Will regulatory reform deepen Abu Dhabi’s capital markets?

Abu Dhabi’s capital markets started 2020 on a positive note, bolstered by solid gains on the exchange’s main index in 2019. Similarly, the local debt market ended 2019 favourably, with the UAE ranking as the biggest issuer of fixed-income instruments in the GCC that year. Although much remains to be seen as global markets deal with the twin ramifications of Covid-19 and lower oil prices in early 2020, an increasingly proactive stance to economic diversification and a policy of domestic rationalisation that is creating an added need for debt financing, and which coincides with suppressed rates in global credit markets, bodes well for Abu Dhabi’s capital markets in the medium to long term. Against this backdrop, an ongoing process of reform and the emergence of a new trading platform are set to add further dynamism to the financial markets.

Rapid Development

The formation of the Abu Dhabi Securities Market in 2000 brought much-needed regulation to what had been an informal trading scene and marked the beginning of modern capital markets in the emirate. In 2008 a new phase began and the exchange was rebranded the Abu Dhabi Securities Exchange (ADX). The following years saw the introduction of exchange-traded funds, procedural enhancements like the rollout of eXtensible Business Reporting Language and technological improvements such as the launch of the X-Stream trading platform provided by Nasdaq OMX. In May 2014 the ADX was added to the MSCI Emerging Markets Index, and four months later Standard & Poor’s Dow Jones made a similar re-classification. The elevation of the ADX from frontier to emerging market (EM) status opened up the exchange to increased inflows of foreign capital: passively managed global investment is automatically directed to ADX stocks included in EM indices, while the ADX as a whole benefits from the increased visibility. In March 2020 the ADX was converted into a public joint shares company owned by state holding firm ADQ, formerly known as Abu Dhabi Developmental Holding Company.

Size & Scope

The federal structure of the UAE means that the development of the ADX has taken place in a competitive domestic environment. Despite its relatively small population, estimated at 9.3m in 2017 by the Federal Competitiveness and Statistics Authority, the UAE is home to three stock exchanges. The ADX and the Dubai Financial Market (DFM) are majority-owned by their respective governments and regulated by the Abu Dhabi-headquartered Securities and Commodities Authority (SCA). Formerly known as the Dubai International Financial Exchange, Nasdaq Dubai is 66.7% owned by the DFM and 33.3% owned by Borse Dubai, an entity backed by the government of Dubai. The ADX’s market capitalisation of Dh421.1bn ($114.6bn) as of March 30, 2020 makes it the largest exchange in the UAE. The ADX has continued to develop its own structure, and is currently in the process of transforming itself from a vertical platform to a horizontal one.

Deepening Market

Abu Dhabi’s capital markets have been significantly deepened over recent years with the emergence of the Abu Dhabi Global Market (ADGM) as an international financial centre (IFC) that oversees the jurisdiction of the 114-ha financial free zone on Al Maryah Island. Opened in late 2015, ADGM’s mandate to develop and regulate the Al Maryah Island financial free zone is a central component of the emirate’s growth strategy. ADGM is home to 2600 registered financial and non-financial licences, of which there are more than 120 regional and global financial services firms, including Citibank, BNP Paribas, Aberdeen Asset Middle East, Bank Lombard Odier & Co and JPM organ, among others. The IFC operates its own legal and regulatory courts and judicial system, based on English common law. ADGM comprises the Financial Services Regulatory Authority (FSRA), the Registration Authority and ADGM Courts, as established by Abu Dhabi Law No. 4 of 2013. As an IFC, ADGM has the mandate and authority to oversee all incorporation, registration, licensing and supervision, in addition to regulatory enforcement.

Fund management is a key activity at ADGM, and in 2019 the segment received a boost when the SCA, the FSRA and the Dubai Financial Services Authority announced the establishment of a new fund passporting facility. The agreement allows funds licensed by each authority to be marketed across the UAE.

ADGM is also looking to develop as a financial technology (fintech) centre, following its establishment of the Regulatory Laboratory, or RegLab, in 2016 – a tailored framework that enables fintech players to conduct their activities in a controlled, cost-effective environment. More recently, RegLab has sought to attract and support cryptocurrency entities, including exchange houses, which could provide a useful alternative asset for investors (see analysis).

