In sharp focus: Diversification of foreign trade has become a higher priority

Abu Dhabi has long been associated with buy-side investment activity, thanks largely to its success in transforming fiscal surpluses into global investments aimed at ensuring future economic security. However, after two full years of lower oil prices, Abu Dhabi’s attractiveness as a destination for inward investment has become more pertinent, with the government seeing boosting foreign direct investment (FDI) inflows as a useful means of mitigating its spending cuts.

The same pressures highlight the importance of diversifying the emirate’s export basket, which is dominated by oil and related products. The UAE’s strong performance in indexes such as the World Economic Forum’s “Global Enabling Trade Report” illustrates Abu Dhabi’s capacity to boost its non-oil export activity, and realising this potential is now a strategic imperative.

ADIA: Abu Dhabi’s prominence as a global investor with sizeable interests across the world largely stems from the activities of its sovereign wealth fund (SWF), the Abu Dhabi Investment Authority (ADIA).

Established in 1976, ADIA, which had its 40th anniversary in 2016 and has been the subject of much scrutiny over the past year. The coverage has served to highlight the central role played by the fund, through which the emirate has sought to use the surpluses generated by its oil and gas industry to ensure the economic well-being of future generations. According to the Sovereign Wealth Fund Institute (SWFI), after financial commitments are taken into account, Abu Dhabi diverts 70% of any budgetary surplus to ADIA on a periodic basis, thanks to what is normally a robust current account, this funding has been sufficient to propel it to near the top of the global SWF rankings. While estimates regarding ADIA’s total assets vary, in 2016 the SWFI ranked it the third-largest SWF in the world, behind only Norway’s Government Pension Fund and China Investment Corporation.

Abu Dhabi’s considerable external buffers are largely attributable to the activities of ADIA over the past four decades, and allow the emirate to manage the fiscal deficits that have resulted from lower oil prices without discomfort in the short- or medium-term. While ADIA does not publish detailed data on its earnings, one consequence of the new oil price environment has been a decline in the SWF’s assets, as the government has sought to meet its spending commitments by tapping this reserve. While ratings agency Fitch estimated that ADIA’s total assets fell by 5.4% in 2016, it expects them to rise again in 2017 as the government finds other ways to cover its budget deficit, including issuance of local and foreign currency bonds (see Economy chapter). ADIA has interests across a broad range of asset classes and markets, with a policy weighted towards equities in developed economies.

While there has been no reported major change to this investment strategy, which includes 12 asset classes over a wide geographic scope, ADIA has shown increased interest in recent years in Asian markets, particularly China and India (see analysis).

ADIC: While ADIA remains the emirate’s principal investment body, it is by no means the only one. The Abu Dhabi Investment Council (ADIC) was spun off from ADIA in 2007 to take over the SWF’s domestic interests, which include systemically important institutions such as Abu Dhabi Commercial Bank, First Abu Dhabi Bank and Abu Dhabi Investment Company. Since then, around 30% of the emirate’s budget surpluses have been directed each year to ADIC. While it has retained its local focus, its current remit goes beyond the emirate’s borders to allow for a globally diversified investment strategy across a wide range of asset classes, including equities and fixed income, hedge funds, infrastructure, real estate and direct investments. In 2016 it was estimated to hold a combined investment portfolio worth $90bn.

MUBADALA: Mubadala Investment Company is another arm of Abu Dhabi government investment activity. Established in 2002, it differs from traditional SWFs in that it is partly self-financing through a debt issuance programme, and is therefore classified by the SWFI as a strategic development SWF. It has played a central role in the diversification of the economy away from hydrocarbons activity, making investments in projects such as Cleveland Clinic Abu Dhabi, Emirates Global Aluminium, aerospace manufacturer Strata, Dolphin Gas and Paris-Sorbonne University Abu Dhabi.

Following its merger with the International Petroleum Investment Company (IPIC) in early 2017 Mubadala has restructured into four primary investment platforms. Petroleum and petrochemicals accounts for 31.1% of the group and incorporates the main assets of IPIC, as well as Mubadala Petroleum’s upstream portfolio, and is led by Musabbeh Al Kaabi as CEO. An alternative investment and infrastructure platform, accounting for 31% of assets, is led by Waleed Al Muhairi as CEO and deputy group CEO, meaning there is essentially no change at the top of what Mubadala previously called emerging sectors. The third-largest division will be technology, manufacturing and mining, with 21.6% of assets. Ahmed Yahia Al Indrissi continues as CEO of this grouping. Aerospace, ICT and renewables will cover 10.6% of the assets and house the aerospace companies, led by Strata, as well as communications assets. The remaining 5.7% of the group will consist of other corporate assets.

