Alastair O'Dell, (chairman) editor, Global Investor/ISF
Chair: There is a very positive economic growth story in the GCC. What are the causes for optimism and concern?
Deon Vernooy, ENBD Asset Management: There is no doubt and the statistics speak for themselves, that the regional oil producing countries’ economic growth is good, the balance sheets are exceptionally strong and cash flows are rich, allowing them to support fiscal and monetary activities. The oil price is very supportive and it looks a very strong proposition in a relatively unstable global environment.
Akber Khan, Al Rayan Investment: Consensus favours Qatar and Saudi Arabia, some would say the UAE too, but that’s more contentious. Bahrain and Kuwait are definitely perceived to have less appealing investment cases. However, concerns obviously exist around the extent GCC countries are exposed to global macro problems.
A key positive driver for this region, but not the global economy, is the oil price. With Brent at $120 and raised production levels, budget surpluses are significantly larger giving GCC governments even greater firepower. And this is at a time when there is pressure to increase domestic spending. All governments globally have the desire to hike up their spending, but few actually have the ability.
Shreen Abeysekera, HSBC: With the current European financial instability, we could expect investors to focus more on the Middle East. Statistics also show that a large portion of the Middle Eastern investments are outside of Middle East. If these are invested in the region, this alone could drive markets in Saudi, Qatar and UAE.
In addition, the recent focus to be independent of a hydrocarbon based economy would encourage foreign investors to take part in the development projects that are currently taking place in countries such as Qatar and Saudi Arabia. One of the concerns a foreign investor who is looking to partner with a local investor would have is the current partnership regulations existing in the Middle East, where the foreign partner owns 49% while the local partner holds 51%. This could raise concerns on investor rights and legal recourse.
Shashank Srivastava, QFCA: The region’s economies are clearly based on hydrocarbons but non-hydrocarbons are increasingly important and growing faster. In Qatar, financial services, real estate and professional services account for the largest shares of GDP outside of hydrocarbons. Oil fluctuates but gas, which is what Qatar depends upon, provides a very stable income stream with typically 30-year contracts.
The population of Qatar has doubled over the last five or six years and yet already very high per capita income is growing so retail is experiencing fast and sustained growth. Since 1980 the GCC economies have grown fourfold; we don’t see that anywhere else and it’s expected to continue over the medium term. The economy is growing rapidly and the savings rate, which is a good measure of retail capacity, hovers around 40%, despite the Ferraris you see, so there’s clearly scope for financial services to channel savings into investments. Government spending is the third leg of the C
Chair: Does everyone agree Qatar and Saudi Arabia are the two growth markets?
Srivastava: Saudi is a huge retail market for everybody. From an institutional perspective, Qatar is expected to become the second largest GCC economy this decade, Kuwait has hydrocarbons ticking along and the UAE will overcome its Dubairelated downturn.
Vernooy: The basic macroeconomic driver for all GCC countries is oil and gas production. An oil price above $100 is good for everybody. Oil revenues are fed through government mechanisms into the real economy. GCC countries are potentially good investment opportunities - not without risk, but the region is a relatively safe haven with the governments generally in a position to stimulate and support the economy to an extent that is way beyond what almost any other country in the world can do.
Mohsin Mujtaba, Qatar Exchange: Qatar and Saudi Arabia are no doubt safe havens. However, in the UAE there is a question around the Dubai crisis. We have seen political uprisings, unrest in other parts of the region, so even though there might be good business cases the political situation will remain an element of caution. We saw capital flight from these countries, so this has to be considered when you apply the safe haven badge.
You can’t only look at returns, you need to look at the security and safety of the assets. It’s not only about the growth, it’s also about the safety and security of assets, policies around inflows and outflows and the control foreign investors have of their assets. Qatar was the first market in the region where foreigners are in full control of their assets, via their custodians.
Chair: Last year, in the lead up to the MSCI rating decision, there was talk about increasing the foreign ownership limits. Will this happen or is it now on the back burner?
