How greater liquidity and new instruments can unlock further capital markets growth in Dubai

Capital markets in Dubai are spread across multiple exchanges, each with an emphasis on a different asset class. With this structure established and still growing, the aim is to boost activity in all asset classes, and to create an overall offering with the breadth and depth to rival major global financial centres.

For now, most securities trading is governed by external factors, foremost among them being oil prices. Equities values in particular have tended to rise and fall with the price of crude.

Building long-term liquidity – the presence of enough securities and investors to make buying and selling easy, fast and free from price distortion – is the goal for most emerging markets such as Dubai, and the emirate is deploying a multi-faceted strategy to achieve this. The exchanges are working to attract new listings and introduce instruments such as futures, options and other derivatives, while the regulators are working with the exchanges to balance risk and opportunity, and to further develop markets. In 2014 Dubai’s securities were awarded a crucial status upgrade along with the rest of the UAE market, when the global indices provider MSCI upgraded its status from frontier to emerging market. The next step is to matriculate to developed market status, a goal that is currently driving the maturation process in Dubai.

Structure & Oversight

Dubai has multiple platforms for trading securities, commodities and other assets. The primary equities bourse is the Dubai Financial Market (DFM), which was created by the government in 2000. There is also an exchange housed within the Dubai International Financial Centre (DIFC), the emirate’s offshore free zone for financial services. It is called Nasdaq Dubai, and was created for companies that wish to list and are doing business primarily on a regional basis rather than strictly within the emirate or the UAE. While secondary trading in debt securities is available on both, Nasdaq Dubai has seen far greater emphasis on bonds and sukuk (Islamic bonds), and there is therefore little overlap in roles between the two exchanges. Indeed, DFM owns two-thirds of the shares of Nasdaq Dubai, with Borse Dubai, a government entity, owning the remaining third, while also being the majority owner of DFM itself. As a result of this arrangement, the behind-the-scenes logistics of both exchanges are shared. In addition, securities from both are traded via the DFM platform, and trading, clearing and settlement are also handled together.

Competition for listings is seen as an international affair, with the challenge for Borse Dubai being to keep local companies from listing in London or elsewhere, while also attracting regional companies. There is also significant cooperation with the third major securities exchange in the country, the Abu Dhabi Stock Exchange (ADX). In 2017, for example, Nasdaq Dubai signed cooperation agreements with both DFM and ADX that allow it to offer futures on those exchanges.

Brokers

Of the 38 brokers listed in the DFM’s online league tables, Integrated Securities had the largest market share as of December 2018, having executed 10.3% of total trades. It was followed by EFG Hermes at 10.1%, and then a group of eight with market share of between 5% and 8%: Al Ramz Capital, Mubasher Financial Services, Arqaam Securities, Mashreq Securities, MenaCorp Financial Services, ADIB Securities, Union Brokerage Company and Emirates NBD Securities. There are five licensed custodians, four of which are global players: Citibank, Deutsche Bank, HSBC and Standard Chartered. First Abu Dhabi Bank (FAB) is the sole domestic custodian. The DFM is the only exchange in the region to have followed the global trend in exchange ownership, in which an exchange is demutualised and incorporated, followed by a sale of ownership stakes in an initial purchase offer on its own trading platform. The DFM reported a net profit of Dh82.8m ($22.5m) for the first six months of 2018. This was, however, down 43% on the same period in the previous year, due to a reduction in trading value.

Commodities

Commodities and relevant derivatives are traded on the main boards as well as the Dubai Gold & Commodities Exchange and the Dubai Mercantile Exchange (DME), which is located in the DIFC free zone complex. The former aims to develop liquid markets for a range of commodities that physically pass through Dubai or are processed there, whereas the latter has emphasised its crude-oil futures contract, which is an effort to offer regional investors exposure to oil prices close to home. As oil and gas in this region are typically extracted by state-owned entities that have not been publicly traded, this has left equities markets in the region exposed to oil prices. Stock values typically follow the price of oil up or down, but do not offer many direct ways to make investments based on oil price expectations. The Oman Crude Oil Futures Contract, the flagship product of the DME, is based on the crude benchmark historically used to price exports of Middle Eastern oil to Asia. In July 2018 it recorded a new open-interest record of 71,586 lots, equivalent to about 71.5m barrels of crude. The record surpassed the previous high of 69,183 lots at the end of May 2018, with the DME recording over 100 traders active on the exchange in 2018. “Gold and oil trading has increased significantly this year, as investors see the volatility of prices as an opportunity for greater investment returns through trading in higher volumes,” Bal Krishen, CEO of Century Financial, told OBG.