One of Mubadala’s most notable contributions to the economic landscape of the emirate in recent years has been its development of Abu Dhabi Global Market (ADGM), a 450,000-sq-metre financial free zone which recently opened and in 2016 was awarded “Financial Centre of the Year (MENA)” by Global Investor/ISF.

ADCCI: The goal of the Abu Dhabi Chamber of Commerce and Industry (ADCCI) is to work towards an active and effective private sector on the local, regional and international levels. The Chamber helps develop and organise commercial and trade activities in Abu Dhabi, increasing the competitiveness of private companies and expanding their opportunities by providing services which contribute to realising sustainable development in the emirate. According to the provisions of the Chamber law, all natural and legal persons with a headquarters, branch or representative office in Abu Dhabi must join the ADCCI and attain membership certificates.

The ADCCI holds regular workshops and meetings in partnership with the Department of Economic Development. For example, in February 2017 a meeting discussed the challenges of economic development, education and tourism. This followed a December 2016 meeting when the two organised a workshop on the challenges facing companies in the health sector in Abu Dhabi. These and other workshops were the outcome of the Abu Dhabi Business Forum in May 2016, at which private sector challenges were identified and addressed at the sectoral level. “We have been adopting the modern embedded-autonomy approach to elicit challenges directly from private companies, and conveying these challenges to the government for targeted solutions through workshops,” Mohammad Helal Al Muhairi, director-general of the ADCCI, told OBG.

INBOUND: Abu Dhabi’s status as an important investor in overseas markets is unlikely to change in the long term. While diversification into industry, manufacturing, services and tourism is gaining momentum at home, the diversion of revenue into foreign assets remains an important aspect of the emirate’s financial security. However, the period of lower oil prices that began in the second half of 2014 has demonstrated the limits of a growth strategy based on government spending and the importance of inward investment to the economy.

There are several factors that make Abu Dhabi an attractive destination for global capital, one of the most important being it and the broader UAE’s status as a safe haven in what has become an FMIT inconstant region since 2011. The emirate’s political stability is largely derived from its leading role in a federal system bolstered by a robust economy which in 2017 enabled Abu Dhabi government debt to retain an “AA” sovereign rating from Standard & Poor’s (S&P) and Fitch, and an “Aa2” rating from Moody’s, all of which places the emirate in the high-grade investment category. Advanced health care and education systems also act as pull factors for investment, and have been boosted in recent years with the arrival of institutions such as Cleveland Clinic and Johns Hopkins Medicine International, as well as a raft of universities, such as the Paris Sorbonne, INSEAD and New York University.

Abu Dhabi has also sought to attract foreign investment by providing a wide range of specialised locations in which industrial and manufacturing activity can take place. These take a number of forms, from the simplest industrial areas such as those at Mafraq and Madinat Zayed – which cater to modest local enterprises in segments such as light industry, packaging and building materials – to the specialised zones operated by the Higher Corporation for Specialised Economic Zones (ZonesCorp) and the Khalifa Industrial Zone Abu Dhabi (KIZAD) being developed by Abu Dhabi Ports.

FDI PATTERNS: The total stock of foreign investment (FI) and FDI in Abu Dhabi has grown steadily over recent years, and official data shows that this remained the case despite the challenging economic circumstances of late 2014 and 2015. Total FI, including that into Abu Dhabi’s capital markets, rose by 18% from Dh298.8bn ($81.4bn) in 2014 to Dh353.1bn ($96.1bn) in 2015, according to Statistics Centre - Abu Dhabi (SCAD). Investment in financial institutions and insurance activity accounted for 53.9% of total foreign investment in 2015, compared to 7.8% for the second-largest investment target, the real estate sector.

In terms of FDI, which refers to investment in physical entities, Abu Dhabi has enjoyed a similar growth trajectory. FDI to the emirate climbed from Dh60.9bn ($16.6bn) in 2012 to Dh79.9bn ($21.8bn) in 2013 and Dh95bn ($25.9bn) in 2016, according to SCAD. Manufacturing industries grew by 11% to Dh19bn ($5.2bn), around 20% of the total. Real estate foreign investment, which includes sales of property to non-residents, remained at Dh24bn ($6.5bn), with its share dropping from 27% to 25%. Investment in financial services grew by 10% to Dh15bn ($4.1bn), with its share rising to over 15%. The extractive industries, including crude oil and natural gas, saw FDI rise by 11% to just above Dh9bn ($2.45bn), for a share of just under 10%.

