Abu Dhabi capital markets expand with new products and a sovereign bond issue

Abu Dhabi’s capital markets have witnessed rapid expansion since the establishment of the Abu Dhabi Securities Exchange (ADX) in 2000. Prior to the creation of the ADX – which was originally known as the Abu Dhabi Securities Market – the sector played a much more limited role in the emirate’s financial services landscape. Historically the region has had a significant amount of capital owing to its oil wealth and, coupled with a relatively robust and liquid banking system, this created little domestic demand for capital markets as means for finance. Nevertheless, the region has long utilised international securities as an investment option, with sovereign wealth funds such as the Abu Dhabi Investment Authority emerging as major buyers of stocks and bonds, though these have usually focused on international investments. However, the emirate has successfully worked to expand its securities offering in recent years, demonstrating a commitment to increasing liquidity and overall activity in its capital markets.

New Developments

These changes dovetail with Abu Dhabi’s decision to future-proof its economy by diversifying away from reliance on the hydrocarbons industry and overhauling public spending to boost efficiency. This reform process has included the expansion of capital markets. In March 2018 Union National Bank, which is majority owned by the emirate, issued a $500m, five-year bond, its first appearance on the international debt market since 2016. In addition, local real estate firm Aldar Investments made history by listing a $500m, seven-year sukuk (Islamic bond) on the ADX, the first corporate sukuk ever listed on the exchange.

Moreover, the emirate carried out an initial public offering (IPO) for a 10% share of the downstream distribution arm of the state-owned Abu Dhabi National Oil Company (ADNOC) in December 2017. This is a notable development in that, while the emirate has launched some IPOs on international markets in recent years – for example, health care provider Al Noor Hospitals Group raised $342m through an IPO on the London Stock Exchange in June 2013 – this is the first IPO on the ADX since 2012. This was followed in September 2018 by an announcement that the ADX plans to enable futures trading on single stocks in 2019. These developments reflect a broader drive to deepen capital markets, providing more options for investors and greater opportunities for government entities to raise capital.

In order to facilitate this expansion of capacity and activity, Abu Dhabi Global Market (ADGM) – the emirate’s offshore financial free zone – is developing a regulatory framework to govern cryptocurrencies and initial coin offerings, as well as other emergent financial technologies (see Trade & Investment chapter). This free zone regulatory infrastructure is expected to complement onshore public markets and help to further mature the emirate’s capital markets.

Size & Scope

The ADX, which is owned by the government of the emirate, had a total of 69 listed companies in 2018, of which 66 were domestically owned. These include listings from other emirates within the UAE, as well as from Abu Dhabi itself. The bourse is one of three onshore exchanges located in the UAE, along with the publicly traded Dubai Financial Market (DFM) and Nasdaq Dubai, the latter of which is 66.7% owned by the DFM and 33.3% by the government-related entity (GRE) Borse Dubai. All three markets are regulated by the Securities and Commodities Authority (SCA), which is headquartered in Abu Dhabi. As a financial services free zone, ADGM falls outside the remit of the SCA and the overall federal legal environment of the UAE, and is instead overseen by a separate legal framework operated by regulators within ADGM.

According to the SCA, the total market capitalisation of the ADX and the DFM has climbed in each year since 2013, with the exception of 2015. The ADX’s total market capitalisation stood at Dh485bn ($132bn) at the end of 2017, up 2.1% from the previous year. This robust performance carried over into 2018, with market capitalisation up 5.4% year to date at Dh511bn ($139bn) in mid-December 2018. Furthermore, approximately 271 investment institutions entered the exchange in the first half of 2018, bringing the total number to around 7900, of which 2008 were domestically owned and 5910 were foreign owned.

ADX

As of late 2018 there were 48 licensed brokers with membership in the exchange, making for a relatively fragmented market. For example, in the first four months of trading in 2018 a total of 19 brokers had a market share of less than 1%. Of the remainder, only five surpassed 5% – namely, EFG Hermes Securities Brokerage, FAB Securities, Al Ramz Capital, Arqaam Securities and Al Safwa Mubasher Financial Services. Furthermore, in terms of its SCA-licensed financial services offering, the ADX has five custodians, 60 registrars, three market makers and 27 data vendors.

Index

The bourse’s general index provides the main measure of the overall performance of the ADX. The index closed at 4398 points at the end of 2017, 3.3% lower than the previous year. By mid-December 2018 the general index stood at 4829, up 9.8% year to date. The headline trend on the index, however, is a decrease in volatility, with 2017 marking the fourth consecutive year the index moved less than 10% in either direction. This stabilisation is notable given that stocks on the ADX and other exchanges in the region have a history of major swings, brought about by exogenous shocks such as financial instability and oil price changes. For example, the ADX dropped 47.5% in 2008 and surged 63.1% in 2013, according to data from Bloomberg.