Stronger Market Structure 

The ADX is Abu Dhabi’s principal platform for the trading of securities. Its range of listed equities reflects the increasingly diverse nature of the emirate’s economy, with the banking, investment and financial services, real estate, energy, consumer staples, industrial, insurance and telecommunications sectors represented on the main board. As of March 31, 2020 there were 60 active companies listed on the exchange. While Abu Dhabi’s real economy is centred on the exploitation of its hydrocarbons resources, exchange activity is dominated by financial services equities – a phenomenon that reflects the emirate’s status as a financial centre and the fact that the bulk of its energy industry remains in government hands. Bank equities accounted for around half of total market capitalisation in late March 2020, according to ADX data; and the emirate’s most prominent financial blue chips, such as Abu Dhabi Commercial Bank, Abu Dhabi Islamic Bank and First Abu Dhabi Bank, are an important focus of trading activity on the exchange. The telecommunications sector, which includes Etisalat, is the second biggest on the stock exchange in terms of market capitalisation, accounting for around 30% of the total. Other sizeable sectors include energy (9%) and real estate (3.4%).

Since 2014 the ADX has also featured a secondary board for private joint-stock companies (PJSCs) called the Second Market. While sharing similar regulations with the main board in areas such as trading, clearance, settlement and share transfers, the Second Market is made more accessible by a less stringent approach to criteria such as capital and reporting requirements. For small- and mid-cap companies, therefore, the PJSC market offers a useful route to funding, while for the ADX it establishes a pool of candidates that might over time join the main market. One of the emirate’s leading investment firms, The National Investor, and one of its most notable real estate players, Manazel Real Estate, became some of the first companies to list as PJSCs in 2014. As of late February 2020 the secondary board’s market capitalisation stood at roughly Dh10bn ($2.7bn).

A further deepening of the exchange with new instruments is part of the ADX’s long-term development strategy. To this end, more trading innovation is beginning to emerge from the new IFC and financial free zone: in late 2019 details surfaced of a new exchange to be located within ADGM, which will host the world’s first futures contracts based on Abu Dhabi National Oil Company’s Murban crude oil. Intercontinental Exchange (ICE), a leading global operator of exchanges and clearing houses, will run the ICE Futures Abu Dhabi (IFAD) exchange, the launch of which was postponed to the second half of 2020, as it awaits regulatory approval. With ICE running the IFAD exchange, Murban pricing will move from a retroactive official selling price to market-driven, forward pricing using a Murban futures contract as its price marker. Pending regulatory approval, contracts traded at IFAD will be cleared at ICE Clear Europe, alongside instruments such as ICE Brent, ICE West Texas Intermediate, ICE (Platts) Dubai and ICE Low Sulphur Gasoil.

Debt Market

A small number of bonds and sukuk (Islamic bonds) are listed on the ADX, including sovereign bonds, medium-term notes and corporate sukuk from local real estate developer Aldar Properties. Most trading in corporate fixed-income securities, however, takes place on an over-the-counter basis. Looking to sovereign issuances, fiscal surpluses have traditionally alleviated Abu Dhabi’s need to issue debt. However, lower oil prices in recent years have increased the need for alternative sources of funding and prompted governments around the region to look to debt markets. Given the renewed drop in oil prices in early 2020, along with the expansionary fiscal response many jurisdictions around the world are using to counteract the negative economic impacts of Covid-19, sovereign issuances in the region could become more common.

In 2016 Abu Dhabi staged its first sovereign bond sale since 2009, with the Ministry of Finance raising a total of $5bn through a pair of $2.5bn tranches. In 2017 the emirate sold its first-ever 30-year sovereign bond, joining a regional trend of issuing longer-term debt in a bid to deepen yield curves and respond to global demand from investors seeking high yields in a low interest rate environment. The decision by US bank JPM organ to include GCC sovereign and quasi-sovereign bonds in its Emerging Market Bond Index provided a useful fillip to the region’s debt market in 2019, helping to push the value of bond issuances in the region to $94.4bn, from $74.9bn the previous year. The UAE finished 2019 as the largest issuer in the GCC, accounting for $34.4bn of the total. Of this figure, corporate issuances accounted for approximately $23.7bn, while government bonds stood at $10.8bn.