Regulation of Dubai’s capital markets is a mixed system, with a federal-level body overseeing onshore markets, the Emirates Securities and Commodities Authority (SCA), and a purpose-built regulator in the DIFC that oversees all offshore offerings, called the Dubai Financial Services Authority.

Domestic Market Performance

The DFM offers 65 equities, plus trading in two private jointstock companies. The three government of Dubai bonds outstanding and available for secondary trading are also listed here, along with three sukuk, two funds and one exchange-traded fund. Given that securities exchanges have been established in just two of the UAE’s seven emirates, namely Dubai and Abu Dhabi, the DFM list is not limited to Dubai-based companies but includes those from other emirates, as well as from other countries in the region, such as the Bahraini financial services conglomerate Ithmaar Holding and Egypt’s NAEEM Holding, an investment bank. As of the third quarter of 2018 market capitalisation was little changed from 12 months previously, at Dh375bn ($102.1bn), slightly lower than the total in the third quarter of 2017, when it reached Dh377.3bn ($102.7bn). The benchmark index, the DFM General Index, dropped by 23.8% in 2018, with declines in all but two months in the period. It had fallen by 4.6% in 2017, with 61.5bn shares changing hands, with this decline coming after a 12.1% uptick in 2016. The index is heavily skewed to banks and real estate, with these two subgroups accounting for 69% of the index. The biggest stock is Dubai Islamic Bank, which itself accounts for 19.1% of the index, and the second largest is Emaar Properties, with 14.3%.

Offshore

Nasdaq Dubai was founded in 2005 and was initially called the Dubai International Financial Exchange. It offers trading in seven equities, two real estate investment trusts (REITs) and 28 bonds. That list encompasses all secondary trading in bonds in Dubai, with the exception of the three sovereign issues listed on the DFM. Given the focus on debt rather than equities, the main index tracking Nasdaq Dubai equities is a country-wide one. The FTSE Nasdaq Dubai UAE 20 Index tracks 20 scrips listed on either its own bourse, the DFM, or the ADX. The measure declined by 0.2% in 2017 on trading volume of 30.9bn shares, after posting a gain of 7.5% in 2016, during which 39.3bn shares were exchanged. Trading volume in equities across all bourses has varied to a large extent in recent years, as investors keep up with oil prices. Trading volume for DFM General Index stocks has varied from 21.4bn shares in 2011 to 115bn in 2014, its highest point this decade.

Sukuk Centre

There are 78 sukuk available for secondary trading. Nasdaq Dubai has focused on gaining market share of this asset class. The desire to play a central role in sukuk trading is one aspect of Dubai’s strategy to establish itself as the capital of the global Islamic economy. There is no index tracking conventional bonds, but the Nasdaq Dubai IdealRatings Global Sukuk Index, which was launched in 2016, tracks investible sukuk across multiple countries and currencies and includes 127 sukuk. Its value has risen 19.3% since inception, but in the first six months of 2018 it declined by 1.4%. Sub-indices have been established to track specific types of sukuk: corporate, financial, GCC-issued, investment-grade and sovereign.

In 2018 brokers on Nasdaq Dubai were led by EFG Hermes, which captured a 66.8% share of traded value on the year, with Mubasher Financial Services second at 10.9% and Arqaam Securities third at 7.6%. All other brokers had a market share of no more than 3%. The value of equities traded on the Nasdaq Dubai in 2018 reached $1.15bn, a decline of 13% from $1.33bn in 2017, while volume reached 164.6m shares, a decrease of 40% from 273.2m in 2017.

In September 2018 the listing of a new sukuk from DP World, the global ports operator, brought the total traded on the platform to $58.9bn, which, according to the exchange, makes it the world’s largest sukuk-trading platform by market capitalisation.

Equity Market

The drive to offer investors ample liquidity is common across emerging markets, and Dubai is no exception. In the emirate a series of strategies are being deployed in order to boost trading volume and increase options for investors. In addition to promoting new listings and instruments, for example, the DIFC has also approved remote access to exchanges within the zone, among them Nasdaq Dubai and the DME, for investors from what the DFSA considers well-regulated foreign markets. “This was an important building block to developing an exchangetraded crude oil benchmark on the Dubai Mercantile Exchange,” Eric Salomons, director and head of markets at the regulatory authority, told OBG. “There are a variety of regulatory tools available to enhance liquidity as a means to establishing proper functioning and efficient markets. For example, there is one that reduces impediments to access to the DIFC markets while maintaining the right risk profile of market participants.” Having more stocks in which to trade is also a central goal, and after several years of drought earlier in the decade, Dubai’s initial public offering (IPO) market has opened up in recent years. The same holds for the wider MENA region, which saw one IPO in 2016, but five in 2017, thanks in part to rising oil prices. After a five-year drought in Dubai, 2014 was a big year for IPOs, with five taking place, although that level of activity was not replicated until 2017.

