BAHRAIN’S STATUS AS the Middle East’s leading financial centre is about to face its toughest challenge. Dubai and Saudi Arabia are introducing new legislation that they hope will help create larger, more liquid capital markets and attract greater interest from investment banks and asset managers.
Although publicly all three jurisdictions insist that they will complement each other and are not in competition, the Gulf market is only big enough for one dominant player. All three jurisdictions have launched recent initiatives to try to claim this position.
Banks’ choices of location are sure to be affected by the recent terrorist attacks in the region. Although Dubai has so far been unaffected, Bahrain has periodically been vulnerable to Shia unrest and Saudi Arabia has been hit by two car bomb attacks on expatriate residence compounds in Riyadh.
Privately, bankers say that financial factors, such as market liquidity, quality of regulation and proximity to the source of funds will drive long-term decisions.
Bahrain is long established as the region’s financial centre and its regulatory system is widely respected. It has successfully diversified away from its original role as a recycler of petrodollars and the Bahrain Monetary Agency (BMA), the central bank, has taken responsibility for the whole financial sector.
Dubai has spent the past two years in complicated negotiations to set up an international financial centre and is trying to woo banks – particularly those with a presence in Bahrain – with a state-of-the-art regulatory structure that can be enforced by its own courts. Most of the regulatory system and management structure is in place and the much-delayed final approval from the UAE’s federal authorities for the Dubai International Financial Centre (DIFC) is expected within weeks.
But the most significant challenge is set to come from Saudi Arabia, which in the past five years has begun to open up the economy to foreign investors and develop properly regulated capital, insurance and leasing markets.
The recently approved Capital Markets Law sets up a formally regulated stock exchange and allows international investment banks into the country. Saudi Arabia has for many years been the sleeping giant of the Gulf’s financial sector. It is the wealthiest country in the region and its stock exchange, although operating as an over-the-counter market and limited to Saudi investors, still accounts for more than half the region’s equity capitalization.
At present, the dozen stock markets in the Middle East have total capitalization of only $250 billion, which means they are well off the radar of almost all emerging-market investors.
Even though Saudi Arabia has until now had obsessively tight rules about new issues, which has meant that there are only 70 quoted companies, it is more than twice as big as the next largest national market.
Sign of potential The clearest example of Saudi potential came even before the market reforms. Last year the exchange, Tadawul, delivered the second-largest IPO in the world with the flotation of a 30% stake in Saudi Telecom. More than 900,000 investors signed up for the SR10.2 billion ($2.7 billion) offering which was more than three times oversubscribed – until then only about 70,000 Saudi investors had held shares.
A key elements of the new law is the establishment of a Securities & Exchange Commission. It will be responsible for regulating the market and will have enforcement powers. Among its duties will be licensing and regulating non-bank institutions, including those from overseas. At present foreign investment banks are excluded from operating directly in the kingdom. Under the new law these non-bank intermediaries will offer investment banking services, including corporate finance, asset management and brokerage.
Bankers say that while the laws are as good as any in the region, the real test will be the quality of senior management at the exchange and regulatory authority. “If the regulatory authority is headed by a senior regulator with experience of these markets, it will have a chance of success. If the appointment is overtly political, international banks will have much less confidence,” says one banker.
There is no doubting the potential if the Saudi authorities make the right appointments. There are 48,000 companies in Saudi Arabia and if even a small number of these came to the market to raise bonds or equity, its domination of the regional market would be even greater.
The first steps are likely to come in the first half of next year with the sale of the state-owned National Commercial Bank and the possible flotation of part of petrochemicals company Sabic.
Equally important for regional business will be the role of foreign banks in managing and investing Saudi assets overseas. This could have major implications for such centres as Bahrain. “There is no point in a bank being outside the pool of liquidity if it has the opportunity to be actively involved in it,” says one banker.
Bahrain’s insurance and leasing business will also be under threat as the Saudi market opens up. There has always been a degree of hostility towards “suitcase” insurance companies, operating in Saudi Arabia but based in Bahrain, which have provided the only competition for the National Company for Co-operative Insurance (NCCI). Bahrain has responded with the creation of Solidarity, an insurance firm that hopes to succeed by developing products that comply with Islamic law.
There is some frustration in Riyadh over the time being taken to produce the final insurance law. But Mousa Al Rubaian, NCCI’s managing director, has no doubt that when it is passed there “will be a significant increase in the number of insurance companies operating directly in the local market”.
Bahrain has made a determined effort in recent years to diversify its business and create a coherent industry around seven asset classes, including Islamic finance, insurance and capital markets, that have been identified for their growth potential.
This integrated approach, argues the BMA, will enable Bahrain to build on the successes of the past 30 years in which it has become the regional base for many of the world’s leading banks and the home for a growing number of international and regional financial sector bodies. Stock exchange ambitions
Bahrain also has ambitions to become the region’s stock exchange. “The BMA is determined to increase the number of IPOs, persuade those companies that are already quoted to issue additional securities and bonds and ensure that at least some of the shares of privatized companies are quoted on the market,” says the BMA’s governor, Shaikh Ahmed bin Mohammed Al-Khalifa.
It is also encouraging the private sector to make a tangible physical commitment to the development of the financial sector. The clearest evidence of this is the $1.3 billion Bahrain Financial Harbour, being built to house the region’s leading financial houses and the Bahrain Stock Exchange.
Backers of the harbour say it will become the Middle Eastern focal point on the world’s financial map.
One of Bahrain’s main selling points has been its development as an Islamic banking centre. It is the base for more than 20 Islamic banks, including international joint ventures and local operations. It has also devised a reporting and regulatory system that takes account of the special needs of Islamic banks.
However, this dominance could be under threat as this sector grows rapidly in Saudi Arabia. Most financial institutions now offer Shariah-compliant products and the number of totally Islamic banks is rising.
Dubai is also working to develop Islamic banking as one of the key elements of its international financial centre. The other areas include a regional equity market, reinsurance, back office management and asset management as well as a major property development.
It has taken more than a year longer than expected to set up the DIFC. Much of this time has been taken up with establishing its relationship with the United Arab Emirates’ central bank and other federal authorities. DIFC managers believe that this process is almost complete and that they will be able to launch the market rapidly as the legal and regulatory groundwork is also nearly finished. The DIFC is also completing negotiations with a leading international stock exchange, which may open a trading floor in Dubai.
Senior managers believe that they have an advantage because of the quality of the regulators, most of whom have held senior positions in internationally recognized markets. This has been one of their main selling points as they have tried to persuade international institutions to opt for Dubai rather than other regional centres.
Already they have had commitments from Deutsche Bank, Julius Baer, Allianz and Standard Chartered.
However, other leading international institutions in the UAE have been more cautious. “We do not see what advantages we would get from being in the DIFC,” says a senior executive at one of these institutions.
There is no doubt that the competition for the financial markets between Dubai, Bahrain and Saudi Arabia is heating up. But it is too early to predict which will win.
Beshr Bakheet, managing director of the Riyadh-based Bakheet Financial Advisers, has no doubt that, when it comes to stock exchanges “the most successful market will be the one that achieves credibility by providing transparency, minimal bureaucracy and efficient regulation. It must show that it is liquid and those investors will only be attracted when there are a broad range of companies to invest in.”