Overall, the index includes 60 stocks, but its movement is generally determined by only a few major stocks. As of May 2018 banking institutions accounted for 56.5% of the general index, followed by telecommunications with 24.5%, according to Bloomberg. The only other group with a share above 5% on the index was real estate, at 6.3%. The index’s banking group contains 13 banks but is dominated by First Abu Dhabi Bank, which accounts for just over two-thirds of the group and 40.1% of the overall index. The banks listed on the exchange are headquartered in Abu Dhabi and other emirates of the UAE. Since 2008 bank stocks have experienced volatility, largely as a result of changing international oil prices. Banking shares experienced a three-year run between 2012 and 2014, gaining 17.8%, 68% and 14.1%, before declining by 17.2% in 2015. ADX-listed banks reported growth in earnings of 1.9% in 2017, according to the Dubai-based securities firm Al Ramz Capital.

The telecoms group, meanwhile, has only one member: Etisalat. The UAE’s former state incumbent and leading mobile carrier has experienced similar volatility in recent years, with an annual gain or loss of 15% or more in five non-consecutive years between 2008 and 2018. The real estate group is also dominated by one major player, with Aldar Properties, the emirates leading real estate developer, accounting for 5.1% of the index.

The dominance of banks on the exchange is common within the GCC, as the upstream energy companies that generate the bulk of economic activity are rarely publicly traded. Nevertheless, there are indications that this may be set to change, given that the emirate issued an IPO for ADNOC in December 2017. Furthermore, in October 2018 neighbouring Saudi Arabia confirmed plans to issue the world’s largest-ever IPO of a portion of its state-owned energy company Saudi Aramco on the Saudi Stock Exchange. While the issuance could provide an impetus for other IPOs of energy companies across the region, this shift appears to be more of a longer-term possibility, with the long-awaited Aramco IPO now expected in early 2021. Conversely, depending on precisely when it is carried out, the Saudi IPO may create a short-term drop in regional capital markets activity, as the sheer size of the proposed issuance could disincentivise or delay other issues.

Fixed-income Securities

The emirate found itself at the centre of two of the largest bond issuances in the region in 2017, one of which was a sovereign issue and the other a commercial one. The emirate raised $10bn in eurobonds in October 2017.

The debt, which was rated as “AA” by Fitch, was sold in three tranches. The first of these was a $4bn in size with a 10-year maturity and priced 85 basis points above US Treasury bills at the time of issuance; the second was a $3bn section maturing in five years and set 65 basis points above US Treasury bills; and the third was $3bn, maturing in 30 years priced 130 basis points above US treasuries. This successful sovereign bond sale may well pave the way for similar issuances over the medium term, especially given the high ratings of recent bonds and the emirate’s low debt-to-GDP ratio.

This move was followed a major commercial bond sale in November 2017. The bond was issued by Abu Dhabi Crude Oil Pipeline, a subsidiary of ADNOC. Closing at $3bn, the bond was one of the largest non-sovereign bond offering in the history of the Middle East. This return to international debt markets follows a broader regional trend, with GCC members seeking to close revenue gaps brought about by the fall in global oil prices using both conventional bonds and sukuk. Debt issuance has been coupled with fiscal consolidation, with Abu Dhabi leading an overhaul in public spending at the emirate and federal level to ensure stability.

Yield Curve

However, a reason for the debt sales that is not necessarily shared across the region is Abu Dhabi’s desire to establish a yield curve, whereby interest rates for government bonds of various maturities can be used as a reference for other debt sales. While debt issued at the national level is typically used to create a yield curve, the UAE’s federal structure features emirates as their own sovereigns within the whole, and the UAE itself has never issued federal debt.

Establishing a yield curve – through which future debt sales can be priced relative to local sovereign debt – would therefore provide a useful tool for Abu Dhabi to reduce spending long term. One of the ways it plans to do this is by curbing direct government transfers to GREs, in effect steering them towards commercial debt markets for capital. A recent example of this is the partial sale of the distribution arm of the state-owned ADNOC in December 2017 (see analysis). A future with more debt sales should dovetail with market needs – perhaps even more so if issuance is in the form of sukuk, as they provide a useful liquidity-management tool for Islamic banks and takaful (Islamic insurance) companies.

Nevertheless, uncertainties have emerged regarding sukuk issuance in the region. The most notable example of this was the dispute between the Sharjah-based energy company Dana Gas and international bond holders that began in June 2017, when the company announced that the sukuk it had sold was no longer deemed sharia-compliant, and as such it would be unable to repay the capital owed to sukuk holders without violating sharia law. While the UK court ruled in favour of the investors, the local UAE court upheld the position of Dana Gas, causing significant uncertainty. While the issue was resolved through a restructuring deal agreed in May 2018, the case highlighted sukuk’s youth and complexity as an asset class, though greater maturity is expected as methods become more standardised.

“The markets are hungry for high-quality sukuk,” Mohammed Ali Yasin, CEO of FAB Securities, told OBG. “Because of the Dana Gas issue there is temporary uncertainty, but the demand is still there.”