European countries have traditionally accounted for the largest share of capital coming into Abu Dhabi, contributing nearly Dh36bn ($9.8bn) in 2015. FDI from Asian countries generally has the second-largest share, followed by non-GCC Arab countries, the GCC states and North America. Austria ranked top in terms of FDI stock from individual countries in 2015, with Dh13bn ($3.5bn), or 14.8% of the total.

ADGM: The last year also saw the official opening of Abu Dhabi’s newest destination for both domestic and international investment, ADGM. Being developed on the city’s Al Maryah Island, ADGM is the emirate’s first financial free zone. Centred on private banking, funds, wealth management and asset management, it has its own regulatory structure and an independent companies registrar, as well as an independent legal system based on English common law. This was chosen as it is the most widely used system for the resolution of commercial disputes, and is being continuously updated by the superior courts of the leading jurisdictions with which the newly appointed ADGM judges have close contacts. “We are positioning ADGM as a premier international centre underpinned by global standards to support more financial intermediation to be conducted in the MENA region, instead of having them exported elsewhere,” Richard Teng, CEO of ADGM’s Financial Services Regulatory Authority (FSRA), told OBG.

ON THE UP: Despite the dampening economic effect of lower oil prices, the establishment of ADGM comes at an auspicious time for the UAE as an investment destination. The recent elevation of the UAE to emerging market status by both Morgan Stanley Capital International and S&P Dow Jones has helped the federation to play a leading role in a regional rise in investment activity, which saw equity investment in the GCC plus Jordan and Lebanon grow from $5bn in 2012 to almost $10bn in 2014, according to investor relations advisors Fairvue Partners. ADGM has also been active on the international stage over the last year, signing memoranda of understanding with a significant number of institutions, including financial services regulatory authorities from Europe to China, as well as a host of other businesses, including the Abu Dhabi Securities Exchange, Bloomberg and Etihad Airways.

INNOVATIVE INVESTMENT SUITE: However, while the UAE’s emerging market status is securing more international portfolio flows for its capital markets, the wealth of the local population is just as interesting to asset managers that are considering establishing themselves in Abu Dhabi. One in five of the Middle East’s ultra-high net worth individuals, classed as those with net assets of $30m or more, reside in the UAE, according to intelligence firm Wealth-X. These individuals have a combined net worth of around $225bn, and many of them are heads of the large number of family-owned businesses (FOBs) which form the backbone of the region’s non-oil economy. “Perhaps the biggest challenge facing FOBs in recent years has been succession planning as the younger generation prepares to take over FOBs in Abu Dhabi,” said Al Muhairi. “The Chamber has prepared a comprehensive study jointly with McKinsey to facilitate this phase.” Abu Dhabi’s new financial free zone is seeking to tap into this segment by establishing a regulatory framework that is not only robust but also sufficiently flexible to attract these family concerns. One of its key innovations from a business development perspective, therefore, is the concept of the restricted scope company, a category of licence to which less onerous disclosure requirements are applied.

ADGM has also made provision for the operation of cell companies, by which a cell – such as a pool of assets attributable to a specific set of investors – may be registered separately to other cells in the same company. This model is often used in fund structures, and its inclusion in ADGM’s framework establishes the basis for the development of new investment structures in the UAE. Another key concept, given the foreign ownership limits which exist onshore, is that ADGM companies may be wholly owned by foreigners. This provision represents a powerful selling point as ADGM sets out its stall for the global investment community.

In January 2016 ADGM issued its first full financial licence to Afkar, an incubator for asset management fund start-ups. As of March 2017, 24 companies had been approved by ADGM’s FSRA to carry out financial services activities in the new financial zone, including Abu Dhabi Financial Group’s Goldilocks fund, as well as international heavy hitters Macquarie Capital and Aberdeen Asset Management. In addition, ADGM saw the fastest pace of new fund creation in the region in 2016, including funds launched by Abu Dhabi Financial Group and Mubadala Capital, two special purpose companies dedicated to aviation financing, as well as more than 70 special-purpose vehicles created.