Before the outbreak of Covid-19, conditions at the outset of 2020 favoured a further expansion of debt issuances. “In December 2018 most market participants were fairly pessimistic about fixed-income instruments heading into 2019, due to an expectation of rising interest rates in the US,” David Rothon, CEO and head of marketing and client services at Abu Dhabi Global Investors, told OBG. “However, US interest rates ended up being a key driver of dollar-denominated debt in 2019, and fixed-income markets performed well as a result. Sovereign and corporate issuances were heavily oversubscribed, with an increase in demand from investors searching for high yields.” Buoying this outlook is a recent legislative change that could lead to a new phase of sovereign issuance activity. In October 2018 the UAE issued a new Public Debt Law, which allowed the federal government to issue sovereign debt for the first time. The legislation serves to deepen the nation’s financial and debt markets, and promises to act as an important liquidity tool for the Central Bank of the UAE as well as the wider banking industry. The law also established a federal Public Debt Management Office (PDMO) within the Ministry of Finance, which will cooperate with the central bank in order to establish national debt-management policies and strategies. The PDMO will also monitor risks associated with the issuing and trading of public debt instruments. At the emirate level, it will work with local governments to develop efficient primary and secondary debt markets. According to government statements issued at the close of 2019, the UAE was preparing for a credit evaluation of the country and planning to make its first federal issuance in 2020.

Performance

The sharp decline in global oil prices that began in mid-2014 has had a significant impact on exchanges across the region, lowering trading volumes and sending main indices into horizontal or negative trends. After a low of 3736.95 in January 2016 the ADX General Index recovered to follow a horizontal channel of approximately 4500 over 2017 and the first half of 2018. Firmer oil prices and a strengthening economy led to modest growth on main index in 2019, hitting a high of 5404.53 in April before settling at a support level above the 5000 mark. It remained comfortably above this level for the remainder of the year. In terms of subsector performance, consumer staples showed the biggest gain, increasing by 99.2%. Real estate followed, with expansion of 29.8%. Meanwhile, investment and financial services recorded the biggest decline, falling by approximately 51%, followed by the industrial subsector, which contracted by 21.4%. As is usual for the ADX, banking shares monopolised the attention of traders, accounting for 183,282 of the 386,056 trades made in 2019, during which period the subsector expanded by 5.5%. The positive direction of one of the least volatile segments of the market strengthens the ADX’s position as an investment platform, as does 2019’s dividend output: companies listed on the ADX distributed more than Dh25bn ($6.8bn) in cash dividends to 572,774 investors – a 6.95% increase on the previous year.

While the index entered 2020 on a similarly positive footing, by February 2020 it began to drop significantly, recording a low of 3323.35 on March 17 before moderating somewhat to 3744.13 as of March 30. This was attributable to global market volatility related to the growing Covid-19 pandemic, as well as a significant drop in international oil prices witnessed earlier in the year (see Energy chapter). As of mid-2020 Brent crude was trading at around $40 per barrel.

Regulation

Both local and federal bodies have played a part in the development of the exchange since its inception. Local Law No. 3 of 2000 established the ADX as an autonomous body with supervisory and executive powers over its processes. 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. Recent years have seen a gradual shift in the relationship between the ADX and the SCA, with the exchange taking more supervisory and executive responsibility for its day-to-day operations. The SCA began the first phase of transforming the ADX into a self-regulatory organisation in 2016, and in 2019 it further expanded the range of operations the exchange has direct control over. The year 2019 saw a raft of new changes, including new guidelines for standards and governance related to PJSCs, the publication of draft regulations concerning virtual assets (see analysis), new solvency standards for investment managers, revised controls for real estate investment funds and an alteration to the way in-kind shares of investment funds are evaluated.

