Abu Dhabi expanding and reforming capital market through new services

Despite the headwinds of low oil prices and recent regional political turbulence, Abu Dhabi’s stock exchange put in a relatively strong performance in 2016, with the main index posting a 5% gain for the year. A sizeable sovereign bond sale also injected life into the emirate’s nascent debt market, reviving a yield curve that had been interrupted by a seven-year absence of sovereign issuances.

The emergence of Abu Dhabi’s new financial free zone, meanwhile, has opened up a range of possibilities for the future expansion of the emirate’s capital markets, both in terms of financial support services and core investment and trading activity.

Rapid Expansion

Over the past two decades Abu Dhabi’s financial markets have witnessed a remarkable expansion. Indeed, prior to the creation of the Abu Dhabi Securities Market (ADSM) in 2000, only a limited amount of stock trading was carried out on an informal basis, with all the heightened risk that such unsupervised activity entailed. The new infrastructure of the formalised market allowed for an array of individuals and institutions to invest with the protection of a regulatory framework, and the early listing of national champions such as National Bank of Abu Dhabi (NBAD) did much to attract a new generation of Emiratis to the exchange. Within five years of its establishment the ADSM was attracting its first foreign listings, and in 2008 it embarked upon a new important phase of development, when it rebranded itself as the Abu Dhabi Securities Exchange (ADX) and began to implement a strategy of deepening the market through the addition of yet more foreign listings, regulatory reform and new products. Significant advances since that time include product innovations such as the introduction of exchange-traded funds (ETFs) and procedural enhancements such as the introduction of eXtensible business reporting language (a protocol which introduces a common standard of financial reporting across the ADX’s listed companies). Technological improvements have also come in the form of the X-Stream trading platform provided by NASDAQ OMX, which brings the ADX into line with some of the world’s largest exchanges and provides it with a cutting edge, internationally compliant, multi-asset framework on which to base future expansion. Over this time the ADX has widened its net in terms of attracting liquidity, acting first as a focus for domestic investment, then emerging as a destination for regional investment capital, and in the present day becoming an increasingly interesting prospect for the global investment community.

The international recognition bestowed on the stock exchange in 2014 has done much to accelerate this process: in May of that same year the ADX was added to the influential MSCI Emerging Market Index, and four months later Standard & Poor’s Dow Jones effected a similar reclassification of the exchange. The elevation of the ADX from frontier to emerging market status offers the prospect of greater international investment flows: passively managed global investment is automatically directed to ADX stocks included in the emerging market indices, while the ADX as a whole stands to benefit from the heightened analyst coverage that its increased visibility will result in.

Federal Position

The federal nature of the UAE means that the development of the ADX has taken place in a highly competitive domestic environment. Despite a relatively small population of 9.2m people in 2015, the UAE is home to three bourses, all of which seek to attract liquidity from local, regional and international investors. The ADX is owned by the Abu Dhabi government, while the Dubai Financial Market (DFM) is a publicly traded company, with 79.6% owned by the Dubai government through the government related entity (GRE) Borse Dubai. Both are regulated by the Abu Dhabi-headquartered Securities and Commodities Authority (SCA). The Nasdaq Dubai (formerly known as the Dubai International Financial Exchange) is 66.7% owned by the DFM and 33.3% by Borse Dubai. It has been in operation since 2005, and is overseen by the Dubai Financial Services Authority. The ADX’s total market capitalisation of more than Dh475bn ($129.3bn) at the end of 2016, compared to the Dh337.6bn ($91.9bn) of the DFM and the Nasdaq Dubai’s approximately Dh94bn ($25.6bn) for the same period, makes it the largest exchange of the three. The presence of three sizeable exchanges in the UAE has meant that the possibility of a merger has been a prominent topic of industry discussion for some years, with rumours of consolidation advancing and receding on a cyclical basis since 2009. The last high-water mark for this speculation came in 2013, when the press went as far as to report that the ADX and the DFM had hired banks to advise on their possible merger. Since then, however, the issue has become less prominent one. Instead, attention has shifted to the developing relationship between the ADX and Abu Dhabi’s brand new financial zone, Abu Dhabi Global Market (ADGM) .

Market Structure

The ADX has developed from a single-product market to include a range of equities which reflect the increasingly diverse nature of the domestic economy, as well as other capital market instruments such as bonds and ETFs. The main board of the market is subdivided into eight subsectors: banking, investments and financial services, real estate, energy, consumer staples, industrial, insurance and telecoms. At the outset of 2017 a total of 68 public companies were listed on the exchange. While Abu Dhabi’s real economy is centred on its successful exploitation of its hydrocarbons resources, the exchange is dominated by the insurance, banking and industry segments, a phenomenon which reflects the emirate’s emergence as a financial centre and the fact that the bulk of its energy sector remains in government hands. The emirate’s most prominent financial blue chips, such as First Abu Dhabi Bank (FAB), Abu Dhabi Commercial Bank, Abu Dhabi Islamic Bank and Union National Bank are an important focus of trading activity on the exchange. The industrial category, meanwhile, is dominated by the cement companies which have thrived on the expansion of the UAE’s real estate and infrastructure over recent years.