Close to 220 financial and non-financial entities were registered to operate within ADGM by the close of 2016, including not only ancillary services such as legal and accounting firms, but also the many retail operators which are concentrated in the zone’s Galleria Mall. In November 2016 ADGM established the MENA region’s first financial technology regulatory regime and regulatory laboratory (RegLab), through which it hopes to establish Abu Dhabi as a centre of financial technology development. The RegLab places ADGM’s FSRA at the forefront of global regulators when it comes to encouraging the growth of this dynamic segment (see analysis).

LEGAL: ADGM is the first jurisdiction in the region to adopt common law in its entirety, similar to Singapore and Hong Kong. The regulatory structure is responsive, with appropriate standards applied depending on the institution’s needs and the risk it poses to the market. With a focus on the requirements of businesses and investors, ADGM courts allow parties to commence cases and file documents from anywhere at any time. The courts accept documents on the day they are filed, and parties can manage documents online.

TRADING ACTIVITY: The reduced oil prices have underlined the need to diversify Abu Dhabi’s trading activity. Oil, oil products and gas dominate the emirate’s export flows, despite the drop in global prices: in 2015 they accounted for Dh185.2bn ($50.4bn) of Abu Dhabi’s total goods exports of Dh234.9bn ($64bn), representing 78.8% of the total. This sector is overseen by Abu Dhabi National Oil Company (ADNOC), an icon of the domestic economy, which controls the extraction, production and export of the emirate’s oil and gas via 16 subsidiaries.

The energy sector remains a mainstay of economic growth in the emirate, and in late 2015 the UAE stated that it would continue to invest in oil and gas development in order to meet a production target of 3.5m barrels per day. In 2015 Abu Dhabi exported 661m barrels of crude oil, with Japan the largest importer, taking 34% of the total. Japan was also the most important destination for refined petroleum exports, purchasing 18.8% of the 18.3m tonnes of the products Abu Dhabi shipped that year. Other important markets for Abu Dhabi’s oil export activity include South Korea, India, Thailand, Singapore and China. More interesting from the standpoint of economic sustainability is the growth of non-oil export activity over recent years. While the decline in oil prices boosted non-oil exports’ share of total exports in 2015 and 2016, the rise in non-oil export activity is real. In 2015 Dh30.8bn ($8.4bn) of non-oil exports left the emirate, up from nearly Dh19bn ($5.2bn) in the previous year, according to SCAD. Non-oil exports have grown from 2.6% of the total trade in goods through the ports of Abu Dhabi in 2012 to 8.7% in 2015. The largest contributor to non-oil exports from the emirate in 2015 was the manufactured goods category, which accounted for Dh12.5bn ($3.4bn) of the Dh30.8bn ($8.4bn) total. This trend is testament to Abu Dhabi’s success in beginning to diversify its economy away from a reliance on oil and gas exports, a process which is being led by rising activity in segments such as steel, aluminium and petrochemicals. The bulk of Abu Dhabi’s non-oil exports in recent years have gone to the growing economies of Asia, which accounted for 68% of all exports in 2015. Europe was the second-largest destination, with 26.3%, followed by Africa (3.6%), North America (1.6%) and Australia and Oceania (0.3%).

IMPORTS: Abu Dhabi’s wealthy consumer market helped make machinery, sound recorder, reproducers and parts the largest import category, accounting for 27.1% of the total in 2015. Other significant categories include base metals, which feed Abu Dhabi’s industrial activities, and transport vehicles. Some 43.7% of total imports originated in Asia, with Europe (29.2%) and North America (16.7%) the next-largest sources. The emirate trades heavily with both East and West, for which its location on the main East-West trade routes makes it ideally suited. In regional terms Saudi Arabia is the largest source of goods entering Abu Dhabi, accounting for 70% of imports from the GCC in 2015.

TRADE AGREEMENTS: Abu Dhabi, as part of the wider UAE, benefits from a number of important trade agreements. The UAE joined the World Trade Organisation (WTO) in 1996, and in 2016 became the first WTO member from the Arab region to ratify the new WTO Trade Facilitation Agreement – a framework that contains provisions for expediting the movement of goods in transit and increasing Customs cooperation. As a leading member of the GCC negotiation team the UAE is at the forefront of talks to establish free trade zones with several significant markets, such as the EU, Japan, China, India and the South American Mercosur bloc, which includes, among others, Brazil and Argentina.

