Driven by enhanced liquidity in the banking sector, rising property prices and an overall improvement in the domestic economy, Dubai’s capital markets began 2013 in full recovery mode. In June 2013 the UAE was finally upgraded from “frontier” to “emerging market” status by the global index compiler MSCI, after nearly five years of efforts to achieve the coveted designation. Though the UAE will not officially be included in the MSCI index until May 2014, the news alone put the UAE’s three equity markets on the radar of global institutional investors with an estimated $7trn in assets under management and is expected to boost liquidity and broaden the investor base of exchanges. HSBC estimated that the upgrade would inject $370m into the UAE, while Merrill Lynch projected an influx of $170m in exchange-traded funds will enter the market in a research note issued on September 23, 2013.
The Market
In the wake of the MSCI upgrade, the second largest of the UAE’s three stock exchanges, the Dubai Financial Market (DFM), posted the biggest gains of the 93 international exchanges Bloomberg tracks annually, and its market capitalisation had increased 36% year-on-year (y-o-y) by the end of third-quarter 2013, surpassing the levels reached in 2008. The exchange’s market capitalisation at the end of November 2013 stood at Dh257.8bn ($70.2bn). Dubai’s international stock exchange, NASDAQ Dubai, continued to bolster its position as one of the top-three global sukuk ( Islamic bond) markets and was home to the emirate’s first initial public offering (IPO) since 2009 in October. The question is no longer whether Dubai is recovering but how to best cater to the anticipated influx of institutional investors to the market and develop the markets to their potential. “It’s clear that Dubai is growing again, but the trick is to achieve the optimal quality of that growth to ensure sustainable returns,” Shailesh Dash, CEO of Dubai-based asset management company Al Masah Capital, told OBG.
The Players
Dubai’s primary stock exchange was created in 2000 as a government-owned entity. In 2006 the DFM was then transformed into a public shareholding company and 1.6bn of its shares, valued at $435.5m, were floated on the exchange in the very first IPO of a Middle Eastern stock market that saw a valuation of $51.7bn. Nearly 80% of the DFM’s stock is now owned by Borse Dubai, a government-owned holding company that also controls a 33.33% stake in NASDAQ Dubai and 20.64% of the shares in the London Stock Exchange and 16% of the NASDAQ OMX Group.
The DFM is regulated by the Emirates Securities and Commodities Authority (ESCA, usually referred to as the SCA), according to federal law governing the securities and financial markets. As of October 31, 2013, there were 65 companies listed on the DFM, including a dozen banks, eight financial services firms, 13 insurers, seven real estate and construction companies, and the remainder split among consumer staples, industry, transportation, telecoms and services. The exchange also listed nine government bonds, seven sukuks and 16 mutual funds.
In 2005 the Dubai International Financial Exchange, now known as NASDAQ Dubai, was established in the emirate’s financial free zone, the Dubai International Financial Centre (DIFC), to cater to international stock offerings. The exchange is regulated by the independent Dubai Financial Services Authority (DFSA), which adopted British securities law and has its own court of jurisdiction within the DIFC. In 2010 the DFM acquired all the shares of NASDAQ Dubai and the two exchanges were consolidated to allow stocks listed on the latter to trade on the DFM platform using a single investor number. NASDAQ Dubai also outsourced its trading, clearing and settling activities to its parent company.
Though NASDAQ Dubai has attracted a few major listings since its launch, the exchange has been affected by low trading volumes, despite its having relatively modest listing requirements compared to the DFM. Just eight corporate stocks were listed on NASDAQ Dubai as of the fourth quarter of 2013.
Interior furnishing firm Depa and ports operator DP World are the only stocks that are traded regularly, though the latter undertook a 1-for-20 stock consolidation in 2011. Depa shares performed weakly in the second half of 2013, falling to $0.58 on October 30, while DP World’s had risen to $16.77.
Though NASDAQ Dubai has yet to emerge as a major international equity exchange, it now rivals Malaysia and London as a leading global hub for sukuk listings. As of October 2013, 13 sukuk were listed on the exchange, along with eight conventional bonds and two exchange-traded funds. Additionally, there were also 20 derivatives listed on the FTSE NASDAQ Dubai UAE 20 Index.
