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Will UAE get an upgrade

Saturday, Jun 18, 2011

Dubai: The moment regional investors have been waiting for is nigh; in just two days the UAE will find out if it has been successful in receiving an upgrade to emerging markets status by index compiler MSCI.

The upcoming announcement has acted as the key catalyst in moving the UAE’s three bourses — the Dubai Financial Market ( DFM ), the Abu Dhabi Securities Exchange ( ADX ) and Nasdaq Dubai — over the last few months as traders realign their positions ahead of a potential influx of liquidity into the marketplace.

MSCI (Morgan Stanley Capital International) global equity indices serve as the basis for over 400 exchange traded funds throughout the world.

More than 70 countries are covered by the investment bank’s developed, emerging and frontier market indices with the UAE currently classified in the latter category alongside financial lightweights such as Vietnam, Slovenia and Kenya. An upgrade would see the UAE join some of the world’s fastest growing economies — including the BRICs (Brazil, Russia, India and China) — in the emerging markets index.

Abdullah Al Turaifi, the chief executive of the Securities and Commodities Authority (SCA), told reporters in Abu Dhabi earlier this month he was expecting a positive response from MSCI when its decision is made public on Tuesday. MSCI will revalue the UAE’s current frontier market status by examining, among other measures, economic development, trading volumes and market accessibility.

Many analysts believe the UAE has satisfied most of MSCI’s requirements for an upgrade, but also say much will depend on whether there is demand for such a move by foreign investors and fund managers. The UAE has already been rejected twice before for an upgrade.

“It is like growing up; it has to happen. There is no two ways about it. This is a natural progression, like giving birth,” said Haissam Arabi, Chief Executive and Fund Manager at Gulfmena Alternative Investments.

“It is not just important the UAE receives an MSCI upgrade, it is absolutely critical. It would be a massive step forward in the economic life of the country in terms of capital development and attracting foreign direct investment,” he added.

Probability

According to Arabi, the chances of the UAE receiving an upgrade are high as the DFM and the ADX have both recently implemented the delivery versus payment (DvP) settlement system; a key prerequisite to an upgrade.

DvP is a securities industry procedure in which payment for a security must be made upon delivery. Usually, the payment is made to a bank, which in turn pays for the security.

“I think an upgrade would make a massive difference. We are not talking about a short term solution; the MSCI emerging markets index is tracked by investors who are managing funds worth trillions of dollars,” Arabi said.

“We may not see much immediate change but over time the country will attract greater cash flows. MSCI is a huge deal in terms of exposure and transparency and inclusion into the emerging markets index would represent a huge moment for the UAE’s economy,” he added.

Another potential stumbling block to an upgrade is the thorny issue of foreign ownership. The UAE allows foreign direct investments (FDIs) of up to 49 per cent but it is up to each individual company to decide whether it opens up to such levels of overseas ownership. The companies who decide not to allow foreign investment levels of at least 49 per cent will not be allowed to join the MSCI emerging markets index.

Qatar, which will also learn on Tuesday whether it has been upgraded, has decided against upping its foreign ownership limit from 25 per cent to 49 per cent. There is a point of view that if Qatar does not receive an upgrade, the UAE could enjoy a heavier weighting on the emerging markets index. However, most analysts are generally keen to downplay that particular issue.

Better chance

“The overall noise surrounding an upgrade is quite positive and the UAE has taken all the necessary steps to be considered for an upgrade; it definitely has a better chance than Qatar, which has refused to change its foreign ownership limits,” said Matthew Wakeman, Managing Director of Cash and Equity Linked Trading at Egyptian investment bank EFG-Hermes.

Wakeman believes Qatar’s situation will have little effect on the UAE’s chances of an upgrade as they are completely separate markets.

“If anything, the UAE’s weighting will not be as much because Nasdaq Dubai , which includes DP World, will likely not be included in any potential upgrade as it has not implemented DvP,” Wakeman said. “However, the increase in net to net inflows would be quite significant and it would be a strong sign that the country’s exchanges are moving forward,” he added.

Egypt and Oman have benefited over the last decade from FDIs, increased transparency and the introduction of new financial instruments. Oman, in particular, is considered to be one of the most progressive GCC markets after opening up to foreign investors a decade ago.

In the UAE, however, volumes have been low this year, particularly from institutional investors, with the geopolitical effects of the Arab Spring generating undesirable volatility on the country’s exchanges.

The DFM has dropped four per cent since the start of the year. The bourse fell to a six-year low on March 3 following the unrest that spread across the Middle East and North Africa, and in particular the protests that led to the ousting of former Egyptian President Hosni Mubarak.

The DFM has rallied since that low, however, gaining 18.4 per cent to 1,600.98 at the close last Thursday. The ADX is up 0.74 per cent year-to-date but thin volumes are a concern for both exchanges.

The volume of shares traded in Dubai plummeted to a daily average of about 116 million in the first quarter, the lowest in six years. In Abu Dhabi, average trading values were down 27 per cent in the first quarter at Dh117 million from the year-earlier period.

“I really believe we should be conservative in our predictions as I do not think the UAE will be upgraded,” said Mohammad Ali Yasin, the chief investment officer at CAPM Investments. “I hope the UAE is included but it is certainly not a done deal. If the UAE does miss out, it will have a negative impact on the markets as disappointed investors will react at the bourses’ failure to meet expectations,” he added. According to Ali Yasin, the UAE would have a much stronger case for an upgrade if it merged its bourses to form one single entity. He also does not think it would be a total disaster if the UAE was to miss out for a third time.

“If the UAE merged the bourses into one, it would be a much better formula and the UAE would become a very important player across the GCC and the wider Arab world. The UAE is in an extremely low position just now with Saudi Arabia, Qatar and Kuwait all ahead of it [in terms of market capitalisation],” Ali Yasin said.

Legalities

“I really hope a merger happens at some point but I do not think such a move is imminent. It is an issue of legalities as opposed to a business problem.

“The UAE actually implemented a DvP settlement system in 2007 but the SCA did not consider it up to standard. I am very happy that an upgrade may happen but I do not want to raise my expectations too high and be left disappointed,” he added.

Ali Yasin also says the effects of any potential upgrade would be gradual. “The main criteria for MSCI inclusion are whether a market is liquid and features investors that are active. In the UAE, we have seen turnover of less than $100 million (Dh367 million) a day over the last few weeks as well as the limited availability of liquid stocks. Even if billions of dollars were to pour into our market, the question would be where to put the funds,” he said.

By Kevin Scott, Staff Reporter

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