Liquid sands

Sweeping reforms and broad market liberalisation are changing the face of the region's capital markets.

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By  Mark Johnson Published  January 27, 2005

|~|capital1.jpg|~|Barclays Capital’s Hegarty says the region has investment grade rating.|~|Traditionally, capital markets in the Arab world have not been big news. The lack of deep, liquid markets, restrictive participation rules, obscure regulatory frameworks and poor transparency in corporate reporting have all held development back. This has created a sluggish regional investor base and kept foreign investors on the sidelines. But the winds of change are now blowing across the desert landscape, and there's more than a whiff of excitement in the air. Across the Gulf Co-operation Council (GCC) states and beyond, more governments are waking up to the benefits - some would say the necessity - of taking the route to privatisation and developing credible capital markets within their countries. Driving the change is massive growth across a number of business sectors, including aviation, construction, telecoms, tourism and financial services. For the companies involved in these areas, the traditional bank-lending route is no longer the only viable option: they want access to new financing structures and new lending markets. Conversely, there is a huge pool of investor liquidity amassing across the region and those investors are looking for a broader range of investment types that will give them better returns than the banks can offer, so the appetite is strong from both sides. This is obvious from the recent IPOs that have been brought before the market. In April 2004, Abu Dhabi-based Finance House floated and was 75 times oversubscribed. Arabian Technical Construction Company (ATCC) was 65 times oversubscribed when it went to market in the same month. And consumer finance group, AMLAK Finance, was 33 times oversubscribed at its January 2004 IPO. Clear evidence, say the experts, that the market is hungry for more deals and bigger deals. Although the regional bond market is still in its infancy, there are signs that this sector is also growing. For example, March 2004 saw the spectacular US$100 million Sukuk issue of National Central Cooling Company (Tabreed). It was a notable transaction because it was the first Islamic corporate Sukuk bond in the world, and the first issue from the Gulf to be listed in Luxembourg. A five-year bond with a 5.5% coupon, it was also heavily oversubscribed. Earlier, in January 2004, Shuaa Capital, one of the region's leading investment banks, launched the first ever non-government corporate debt instrument to be listed on the Dubai Financial Market (DFM), in the shape of a US$24 million bond. The occasion was further marked by the fact it was the first dollar denominated bond to list on the exchange. A floating rate note (FRN), this bond has a three-year maturity and pays 175 basis points over Libor (London Interbank Offered Rate), and is fixed every six months. According to figures from the Gulf Investment Corporation, the United Arab Emirates (UAE) market has witnessed a stellar performance over the past year with a 47.5% rise in value. Saudi Arabia came in a strong second with 47.3%, and Qatar has shot up by 41.2% over the past 12 months. Meanwhile, Bahrain, Oman and Kuwait have all risen by an average of 26%, still far outstripping all of the world's major markets. Dr Karim El Sohl is CEO at The National Investor, one of the UAE's leading investment and advisory firms. He says the appetite among domestic investors for local and regional stocks is outstripping international offerings: "We market both local and international products and it's probably easier to sell local products on a ratio of five-to-one. This is mainly because there is a scarcity of local products, they provide better return, the economies are very strong and it just makes more sense for them to be invested here than abroad." Ghassan Medawar, head of corporate finance at the Dubai International Financial Exchange (DIFX) agrees: "There's definitely an appetite for it. The region is yearning for new asset classes in which to invest, as there is a strong desire to keep the liquidity within the region. People are becoming more averse to sending their money out to the US, or Europe in light of the political situations there, and at the same time, with the price of oil being where it is today, it is creating that much more liquidity in the region. So there's a compounded effect of just pools of liquidity, say, in the GCC where funds are just trying to find somewhere to park." There has also been a trend towards retaining locally earned wealth. El Sohl told The Gate: "It's not just about repatriation of wealth, but more of retention of earnings. The lion's share of all the money that has been earned since 2001 has been retained locally, and it's looking to be re-invested regionally." There is a general consensus that the current lack of investment options in the immediate region is an issue that needs to be addressed. But El Sohl believes it is only a temporary situation: "There are a number of listed companies in the regional markets that have a large governmental holding, such as the banks, which leave a very small float for trading. However, I think that as governments privatise and offload larger proportion of their holdings, you will have more shares available for trading and that will quickly improve the liquidity and the volumes." The upcoming Etisalat IPO in Saudi Arabia will doubtless have market experts watching how the government handles the flotation. ||**|||~|capital2.jpg|~|Shuaa’s Saadeh says the market needs clarity when it comes to processes.