Sustainable Finance

The UAE is actively embracing socially responsible investing. In January 2019 the SCA it hopes to have fully implemented by mid-2020. The document focuses on a number of pillars, including responsible investing, transparency and disclosure, awareness, effective governance, incentives, guiding standards and principles, innovation, engaging stakeholders and cooperation. In early 2019 the ADX also introduced environmental, social and governance (ESG) guidelines for listed companies, which are encouraged to disclose ESG issues according to a set of 31 criteria. While this represents an increased administrative burden, the implementation of the ESG framework brings potential long-term advantages; international fund managers are increasingly concerned with the ESG performance of potential investments, and it is estimated that $83trn of globally managed funds are allocated to companies that apply ESG standards.

Similarly, in January 2019 ADGM introduced the region’s first sustainable finance framework and agenda to steer the financial and capital markets towards the adoption of sustainable finance and responsible investment. More than 25 UAE financial regulators, banks, funds and private firms stepped forward to pledge their support for the UAE’s ESG goals and strategy. In a similar vein, the SCA and ADGM became members of the Global Financial Innovation Network in 2019, joining a group of 50 leading regulatory institutions.

Such moves have been moving the investment agenda in the region towards sustainable financing, and shaping the development of trade and investment. According to ADGM, as of January 2019 the MENA region had already attracted $163bn in clean energy investment. In August 2019 renewable energy firm Masdar announced a $1.6bn refinancing for a wind farm in the UK, of which $900m was raised via a green bond. That same year, the UAE’s flagship carrier Etihad Airways secured funding partly through ADGM for a project that supports the UN’s Sustainable Development Goals.

Exchange Development

As the exchange authorities and the regulator continue to develop the market, broadening the investor base remains a priority. Attracting international investors is one possible route to this goal. Starting from a low base, foreign interest in the exchange has increased: net foreign investment on the ADX reached Dh9.7bn ($2.6bn) by the end of 2019, up 309% from Dh2.4bn ($653.3m) in 2018.

Raising foreign ownership limits for listed companies has been a topic of discussion for some years, but as of March 2020 no listed firm had reached its existing foreign ownership limit, which varied from 15% to 49% of total shares. In March 2020 the stock with the greatest degree of foreign participation was Commercial Bank International, which was 42.66% owned by GCC interests, with Arab and other investors accounting for 0.06% and 6.27%, respectively.

Lowering participation costs is another way the exchange authorities are attempting to attract new investors. Both domestic and foreign investors benefitted from a July 2019 decision to cut trading commission fees by 50-90%. The exchange authorities are also utilising new technologies in a bid to make it easier for exchange participants to interact with each other. The ADX was the first stock exchange in the MENA region to introduce blockchain technology to its services, applying it to the e-voting function for the annual general meetings of listed companies. Other notable steps taken in 2019 include the rollout of its Arqam platform, an artificial intelligence tool that provides trading advice to investors; the introduction of the ADX Digital Wallet powered by Payit, which allows funds linked to an ADX-issued investor number to be transferred digitally; and the launch of the Sahmi platform, which provides information to investors by linking it to the SmartPass and Whole of Government Initiative.

Outlook

As the SCA and the ADX set their sights on progressing from emerging to developed status, structural and regulatory reform will remain priorities. The establishment of a new Capital Markets Advisory Board by the SCA in late 2019 promises to improve feedback channels between the regulator and the securities industry during this process. Made up of experts in various disciplines connected to the investment arena, the board will discuss new initiatives aimed at enabling the UAE to keep pace with global capital markets trends.

While previous favourable outlooks for 2020 promised to make it an interesting year for listed equities, it is not yet clear how markets across the globe will navigate the volatility caused by Covid-19. Abu Dhabi’s three-year stimulus package (see Economy chapter) should help propel growth, even if performance does not match previous forecasts. In June 2020 the IMF predicted that the UAE’s economy would shrink by 3.5% that year, down from 1.3% in 2019 and in line with the contractions it forecast for other economies around the world. In the debt market the likelihood of increasing the number of GCC issuances in 2020 similarly remains to be seen, as this was to be supported by corporates increasing their borrowing in response to improving economic growth, as well as sovereigns continuing with their debt programmes in order to meet spending commitments and establish domestic currency yield curves.