New Talent

Attracting new and high-quality listings to the market remains a priority for exchanges across the region, and one of the ways the ADX has sought to achieve this goal is by creating a secondary board for smaller companies. Inaugurated in 2014, the ADX’s second market for private joint stock companies (PJSCs) had two listings as of January 2017: The National Investor, one of Abu Dhabi’s leading investment firms, and one of the emirate’s most prominent real estate sector developers, Manazel.

The attraction of the board for important firms like these is that, while sharing similar rules to the main board in core areas such as trading, clearance and share transfers, the new market is made more accessible by a lenient approach to criteria such as capital and reporting requirements. For Abu Dhabi’s small and mid-cap companies, therefore, the PJSC market offers a new route to funding by which they can drive their expansion, while for the ADX it promises to create a pool of candidates which might over time be elevated to the main market through a public listing.

The ADX is also home to a small number of listed funds, all of them open-ended, and over recent years NBAD — now FAB following its 2017 merger with First Gulf Bank — has emerged as the primary operator of funds listed on the exchange. Since 2009, NBAD has also run the only ETF listed on the exchange, the NBAD OneShare MSCI UAE – the first of its kind to be established in the emirate, and an innovation which grants investors low-cost and low-risk access to a broad mix of securities. Looking to the debt instruments, as with other exchanges in the region most trading in this area is carried out off the ADX, on an over-the-counter basis. As of January 2017, just one bond was actively traded on the ADX: the Abu Dhabi National Insurance Company Mandatory Convertible Bond 2019, which was listed in June 2016.

Debt Market

Despite the limited trading volumes on the ADX’s debt instruments, in a broader context the question of bond and sukuk (Islamic bonds) issuances has become an increasingly salient one in the emirate. At the sovereign level, Abu Dhabi has not been a consistent issuer of debt. While a run of sovereign issuances culminating in a $3bn bond offering in 2009 formed the beginnings of a useful yield curve by which corporate issuers might efficiently price their bond and sukuk, the following seven years saw no further debt raising by the emirate. Instead, GREs were the most active issuers during this period. According to Abu Dhabi’s Debt Management Office, which since 2009 has been advising the Abu Dhabi Executive Council on the emirate’s debt profile, around 90% of all debt issued has come from GRE activity. Prior to the merger of Mubadala Development Company and the International Petroleum Investment Company (IPIC) in 2016, the most regular issuers were the Tourism Development and Investment Company, Mubadala, IPIC and Abu Dhabi National Energy Company (TAQA). However, the oil price decline, which began in the second half of 2014, has renewed the government of Abu Dhabi’s interest in debt issuance as a means to meet its fiscal obligations, and in 2016 it staged a $5bn bond sale offered in two tranches, of five years and 10 years (see analysis). The renewed activity has raised hopes that the UAE will finalise its long-anticipated public debt law. Such a development would permit the federal government to issue its first sovereign bonds to finance government development projects, and also enable the central bank to issue short-term Treasury bills as a banking liquidity tool.

Broadening The Base

As well as increasing the range of products and services on the ADX, the exchange authorities have also sought to deepen the market by establishing a wider base of investors, both retail and institutional. The elevation of the ADX to emerging market status by some of the world’s most influential indices represents a useful fillip in this regard, but even prior to this development the ADX was already acting as a location of interest for investors across the globe.

The investment base of today’s ADX is a healthy mixture of local, regional and international individuals and institutions. Companies bought around Dh26.6bn ($7.2bn) of equities on the ADX between January 1, 2016 and January 1, 2017, according to ADX statistics, and sold approximately Dh21.5bn ($5.9bn) over the same period. Individuals traded a similar value over the year, buying Dh22.4bn ($6.1bn) worth of stock and offloading around DH27.5bn ($7.5bn). In terms of nationality, UAE citizens accounted for 52.4% of total trading value in 2016.

Non-GCC Arab countries accounted for 10.3% of traded value over the same period, with Jordanians accounting for the largest share of the total, followed by Syrians, Palestinians and Egyptians. Investors from countries further afield accounted for 31% of the value traded on the ADX during 2016 — a figure that reflects the exchange’s success in establishing itself as a global investment platform. Of non-Arab and GCC investors, citizens and institutions from the UK accounted for the largest share of traded volume, followed by those originating from the US and Luxembourg.

