|02 January, 2019

Derivatives: Gulf's nascent futures market still needs to develop

Exchange moves create opportunities, but activity remains limited, analysts say

Image for illustrative purposes. Nasdaq Tower in New York welcomes Menacorp's No. 1 spot on Nasdaq Dubai's futures market.

Image for illustrative purposes. Nasdaq Tower in New York welcomes Menacorp's No. 1 spot on Nasdaq Dubai's futures market.

Nasdaq Dubai/Handout via Thomson Reuters Zawya

With the Dubai and Abu Dhabi equity markets having lost ground in the second half of 2018, this should have provided fertile ground for investors to use equity shorts to hedge their portfolios.

Indeed, in November, futures volumes on the Nasdaq Dubai jumped 119 percent compared with the previous month, to 20.48 million United Arab Emirates dirhams ($5.6 million). But given that the combined turnover of stocks on the Abu Dhabi Securities Exchange (ADX) and the Dubai Financial Market (DFM) was over 8 billion dirhams, the volume of futures is “extremely irrelevant,” Marwan Shurrab, senior vice-president and head of HNW and retail equities at Al Ramz Capital told Zawya in a telephone interview last month.

“[To be relevant] the future volumes need to be a percentage of the total turnover. In certain mature markets, the futures market actually does multiples of the real equity market,” he said.  

The low figure shows how immature the futures market in the UAE is, he said, but also how much potential there is for it to grow.

Developing the market – currently investors can short 17 individual UAE equities on the Nasdaq Dubai, as well as the DFM and ADX indices – is crucial for increasing market liquidity and reducing volatility, Shurrab believes.

When short-selling is in greater evidence, it boosts liquidity during down cycles because short-sellers also need to buy shares to cover their shorts, creating appetite. This in turn reduces market volatility, “because it gives an indication that there is always appetite for a stock at all levels,” he said. “It’s an extra tool for markets, to stay liquid and relevant.”

Since their launch in September 2016, many of the single equity futures offered have witnessed very low trading volumes. “Sometimes it’s not about the instrument – futures­ itself – it’s about overall market sentiment,” Issam Kassabieh, a senior financial analyst at Menacorp said in a telephone interview in late November.

“These futures come with higher leverage, and investors are not willing to increase their leverage in these volatile markets.”

Rather than looking at individual equity futures, index futures may hold more appeal, said Kassabieh. “Index futures are easier to manoeuvre than individual stocks­ – you can get an overall insight on the market, on the economy and which direction it’s going. It’s also a basket, so the risk is reduced,” he said.  

Recognising this, Nasdaq Dubai announced on December 19 that it would also begin a futures trading offer based on MSCI’s UAE index, alongside the individual Abu Dhabi and Dubai market indices already traded.

Nevertheless, low liquidity also contributes to making futures less attractive. With the UAE’s equity markets traditionally having been long-only, when markets fall, investors tend to hold on to their shares, which dries up liquidity, explained Shurrab. That makes holding inventory more expensive and thus riskier for market makers. Low inventory means less quantity and depth in their order books, and less attractive pricing, all of which discourages investors.

Shurrab is looking towards the introduction of stock lending and borrowing as a measure that could increase inventories and thus make equity futures more attractive. Al Ramz Capital recently received licences for securities lending and borrowing from both the DFM and ADX  

While this will allow institutional investors to earn fees on their static portfolios by lending out shares, it will also boost Al Ramz’s inventory and allow the investment bank to show more depth to the market.  

“Importantly, this will deliver closer pricing to what people are expecting, not only in terms of the price as a standalone, but also the appetite, the quantity and depth of the order book,” said Shurrab.

Shurrab said Al Ramz Capital hopes to go live with its stock lending and borrowing offer either at the end of the first quarter of 2019, or during the second quarter.

 The biggest challenge is ensuring that the demand is there from institutional investors to lend out their portfolios, he said. “The borrowers are always going to be there, the question is always on the lending, and our ability to get the inventory at an attractive price.”

Will Saudi land ahead of the pack?

In Saudi Arabia, plans are also afoot for Tadawul to launch its own futures, starting with an index future in the first half of 2019. The exchange plans to launch an index futures contract based on the tradeable index jointly developed with MSCI, it said in a press release in September.

Foreign investors can already take some short positions on Saudi Arabian equities in the form of synthetic options via investment banks, but these have not been popular, Osman Raie, managing director and senior advisor for Saudi Equities at HSBC Bank Middle East said in a telephone interview last month. Nasdaq Dubai also intends to offer futures on 12 individual Saudi equities, which make up around 40 percent of the exchange’s total market capitalisation, though initial implementation, which was planned for September, has been delayed.

Given the size of the Saudi market – with a market capitalisation of around $491 billion, it’s the largest remaining market to gain inclusion into FTSE Russell and MSCI emerging market indices – announcements that it will begin to offer more sophisticated products has already piqued the interest of global hedge fund managers.

In March, the Winton Group and Saudi Fransi Capital announced in a press release that they are collaborating on a systematic trading programme for Saudi equities, which will bring “big data, scientific techniques, algorithmic trading and similar quantitative methods” to the region. 

Meanwhile, Dalma Capital, a hedge fund management company in Dubai which currently manages a long-only Saudi equities fund is considering launching a hedge fund focused on Saudi Arabian equities in 2019, its CEO Zachary Cefaratti said in a telephone interview in November. “We realise that we could actually be generating better performance, or out-performing if we had the ability to short,” he said.

The Saudi market is attractive because of its large size and liquidity, while the heavy presence of retail investors means that the market is relatively inefficient, since retail traders “don’t have access to the resources, to the information, the time that it takes to conduct analysis, to be able to do pricing accurately,” said Cefaratti.

“Introducing shorting helps a market tend towards efficiency,” he said. “When the market becomes overpriced, short sellers are able to increase selling pressure in the market, so we think that this is an important step towards the Saudi market becoming more efficient.”

With most institutional investors – mutual funds, pension funds, and funds belonging to government entities – taking long-only positions in the market, hedge funds are probably the investor class that will see the biggest benefits of equity shorting being available, believes Raie.

QFIs are the priority

Nevertheless, planning for introduction of equity futures is still at an early stage, and the number one priority for Tadawul is “making sure that investors are comfortable with the current model for Qualified Foreign Investors (QFIs)” ahead of inclusion in emerging market indices, Raie said in a telephone interview last month.

The next step for the Tadawul after EM inclusion is to make available a full suite of products for those foreign investors, said Raie, “allowing [investors] to access the market across the spectrum–not just cash equities, but all the derivatives, stock lending and borrowing, short selling, and other ‘developed-market’ stock exchange products. This is another pillar that needs to be delivered.”

“The next step, next year, will be a big push for derivates market to go live,” he said.

(Reporting by Stian Overdahl; Editing by Michael Fahy)

(michael.fahy@refinitiv.com)

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