MARKET PERFORMANCE: After average daily trading volumes on the DFM reached a low of Dh120m ($32.7m) in November 2011, the markets then began to rebound in the first quarter of 2012, mostly due to a 90% average increase in the net profits of listed companies since 2010.
In fact, by the end of 2013, the DFM General Index had risen more than 107% y-o-y, to 3369.8 points compared to 1622.5 points at the end of 2012, despite a brief panic in late August 2013, when it plummeted 7% and the exchange experienced its biggest one-day sell-off since 2009 due to concerns over US military intervention in Syria. By the end of September, share prices on the DFM had rebounded to an average of Dh2.05 ($0.56), and the exchange reported second-quarter net profit of Dh69.5m ($18.9m), compared to Dh10.2m ($2.8m) in the first half of 2012. Overall, trading volumes had surged 166% y-o-y as of the third quarter of 2013, according to DFM figures. Since the announcement of the MSCI upgrade in May 2013, average daily trading volumes on the exchange have risen from 2400 to 2762.5, compared to 1622.5 at the close of 2012.
Market Makeup
Currently, the DFM remains a largely retail market, but it was gearing up for an anticipated surge in institutional trading activity and an influx of foreign investment in the fourth quarter of 2013 in preparation for the MSCI upgrade to take effect. Institutional investors accounted for 71% of total share ownership on the DFM as of the third quarter of 2013, according to DFM figures. The UAE accounted for 57% of trading activity on the DFM in the first nine months of the year, compared to 54% in full-year 2012. However, the ratio of foreign ownership as a percentage of market capitalisation on the DFM rose from 11% to 12% between 2011 and 2012 and 16% as of the third quarter of 2013.
Non-GCC Arab nationals were responsible for approximately 22% of total trading on the DFM as of the third quarter of 2013, as compared to 25% in 2012, although GCC nationals’ share of DFM trading did increase from 6% to 7% during the period for the first time since 2006, when the region was responsible for 9% of foreign activity on the market.
According to DFM figures, 84.34% of shares on the exchange were owned by UAE investors at the close of the third quarter in 2013, followed by the GCC with a 5.12% ownership stake, other Arab nations with 3.21%, while the remaining 7.33% of shares were owned by other international investors.
Over the past few years, there has been much discussion about the need to diversify the sectors and size of listings on the DFM, and though trading activity during the first nine months of 2013 did remain disproportionately concentrated on real estate stocks, and to a lesser extent banking and finance/investment companies, this dominance appears to be changing.
Though real estate and construction companies listed on the exchange accounted for 43.9% of trading activity during the first nine months of the year, according to the DFM third-quarter 2013 investor report, the sector’s share of annual trading volumes has decreased significantly since reaching 67% in 2010. Banking stocks appear to have picked up much of this slack, accounting for 19.7% of trading volumes as of the third quarter of 2013, compared to 17.75% in 2012, 12.7% in 2011, 1% in 2010 and 7.3% in 2009. Finance and investment companies listed on the DFM have also witnessed a gradual decrease in their share of annual trade, from 18.4% in 2009 to 16.7% as of the third quarter of 2013. Though insurance is the sector with the most listed companies, its share of annual trade has also declined from 4.1% in 2009 to 1.9% as of third-quarter 2013.
Telecoms, transport and service company shares also claimed relatively small portions of annual trading volumes in the first nine months of 2013, totalling 3.2%, 7.6%, and 7%, respectively.
Best Performers
Buoyed by a resurgent property market, real estate companies listed on the DFM were the biggest beneficiaries of the stock market rally in the second quarter of 2013. After beating analysts’ expectations and reporting a 50% increase in third-quarter profits totalling $158m, shares of the emirate’s largest publicly traded real estate development company, Emaar Properties, rose 1.8% to Dh6.21 ($1.69) on October 28. The company, which accounts for roughly one-fifth of the DFM’s market capitalisation according to Bloomberg, fell by 0.2% to Dh6.08 ($1.65) when new central bank regulations limiting the value of mortgages banks can offer home owners went into effect on October 29, but had rebounded to Dh6.13 ($1.67) per share by the close of the following trading day.