IPO Pipeline

There were two IPOs on the DFM in 2017. Orient UNB Takaful Insurance came to market and raised $16.3m in the second quarter of 2017, and in the fourth quarter Emaar Development, the property developer, raised $1.3bn. Meanwhile, Nasdaq Dubai added a second REIT, Emirates NBD Asset Management, which raised some $105m.

On the back of this, at the start of 2018 analysts predicted that the year would see considerable growth in IPOs for the UAE and Saudi Arabia, and identified 30 IPOs in the pipeline. One question was whether these would come on the DFM, Nasdaq Dubai or ADX, or whether the activity would in fact escape to foreign bourses: competition for the biggest IPOs is difficult for the young and growing exchanges in the country, when compared with the deep and established platforms in London, Hong Kong and New York. In the event, however, activity was muted, and as of the end of 2018 many of the most notable prospects remain exactly that. Among these are Emirates Global Aluminium, the Middle East’s largest producer of the product. Jointly owned by Mubadala and Investment Corporation of Dubai, the emirate’s sovereign wealth fund, it constitutes the consolidation of each individual emirate’s respective aluminium producer. Both owners have expressed a desire to list, and the company could raise up to $3bn. However, after initially being slated to take place in 2018, this IPO been pushed back until market conditions are more favourable.

Another prospect is Dubai-headquartered ServeU, a facilities management company, which was expected to list in 2018 on the DFM. The company is gearing up to introduce automated cleaning robots at facilities it services, and wants to grow through acquiring smaller competitors. Dubai Investments, a conglomerate in which the sovereign wealth fund Investment Corporation of Dubai has an 11.5% stake, was expected to sell at least 30% of its district-cooling unit Emicool on the DFM and hired Al Mal Capital to manage the IPO. As yet, however, this sale has not gone through.

Another major IPO that has been delayed is that of GEMS Education, a Dubai-based schools operator which counts Blackstone Group, the world’s largest alternative-investment firm, as an investor. The delay followed the Dubai government’s announcement of a temporary freeze on school fees in the emirate, part of a wider economic stimulus effort by the government of Dubai through which it hopes to boost economic activity by lowering the fees it charges to businesses, as well as residents and tourists.

Lastly, foreign interest is pending from India’s Malabar Gold, the world’s fifth-largest jewellery producer by sales. It is planning to carry out an IPO in India by 2020, but with a dual listing in either Dubai or London, according to company executives.

Debt Market

Nasdaq Dubai is now home to 90% of globally listed sukuk, with a total value of $57bn, the exchange’s CEO, Hamed Ali, told OBG. Given that the region has historically preferred debt to equity as a method for accessing outside capital, he expected further growth in the pass of bond sales and volume in secondary trading. Just as with equities in Dubai, the challenge for the authorities is to convince companies in the region to use the local trading platforms. In 2017 some 73.3% of bonds and sukuk sold were listed on exchanges, though all but $890m of that total was placed outside the region, according to the 2017 “GCC Bonds and Sukuk Market Survey”, published by the Kuwaiti investment firm Markaz. The hot spots were the London Stock Exchange, the Irish Stock Exchange and the Luxembourg Stock Exchange.

The bonds listed on Nasdaq Dubai are a combination of sub-sovereign government entities, corporations and, in recent years, foreign entities such as those of the Industrial and Commercial Bank of China and the China Construction Bank (CCB). CCB announced a $6bn medium-term note programme in 2016, and has thus far raised $1.8bn in two separate sales. The first to market from outside the region was the Agricultural Bank of China, which came to market in 2014, selling RMB1bn ($147.7m) in debt.

The rise in debt sales in recent years is partly attributable to the drop in oil prices, which has reduced regional governments’ revenue. Bonds and sukuk have come to serve as tools that plug those revenue gaps, and therefore any sustained increase in crude prices could give rise to a reduced reliance on debt.

In 2017 the UAE saw the most issues in the region, with 175 primary sales in 2017, or 62.5% of the total in the six countries of the GCC. The sales raised $32.6bn, which was 31% of the total for the region. Saudi Arabia recorded $41.6bn in sales. In most countries in the region sovereign sales outpaced government ones, with the exceptions being the UAE and Qatar. In the UAE, public sector issuers are typically emirate-level governments. In October 2018 the UAE’s federal government issued a long-awaited law that will allow it for the first time to issue sovereign debt.