Close To Home

A vibrant domestic financial industry has grown up to serve both nationals and foreign investors. In 2017 the Central Bank of the UAE listed 25 licensed investment companies under its jurisdiction, which operate alongside the investment and brokerage units of the national and foreign commercial banks and five dedicated investment banks. Between them they offer a broad range of asset management and investment services to both individual and institutional investors, including a wide range of funds. Funds marketed in the UAE are largely focused on MENA equity markets, although recent years have witnessed an increasing number of real estate and private equity funds enter the mix.

In 2014 Abu Dhabi-based Gulf Capital raised its third and largest private equity fund, which closed at $750m, and many of the capital’s financial institutions have tapped into the emirate’s pools of private wealth in a similar fashion. Waha Capital, an Abu Dhabi-based investment firm that focuses on emerging markets in the Middle East, for example has used private equity structures to establish a diverse portfolio of equity interests, which include AerCap, a New York Stock Exchange-listed global aircraft leasing company; Dunia Finance, a fast-growing consumer finance business; and Dubai-based Stanford Marine Group, a leading operator of offshore supply vessels for the oil and gas sector. Waha Capital’s balance sheet is split between principle investments and asset management. While total assets are currently weighed in favour of principle investments, its asset management portfolio continues to grow, with both a fixed-income fund and an equities fund coming to the market over the last five years, and three new funds in the process of being created as of early 2017. “Overall it is a highly competitive space for asset management in the UAE, and you have to be pragmatic,” Salem Al Noaimi, CEO and managing director of Waha Capital, told OBG. “More and more the focus is on needing to see something tangible and creating a different proposition. Too many look at the short term.”

The oil price decline, a strong dollar and political disruption in the region has made fundraising for private equity activity a challenging prospect in the short term, but the segment is well entrenched in Abu Dhabi, which benefits from a sophisticated pool of investors and a robust legal environment. “The volatility in markets and lower oil price has to some extent brought more caution, but an overarching theme for us is avoid focusing on short term gains, and take a longer term approach,” Al Noaimi told OBG. “We have evolved with the times, leveraged our expertise, and focused on different asset classes.”

Performance

As with other exchanges in the region, market activity has been significantly affected by the sustained period of lower oil prices which began in the second half of 2014. The ADX entered this period from a high point in 2013, when the exchange saw its most rapid growth since the pre-2008 era, with the main index rising by 1659 points over the year to close at 4290, an increase of around 63%.

A more modest rise of 6% was recorded in 2014, and a temporary low of 3892 points in the fourth quarter of the year, largely the result of a precipitous drop in oil prices, provided a foretaste of the investor uncertainty that was to prevail in 2015.

Index movement during 2015, therefore, was broadly horizontal, with the market trading in a range between the high of 4902 set in July 2015 and a low of 4096 seen in November of that year. After a short-lived dip at the start of 2016, the main index continued this sideways movement during the year, establishing a support level around the 4200 mark and a resistance level in the 4600 region. By the close of 2016 the ADX index stood at 4546, which represented a 5% gain on its level at the close of 2015. Given the prevailing economic backdrop in the GCC, the ADX’s performance during 2016 was a robust one.

In September 2016 Rashed Al Baloushi, CEO of the ADX, pointed out that the exchange had seen its market capitalisation rise by Dh441bn ($120.1bn) in the first eight months of the year, which established it as one of the fastest growing in the region.

Regulation

A sustained process of regulatory enhancement has been central to the ADX’s rise to regional prominence. Both local and federal bodies have played a part in this development. Local Law No. 3 of 2000 establishes the ADX as an autonomous body with full supervisory and executive powers over its processes, granting the exchange considerable leeway to develop its own capabilities. At the federal level the activities of the ADX are governed by the SCA, which oversees the UAE’s capital markets according to Federal Law No. 4 of 2000. A third tier of regulation exists in the form of the UAE’s Ministry of Economy, which the SCA must defer to if it wishes to address the legislative, rather than regulatory, framework by which the capital market is governed.

Recent years have seen the SCA introduce a number of significant regulatory changes aimed at enhancing market processes and deepening liquidity. For example, the introduction of market making (the practice of a broker or dealer holding shares in a security, offering a buy and sell price for them and seeking a profit in the spread) has seen NBAD — now FAB — and more recently Al Ramz Capital, attain licences to practice on ADX. The lending and borrowing of securities, which enables the lending of stock to an investor or firm, usually for a fee, is another.

The ADX and the SCA have also sought to ensure market stability by establishing best practice market standards, for example by introducing a new framework in 2012 to govern the marketing of investment funds in the UAE. In 2016 a number of regulatory changes were of particular interest to the investment community. The extensive revisions made by the SCA to the UAE Mutual Fund Regulations of 2012 impose a number of restrictions on foreign firms marketing international funds in the UAE, including funds based in a UAE free zone — a move which brings funds operating from Abu Dhabi’s ADGM within the scope of the legislation. Under the new framework all funds promoted in the UAE must be registered with the SCA and an agreement with an SCA-licensed promoter concluded. At the close of 2016 the SCA was also receiving feedback on its proposed amendment to the federal law of 2000 which governs the entire securities industry. The aim of this initiative is to ensure that the SCA can, in its own words amongst other things, respond to the “development of the capital markets and the diversity of the new financial activities, and … to enhance the efficiency of the UAE market.”

