Middle East: UAE and Qatar wait for index boon
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Middle East: UAE and Qatar wait for index boon

Al Noor listing shows reality; Morocco suffers on frontier downgrade

In recent years a familiar pattern had emerged around the UAE’s and Qatar’s possible reclassification as MSCI Emerging Markets Index constituents, rather than constituents of the less-watched frontier index.

Expectation of an upgrade early in the year, then disappointment in June at the annual market classification review – so went the cycle. But finally, after five years on review, both markets will join the emerging markets index in May 2014.

It was June 2008 when MSCI Barra (as it then was) announced a consultation to reclassify the two markets, plus Kuwait (which didn’t go far), from frontier to emerging. Getting there has required changes in both states.

In Qatar’s case, changes were needed in operational efficiency, delivery, custody and foreign-ownership limits. The UAE needed to implement a proper false-trade mechanism and move away from dual-account structures.

Now that it has happened, what does it mean? HSBC expects $430 million to flow into Qatar and $370 million into the UAE over the next year from passive index investors that track the MSCI Emerging Markets Index.

These are relatively small amounts, but perhaps catalytic: HSBC also estimates an additional $4 billion in actively managed funds could be available for investment in those markets, if they can attract it.

"We are hoping this will bring in the liquidity that has been lacking in the local markets," says Sandeep Nanda, executive vice-president at Qatar Insurance Company in Doha and investment adviser to the Qatar Investment Fund. "When we meet investors, in London for example, a lot of them are constrained by not being allowed to take positions in frontier markets. A lot of investment managers will now be able to allocate serious money to these countries."

Others say the fact that MSCI required the markets to make operational changes is clearly good for investors.

"Although it has been a cautious process, it has resulted in material benefits to investors in public markets," says Daniel Broby, CIO of Silk Invest, which invests in public and private markets in the Middle East, Africa and frontier Asia.

Chris Laing, managing director, emerging market equity capital markets at Deutsche Bank
Chris Laing, managing director, emerging market equity capital markets at Deutsche Bank

It should also add impetus to capital-raising. "It’s a very significant step," says Chris Laing, managing director, emerging market equity capital markets at Deutsche Bank. "One challenge we have had when we do transactions in these countries is that they are off-index. That was a big hurdle for many investors and issuers to overcome. Having that hurdle removed will make transactions an awful lot easier to do."

But perhaps the key question is the possibility that other, bigger Gulf markets, having seen UAE and Qatar make the step, might feel inspired to do the same. Saudi Arabia is the one everyone wants to see.

Although today it has 100% restrictions on direct foreign ownership of stocks, "at some stage that will be relaxed and you will be looking at 40% of the Arab market moving" to the emerging market index, Broby says.

There has, in recent years, been modest liberalization in Saudi Arabia, such as allowing mutual funds based in other Gulf countries to take positions in Saudi stocks. But as one banker says: "Expectations have been raised too many times over the last five years, and we have been disappointed."

Some think Kuwait is a more likely next candidate, having been part of the 2008 consultation for Gulf market reclassification. "Kuwait would be the most likely next country," says Laing. "It is a decent sized market as well."

But as Gulf markets have ascended, north African markets have been heading the other way. Morocco was downgraded in the same review last month, with MSCI saying the country’s index "has failed the emerging market liquidity criteria for several years and this downward trend in liquidity has shown no sign of reversal."

MSCI also said it "may be forced to" launch a public consultation on excluding Egypt from the index, because of the shortage of foreign currency on the domestic foreign exchange market, which impedes repatriation of funds by foreign investors.

Few were surprised by the Morocco downgrade. "Morocco is attractive and has good returns, but the locals have been buying the investment opportunities more than the internationals, restricting what’s available," Broby says.

Although the reclassification of Gulf markets is encouraging, it was sobering to note the successful pricing of Al Noor Hospitals on June 21 in London, valuing the company at £672 million ($1.04 billion).

A company as big as this, and with as much potential, might still be unlikely to choose the UAE as its listing venue and it might be some time before the country can attract such capital-raisings to stay at home.

Correcting that will take some time and effort, for example, it will mean further reducing foreign ownership restrictions (Qatar’s limit still stands at 25% of market capitalization on most companies, and the UAE’s at 49%).

Also crucial will be removing withholding taxes on dividends in such places as Kuwait, and most of all opening up Saudi Arabia: that’s when big institutional investors will no longer be able to ignore the region.

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