Confidence boost: Ongoing reforms enhance the trading environment

While it has been another challenging year for Abu Dhabi’s capital market, some developments in the fixed-income segment, new equities listings and a raft of regulations that promise to add more depth to the market have ensured that it was also an interesting one. Indeed, at just 12 years of age, the Abu Dhabi Securities Exchange (ADX) has travelled much ground in its short history.

A BRIEF HISTORY: Although unregulated trading in company stock has existed in Abu Dhabi for decades, officially sanctioned market activity began in the emirate with the creation of the Abu Dhabi Securities Market (ADSM) in 2000. The first task of the new institution was to persuade Abu Dhabi’s considerable number of large, privately held companies of the advantages of public listing, a job made easier by a number of high-profile first movers, such as National Bank of Abu Dhabi (NBAD), which helped to inspire confidence in the exchange.

By the mid-2000s the ADSM was hosting its first foreign listings, and its recruitment drive was given a significant boost by a government mandate requiring that all public companies should be listed. A third phase of development came in 2008, when the ADSM was rebranded as the ADX. The new logo was only the outward sign of a comprehensive strategy aimed at deepening the market through new products, such as exchange-traded funds (ETFs), and adding more foreign listings to the board.

Enhancing the regulatory environment was a necessary corollary to this effort, and the ADX worked closely with the regulator to implement a new corporate governance code in 2009, which was applied to all joint stock companies and institutions whose securities were listed on the market.

The ADX is approaching another milestone, as it awaits a long-planned move from its current location in central Abu Dhabi to its new home on Al Maryah Island (previously known as Sowwah Island), the city’s new business district. The ADX will be the anchor tenant of the island’s Sowwah Square, a development consisting of four commercial towers of between 30 and 36 floors each. The ADX will also maintain its off-site trading locations in Al Ain, Fujairah, Sharjah and Ras Al Khaimah.

REGIONAL POSITION: Capital market activity in Abu Dhabi takes place in line with the UAE’s federal-level regulatory framework, and the ADX holds a spot in the domestic market alongside a number of other exchanges. Despite having a relatively small population of 7.9m in 2011, according to the latest World Bank estimates, the UAE boasts three bourses. The ADX and the Dubai Financial Market (DFM) are both owned by their respective governments and are regulated by the Emirates Securities and Commodities Authority (SCA), a national body with its headquarters in Abu Dhabi. The NASDAQ Dubai (formerly known as the Dubai International Financial Exchange) is a privately held institution that has been in operation since 2005 and is overseen by the Dubai Financial Services Authority.

In terms of market capitalisation, the ADX is the largest of the three, with a total market capitalisation of around $79.5bn as of October 2012, compared to the DFM’s $48.5bn and the $27.9bn of NASDAQ Dubai. The combined market capitalisation of the two government-run exchanges alone stands at around $128bn and establishes the UAE market as the third-largest in the GCC, narrowly behind the Qatar Exchange ($129bn as of October 2012) and Saudi Arabia’s Tadawul, at $367.8bn. The prospect of a merger between the UAE’s two major exchanges has been a matter of speculation for some years, and the public discourse surrounding the issue has gained in intensity in the wake of the global economic crisis, which has left exchanges around the world searching for liquidity. The potential gains in efficiency and the ability to attract more investors that a single UAE exchange would result in are clear, and in 2010 the CEO of the DFM announced to the local press that the two exchanges were pursuing a merger. For now, however, negotiations remain at exchange level, and no application to the regulator for a structural alteration has been made.

MARKET STRUCTURE: The nine sectors by which companies listed on the ADX are grouped – banking, investments and financial services, real estate, energy, consumer staples, energy, industrial, insurance, telecommunications and services – reflect the increasing diversity of Abu Dhabi’s economy, and the fruits of a government-led drive to reduce the emirate’s reliance on its hydrocarbons resources. The challenging conditions of recent years have not diverted the ADX from its goal of increasing the diversification of its listings, enhancing the sophistication of the products and processes of the exchange, developing strategic partnerships and attracting a greater number of institutional investors.

As of November 2012, 67 companies had listed on the exchange, the most recent of which came in November 2011 with the addition of National Takaful Company (an Islamic insurer also known as Wataniya), after its initial public offering (IPO) in May of that year. The second half of 2011 also saw the listing of Eshraq Properties, a UAE-based real estate firm. The board is also home to nine openended funds, five of which are run by the emirate’s largest bank, NBAD, and a single debt instrument, the NBAD Convertible Note, which dates from 2006.

In March 2010 the ADX announced the creation of the region’s first ETF – the NBAD OneShare Dow Jones UAE 25. The index-tracking fund allows investors to gain exposure to a wide array of asset classes – in this case 25 blue-chip companies from across the UAE – via a single low-cost, low-risk instrument, using a model that has proved popular in other markets. The design and implementation of the ETF was largely the work of the ADX with the support of the SCA, which granted it permission to deploy its own rules until the national regulator developed suitable regulations, which were subsequently established in June 2011.

