Awaiting developments: The sector continues to innovate, but external factors could affect further advancement

Dubai is home to a domestic stock exchange, an international market with one of the largest concentration of sukuk (Islamic bonds) in the world, as well as equity futures and three derivatives platform operators: the Dubai Gold and Commodities Exchange (DGCX), Dubai Mercantile Exchange (DME) and Nasdaq Dubai. The emirate continues to attract major international sukuk listings and all of its exchanges are in the process of expanding their product offerings, including moves into areas such as index funds and real estate investment trusts, and various new types of derivatives contracts.

DOMESTIC STOCK MARKET: The emirate’s domestically oriented stock market is the Dubai Financial Market (DFM), which has been operating since 2000. The majority shareholder in the firm is the Dubai government-owned Borse Dubai, with a stake of 79.6%; shares in the exchange operator have also has been listed on the DFM since 2007.

There were 60 companies on the DFM at the end of 2015, and the number rose to 61 in 2016 thanks to the listing of Afkar Capital’s exchange-traded fund (ETF) and 63 in 2017 following the listing of takaful (Islamic insurance) provider Orient UNB Takaful in June and real estate developer Emaar Development in late November (see analysis). Most are Dubai-based entities, though some companies from other emirates – as well as firms from foreign countries including Sudan, Kuwait and Bahrain – are also listed on the exchange.

MARKET CAP & MAKE-UP: The exchange’s market capitalisation increased by 16% to Dh394bn ($107.2bn) at the end of 2017. This was up from Dh337.6bn ($91.9bn) in the final quarter of 2016 and Dh300.7bn ($81.9bn) at the end of 2015, with most of the rise accounted for by the market’s positive performance.

At the end of 2017 listings were dominated by shares from the financial services sector, with 14 insurance firms, 12 banks, and 10 investment and financial services providers. This was followed by the property development industry, with nine listings, and seven consumer staples firms, according to DFM figures. Finance dominates the market even more heavily in terms of capitalisation: financial services accounted for 49% of overall market cap in the fourth quarter of 2017, followed by real estate and construction on 33.5%. The market is also dominated by a small number of large-cap stocks: the 10 largest stocks accounted for 75% of capitalisation as of the fourth quarter of 2017, with the largest individual listing – Emirates Islamic Bank – representing nearly 14% of the total.

TRADING & PERFORMANCE: The value of trading in 2017 stood at Dh115.1bn ($31.3bn), down 13% from Dh133.2bn ($36.3bn) in 2016 and Dh151.4bn ($41.2bn) in 2015, which the DFM attributed to the performance of oil markets and a weak international economy.

As regards performance, the market’s main index, the DFM General Index (DFMGI), had a good 2016, rising by 12.1%, with most sectors showing positive performance, led by services (36%), consumer staples, such as food, beverages, tobacco and household items, and discretionary items (22.1%) and telecoms (21.6%), according to the DFM. At the end of 2017 the DFMGI was down 4.6% to date, having declined for much of spring and summer before recovering in July and falling again during the fourth quarter. In 2017 the best-performing sector index was services, rising 26%, followed by banking, up 3%, while the worst performers were consumer staples and telecommunications, which were down 53% and 18%, respectively.

LISTING PROSPECTS: Initial public offering (IPO) activity has been slow in recent years, with only three new equity listings on the DFM since the end of 2014, though that year did see four share introductions, including that of Emaar Malls, a subsidiary of Emaar worth Dh37.7bn ($10.3bn), and DXB Entertainments valued at Dh6.3bn ($1.7bn).

There were five rights issues in 2016, the largest of which was DXB Entertainments’ Dh1.68bn ($457.3m) issue, in addition to the listing of Afkar Capital’s ETF.

Structural domestic economic factors help to underpin the relatively slow IPO pipeline, in particular outside the finance and real estate sectors. “We are not seeing much interest in equity listings by local conglomerates, which are often hesitant to give up control of their firms and in many cases are not currently in need of the cash,” Salman Bajwa, head of assets management at Emirates NBD Asset Management, told OBG, noting that it was also often difficult for such companies to expand within the region beyond their own firm due to various barriers to entry, further reducing their need to obtain new financing. However, he said that such reluctance to go to market could change as a new generation began to take over major family firms, a process he said was already under way in Saudi Arabia.

