DUBAI’S PLANS FOR the development of its financial sector have taken a new step forward with the appointment of Ian Hay Davison to head the regulatory council of a proposed international financial centre.
The grandeur of the design, which envisages a capital market as well as insurance, offshore banking and Islamic banking centres, is typical of the approach Dubai has adopted in efforts at modernizing and diversifying its economy. While other Gulf states anguished over the need to provide investable opportunities for local and international money, Dubai has moved characteristically rapidly since the announcement of the project last November.
As well as the appointment of Hay Davison, a former chief executive of the Lloyd’s of London insurance market and sometime managing partner at Arthur Andersen, a shortlist of three has been drawn up for the post of chief commissioner responsible for regulation and enforcement. An appointment is expected in a couple of months.
Talks about a strategic partnership have started with leading international exchanges on both sides of the Atlantic, with candidates thought to include the London Stock Exchange and the Deutsche Börse.
One of these will be selected as a partner for the capital markets with the objectives of attracting a pool of international liquidity to the Gulf. The new markets will quote prices for international and regional companies as well as providing opportunities for Gulf companies to launch IPOs and raise bonds in currencies other than the dirham.
Proposals have been announced for a regulatory commission of five members. These will be “alumni” of or on secondment from the regulatory authorities of London, New York, Singapore, Hong Kong and Switzerland.
Ultimate responsibility for regulation will be a sensitive issue. The Central Bank of the United Arab Emirates – Dubai is one of the seven constituent emirates – made it clear when looking at earlier attempts to set up an offshore financial centre in Abu Dhabi that it expected to be the ultimate regulatory authority. That plan for an offshore financial and commodity market on Saadiyat island now looks doomed to fail as Dubai’s project gathers momentum.
Negotiations are now taking place between the central bank and the Dubai International Financial Centre (DIFC) on a memorandum of understanding to define the responsibilities of each regulator.
The financial centre would, its supporters say, supply one of the final elements in Dubai’s 30-year plan to create a global business, banking and leisure centre. It would complement the internet and media cities, the various free trade zones and the luxury tourist hotels. Dubai would have earned its place alongside Singapore and Hong Kong.
Some bankers have reacted positively. “I would not underestimate Dubai. One of their objectives is to create a brand name. It is a beautiful place with a first-class infrastructure and there is a lot of business to be done there. The appointment of Hay Davison adds to its credibility,” says Philip Winder, Middle East director at Schroder Investment Management.
The reaction in other Gulf states, which for 20 years have been less than happy with Dubai’s readiness to blaze its own trail, is more sceptical. “It will be a triumph of style over substance. There will be a lot of talk but don’t hold your breath,” says one banker.
Creating the DIFC will be a far harder task than developing the region’s tourism and business capital. For one thing, most of the banks that want to be in the region are already there. To succeed, Dubai will have to attract banks that are in other jurisdictions rather than institutions that do not already have a presence.
Nor will Bahrain, its long-term main rival as a financial centre, give up without a fight. Bahrain, once the regional hub for all business activity, has held on to its international banking lead much more effectively than other sectors. This is primarily a result of its ability to balance a rigorous regulatory regime with the flexibility to allow new sectors, such as Islamic and investment banking, to prosper. International banks, headed by Citibank, whose regional head office is in Bahrain, are comfortable with the Bahrain Monetary Agency, which has built its reputation over the past 30 years.
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Sultan bin Nasser Al Suwaidi |
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Sultan bin Nasser Al Suwaidi, the UAE central bank governor, is highly respected for the way he has tried to introduce regulations and improve banking standards. But his freedom is severely constrained. Banking regulation is a federal responsibility and it is often difficult to get agreement on legislation from member governments. Consequently banking reforms are often delayed for years.
Perhaps the toughest challenge of all is to persuade local investors to take the lead and place their money in local markets. Only then are financial investors likely to follow suit. There is a long way to go. The trading floor of the Dubai Financial Market is a quietly convivial place where investors chat with brokers over cups of coffee. The relaxed mood is only occasionally interrupted by a transaction.
The UAE’s stock markets – there is also one in Abu Dhabi, where business is even quieter – have not had a dramatic impact on the financial world in the two years since they were established. Like the rest of the Gulf’s stock exchanges they are too small, too volatile and too weakly regulated to register with international investors.
The aim of the DIFC is to address a Catch-22 problem, which has held back the Gulf for a decade. Investors, whether local or international, will not put their money into the region, in local or international currencies, until there are attractive investment opportunities. But these products will not be offered until there is clear evidence that investors are prepared to buy them.
Hussain Al Qemzi, the DIFC’s chief operating officer, is confident that these challenges can be overcome. He tells Euromoney that the “strategy is to position Dubai as the hub for institutional finance in the region. We want to attract the leading international finance houses and be the place where the major deals in the region are completed.”
Al Qemzi, who worked for Citibank and HSBC and as strategic manager at Abu Dhabi-based First Gulf Bank before joining the DIFC, says the choice of the leading international exchange partner is crucial. This exchange, which he says “would take a strategic share” in the DIFC, should enable it to “offer a new way of raising finance. The relationship with an international market will allow our blue-chip companies, particularly those being privatized, to have access to a new pool of international liquidity.”
