The improvement and development of market infrastructures in Gulf Corporation Council (GCC) countries must be a priority if they are to diversify their economies and attract more foreign investment, according to panellists at the Middle East Securities Forum (MESF) Conference in Doha, Qatar.
The drop in oil prices has given a renewed urgency to a number of GCC countries to reduce their dependency on commodities. There is likely to be a sell-off of state backed enterprises and public listings in GCC countries so as to plug government budget deficits. Saudi Arabia, for example, is speaking with a number of investment banks about a partial or full floatation of its state backed oil enterprise ARAMCO. Saudi Arabia is also assessing whether to tap international debt markets, and has introduced liberalising measures to attract foreign investors. MSCI upgrades of Qatar and the United Arab Emirates (UAE) from the Frontier Market Index to Emerging Market Index have also resulted in increased investment in the region. There is speculation Saudi Arabia could be upgraded as well in the next two years by MSCI.
Nonetheless, there are still a number of areas where improvements need to be made around market infrastructure. One expert said corporate action processes were highly manual and this could be a hindrance for end shareholders. Other countries require foreign investors to custody assets at local broker dealers whose risk management, anti-fraud mechanisms and balance sheet capital strength could be found wanting. This counterparty risk is often unacceptable for mutual funds or UCITS. There is progress being made. Saudi Arabia’s Capital Market Authority (CMA) said in 2015 that foreign investors could use an independent global custodian model if they prefer.
One participant urged regulators in the GCC to reform trade settlement times. A number of countries including Saudi Arabia have a T+0 trade settlement time-frame meaning trades must be pre-funded. Again, this heightens counterparty risk for investors and discourages inward investment. While currency risk is minimal in Saudi Arabia as the Riyal is pegged to the US Dollar, pre-funding is not ideal, and the participant advised the country introduce a T+2 mechanism in line with the international norm.
Many countries are making progress. Qatar has established an independent central securities depository (CSD) while Bahrain, Oman and Kuwait are evaluating how to improve their market infrastructures. The big debate is whether these countries should build central counterparty clearing houses (CCPs).
“Building a CCP is important and can help facilitate inward investment. The UAE has circulated a draft regulation on CCPs, which is being reviewed. The key point in any CCP is to ensure that a clear distinction is made between the clearing member and the custodian as both play very different roles. Over-the-counter (OTC) derivative trading will not happen in the GCC unless there are CCPs. It should be something that regulators and governments are thinking about,” said George Cattan, head of HSBC Securities Services in the UAE.
The challenge therein lies whether to pre-empt the emergence of an OTC market by building a CCP or establishing a CCP once OTC trading becomes more settled. Creating a CCP from scratch is not cheap and would be a costly error if OTC trading never properly developed. Misnad al-Misnad, chief executive officer at Qatar Central Securities Depository (QCSD), said building a CCP in Qatar was not a priority.
Perhaps one advantage for emerging markets is that they will not be saddled with legacy systems when they build market infrastructures such as CCPs. This is a common complaint in more developed economies. Nonetheless, GCC economies should look to international standards to guide them with any attempts to build a CCP.
Other infrastructural improvements include hastening the process to open accounts at CSDs. It is fairly straightforward for global custodians to open client accounts but opening accounts at GCC CSDs could be time-consuming and off-putting for foreign investors. The rules governing account openings at CSDs are divergent across the MENA region and there have been calls for enhanced harmonisation.
“One of the things that continues to frustrate our clients is the complexity of getting access to the GCC markets. In markets like Saudi Arabia and Kuwait, there is a significant amount of documentation to be completed and a number of approval processes which need to be gone through.This comes at a cost, particularly because most of the documentation must be notarised. Generally speaking, our clients would like to see greater efficiency in getting investors access to those markets to enable them to achieve their investment strategies,” said Bogart Miheaye, regional head of network management for W-EMEA at BNP Paribas Securities Services.
Regulations of domestic fund managers in the GCC were also criticised. Market participants complain the rules are complicated and expensive, and this was stymieing the development of a GCC funds market. GCC countries are home to enormous wealth including high net worth individuals (HNWIs), family offices and sovereign wealth funds (SWFs). “Distributing across the region is very difficult because of the regulations,” said one asset manager. Simplifying rules in the GCC would give a massive boost to its funds industry, which is small relative to other markets.
One possibility could be the creation of a regional funds passport mirroring UCITS or the Alternative Investment Fund Managers Directive (AIFMD). There are currently two fund passport schemes underway in Asia-Pacific including the Asia Region Funds Passport (ARFP) and the ASEAN Collective Investment Scheme (CIS). There is nothing to prevent the GCC doing something similar. Nonetheless, most MESF attendees felt this was a long-term project and it was unachievable within the next five years.
There is also limited desire among institutional investors in the GCC for asset managers. SWFs whose reserves primarily derive from commodities have been withdrawing from open-ended asset managers globally. Data from eVestment found state funds redeemed at least $46.5 billion from asset managers in 2015. These outflows are more sizeable than the redemptions by state funds during the financial crisis. Brand name asset managers including Blackrock, Franklin Templeton and Aberdeen Asset Management have all been impacted. As such, the emergence of a sizeable funds industry might be some way off in the GCC.