Mujtaba: We currently allow 25% foreign ownership but foreigners own roughly around 7% of the market value so there is still 17-18% available, $4 or $5bn could easily be invested. The law allows various individual corporates to increase their foreign ownership limits beyond 25%. QTel and Vodafone do not have any foreign ownership constraints. However, the issue is perception as 25% doesn’t look like a very large number.
Vernooy: It has gone quiet in the months following the MSCI announcement but it’s an important issue that hopefully can be positively addressed. Saudi’s not even been part of that discussion but if it gets MSCI qualification for access, it will be a significant development. That would lift exposure to the international community and we would move away from ad hoc foreign market participation to more sustained involvement.
Malek Kanawati, Mubasher: There is a strong possibility we may see Saudi make it into the Morgan Stanley Index ahead of other GCC markets, despite not having been under consideration earlier, where previously the prime reason for exclusion was due to foreign participation being restricted to the swap market, which will shortly not be the case with the opening of the cash market expected in the near future. However, a country being included in an index is in itself not a reason for international institutions to invest, and one could say that these investors identify the potential of investing in a market well before inclusion in an index, which would then follow the investors by upgrading the status.
Srivastava: There’s far more to the development of capital markets than equities, for bond markets to develop for instance. Even if you increase foreign ownership limits, what happens to the institutional capacity? Regulators need to help build institutional capacity.
Mujtaba: It’s not only inclusion in the MSCI Index that will drive the investment. A number of very large emerging market investors are already investing. It’s the way the MSCI process works. These investors provide feedback to MSCI and get a country to want an upgrade.
Akber Khan: The difference between regulatory and legal frameworks in the region clearly impacts investors. In addition, when laws do exist, how comprehensive they are is key - we have encountered some gaps in certain investment-related laws leading to regulatory delays when seeking to launch products.
There are also varied levels of access and support for investors. Kuwait didn’t actually have a regulator at the time of the initial MSCI EM discussions a few years ago while Qatar possibly has the opposite problem. Saudi does not allow foreigners to invest directly in equities but the rapidity with which steps have recently been taken suggests change is in the air. The ease of both entering and exiting and the comfort of a familiar regulatory regime are obviously important. A disproportionately high number of funds and companies are domiciled in Bahrain because of the regulatory environment.
Kenneth Freeling, K & L Gates: Qatar’s two financial regulatory systems create challenges for financial institutions regulated by the QFC because of potential overlap. No matter how complete the regulations are, foreign investors will ask ‘is there a strong compliance mechanism? If I invest or take my investors into this country, does the rule of the law control? Is there a competent and efficient civil justice system to resolve disputes? There is external pressure from foreign investors to have the legal and regulatory framework strong and reliable. When that exists there is the basis for significant foreign investment.
Srivastava: I don’t think these concerns are valid for Qatar. There are a multitude of regulators. QFMA regulates the stock market, the Central Bank regulates the banking sector, the State of Qatar insurance regulations were written in the 1960s, and the Qatar Financial Centre is ‘one country, two systems’. But there is only overlap in wholesale banking. There is not much supervision and authorisation capability outside of the QFC, so there is no overlap over there.
It’s ‘one country, two systems’. In China the mainland and Hong Kong have two completely different systems but it’s the same country. When you have such arrangements you will come across situations but you just need to iron them out – as happens in the US or UK. In any market, products are regulated at the state and federal level. Companies are used to dealing with multiple regulators in the same country, all around the world.
Vernooy: It is true that we are used to dealing with many different regulators but it does not make it easy in this region. To provide one example, to distribute a fund product you have to work through each market separately. Europe has passporting of approvals between different countries, which makes it so much easier. We’ve raised this on occasion with the regulators and feel that there exists an opportunity to simplify processes substantially.
Srivastava: I agree but Europe’s UCITS is perhaps the only example of a single passporting system. You won’t find that in Southeast Asia, Africa or any other emerging markets. I’m not saying we shouldn’t do it - I agree with the concept because each individual market is small and it makes sense to consolidate - but let’s be practical. It’s not going to happen anytime soon because the countries have had different experiences.