The regulation, aimed at curbing the type of real estate speculation that lead to the property bubble in Dubai before the global recession, limits the amount of money foreigners and UAE nationals can borrow to purchase a first home costing more than $1.36m to 65% and 70% of the property value, respectively, and caps the loan-to-value ratio of all second homes at 60% of the purchase price for foreigners and 65% for UAE citizens. The rule also limits off-plan home loans to 50% of the property price.
Arabtec was also a major gainer in the second half of 2013. Its share price rose 0.7% to Dh2.73 ($0.74) on October 28, its highest level since May 2012, and was relatively unaffected by the new mortgage rules, closing at Dh2.71 ($0.74) on October 30. Dubai Islamic Bank also saw share prices surge in 2013 to reach Dh5.36 ($1.45) on December 31.
Perhaps the most significant indicator of the market’s renewed confidence was the tightening of yields on bonds issued by real estate giants such as Emaar and Nakheel during the first nine months of 2013. While corporate sukuk yields in the GCC increased by an average of 110 basis points during the first 10 months of 2013, Bloomberg reported that the yield on Nakheel’s sukuk due August 2016 had fallen by 212 basis points to a record-low of 7.15% on October 28, while yields on Emaar’s sukuk due at the same time fell 96 basis points year-to-date.
On the NASDAQ, the total value of equities traded dropped 25% between 2011 and 2012, from $675m to $508m. There was an uptick during the fourth quarter of 2012, however, when shares worth a total of $150m were traded, compared to $133m during the same period in 2011.
In an indicator of the renewed demand for equities in Dubai, in 2012 the NASDAQ’s FTSE UAE 20 index, which tracks share prices across all three stock exchanges in the UAE, rose 32% y-o-y, according to NASDAQ Dubai’s figures.
Meanwhile, yields on the HSBC/NASDAQ Dubai SKIX sukuk index dropped from 6.49 basis points to 3.92 basis points, signalling an increased appetite for fixed-income instruments in the UAE.
On the bond front, Jebel Ali Free Zone issued a $650m sukuk on the exchange in June 2012, which was more than three times oversubscribed. A month later, Emaar brought a $500m sukuk to the NASDAQ that was almost 10 times oversubscribed. The two listings brought the value of bonds listed on NASDAQ Dubai to $9.5bn as of 2012, according to the exchange’s annual report. The NASDAQ also hosted the first IPO in Dubai since 2009, and two other companies announced plans to float shares on the exchange in 2013.
Commodities
The Dubai Multi Commodities Centre (DMCC) is the UAE’s largest and fastest growing free zone and the majority owner of the region’s largest commodities exchange, the Dubai Gold and Commodities Exchange (DGCX), which has experienced triple-digit growth in trade volumes for three consecutive years. Commodity segments represented at the DMCC include diamonds, gold, other precious metals and stones, agriculture, tea and pearls.
Dubai is the world’s leading physical gold market, with over 25% of the world’s gold passing through the emirate. In just over a decade, the DMCC has helped boost the flow of trade and enterprise through Dubai, with the flow of gold increasing from $6bn in 2003 to $70bn in 2012. By the end of the third quarter of 2013, a total of 13.76m contracts were traded on the exchange, an increase of 43% from 2012. In June, the DGCX recorded the highest monthly volumes the exchange has ever seen, with a total of 1.6m contracts, valued at $43.77bn, traded. Increased global volatility in precious metal prices pushed the volume of silver futures contracts traded on the exchange up 53% in 2013. Gold futures volumes also traded 464,800 contracts in 2013.
Dubai has also emerged as one of the world’s top three diamond trading centres, competing with hubs such as New York and Mumbai. Leveraging its geographic location, with close proximity to established and emerging markets, the DMCC and the Dubai Diamond Exchange are central to fostering segment growth by connecting producing and consuming nations. Between 2009 and 2010 diamond-trading volumes in Dubai almost doubled to $35.1bn. The Indian government’s imposition of a 2% Customs duty on imported diamonds in the spring of 2012 has further boosted trading volumes in the DMCC. In the first half of 2013, the volume of rough diamonds traded in the DMCC increased by 10% y-o-y to 66m carats valued at $6.2bn, according to DMCC figures.