The DIFC is also looking to win a share of the Islamic banking market. This is dominated by Bahrain, which has made a concerted attempt to attract this business by establishing regulatory and accounting standards designed to meet the particular needs of Islamic banking.
However, Al Qemzi believes the DIFC can play a complementary role. “Most of the Islamic products bought by investors are in western-regulated markets. The opportunity to buy and sell them in Dubai is an attractive proposition,” he says. Provided Dubai focuses on establishing an international capital market rather than a regional banking centre, bankers say it has a good chance of success.
In financial terms the timing of the DIFC’s launch could not have been better. Following the large falls in western stock market values and low western interest rates, which have made Gulf currency deposits more attractive, there is more liquidity in the region than for some years.
There is also a shift in the region towards an economy more driven by the private sector. Governments, worried about the difficulties of maintaining consistent fiscal policies when their revenues are so vulnerable to oil-price fluctuations, are looking to privatize state-owned industries and have new projects financed from the private sector. Saudi Arabia alone needs to attract billions of dollars of foreign investment to pay for electricity and water projects.
A more vibrant private sector shows signs of emerging. Last year, in Saudi Arabia for example, GDP grew by 2.2%, including a 5.9% growth in the non-oil private sector. “The path of economic reform aimed at increasing private-sector growth in Saudi Arabia was not seriously disrupted by world developments in recent months,” says Brad Bourland, chief economist at Saudi American Bank (Samba).
With local stock markets booming, merchant families are once again considering floating their companies on the market, rather than using bank overdrafts and loans, their traditional approach. Several local stock markets have made a determined effort to convince these families of the virtues of creating publicly quoted companies. In particular, the younger generation of businessman, who want to develop their own companies, are more positively disposed to raising money through bonds and equities.
Another significant shift in behaviour has been the development of a dirham-denominated bond market, with the most significant issue a heavily oversubscribed bond for Emirates Airline last year.
Another keynote deal was the Eurodollar bond for the National Bank of Kuwait, which raised $450 million at only 25 basis points over Libor – an extremely tight rate for a first-time borrower in a 100% risk-rated country.
That bond was extremely successful but more than $400 million of the total was placed in the Gulf. This caused some bankers to question why NBK should chose to use JPMorgan and Morgan Stanley rather than a regional institution. “Why should a Middle East borrower go all the way to London to find a lead manager that promptly sells the issue back into the region. We should be able to do this through our local capital markets with our own institutions,” says a banker.
One of the main barriers to the development of Gulf capital markets has been the strong nationalism that has driven each state to have its own market. As Ibrahim Dabdoub, chief executive of NBK, which has a dominant local position, a strong international business but virtually no regional operation, notes: “The doors are still closed to us in the Gulf Cooperation Council (GCC) countries. We cannot open branches in other countries.”
Now World Trade Organization membership is driving change and there have been early signs of reform, with Saudi Arabia, once the most protected market, introducing some of the most liberal foreign investment laws. It has also allowed Gulf International Bank and Emirates Bank International to open branches in Saudi Arabia.
Regional co-operation boosts gulf markets
There are also the first signs that stock exchanges are prepared to go further than the cross-listing of a few shares. The Dubai Financial Market, which, says Essa Kazim, the director general, will complement the DIFM by “catering for the regional and domestic market,” is completing negotiations with Bahrain and Jordan to form a high-technology exchange.
Negotiations are at an advanced stage though no date has been set for the opening of what will be the first market to span Arab countries. At least five companies from the Dubai stock exchange are likely to participate and part of the exchange will move to internet city.
According to bankers in Bahrain, the new exchange, to be called Minex, will be a virtual market on which the information technology, pharmaceuticals and media shares of the three countries can be traded. Egypt has also expressed an interest and is expected to join at a later stage.
However, even if the Gulf can evolve into a single financial market, there are further questions that western investors and bankers will need to ask. Paramount are regulatory issues. Despite the strong anti-money laundering legislation introduced by several Gulf governments, headed by Bahrain and the UAE, both of which now have regulations that meet the highest international standards, there is still concern.
Dubai in particular is an economy in which large sums of money are moved around completely legally to finance trade transactions. Local bankers say it can be difficult to distinguish between legitimate and illegal money though they also point out that western banks are just as likely to make mistakes as are local ones.
A further problems is the fallout from the American bombing of Afghanistan and the present crisis in the Palestinian Authority, which could be followed by an attack on Iraq.
Political tension hurts trade
There is significant anti-American and anti-British sentiment in the region, reflected in demonstrations in Kuwait and Bahrain, where the protests have included attacks on American restaurants. Just as significantly, at the annual meeting of the Qatar International Islamic Bank, the board was strongly criticized for continuing to do business with British and US banks. It was forced to agree to reduce the amount of business done with these institutions.
The winners from this are expected to be the continental European countries and Asian states, which will remain a growing market for Arab oil and gas. In contrast, there are likely to be calls for trade boycotts and embargoes of the US and the UK at future meeting of the Organization of Islamic States. These might be rejected but one banker says he expects to see “a creeping informal embargo on the orderly flow of commerce”.
The regional mindset is to reject American analysts who say that the dependence of Arab investors on western markets means that no economic measures will be taken to disrupt prices on the New York and London stock exchanges.
It is hard to see how an international financial market in Dubai can reach its full potential until there is at least an absence of war in the region. At least the DIFC will be in place to take full advantage of the next change in political sentiment.