RISING INTEREST: Julian Bruce, head of brokerage at stock broker EFG Hermes, said the existence of two separate domestic exchanges in Dubai and Abu Dhabi, which is home to the Abu Dhabi Securities Exchange (ADX), was an inconvenience with regard to the development of the UAE’s domestically focused capital markets. “There has been talk in the past of unifying the two markets, but this appears unlikely to happen any time soon,” he told OBG. However, Bruce added that he was seeing increased interest in IPOs, including from companies in sectors that are under-represented on local markets, and the market was therefore likely to see an increase in listings activity in 2018. Several major sectors of the local economy, such as trade, manufacturing and tourism – which have a combined contribution of over 80% of the emirate’s GDP – only represent 24% of listings on the DFM, suggesting there may be opportunities for further listings in these sectors.

The UAE Commercial Companies Law of 2015, which came into force on July 1, 2015, increases the maximum stake founders are permitted to retain in companies following a public offering from 45% to 70%, which may help to alleviate family conglomerates’ concerns about losing control over their companies should they list.

INVESTOR MIX & NATIONALITY: Institutions owned 81% of the DFM’s market cap at the end September 2017. However, such institutions tend to adopt buyand-hold strategies, and as with many markets in the region, retail investors predominate over institutional investors in terms of trading activity. In 2017 individuals bought Dh74.3bn ($20.2bn) worth of stocks on the DFM, while institutions bought Dh41.3bn ($11.2bn).

Restrictions on foreign ownership have limited institutional activity, with foreign nationals generally allowed to hold a combined total of 49% of the value of onshore companies based in the UAE. This rule does not apply within free zones, but it does apply to most domestic equities listed on the DFM.

Some companies have put in place even stricter limits; for example, foreign ownership of Emirates NBD, the largest bank headquartered in the emirate, is limited to 5%, while foreign ownership of National Bank of Dubai is entirely prohibited. Observers say such restrictions have led to reduced activity in the market and held down valuations by limiting investment from major foreign institutions.

UAE nationals accounted for 56.5% of stock purchases in 2017, on Dh65.4bn ($17.8bn), while foreign purchases were worth Dh50.2bn ($13.7bn), including Dh8.6bn ($2.3bn) by non-UAE GCC nationals and Dh20.1bn ($5.5bn) by non-GCC Arab nationals.

Nevertheless, the proportion of market capitalisation held by foreigners has been rising in recent years, from 11.7% in 2012 to 16% in 2014 and 21.9% in 2016, albeit falling back slightly to 21.7% at the end of September 2017. Recent years have also seen some moves to relax restrictions on foreign equity investment in the country. For example, the UAE federal government in June 2015 lifted a ban on foreigners owning shares in Etisalat, the Abu Dhabi-based, ADX-listed telecoms network operator, allowing them to purchase stakes up to a combined limit of 20% of the company’s equity. This was followed by a strong rise in the firm’s stock price, which could encourage similar moves from other major companies. The new Commercial Companies Law also allows for ministers to grant exceptions to the 49% cap on foreign ownership of domestic onshore firms.

In addition, there has been a long-running discussion about the possibility of relaxing or abolishing the ban on foreign majority ownership of onshore companies in some sectors. This move, which the authorities appeared to suggest in mid-2016, remains on the cards, potentially in the form of a new foreign ownership law.

DOMESTIC BOND MARKET: While Nasdaq Dubai has emerged as a premier international listing venue for sukuk, and several major players in the economy – such as Emirates NBD, DP World and Emaar – have large listings on it, the DFM’s debt market is relatively quiet, with four government bonds and five government-backed sukuk listed (see Islamic Financial Services chapter).

“The Dubai corporate debt market is traditionally dominated by private placements and bank loans,” Mathias Angonin, an analyst in the sovereign risk group at Moody’s Investor Services’ Dubai unit, told OBG.

