build 37 towers in the UAE, and a $40bn agreement with the Egyptian government to build 1 million affordable homes without providing substantial details on the project’s financing or feasibility.

Muted reaction

In February, the SCA suspended Arabtec’s stock for a day, after rumours that it planned to acquire Kuwaiti contractor Kharafi National. Arabtec issued a prompt denial of the rumour and the suspension was lifted. Despite this, and ongoing speculation surrounding Arabtec and the volatility in its share price, the SCA did not investigate trading activity in Arabtec shares or publicly ask for clarification on announcements.

“Ismaik’s plans sounded quite ambitious when he announced them a few months ago,” says Sebastien Henin, head of asset management at Abu Dhabi-based The National Investor. “For instance, he was targeting the construction of 1 million homes in Egypt by 2020, while the regional leader, Morocco’s Groupe Addoha, delivers up to 23,000 units a year.”

During the four-month period, heavy trading in Arabtec shares often occurred in the weeks or days before news became common knowledge, yet the SCA did not investigate the movements.

Further, despite companies not being supposed to predict their own share price, the SCA did not step in when it was reported that Ismaik told Arabtec’s annual general meeting on 30 April that the company’s share price should be AED14 based on its order book.

In late June, Ismaik issued a statement to the media saying he would be willing to sell his shares “at the right price”. Analysts and investors immediately saw this as evidence that the largest shareholder had lost an internal power struggle. The regulator said in early July that it had demanded a response from Arabtec to the rumours and has asked for clarification surrounding Ismaik’s departure.

At a press conference on 2 July, Arabtec’s directors said the firm was not responsible for leaking rumours that had driven up its share price, saying the share price is “subject to supply and demand, as well as other prevailing political situations in the region and availability of cash in the markets among other elements, which are out of Arabtec’s control”.

What did become clear after the subsequent departure of several key personnel, including Arabtec’s head of mergers & acquisitions, was that the company would no longer be the same.

“The news has confused investors as a lot of future growth had been priced into the stock,” says Nishit Lakhotia, head of research at Bahrain’s Securities & Investments Company. “We suddenly saw a different Arabtec expecting its direction to likely change compared with what was laid out three months ago. It is positive that Aabar is still in control, but there is a lot of uncertainty surrounding the stock.”

Until the weaknesses exposed by the Arabtec price swings have been explained thoroughly by the authorities, and clear action to address any failings are announced, uncertainty will continue to hang over the UAE’s stock markets.

Regulators in Morocco and Egypt have not hesitated in the past to suspend trading in a particular stock where unusual volatility is seen until an issue is clarified. And they will publicly push firms to provide more clarifications.

Within the GCC, regulators follow a variety of approaches. Saudi Arabia’s Capital Market Authority has over the past year imposed heavy fines on firms that fail to adhere to reporting deadlines and standards.

Some analysts say regional businesses and regulators need to take a more serious approach towards corporate governance. Details about major financial deals are often missing from company reports, they say, and quarterly earnings reports are frequently late, often leaving investors to rely on rumour.

Relaxed approach

Some analysts speculate that the SCA may have chosen to take a more relaxed approach in order not to destabilise the growth in market activity that has accompanied Dubai’s economic recovery over the past two years.

The SCA rejects the criticisms that it should bear responsibility for the extreme levels of volatility in Arabtec shares and that it must take tough action against the company.

In a statement on 2 July, the SCA said it was “scrutinising the level of adherence of local public joint stock companies listed on the UAE markets to the rules of the Commercial Companies Law, the regulations and requirements of disclosure and corporate governance according to the best international practices accredited by the International Organisation of Securities commissions, the IMF and the World Bank”.

It said the suspension of trading in a company’s shares can be taken only in certain circumstances. “This does not apply to any case of the companies listed currently on the market as they all play according to laid down rules of listing, disclosure and trading,” the authority said.

The UAE’s capital markets are still very young and need time to learn from past mistakes. The SCA is only 14 years old. “It will take time before they are fully developed. We are moving in the right direction, but it would be good if we saw more progress across the region to increase transparency,” says Sebastien Henin, head of asset management at Abu Dhabi-based The National Investor.

Recent efforts to improve trading systems have earned the UAE an upgrade, which is an encouraging sign. But the focus now needs to be on attracting long-term investors through growing transparency, limiting speculation and putting a stop to suspicious market behaviour.

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