Market Development

One long-term trend that could ease the way for more sukuk issues in the UAE is the push for standardisation in products. While ensuring compliance with Islamic precepts has traditionally been the job of individual product providers in Islamic finance, the current trend is towards standardisation, which would lower the cost of issuance of sukuk by providing set documentation that can be copied. International bodies such as the Accounting and Auditing Organisation for Islamic Financial Institutions have pushed for standardisation. In the UAE, meanwhile, the Central Bank of the UAE’s Higher Sharia Authority, a newly created board of sharia scholars, is expected to collaborate with others to support standardisation.

The SCA is playing an active role in expanding the size and scope of on-bourse trading in the UAE. One of its strategic objectives is to help the exchanges in the country meet the criteria to be reclassified as a developed market by MSCI. This is important to attract additional foreign portfolio investment, as it would mean greater representation within MSCI’s indices, which would result in index funds that track the composition of those MSCI indices buying more UAE shares to reflect the heftier weightings. As of June 2018 there were $1.9tn in assets worldwide in portfolios that mimic the composition of MSCI indices. Efforts to move up this ladder are taking place across the region. Qatar was upgraded from frontier to emerging at the same time as the UAE, and Saudi Arabia will be likewise upgraded in June 2019.

Outside Influences

In March 2018 Obaid Al Zaabi, CEO of the SCA, told local press that the UAE must meet all requirements by 2020, including greater oversight of exchange-traded products, the separation of clearing and settlement functions, and securities depositories and trading platforms. More products are also needed, including futures, swaps and other hedging tools. While the hope was that the MSCI upgrade would usher in a new era of enhanced liquidity for the market, it came in the same year that oil prices began sinking into a bear market, and the correlation between crude prices, equities values and trading activity in Dubai has proven to be another strong influence over pricing and sentiment.

Another regulatory focus is the development of a trading platform for small and medium-sized enterprises (SMEs), whose access to funding in the UAE could improve with more options. At the same press conference in March 2018 Al Zaabi announced that SCA had agreed to work with the OECD on a crowd-funding platform for SMEs. DFSA’s Salomons said his agency is collaborating with others as well. “An important dimension of financial technology solutions is that they are global in reach,’’ he told OBG. “It is therefore important for the DFSA to coordinate and align regulation with peer regulators.” DFSA has signed memoranda of understanding with international regulators, he said, and also joined the Global Financial Innovation Network, which was launched in 2018 as a joint project of 12 regulators to explore more efficient ways for innovative firms to interact with regulators. It is being referred to as a global sandbox, and members include the Monetary Authority of Singapore, the Central Bank of Bahrain and the Abu Dhabi Global Market. Both SCA and DFSA are working on regulations to enable the use of more financial technologies in capital markets. In February 2018 SCA said it had partnered with PwC to work on developing a regulatory framework. “Although technology has been a great benefit in more accurately predicting market changes and improving reactivity, it has also brought about many challenges. New financial technology companies with disruptive business models are forcing financial firms to be more creative with their product offerings and to offer increasingly competitive prices,” Iyad Hweij, managing director of Allied Investment Partners, told OBG.

Investor Base

Dubai’s securities investors are primarily Emiratis and nationals from the wider GCC, with foreign investors from outside the region providing a minority of trading volume. In 2017 foreign investors bought 43.5% of traded value on the DFM, and 44.5% of sales. Outflow was Dh1.2bn ($326.6m). Institutional investors accounted for 34.9% of total value traded and an inflow of Dh967.8m ($263.4m). Foreign investment in most stocks is capped, often at 49% but sometimes at as low as 5%, such as for Emirates NBD, Dubai’s largest bank. There are 10 stocks on the DFM for which no cap exists. In almost all cases, however, non-GCC investors have not filled their quota. As of late 2018 the only stocks in which they had come close were those of the logistics firm Aramex, the property developer Damac and Tabreed, a cooling-systems company. NonGCC buyers account for over 10% of holdings of five stocks on the DFM, namely the above three, Emaar Properties and Air Arabia.

Outlook

While equities are likely to rise and fall with oil prices, and debt sales are more probable if crude drops and governments experience budget deficits, Dubai’s authorities remain focused on their long-term goals, namely, adding new IPO instruments, encouraging greater numbers of investors to participate and meeting the criteria to receive a further MSCI upgrade.