In terms of fixed-income products, Abu Dhabi’s exchange has generally listed one or two bonds at any one time since its inception. Currently, the NBAD Subordinated Convertible Notes product is the only debt instrument listed on the exchange. An historic lack of sovereign issuances, due to the high levels of liquidity in the Abu Dhabi economy, has more recently given way to a government debt programme that was established to create a yield curve against which corporate issuances might be benchmarked. While the most recent government issuance was in 2009, recent announcements by the emirate’s Debt Management Office suggest that more government debt will be issued in the short term. In the meantime, an uptick in well-received corporate issuances originating from Abu Dhabi has revived hopes that a more substantial secondary debt market can be established on the ADX (see analysis).

The tracking of Abu Dhabi’s increasingly sophisticated exchange is primarily carried out via the ADX General Index, a capitalisation-weighted index of stocks listed on the ADX. To be included, a stock must have been traded at some time during the previous five days. Nine sub-indices track the economic sectors by which the ADX’s listings are classified.

The market was also served by 52 licensed brokers as of October 2012, including locally based, dedicated firms, as well as the brokerage operations of large multinationals (such as HSBC Middle East Securities), regional players (such as EFG-Hermes Brokerage – UAE), UAE-based firms (such as Emirates NBD) and financial houses or banks originating in Abu Dhabi (such as First Gulf Financial Services).

RECENT PERFORMANCE: All of the GCC markets have followed a bearish trend since the global economic crisis of late 2008, and continue to show subdued levels of trading. Lower levels of liquidity, the volatile political situation that has persisted in the broader region for more than a year, the ongoing eurozone crisis and a sluggish US economy all make for a challenging economic backdrop.

Nevertheless, the performance of the ADX over this period compares well to its regional peers. In 2010 the market put in a U-shaped performance, starting the year with an upward General Index swing that reached a peak in March with a gain of 6%, declining slightly over the summer, and rallying from September to close the year down 0.8% compared to the end of 2009. In 2011 the ADX followed a regional trend of decline, which saw the General Index dropping by 11.7% year-on-year (y-o-y), according to data released by the exchange. In a reverse image of the previous year, the high point for the General Index came on June 19, when it reached 2775.4 points, while its lowest level of 2343.3 points was reached on December 21.

In terms of volume, the number of shares traded on the ADX decreased by 9.6% from 17.6bn in 2010 to 15.9bn in 2011, while the aggregate value of trading showed a 24.9% retrenchment from Dh34.1bn ($9.3bn) to Dh24.8bn ($6.7bn).

SECTOR-BY-SECTOR: All nine sectors on the exchange showed declines and, as anticipated, it was the real estate industry that showed the largest drop-off (54.25%), largely as a result of the subdued performance of two sector heavyweights, Aldar Properties and Sorouh Real Estate Company. The investment sector also posted a sizeable 33.8% decline, while the energy sector showed the third-highest fall at 25.6%. Conversely, the banking index demonstrated considerable robustness during 2011, thanks to the sustained profitability shown by the banks over the year and a widely held conviction that the sector had reached a more favourable position with regard to the non-performing loan cycle. Despite the challenging environment, the banking index declined by a modest 0.04% during 2011.

Values and volumes were steady in the first half of 2012, and optimism within the financial community regarding the exchange’s future growth remains firm. This sentiment was buoyed early in the year when listed company reports showed an aggregate 95% rise in profits for the first quarter, from Dh14.99bn ($4.1bn) to Dh29.2bn ($8bn).

The improvement came largely as a result of the recovery staged by the real estate sector, as well as a 26.3% rise in banking sector profits over the period. While some sectors, such as industrial, consumer, and investment and financial services, have had difficulty gaining ground in the current environment, the overall improvement in profitability displayed by the ADX’s listed companies has been welcomed as a useful fillip to market confidence.

REGULATION: Much of the optimism which surrounds the long-term prospects of the ADX can be attributed to a regulatory system which has allowed the market to grow rapidly in the 12 years since its establishment, and continues to evolve as the exchange prepares for what it hopes will be another phase of growth. The existing regulatory framework is also one that grants the ADX considerable freedom to set its own growth agenda. Local Law No. 3 of 2000, by which the exchange was established, defines the ADX as an autonomous body, with independent finance and management structures, as well as full supervisory and executive powers over its processes. Under the law’s provisions, the exchange is charged with ensuring the soundness and accuracy of transactions, protecting investors and promoting investment awareness.

In doing so, the ADX works in tandem with the SCA, which acts as the federal regulator and shares a head office with the ADX in Abu Dhabi’s Hamdan Street. Established in the same year as the ADX, the SCA governs the country’s capital markets according to Federal Law No. 4 of 2000, and to date has shown its ability to work closely with the exchange in the formulation and implementation of new products and regulations. 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.

