Six more months

By Kathryn Gaw

16 Aug 2011

It was the windfall that never came. After months of preparation and occasional optimism, both the UAE and Qatar failed to be awarded emerging market status by MSCI on 22 June. However, in an unprecedented move, MSCI announced that rather than reject the upgrade entirely, it would delay its final decision for six months, leading many insiders to suggest that a ‘yes’ is all but inevitable come December.

But how important is emerging market status for two of Mena’s most liquid markets? While fund managers were undoubtedly hoping for an investment boon off the back of reclassification, many believe that index approval is not the be all and end all. “A lot of investors can invest into Mena anyway so this decision is only really relevant for people who have benchmarks that prohibit them from investing into anything other than, or anything below emerging markets status,” says Alan Durrant, CIO of National Bank of Abu Dhabi’s (NBAD) asset management group. “There are plenty of people who are able to invest into frontier markets anyway and there are certainly plenty of foreign investors who come in and out of our markets every day. It would just put the UAE and Qatar on the radar for more international investors.”

However, there is little doubt that increased interest from foreign investors would have been welcome in a market that has been struck by crisis after crisis over the past few years, and regulators were doing all they could to ensure an upgrade. A spokesperson for the Emirates’ Securities and Commodities Authority (SCA) told Mena FM of its hopes for reclassification the day before the announcement was made, and an official statement by the regulator suggested disappointment in the outcome. “The SCA had met in time all the requirements of qualifying UAE securities markets for the MSCI index,” an SCA official said in a statement. “In collaboration with the local markets, we made all the necessary contacts and arrangements required by the concerned rating agency, having met all the list of requirements from the concerned agency, but which did not include a timeframe for implementation of the regulations outlined in the list of the agency’s requirements.”

Foreign ownership

So what led MSCI to promulgate its decision? In a statement, the company said it had chosen to wait “in order to give additional time for market participants to assess recent enhancements implemented on the Qatari and Emirati markets”. These enhancements include the key issue of foreign ownership, as well as delivery versus payment (DVP) systems, clarity in relation to corporate governance, listing laws and regulations for custodians and brokers’ rights. Although moves had been made to update both the UAE and Qatar markets to MSCI standards, it seems to have been a case of too little, too late. “To be honest we did not expect the delay, but it didn’t come as a complete surprise,” says Husam Hourani, managing partner and head of banking and finance at key Mena law firm Al Tamimi. “I think we always knew that there were important issues that had not been dealt with, or had not been dealt with satisfactorily, that may delay the decision.”

Hourani’s view has been echoed by numerous fund managers and service providers in the region, many of whom accepted the announcement as something of a compromise. “I was slightly disappointed in the decision and I think that’s going to be the reaction of most people,” says Durrant. “But I wasn’t entirely surprised and equally I don’t think that that will be the broad reaction of the market either.”

MSCI’s final decision on market reclassification rests with a board of institutional investors. It is therefore significant that foreign ownership was singled out as an issue. Institutional investors are clearly keen to invest in Mena, but a restrictive investment process is holding them back. Important issue,” says Hourani. “We have a commercial companies’ law which explicitly states that all companies should have no less than 51% UAE national ownership, which later on was changed to 51% by GCC nationals to give it more flexibility. Foreigners may not own more than 49%.” It remains to be seen whether investors, particularly those with private equity or venture capital remits, will be deterred from investing in companies with a foreign ownership limit of less than 50%.

“It changes the judgement,” says Morgan Harting, emerging markets multi-asset team leader at AllianceBernstein. “As an active emerging markets investor, we would certainly want to see as broad a range of potential buyers for publicly traded shares as possible.” This issue looks set to create further problems in Qatar, where foreign ownership limits are well below the 50% mark. Qatar has huge potential for investment: it exports a third of the world’s liquefied natural gas (LNG) supplies, and was recently named the richest country in the world, with a GDP per capita far above developed markets such as the UK and US.

“Qatar’s limits are so much lower than in the UAE,” says Durrant. “All the noises we’ve heard from Qatar suggest that there is a reluctance to move the foreign ownership limits in the short term. I think that that probably makes it less likely that it will go into the index.” However, Harting dismisses this as a major obstacle. “Foreign ownership restrictions are used across countries of all scales – in the US there are foreign ownership restrictions in some industries, and whether they are explicit or not, they are certainly in effect,” he says. “It is a matter of degrees and one shouldn’t assign such binary distinctions between companies with or without foreign ownership restrictions.”

In the UAE at least, improved foreign ownership seems to be on the horizon. The Dubai Financial Market (DFM) has pledged to continue implementing upgrades including the introduction of short-selling and securities borrowing and lending, in order to make the market more attractive to investors. Certainly, investors seem to be waiting for a sea-change to take place in both markets. By the end of June, Qatar was priced at -0.11% on MSCI’s frontier markets index, while the UAE was at -3.29%. However, it would be naive to assume that investor interest would suddenly take off, should either or both of the markets be added to the emerging markets list.

“There is a paradox that people assume that if markets go into the MSCI emerging that there will be this instant flood of cash,” says Durrant. “But if you’re up against foreign ownership limits there may be lots of people who want to come in, but no room.”

Competitive landscape

Even if the UAE and Qatar win emerging market status, they will face plenty of competition in an already saturated index. The failure of South Korea and Taiwan to win an upgrade to developed market status means that the UAE and Qatar would have to compete with two huge existing players. “These are two huge markets,” says Durrant. “If those two heavyweights moved up to developed then clearly that would mean that whatever portion the UAE and/or Qatar come in as, is going to be a little bit bigger, so that would be good.”

If, come December, emerging market status is granted, the UAE and Qatar would be officially migrated to the new index in November 2012, as part of MSCI’s Semi-Annual Index Review. This would give investors another year to reallocate to Mena or test the market. “Today the investor base is narrower than it would be and so you can get ahead of MSCI’s change in view, whether that comes in six months or 18 months,” says Harting. “There could be a benefit when MSCI upgrades, however. There’s plenty of money to be made, whether or not MSCI upgrade Qatar or UAE. That is not what drives value in the marketplace.”

The UAE certainly seems to be in a better position than Qatar to ‘emerge’ in December. New fund regulations, DVP implementation and, of course, competitive foreign ownership limits make it a strong contender for reclassification. In Hourani’s view, short of a foreign ownership stalemate, there is nothing else that could happen within the next six months to jeopardise the UAE’s chances of an upgrade.

“All of the indications are quite positive they are all going in the right direction,” he says. “It is all down to the implementation and moving more into regulations and more into being more cautious in the market so I don’t see anything drastic or negative happening, I can see only positive things happening for that.” Durrant agrees that a ‘yes’ is now expected in six months’ time. “I think it is now very likely,” he says. “I think if you do not say no, it gives an impression that yes is far more likely at the end of the year.”