Despite the impressive growth of this commodity segment, banks have been slow to develop loan facilities catered to the needs of the industry, according to Rihen Mehta, the executive director of Rosy Blue, a leading global diamond producer. “Financing is still a bit of an issue for the diamond trade, with financiers offering a spread as much as 2% or 3% higher than rates in Europe, while most would argue there is, in fact, less risk and fewer bad-debt allocations associated with the Dubai market,” Mehta told OBG. “These higher rates easily can, and often do, offset any tax benefits Dubai offers purchasers.”
Global Impacts
India has been a driving force in the DGCX’s recent growth story – particularly the government’s efforts to counter the rupee’s free-fall over the past 18 months. In 2012 foreign currency futures trading on the DGCX increased 28% y-o-y to 1,124,507 contracts. By the end of 2013, currency futures trading had spiked 48% y-o-y, with Indian rupee futures, Swiss franc futures and yen futures rising 36%, 54% and 32%, respectively, according to DGCX figures. Additionally, trading of DGCX’s new mini-Indian rupee futures contract, DGCX’s smaller version of the regular Indian rupee contract launched earlier in 2013, which notched volumes of 1.2m contracts in just over eight months of trading.
The steep decline of the rupee in 2013 has been a boon for the DGCX, which is the only exchange in the region where rupee contracts are traded significantly, though Bahrain’s commodities exchange also offers a rupee contract. The Indian government’s escalating restrictions on forex trading licences and gold imports to bolster its currency in 2013 has pushed many Indian traders to establish themselves in the DGCX, while the volatility of the rupee has increased their demand for tools to hedge their currency risk. Though this makes the DGCX vulnerable to global fluctuations in gold prices, it has also boosted demand for new products.
Diversification
The DGCX plans to introduce a spot gold contract during the first half of 2014, which should eliminate the need for offshore credit and collateral that is required to trade spot gold contracts over-the-counter. The DGCX will also be launching a polypropylene plastics contract and a MSCI Indian futures contract during the first half of 2014. This follows the introduction of a variety of new contracts such as copper, mini Indian rupee and S&P BSE Sensex to offer investors arbitrage opportunities between the leading global markets. “By diversifying the number of asset classes listed on DGCX with a focus on the region’s requirements, we will provide local and global investors with new products that allow them to mitigate their risk or gain exposure to foreign exchange, energy, precious metals or equity contracts,” Anderson told OBG.
The DIFC also hosts its own energy futures exchange, the Dubai Mercantile Exchange (DME), which trades the regional benchmark Oman Crude Oil Futures Contract, DME Oman. The DME was established in 2007 as a joint venture between Dubai Holding, the Oman Investment Group and the Chicago Mercantile Exchange (CME), whose participation ensures that all trades on the DME are guaranteed by one of the CME’s subsidiaries, the New York Mercantile Exchange.
As of August 2013, average daily trading volumes on the DME had risen 15% year-to-date, from a total of 4667 contracts in 2012 to 6192, according to the DME’s own figures. In January 2013 the DME Oman was included in an international commodities fund, the US Asian Commodities Basket Fund, marking the first time it has been recognised as a viable global benchmark. In September, the DME reached the 5bn barrels traded mark (which is equivalent to 5bn traded contracts).
Regulations
In May 2013 the UAE introduced a false trade mechanism on both exchanges that abolishes a rule requiring international investors to have a dual-account structure, which was one of the reforms that paved the way for the emerging market upgrade to take effect, MSCI said in a June 2013 statement. The MSCI welcomed the UAE’s new regulation governing stock borrowing and lending agreements that was expected to be implemented by the end of 2013. The MSCI statement also applauded the introduction of a delivery-versus-payment model on the DFM and Abu Dhabi Securities Exchange, though highlighted Dubai had yet to put in place a “buyer cash compensation” mechanism allowing a buyer to be paid in cash if a security cannot be delivered on the agreed-upon date.
In February 2013 the UAE’s new Competition Law went into effect. It requires companies to get government approval for all mergers and acquisitions that would lead to a dominant market position and imposes penalties on companies that engage in monopolistic practices. Businesses were given a grace period of six months to comply with new rules before being subject to penalties.