EXCHANGE STATUS: The evolution of the regulatory system that applies to the ADX and its counterpart in Dubai is central to the exchange’s long-term growth strategy. Deepening the market, introducing best practices and adopting more secure technology offer the possibility of greater access to international capital. The reforming efforts of the SCA to date have resulted in the 2010 reclassification from “frontier market” status to that of “secondary emerging market” by the FTSE Group, and the upgrade to the “emerging market” category by US-based Russell Investments in 2011. In 2012 global indexer MSCI delayed its reclassification decision for the UAE and a number of other markets for another year, and achieving MSCI “emerging market” status remains the principal medium-term goal of the SCA and the UAE’s exchanges. Having implemented a best-practice delivery-versus-payment system in 2011, a new package of regulation is due for final approval in 2012 which will introduce market making, short selling, and securities lending and borrowing to the market for the first time (see analysis).

CORPORATE GOVERNANCE: While these measures represent the central regulatory thrust by which the SCA intends to secure a further market upgrade, they form part of a wider process of reform which has greatly enhanced the trading environment in the UAE. This includes the new corporate governance regulations that were introduced by the SCA in 2009, with which listed companies were obliged to comply by April 30, 2010.

Based on international standards, the corporate governance code addresses fundamentals such as board structure (establishing independent directors, audit and remuneration committees, and compliance officers), reporting standards, disclosure obligations regarding shareholders and ongoing compliance commitments. Another boost for disclosure and transparency came in June 2012 when the SCA implemented new stock ownership rules requiring buyers to inform the market if they intend to purchase 30% or more of a listed company. The regulator retains the authority to reject proposed transactions if they are deemed to run counter to the interests of shareholders or the economy.

INVESTMENT FUNDS: The SCA has also turned its attention to the issue of investment funds over the past year. The high levels of liquidity within the Abu Dhabi economy have made it an important centre of fund activity both within the UAE and the wider GCC region, although the absence of comprehensive fund industry data makes its precise contribution to either market difficult to ascertain.

“The Gulf Cooperation Council Mutual Fund Industry Survey”, published each year by NBAD, tracks the information available and shows that investment funds in the emirate are largely those of local banksponsored entities or local and regional investment companies, but it notes that data for foreign banks and institutions is generally not readily accessible. According to the published data, there were 35 locally domiciled funds in the UAE as of June 1, 2011, with assets under management of $792m, as well as 21 funds in the GCC that indicated the UAE as their geographic focus, with assets under management of $564m. Of the UAE’s fund managers, Abu Dhabi’s NBAD controlled the second-largest percentage of total assets, at 11.6%, while other prominent Abu Dhabi-based managers include The National Investor and ADIC Investment Management.

In July 2012 the SCA issued resolution No. 37 of 2012, concerning the rules governing investment funds. The new regulations establish a comprehensive regulatory framework by which investment funds in the UAE are to be operated. The first chapter deals with, inter alia, the licensing of local funds, their investment policies, asset evaluation, financial reporting, the board of directors, conflicts of interest and inspection procedures; a second chapter includes a number of articles relating to the obligation of investment funds’ service providers and custodians; the third chapter deals with foreign investment funds operated within the country, setting out terms and conditions regarding their promotion as well as their obligations; while the final chapter outlines a range of offences, penalties and appeal procedures.

At the announcement of the regulations’ implementation, Abdullah Al Turifi, CEO of the SCA, explained the rationale of the regulator’s decision. “The resolution is part of the SCA’s endeavour to issue new investment products and diversify the investment tools available to traders in the markets. It will boost the investment climate in the local markets and help attract new investments and liquidity.”

OUTLOOK: The significant regulatory steps taken over the past year, and a pipeline of reforms still to come, form the framework on which the future expansion of the ADX will rest. Yet more functionality will come with an upgraded trading platform planned for the second half of 2013. The NASDAQ OMX X-Stream technology will provide Abu Dhabi’s exchange with a multi-asset-class platform capable of handling trades in equities, fixed income and ETFs, as well as offering capacity for additional financial instruments such as options and futures as the exchange continues to develop.

Like all exchanges in the region, the ADX faces a challenge in attracting new listings and liquidity, in part due to factors that are beyond its control. However, an upgrade by MSCI, which the SCA and ADX are working assiduously towards, has the potential to offset the adverse effects of Europe’s debt woes, regional unrest and a struggling US economy. The ADX also derives strength from the domestic economy, which grew at a robust 3.3% in 2011, with nominal output regaining its pre-crisis level of $360bn, according to the Central Bank of the UAE. While mixed results are expected in the short term, the longterm prospects of the ADX remain as strong as ever.