Factors explaining this include the important role oil plays in the wider national economy, which has led to large government deposits in the national banking system that banks are keen to lend out, reducing the need for bond-based financing. The lack of a well-developed local government bond issuance programme also helps to explain limited bond activity: the federal government does not currently have the power to issue domestic or international bonds, and as a result there is no domestic yield curve – that is, a range of interest rate prices for given maturity periods – against which the cost of private sector debt can be calculated.

However, this could be about to change. In 2010 a draft federal debt law that would allow the national government to issue bonds, both domestically and internationally, was approved by the Federal National Council. The draft law reportedly encourages the federal government to issue debt in the local market in particular. While the law had not been ratified as of early 2018, in September 2016 the federal authorities said the legislation was under discussion with the central bank, and would be issued once agreement had been reached about debt servicing and debt ceilings.

The ongoing implementation of Basel III banking regulations – which are due to be fully in place by the end of 2018 – increases the likelihood that the law will be passed soon, as banks will need more liquid assets, such as government bonds, in which to invest in order to meet the framework’s liquidity requirements without undermining their profitability (see Banking chapter).

Such a development could have a substantial impact. “A government bond issuance programme would be a major boon for the development of local capital markets, which is currently limited. Government issues would also allow banks to better manage local currency liquidity,” Bashar Al Natoor, senior director and global head of Islamic finance at Fitch Ratings, told OBG.

“A yield curve wouldn’t necessarily lead to a big jump in corporate issues, but it would certainly help to remove the mystery about the real cost of funding,” Michael Grifferty, president of the Gulf Bond and Sukuk Association, told OBG, noting that the establishment of debt management offices by various emirates was a promising sign of progress as regards preparations for the eventual passage of the law. He said there were opportunities for corporate issues across all industries, with the health and public works sectors looking particularly promising. “The oil price fall has boosted the supply of bonds, which has in turn boosted awareness and investor demand, and led to the establishment of more fixed-income funds in the region,” he added.

DEVELOPING INVESTMENT: Another of the barriers to the development of GCC capital markets in general has been on the demand side, with traditionally generous social security provision having limited the emergence of actors that tend to invest in securities, such as pension funds and large life insurance firms. However, as local populations age, regional governments, including the UAE federal authorities, are increasingly considering their options to ensure that pension payments remain sustainable, which could lead to the development of pension fund-type investors in the long term. In the meantime, Grifferty sees savings schemes operated by employers in the region to provide end-of-service benefits to departing employees as a promising potential source of investment.

Bajwa agreed that employment savings schemes could have a major impact on the sector, and fund management in particular. “A requirement that such funds be invested with asset managers would be the most helpful step that could be taken to develop the industry and would lead to very large inflows into funds,” he told OBG, describing it as the missing key for the fund management industry. “There have been discussions about bringing in such requirements in the past but nothing has come of it so far,” he added.

However, investment funds are seeing growing interest. “The fund industry in the Dubai International Financial Centre (DIFC) is growing and continued to accelerate in 2017, and increasingly we see use of the qualified investor fund regime as a way of structuring investments in the region,” Eric Salomons, director and head of markets at the Dubai Financial Services Authority (DFSA), told OBG.

INTERNATIONAL MARKET: In addition to the domestically focused DFM, Dubai is also home to Nasdaq Dubai, which was founded in 2005. As with the DFM, the exchange is effectively owned by the Dubai government-backed Borse Dubai, via a direct one-third stake of its equity, and via a two-thirds stake held by the DFM – which is in turn majority-owned by Borse Dubai.

The exchange, which is based in the emirate’s financial free zone the Dubai International Financial Centre (DIFC), and regulated by the DFSA, has a more international focus than the DFM, though it is also home to some securities linked to Dubai-based entities, such as shares in global marine terminal operator DP World, Dubai-focused real estate investment trusts (REITs), and bonds and sukuk issued by large local institutions such as Emirates NBD, Dubai Islamic Bank and Emaar.