Forthcoming
Implementation rules clarifying the scope of certain provisions of the law – including the timeframe within which companies must file merger review documents and the definitions of exempted sectors – were supposed to be released in the summer of 2013, but had not been published in February. Federal and local government entities and small and medium-sized enterprises (SMEs) – though neither category is defined outright in the text of the law – in addition to the telecommunications, financial services, petroleum and gas, production and distribution of pharmaceuticals, land, sea and air transport, sanitation and waste disposal services, electricity and water production and distribution, and cultural activities sectors are exempted from provisions of the Competition Law.
The DFM announced that it would be carrying out other reforms “to enhance its appeal to foreign investors” in the months before the MSCI designation takes effect, including the implementation of the securities buying and lending law once it passed the regulatory process.
New Rules
In 2012 the DFSA gave NASDAQ Dubai the green light to decrease the minimum market capitalisation for IPO issuers from $50m to $10m as part of its plan to launch a secondary market for SMEs. In NASDAQ Dubai’s 2012 annual report, the exchange also said that it planned to introduce new rules to support liquidity in the secondary equity market in 2013 (see analysis).
The International Finance Corporation, the private sector arm of the World Bank, ranked the UAE as the economy that improved minority shareholder protections the most in 2012/13, in its 2014 “Ease of Doing Business Report,” due to the adoption of a law in August 2012 requiring companies to include in their annual financial statements detailed information on transactions concluded in the past year with parties closely related to the company through family ties, cross-investments or common executives. In addition, the law entitles any shareholder of a company to file a petition in court to suspend any transactions that have allegedly been concluded in breach of the rule, the report said.
Perhaps the most significant regulatory milestone of 2013 was the UAE Federal National Council’s (FNC’s) long-awaited approval of a revised, 338-page draft of a new Companies Law – formerly known as the Commercial Companies Law.
Though the law was widely expected to include a provision that would relax the current 49% foreign ownership limit on corporations, the clause was removed after an earlier version of the bill under review was kicked back to the FNC for debate in February 2013. The Companies Law also contains rules on corporate governance, social responsibility and shareholder voting rights.
The law has yet to be ratified by the UAE’s Supreme Council and signed by the president, but the Minister of State for FNC Affairs promised that it would go into force if all parties cooperated on the current version, according to local media reports.
In March 2013 the SCA, the regulator, issued an amendment to the Investment Funds Regulations that came into force on August 27, 2012, which allows foreign companies more latitude in promoting their funds onshore. The resolution exempts foreign fund managers from contracting a local partner or gaining prior approval of the SCA in order to market investments to UAE sovereign wealth funds and certain international investors.
Government officials continued to consider plans to unify Abu Dhabi’s bourse and the DFM in 2013, and in late 2013 Reuters reported that the exchanges had hired banks to advise them on a possible merger. However, hopes of a deal that would centralise liquidity between the exchanges were overshadowed by news of Abu Dhabi’s plan to create a new financial services free zone on Al Maryah Island.
The decree establishing the Abu Dhabi Global Marketplace that was passed in February 2013 does not contain many legal or regulatory details, but according to media reports, the new free zone will be similar to the DIFC’s model, based on British law. In a September 2013 interview with The Gulf News, Jeffrey Singer, the CEO of the DIFC, said Dubai’s free zone would be open to cooperating with its erstwhile rival when the time comes and said the competition would “help us take our game up a little”.
Indeed, DIFC announced that it had welcomed its 1000th company in October 2013. The DIFC currently houses 365 active regulated financial firms, including four of the top five banks in China which collectively control 80% of banking assets in the country, 21 of the world’s top 25 banks, 11 of the top 20 international money managers, six of the 10 largest global insurers and multiple international financial services companies.
FROM MENA TO MEASA: In 2013 the DIFC further amplified its effort to position itself as a bridge between Western investors and fund managers and emerging markets in the Middle East, Africa and South Asia (MEASA). During the first half of 2013 the free zone granted a category one licence to the Agriculture Bank of China and the China Construction Bank, meaning that four of the top five banks in China are now operating in the DIFC.
To woo additional and geographically diverse occupants to the DIFC, particularly those from the MEASA region, the DIFC plans to continue to pursue bilateral cooperation with various federal regulators across the globe. The DIFC is expected to enhance engagement within its network of clients, boost collaboration with other global financial centres, and step up integration with governments, regulators and the industry within the UAE and across MEASA. There may also be potential for the DIFC to work closer with more jurisdictions on areas such as cross-border recognition, knowledge-sharing and research.