Leading Issuer

The UAE as a whole led the region in terms of the frequency of bonds in 2017, issuing 175 primary sales, or 62.5% of the total in the GCC, according to a report published in July 2018 by the research firm Kuwait Financial Centre. UAE bond issuers raised $32.6bn, a 35% increase from 2016. In terms of overall value, these sales constituted 31% of the regional total, second only to Saudi Arabia, which led the region with 39.9%. Furthermore, the UAE was one of only two countries in which corporate sales outpaced sovereign ones.

While it is clear that GCC member states are increasingly interested in establishing themselves in global and local debt markets, the phenomenon has thus far been mostly limited to primary markets. Secondary trading is either minimal or happens on bourses located outside the region. Of the $76.5bn in GCC bonds and sukuk sold in 2017, 73.3% were listed on exchanges, but 99% of these were listed on international capital markets, most notably on the Irish Stock Exchange in Dublin, followed by the London Stock Exchange.

ADGM

One of the most notable contributions to the emirate’s economic landscape in recent years has been the development of ADGM. Opened in 2016, the 450,000-sq-metre financial free zone is still in its early stages. Nevertheless, ADGM has so far attracted 80 firms offering services in 15 areas. Furthermore, 12 funds have been registered, seven of them domestic and five foreign owned. The free zone also offers specialist products, including aviation finance and a private real estate investment trust offered by the Dubai-headquartered Equitativa.

ADGM is also planning to create a niche capital-raising platform for China’s Belt and Road Initiative (BRI), a multibillion-dollar international infrastructure programme largely financed by Chinese state-owned banks. Furthermore, the free zone signed a memorandum of understanding with Beijing Financial Street Service Bureau in September 2018 to develop financial centres in both the emirate and China. “What we are looking at is a platform serving the Middle East, North Africa and South Asia, along with the BRI economic route,” Richard Teng, CEO of the Financial Services Regulatory Authority (FSRA) of ADGM, told OBG.

In order to regulate free zone activities, Abu Dhabi established a bespoke civil and commercial legal framework for the ADGM. The framework draws on international standards and best practice from the financial centres of London, Hong Kong and Singapore. The free zone has its own courts and judicial system are based closely on English common law, and the FSRA oversees all incorporation, registration and licensing under powers established by Abu Dhabi Law No. 4 of 2013. As part of its stated goal to become a regional leader in financial technology (fintech) the ADGM established the Regulatory Laboratory (RegLab) to provide a platform to develop and test its new regulatory regime for fintech companies. The RegLab places ADGM’s FSRA at the forefront of global regulators when it comes to encouraging the growth of this dynamic segment.

Market Upgrade

The federal-level SCA is also playing a leading role in broadening and deepening the capital markets in Abu Dhabi, along with the wider UAE. One of its strategic objectives is to matriculate through the qualification process of international index providers in order to have the country’s markets reclassified from the “emerging” category to “developed”. In May 2014 the ADX was added to the influential MSCI Emerging Market Index, and four months later Standard & Poor’s Dow Jones similarly reclassified the exchange from the “frontier” category to “emerging”.

Classification as a developed capital market on international indices would likely precipitate increased foreign investment in domestic securities, this is because some funds and investment vehicles are barred from investing in emerging and frontier markets. Speaking at the annual conference of the SCA in July 2018, Obaid Al Zaabi, CEO of the SCA, stated that the bourses of the UAE were working towards meeting all the necessary requirements to achieve the market upgrade by 2020. According to Al Zaabi, the SCA had so far ensured that 80% of requirements had already been met, and that the UAE’s exchanges would have to ensure the final 20% of compliance. This will require regulating exchange-specific products, and separating clearing and settlement houses, and securities depositories from trading platforms. It will also require a greater offering of financial products, including futures, swaps and additional hedging options.

As part of a broader effort to achieve these strategic objectives, the SCA entered into a partnership with PwC in February 2018 to develop a regulatory framework for cryptocurrencies and fintech products in the UAE. Furthermore, Al Zaabi announced a collaboration between the OECD and the SCA in March 2018 to develop a funding platform for small- and medium-sized enterprises. The platform is expected to operate in a manner similar to crowdfunding platforms, with separate arrangements to be devised for the UAE’s free zones. In addition, Rashad Al Blooshi, CEO of the ADX general index, announced in September 2018 that the exchange will begin futures trading in 2019.

Outlook

With a move towards international debt markets and efforts under way to trade and regulate a range of new products, including cryptocurrencies and fintech, 2018 and 2019 are looking brighter for Abu Dhabi’s capital markets. Ongoing efforts to support a further upgrade in market classification and establish a yield curve appear set to support continued expansion of the sector. Furthermore, domestic banks may well need to raise additional funds over the medium term, either through the sale of stocks, rights issues or debt, in order to maintain adequate capitalisation levels in accordance with Basel III. Over the long term, liquidity challenges appear likely to remain, as evidenced by lower trading volumes since the fall in global oil prices in 2014. Nevertheless, the emirate is pursuing a multi-pronged approach, featuring new products, more IPOs, further commercial debt sales – and eventually, it hopes, a sustainable base level of market activity that will endure regardless of broader economic cycles.