The total value of new listings on the exchange – including sukuk, equities and bonds – grew sharply in the early years of the decade, from $1bn in 2012 to more than $8bn in 2013 and over $16bn in 2014, with sukuk dominating every year. Listings reached $17bn in 2015 before falling to $13bn in 2016. However, they increased again in 2017, reaching more than $14bn by the end of November 2017. “The comparative success of institutional investment activity on exchanges inside the DIFC is a result of factors like the drive for transparency, the absence of foreign ownership limitations and the legal certainty provided to international firms operating in this market,” Salomons told OBG.

The exchange’s market capitalisation stood at Dh74.4bn ($20.3bn) at the end of the third quarter of 2017, up from Dh58.1bn ($15.8bn) at the end of 2016 and Dh67.6bn ($18.4bn) at end-2015, according to the latest available data by the Dubai Statistics Centre.

The value of trading on the exchange, meanwhile, reached $1.33bn in 2017, up 7% from $1.2bn in 2016. Volume totalled 273.3m shares, 98% higher than the previous year. In December 2017 the value of equities traded was $69.7m, down 39.5% from $115.2m in December 2016. Although total value traded declined, trade volume increased to 15.3m shares in December 2017, up 33% from 11.5m in December 2016 and 30% higher than in November 2017.

As of November 2017 there were nine equities, 23 conventional bonds and 63 sukuk listed on the exchange. Debt issues, and in particular sukuk, have dominated listings in recent years, both in number and value. There have been just three equity listings since 2014, the most recent of which was the ENBD REIT in March 2017, which raised $105m in an IPO. By contrast, as of November 2017 there had been seven conventional bond listings year to date with a combined issue value of $3.7bn: three by Industrial and Commercial Bank of China, and listings by China Construction Bank, Investment Corporation of Dubai, Yinchuan Tonglian of China and Emirates NBD. There were also 11 sukuk listings, worth a total of $10.2bn, making the exchange one of the most important sukuk markets in the world since 2015 in terms of the value of listings (see Islamic Financial Services chapter).

According to Salomons, debt was likely to continue dominating listings in the coming year. “The low interest rate environment makes debt issuance more attractive than raising capital through the equity market,” he told OBG, adding that what equity listings take place in the coming years are likely to take the form of investment funds such as REITs and ETFs (see analysis).

In contrast to the DFM, trading activity is dominated by institutional investors, due to factors such as comparatively limited market liquidity, though there is some retail activity in the equity futures market. Equity trading on the exchange is dominated by shares in DP World, with transactions worth almost $100m in May 2017, and over $140m the previous March: no other instrument passed the $20m mark.

There is no major index that tracks the performance of Nasdaq Dubai alone; however, the FTSE Nasdaq Dubai UAE 20 tracks 20 stocks spread across the exchange, the DFM and the ADX. At the end of December 2017 the index was down 0.2% since the end of December 2016, according to Nasdaq Dubai data.

EQUITY FUTURES: In addition to its equity listings, Nasdaq Dubai hosts trading in single-stock futures. The market concentrates on the most liquid UAE shares, with contracts on 16 equities on offer. The market was launched in September 2016, and was intended to help the wider development of the country’s capital markets by providing additional investment and hedging opportunities for stocks traded in the country, where short-selling was restricted. Activity has grown rapidly since then; contract values rose from less than $2m in September 2016 to around $13m in April 2017, and more than $16m in August. Traded value reached Dh463.9m in 2017, the first full year for the equity futures market. However, according to Bruce, activity in the single-stock futures market has initially been somewhat subdued due to constraints on the development of derivatives markets. Shares in the DFM-listed Emaar Properties and DXB Entertainment and the ADX-listed Aldar Properties have been among the most popular underlying securities for such derivatives.

NEW INDEX FUTURES: In October 2017 Nasdaq Dubai announced three agreements to launch index futures, signing deals with the DFM, the ADX and MSCI, a US-based leader in the provision of market indices.

Nasdaq Dubai and the DFM’s licensing agreement, signed on October 22, 2017, paves the way for futures contracts linked with the DFMGI to be traded on Nasdaq Dubai’s futures market. The deal, the first of its kind in the region, will allow for a diversification of the product range and provide new investment opportunities through Dubai’s capital markets. According to Nasdaq Dubai officials, trading of DFMGI-linked futures is expected to begin following regulatory approval.