In this regard, the DIFC already has pre-existing cooperation agreements established in areas such as cross-recognition, collaboration and knowledge-sharing with a number of regional and international jurisdictions, including Malaysia, London, Hong Kong, China, Saudi Arabia, Qatar and several other GCC member states.
In August 2013 the audit monitoring system used by the DIFC’s regulatory body DFSA was granted “equivalent status” by the European Commission, allowing it to sign supervision agreements with 27 EU member states which permit the DFSA to monitor cross-border fund managers operating between the DIFC and Europe. The regulatory cooperation agreements are expected to help asset managers based in the DIFC access a previously untapped pool of European capital.
PLANS FOR GROWTH: One of the objectives of the DIFC in 2014 is to broaden its access to African markets, Pinaki Aich, the DIFC’s director of strategy, told OBG. “Africa is growing today and there is a need for capital, and there are banks and asset management firms here who want to invest in Africa,” he said. “Initially, we thought we would serve the Levant, GCC and North Africa, but now what we are seeing is that when new players come to the DIFC, they want access to the whole of Africa. We are looking to use our role as a government authority to facilitate more access to the region for players operating from the DIFC.”
The DIFC plans to double the size of the free zone by 2017, so it will focus on developing the soft infrastructure to cater to its anticipated expanded client base. This not only includes encouraging more financial services, accounting and legal firms to open offices in the DIFC, but also developing new laws and regulations, streamlining existing rules and even lobbying to reduce telecoms rates, Aich said.
In the year ahead, the DIFC will also continue to bolster efforts to convince more sovereign wealth funds and family businesses in the GCC to set up in Dubai’s financial free zone. Though the DIFC was one of the first financial centres in the region to establish a family business jurisdiction, Aich said the DIFC plans to boost its promotion of this segment of the free zone to raise awareness of the services it offers among regional businesses.
“Today the Middle East has over 1100 good, strong family businesses, and 75% of these are moving from the second to third generations in the next 10-15 years and that brings in its own sets of needs – succession planning, services, etc,” Aich explained to OBG. “Among the family businesses that are aware of it, we see very high usage, so what we want to do in the future is speak to the Kuwaiti family businesses and the Saudi families and let them know that there is a place for them to manage and structure their family businesses.”
And of course, the DIFC will try to attract more institutional investors to the free zone to boost liquidity in the market, which is a key reason why many of the UAE’s most successful corporations continue to choose London over Dubai when issuing an IPO.
EXPO 2020: Investor sentiment will also be bolstered by the news in November 2013 that Dubai was chosen to host the 2020 World Expo. Before Dubai had won its bid to host the event, an anticipated burst of construction and infrastructure development was already creating “euphoria” and a “bond-bonanza” in the emirate’s capital markets, according to national media reports. The economy is expected to benefit from large-scale investments relating to the Expo, with HSCB estimating that total spending by both the public and private sectors related to the exhibition could reach Dh67.2bn ($18.3bn). Capital spending by the Dubai government for the event was expected to reach Dh24.9bn ($6.8bn), according to Bank of America/Merrill Lynch, and could boost GDP by 0.5% in 2016-19 and by 2% in 2020-21. Spending on new projects like hotels needed to cope with the visitor numbers will likely require the issuance of new, higher-yielding bonds, analysts said.
OUTLOOK: The performance of the emirate’s two stock exchanges in 2013 signals a new era of investor optimism and the end of the caution that characterised Dubai’s early recovery from the global financial crisis. The UAE’s inclusion on the emerging market index and the renewed activity in its bond and equity markets are evidence that the emirate has been able to move on from the slowdown of 2008 and 2009 and has since regained its position as a leading regional finance centre.
Winning its bid to host Expo 2020 is the culmination of what has been the best year for Dubai’s markets since the onset of the global recession.
Even so, preparing for the event will also require addressing structural issues that were evident during the crisis or slow the pace of the regulatory reforms needed to broaden the investor bases of Dubai’s bourses, boost liquidity in the markets and encourage more local companies to list locally.
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