Some are strategic. Age is catching up with the first generation of beneficiaries of the immense wealth generated by oil export surpluses in the late 1970s and early 1980s, and imminent mortality is encouraging close examination of inheritance issues, succession questions and the need to institutionalise wealth.
Some are political. The ruling families and governments of the GCC states have embraced the principle that, in the face of testing demographic trends and development needs, a growing proportion of future infrastructure and industrial projects will have to be financed by the private sector. With this firmly at the top of the agenda, the options are limited: either foreign direct investment (FDI) is lured into what have historically been viewed as unattractive markets, or some of the private locally owned wealth invested abroad is brought back home, or a combination of both is chased. Against such a backdrop, the pressure applied to regional high-net-worth individuals (HNWIs) to repatriate a growing proportion of their holdings is becoming more intense.
For the private banking community keen to serve these troubled HNWIs, boom-time beckons. ‘Our industry is well insulated from cycles and trends: whatever is happening on global markets there is work for us to do,’ says a head of territory international private banker based in Dubai. ‘Past experience tells us that regional instability is particularly good for business. It is no coincidence that Kuwaiti appreciation of diversified portfolios, strong trusts and the benefits of institutionalised wealth is by far the most advanced in the region.’ Others agree. ‘We have felt the impact of 11 September on the psychology of the market,’ says Jonathan Watson, head of private banking at HSBC Republic. ‘There has been an increased awareness of risk management.’
For the owners of this huge offshore wealth, the practical, strategic and political pressures might appear to be contradictory. Events on global equity markets over the last 18 months will have bruised almost all portfolios, even those structured with low-risk profiles. Equally, 12 cuts in US interest rates in the last 12 months have stung those seeking yields from deposit accounts and fixed-income instruments. A comparatively gloomy outlook for the global economy in the near term will do little to shore up confidence. Neither will fears of terrorist-related asset freezing.
‘There have been horror stories of people with the wrong names having US-based assets frozen,’ says another private banker. ‘And there is genuine discomfort and concern. Anecdotal evidence and our experience would suggest that these concerns have not led to massive movements of money out of US markets, but some of the relationships with US financial institutions might have become more strained. There are certainly some European banks trying to exploit this.’
Will a combination of lower returns, fears over asset freezing and inheritance issues magnify and lend weight to government-led calls for the repatriation of private offshore wealth? In the short term the answer is probably not, as one of the primary factors driving the assets offshore in the first place – a lack of strong-yielding, well-structured, liquid and diverse investment opportunities within the region – has not materially changed.
Not only are regional equity markets relatively small – the total market capitalisation of the six GCC stock markets is $140,000 million – but they are also illiquid, tainted by comparatively poor transparency and lack the ancillary investment-banking activity, such as high-quality equity analysis and fund management, which lubricate the inflow of capital. Even more inadequate are local debt markets. With activities in Kuwait excepted, the number of properly structured local corporate bond issues in the GCC can still be counted on two hands. In the context of established investment patterns – Saudi American Bank (Samba) estimates that 40 per cent of offshore private Saudi wealth is invested in fixed income and another 35 per cent in equities – such limitations are considerable barriers to the repatriation of offshore private wealth.
‘The fundamentals are opportunity and returns,’ says the first private banker. ‘Our clients ask us about investing at home, but the way markets are structured at present, they would have to dramatically alter their investment parameters to do so.’
Whichever estimates are taken of the volume of GCC offshore private wealth – and the figures vary wildly (see box) – there can be no doubt that if attempts to lure it back to domestic markets are successful in any measure, it could have a massive impact on regional economies.
The most telling example is the phenomenal rise of Dubai. The transformation, and growth, of the emirate over the last 20 years has been in large part achieved by the political focus the Al-Maktoum family has placed on Dubai nationals investing in their home town, and developing its business and tourism infrastructure. If the example were to be followed elsewhere in the GCC, the volumes of capital inflows would far exceed the FDI flows being sought.
‘There is clearly a need for better regional investment opportunities,’ says Brad Bourland, chief economist at Samba. ‘This would be a good time to push ahead with privatisation and new equity offerings, either through private placements or listed offerings.’
There are benefits for both the demand and supply sides of the equation. ‘The feedback we get from our major clients is that there is a growing focus on their domestic markets – particularly local private equity deals,’ says HSBC Republic’s Watson. ‘There is definitely good appetite, but developing good products is harder.’ Perhaps the richest irony is that, having forged their investment habits in the furnace of mature US and European markets, the notoriously secretive HNWIs of the Gulf will be among those clamouring loudest for improved regional transparency.
There is also a demographic factor. While the young and rapidly expanding populations are swamping the ability of government to foot the infrastructure and economic development bills, and forcing the need for the repatriation of offshore wealth, the same demographic trend is likely to force that wealth home. The Merrill Lynch/Cap Gemini Ernst & Young ‘World Wealth Report’ suggests that in 2000 there were 220,000 HNWIs in the Middle East. Large families dictate that generational change will see the pot divided along exponential lines: those 220,000 might have on average five heirs each. As each slice of the pie gets smaller a growing proportion will be pulled back into the local economies by the demands of personal expenditure. But it will also limit the capacity for big-ticket investments.
For the regional governments, the race is on. For the HNWIs, the choices are becoming more complex. For the private bankers, the region still offers a wealth of opportunities.