|~|Salam Saadeh is head of capital markets at Shuaa Capital. She agrees there is a need for more asset classes. However she also believes there has been a marked improvement in liquidity levels which those outside the region may have overlooked: "One of the main problems marketing this region is that people say there is no depth, or liquidity, but if you look at the last two years, the situation has completely changed. Turnover on these markets has tripled, quadrupled, even gone up by a multiple of 10, in some cases. Saudi Arabia, Kuwait and UAE are all very liquid. Qatar has its days, sometimes it is very liquid, but that's because the market is confined to only a few stocks." These improvements may be adequate for local and regional players, but if large international institutional investors are to be persuaded to join the region's markets, liquidity will need to rise exponentially. "The international players will not come until there is enough depth. The likes of Fidelity, Templeton and so on would only entertain coming to a market that can easily absorb their large ticket investments on the entry and the exit," says Saadeh, adding that these players normally deal in US$50 million deals. "If you're trying to buy US$50 million worth of stocks here, you'll send the price sky high and when you try to exit you depress the whole market, so until there's enough liquidity and depth, they will remain shy." Saadeh adds that the Turkish stock market has that kind of depth, which is why there are plenty of international players there. "But if we can provide the range of investment alternatives, and the depth as well, we will eventually attract the big institutional investors here, too." Despite the impressive performance of the region's indices, many still classify it as an emerging market. However, this does not automatically reduce it to being a sub-investment grade market, as experts, such as Nicholas Hegarty, managing director, Barclays Capital, Middle East and North Africa (MENA), are quick to point out. "Most of the region has an investment grade rating; it's only the wider region that currently doesn't have a rating, such as Jordan and Sudan," he says. "We treat it as an investment grade market for two principle factors: one is the invested wealth from the region, and the liquidity that you have here. Also, the preferences for single-A rated products, as there is a high level of risk aversion here. The other is that you are dealing with the same entities in terms of their investments. With the Gulf Investment Bank (GIB) or with an Emirates bank, you market and work with them on both sides of the balance sheet - the asset and the liability side." Perception, though, does cast a long shadow, which is why efforts are being stepped up to push ahead with capital markets reforms. "The issue with this part of the world, versus other emerging markets, is that they have never been taken seriously by international investors for a variety of reasons," says Medawar. "We really haven't had the reforms in this part of the world. It's been a kind of two steps forward one step back situation. With privatisation, there's never been that level of commitment to do what the international community wants in order to be taken seriously. But that's now beginning to change." To this end, in 2003 Saudi Arabia passed new capital markets and insurance laws and set up the Saudi Arabia Securities and Exchange Commission (SASEC) to monitor the market and protect investors. The law also established the Saudi Arabian Stock Exchange (SASE), incorporating the national securities depository centre. Implementation of the new law is ongoing, and many believe it will lead to a revolution in the kingdom's financial services sector and cause a considerable stir among its neighbours too. But while Saudi may be seen as leading the way on capital markets reform, some believe the committee responsible is doing so at a painfully slow pace: "We know that the Saudi regulations are out there, but the procedure for implementation is not out there yet," says Saadeh. "Lately, they (the committee) have released details of how to apply for a brokerage licence for example, and this kind of thing, but they are advancing slowly" she adds, commenting that, while the regulations themselves all sound good and workable, there is a definite lack of clarity on processes, which is slowing development: "How they plan to implement the regulations, who's going to get a licence and who isn't, what will be the process for IPOs and so on, is still not very clear." Just how quickly and clearly the Saudi authorities can develop their processes remains to be seen, but the experts say there is much to be gained from moving ahead. "Transparent, well regulated capital markets are an engine for the growth of the economy," says El Sohl. "When companies can tap these markets efficiently it funds their growth, contributes to productivity. It will actually attract more and more regional and international investors and then it will attract the blue chip companies to list on these markets or issue securities on these markets, all of which will benefit the economy." Hegarty agrees. However, he adds that, while the growth of the markets are subject to the will of the region's governments to make it happen, the banks will also need to step up to the plate: "What's going to drive this is the IPO stream. The government's have committed to bringing new products to the market, and there are sufficient opportunities that can be privatised, if they seize them. But when they have set it up and put the products in there for the banks that deliver, those banks will need to commit the right resources and the right people to make it work." To this end, Hegarty says many international companies, including Barclays Capital, have already made that commitment: "To be active in this market, to have real traction, you need to have the real relationships - you need to be here. Briefcase bankers are accepted but they are not overly welcome these days. You are seeing a change in dynamics, there is now a focus on the building of sustainable relationships, a sharing of minds in terms of advice and in terms of getting beneath the traditional deal." Overall, it's been an interesting, not to mention profitable, year on the region's capital markets scene, and judging by the number of IPOs and new bond issues lining up for 2005, that trend looks set to continue. The only question that remains is: can the governments keep pace?||**||

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