The proposed changes will grant the regulator greater supervisory powers over the market and increase its independence as a financial body, both of which will aid it in its ambition to align the financial market with international best practice. Additionally, in April 2016 the SCA issued a decree setting out a new set of corporate governance rules for PJSCs, which functions in tandem with changes to the commercial companies law of 2015. Improvements in shareholder rights and minority investor protection were largely responsible for the UAE’s rise to 26 on the World Bank’s “Doing Business Report 2017”, making it one of the top 10 most improved nations.

Exchange Development

The further development of the exchange, through regulatory change and the introduction of new processes and systems, continues to occupy the ADX authorities.

The exchange has recently completed the implementation of its 2012-16 strategy, aimed at introducing best standards, product diversification and increased institutional participation.

Looking ahead, the exchange’s stated strategic objectives are three-fold: increasing market capitalisation and its range of products; attracting and activating a wider range of investors; and redesigning the organisational structure and governance. At the close of 2016 the ADX announced a new service that represents a considerable advance in its long-term strategy of enhancing exchange functions. The practice of short selling, by which investors are able to borrow assets such as equities, sell them, and then buy them back at what they hope will be a cheaper price, has hitherto been confined to market makers in the UAE. Regulators in the region have adopted a cautious approach to the wider introduction of the practice, concerned by the increased risk to investors.

Until 2017 Kuwait was the sole market in the region to implement a comprehensive short-selling framework, but the ADX’s decision to allow brokers to engage in technical short selling establishes it as the second exchange to introduce the process. In a statement released at the time of the announcement, Al Baloushi explained the move: “This service is part of continuing efforts to modernise, enlarge and upgrade the market… It also aims at diversifying investment instruments in order to increase the level of liquidity to match global markets. This will enable us to attract foreign investors accustomed to these instruments.” However, mindful of the higher levels of risk attached to short selling, the exchange has opted to introduce it in a restricted and gradual manner.

Beyond The Adx

The recent inauguration of ADGM on the capital’s Al Maryah Island has opened up new possibilities for further market development. ADGM, which has its own regulatory structure, legal system and independent companies registrar, has established its core functions as wealth and asset management, as well as related activities such as its innovative approach to financial technology development (see Trade & Investment chapter).

However, the modern infrastructure and regulatory framework of Abu Dhabi’s new financial free zone allows for a full spectrum of securities functions, from equities listings to derivatives trading. Registering one of the fastest paces of fund creation in the region, the ADGM has five domiciled funds and three foreign funds established within the ADGM. Indeed, in April 2017 the ADGM lowered its capital requirements from $250,000 to $150,000, bringing it in line with other international jurisdictions. ”We are very bullish about ADGM, but see it as a 10-year play, not something that will realise enormous immediate benefits,” Al Noaimi told OBG. “It will be a huge contributor to the Abu Dhabi economy, and opens huge opportunities for not just asset managers, but also family offices,” he added.

The presence of a high-tech trading floor within the ADGM has led to speculation in the press as to the possibility of the ADGM creating a trading platform in Abu Dhabi, perhaps by merging its activities with those of the ADX. Such a development would represent a major alteration to the structure of the emirate’s capital markets, but as of 2017 the relationship between the two entities remained one of cooperation rather than formal partnership. This follows the signing of a memorandum of understanding between the parties in 2016, which was aimed at promoting synergy between the two markets.

Outlook

The developing relationship between the ADX and the ADGM is likely to remain a prominent issue over the coming year. In the meantime, the ADX authorities will continue to develop exchange functionality, their commitment to which was demonstrated in 2016 when the ADX became the first stock market in the MENA region to gain membership in the Institute of International Finance (IIF). Membership in the IIF will provide ADX with useful economic and financial research, timely analysis of capital flows to emerging markets and insight into developments in international financial markets. It will also enable the ADX to further promote the investment opportunities available both within the ADX and the emirate.

In terms of performance, in the short term the main index will remain subject to external factors such as oil prices and interest rate changes on the dollar. The longer-term prospects for market growth, however, are buoyed by the robustness of Abu Dhabi’s domestic economy. With ample external assets to ride out external shocks coupled with one of the most business-friendly environments in the region, an ambitious government programme of infrastructure development and an expected UAE real GDP growth of around 2.5% in 2017, according to the IMF, the outlook of the ADX continues to remain a positive one.