Meanwhile, the UAE continues to strengthen bilateral ties on its own account. In 2016 the country signed a memorandum of agreement with the Hong Kong Trade Development Council aimed at increasing cooperation in trade, investment and innovation. On January 1, 2015 the free trade agreement (FTA) between Singapore and the GCC entered into force, in the culmination of a process that began in 2006. The new FTA removes the tariffs from 93.9% of tariff lines on Singaporean goods imported to the GCC, with a further 2.7% to be removed by 2018. All GCC imports to Singapore are, in return, granted zero-tariff status. While an FTA between the EU and the GCC has proved elusive, the region has made progress with the European Free Trade Association (EFTA), comprising Norway, Iceland, Liechtenstein and Switzerland. A long-anticipated EFTA-GCC FTA came into force in June 2015, introducing a framework that includes trade in goods and services, government procurement and competition. The agreement also establishes an EFTA-GCC Joint Committee, which first met in January 2015 and has been mandated to supervise the FTA’s application. Other important components include a provision for dispute settlement through arbitration, and a number of bilateral arrangements on agricultural products between three individual EFTA states and the GCC. Looking towards the Southern Hemisphere, trade agreement negotiations with important markets such as Australia, Malaysia and New Zealand continue, and are at various stages of completion.

INFRASTRUCTURE: The increasingly diverse array of trade agreements linking the UAE to important foreign markets is matched by a similar expansion of trade-related infrastructure. The federation’s road, sea and air links enable it to take advantage of its strengthening ties to global trading partners, and establish it as one of the most trade-friendly jurisdictions in the world. The UAE was the highest-ranked MENA country in the “Global Enabling Trade Report 2016”, which placed it 23rd out of 136 nations, only one place behind the US.

The report highlighted the UAE’s success in establishing itself as a logistics, trade and tourism hub, and credited its transport system – for which it is ranked sixth globally – as a key enabler of this status. Abu Dhabi’s trading companies benefit from their proximity to Dubai International Airport, which is one of the busiest in the world, and Jebel Ali Port, which is the largest in the region. Abu Dhabi International Airport is undergoing a multi-billion-dollar development programme which will significantly increase its cargo capacity and bring its passenger capacity to more than 45m per year, while the emirate’s Khalifa Port Container Terminal, which opened in 2012 with a capacity to handle 2m containers per year, has embarked on an expansion project that will enable it to accommodate the world’s biggest ships. The latest phase of development will see the addition of 1000 metres of quay wall, 600,000 sq metres of cargo handling space, and a deepening of the main channel and basin from 16 metres to 18 metres – all scheduled for completion by mid-2018. Further planned expansions will bring the total capacity of the port to 15m containers per year by 2030 (see Transport chapter).

Meanwhile, Abu Dhabi continues to upgrade its already extensive road network. New projects include a 62-km expansion of the existing highway between the capital and neighbouring Dubai, while the minor road network is still growing, and now extends further than 18,000 km. The federation’s internal transport links have also been greatly improved by the successful completion of the first phase of the Etihad Rail Network, a Dh40bn ($10.9bn) project that will eventually establish a 1200-km rail network in the country. The existing 264 km of track had by early 2017 transported 10m tonnes of sulphur on behalf of ADNOC. Tendering for the 628-km second stage link between Khalifa Port and Dubai’s Jebel Ali Port was, however, postponed in 2016 as part of the government’s efforts to prioritise spending.

OUTLOOK: Abu Dhabi has benefitted from the UAE’s determination to work with regional and international partners to enhance trading links, and improve the trading environment in terms of administration, Customs and border controls. However, there are still some areas where the authorities have room to make further improvements. The “Global Enabling Trade Report 2016” draws attention to export tariffs and limited preference margins as potential blocks to trade growth, and it is issues such as these which are likely to occupy government planners over the coming year. Abu Dhabi’s status as a major oil exporter means that primary hydrocarbons products will continue to occupy a dominant position in the export basket, but the downstream manufacturing processes which these resources enable offer an opportunity for future diversification.

This growing industrial and manufacturing base will continue to attract FDI, thanks in large part to a supportive government policy which has seen the implementation of investor-friendly incentives and state investment in infrastructure. The weightings granted to UAE firms in emerging market indices expose them to more substantial capital pools, and raise the prospect of further gains in international investment.

In the short term a new investment law – a draft of which has already been approved by the UAE Cabinet – promises to significantly alter the investment environment in the country by allowing 100% ownership by foreigners of companies in selected activities. While the precise areas of the economy which this development will make accessible to foreign investors remains to be seen, social infrastructure sectors such as health and education are thought to be potential starting points.