A day after closing its deal with the DFM, Nasdaq Dubai signed an agreement with the ADX to introduce index futures. As with the DFM, the deal foresees the development and launch of an index futures contract based on the Abu Dhabi General Index, which tracks the performance of 66 listed companies and serves as a benchmark for wider ADX activity.

In addition to its agreements with ADX and DFM, Nasdaq Dubai also brokered a licence agreement in mid-October 2017 with MSCI to create futures contracts based on the MSCI UAE Index, which covers some 85% of the UAE equity landscape and lists 10 of the top UAE firms from all sectors of the economy.

The new index futures already have a market maker in place, with Shuaa Capital announcing in October 2017 that its liquidity provision unit, Shuaa Capital International, would serve in this capacity when the new index futures are rolled out. Shuaa Capital is already the market maker for the emirate’s existing single-stock futures market.

BROKERAGE MARKET: In 2017 the total value of brokerage transactions on the DFM stood at Dh230.3bn ($62.7bn). In December 2017 there were 48 companies providing brokerage services for trading on the exchange, with the top 10 brokerages by trading value accounting for Dh12.2bn ($3.3bn) worth of deals, or 71% of brokerage transactions that month.

The leading firm by transaction value was Mubasher Financial Services, with Dh2.58bn ($702.3m), or 15% of the market, followed by EFG Hermes on Dh1.6bn ($435.5m), ADCB Securities at Dh1.5bn ($408.3m), MenaCorp Financial Services with Dh1.25bn ($340.3m) and Brokerage House Services on Dh1.2bn ($326.6m).

The brokerage market for trading on Nasdaq Dubai is much more heavily concentrated, with EFG Hermes recording an average monthly market share of 54.7% in the last six months of 2017.

DERIVATIVES EXCHANGES: In addition to its two primary exchanges, Dubai has two derivatives-focused exchanges. The first was the DGCX, which was launched in 2005, making it the first derivatives market in the MENA region, where it is also still the largest exchange. The market is a unit of the Dubai Multi Commodities Centre, a Dubai government initiative to boost commodity trade flows through the emirate.

The DGCX offers several different types of futures contracts; however, trading is currently dominated by US dollar-rupee contracts. In July 2017 local press reported that trading in such products on the exchange had received a boost in the form of a crackdown by the Indian financial markets regulator – the Securities and Exchange Board of India – on the use of promissory notes. This, in turn, is likely to reduce activity in India-based futures markets and therefore could potentially shift some dollar-rupee trading to the DGCX. The exchange also offers futures on 14 other currencies and a range of other underlying assets, including various metals and hydrocarbons products. In recent years the exchange has also launched a range of new products, including single-stock equities contracts focused on several major US and Indian shares, and a Shanghai gold futures contract (see analysis). In addition to futures, the exchange also offers trading in options on the Indian rupee.

OIL FUTURES: The other of the emirate’s two futures exchanges is the DME, which is located within the DIFC and regulated by the DFSA. The DME is a joint venture between Dubai-owned entity Dubai Holding; Oman’s sovereign wealth fund, the Oman Investment Fund; and the world’s largest derivatives market operator, the US-headquartered CME Group. Several major international financial institutions and energy companies also hold stakes in the DME.

The flagship product of the exchange, which was founded in 2007, is a futures contract for Oman crude oil, known as DME Oman, which is the benchmark for official selling prices for Oman and Dubai crude oil sold to Asia. In contrast to other crude futures markets such as the Chicago Mercantile Exchange, where trading activity is predominantly financially settled, trading on the DME mostly involves Asian buyers seeking physical delivery of oil. However, Salomons told OBG that the market was growing and heading in the direction of greater hedging activity, and now include the trading of financially settled contracts as well.

OUTLOOK: The emirate’s capital markets continue to see innovation in a range of areas. However, the development of the sector – and domestic corporate debt activity in particular – will depend on local and regional economic developments. These include oil price movements, and political and regulatory decisions on various issues, including foreign investment limits, and whether or not the federal government goes ahead with plans for a domestic bond issuance programme.