Vernooy: There is an opportunity to cooperate and align regulations to make it easy for market participants to set up one country and operate across the region.
Khan: Unfortunately, this is not the only area where the GCC would significantly benefit from greater cooperation.
Freeling: The dual Qatari legal system for QFC financial institutions is different from the US where there is one legal system. In Qatar there are completely different legal systems. One is civil, one is common law. One is French-based, the other one is English-based. Different courts, different languages.
The concept of ‘federal’ also has a different meaning. In the US, the 50 states have powers reserved to them, separate from the federal government. In Qatar it’s more challenging to understand – I can tell you because I counsel them all the time. I’m not suggesting that this isn’t a good model, I’m just suggesting that it’s a bit tricky and it will take time before the two operate smoothly side-by-side. I’m very optimistic, but it has its challenges.
Vernooy: This region has got a fantastic opportunity now, after a 10-year bull market in its main products, oil and gas, to put substantial resources to use and develop other parts of the economy. However, one has to be aware that GCC governments have ramped up fiscal expenditure significantly by between 100% and 200% over the last five years. If the oil price moves sustainably below the fiscal ‘breakeven’ levels we could very quickly see pressure on fiscal expenditures, capital expenditure programmes and even national balance sheets. The opportunity has to be used now.
Chair: To what extent is the GCC insulated from the problems in the West, especially the eurozone crisis?
Mujtaba: The UAE and Dubai are more affected than Qatar, Kuwait or Saudi. European markets assume some danger, that the market has already priced in that there will be a follow-up to Greece, maybe Portugal, Spain or even Italy. There is enough optimism in the local market to carry us through, but we may have to worry about the disengagement of international banks. Ten banks in the UAE alone have exited in the past two or three years. We’re seeing banks selling assets and businesses to local banks.
Khan: There are two sides to the Europe story. There are the many negatives but also some silver linings. As some participants withdraw, there are greater opportunities for local banks that have balance sheet capability or access to funding. The region is over-banked so less competition is clearly welcome for the locals.
Last year the single largest project financing transaction in the world was in Qatar. The $10bn Barzan gas infrastructure development was significantly oversubscribed. International demand was a testament to how investors perceive risk in the region, or perhaps the Qatar sovereign specifically. Local and regional institutions’ participation in the syndication was probably higher than it would have been if foreign banks had been at full strength.
As the overall lending environment tightens, there will be increased fee earning opportunities as regional corporates tap debt markets. On the negative side, GCC countries have varying resources to combat the issues. 2008/09 was pretty much a disaster all round as the region’s governments, regulators, investors and corporates were largely unprepared. Significant changes have since occurred in many markets and, importantly, governments and central banks have strengthened financial systems. A simple example is the withdrawal of credit lines.
In 2009 there was panic but many governments intervened. Bailouts and injections here are no different to the West – the key difference is many governments are wealthier than the financial systems in their countries. Although the GCC is better positioned now, during a time of stress there will be increased differentiation between the countries with greater capital surpluses and those with less. Europe’s indebtedness is a long term issue with no quick fixes. The GCC will not be immune to a further deterioration but local stresses and geopolitics are arguably of greater interest as they affect us directly.
Srivastava: The significant investors in the region are local high net worth individuals and institutions. Four of the world’s top six sovereign wealth funds are in the region. Qatar has the world’s highest per capita proportion of millionaires. High net worth individuals in the region have invested nearly $1.5trn – almost as much as the sovereign wealth funds. The region is a net exporter of capital so it is more interesting to talk about investors in the region rather than foreign investors’ views. Those gathered around this table focus on regional investors before foreign ones. On a global scale they are huge.
Freeling: The expectations of the investors here, as opposed to those of US or EU investors, are very different in terms of transparency and disclosure. I agree with you entirely that the first place to start is the expectations, meeting the expectations of the investors here that drive the markets.
Chair: Are sovereign wealth funds repatriating money from Europe and investing domestically?
Vernooy: Of $3trn of investable assets, 80% is invested outside of the region so local investors do ostensibly have an appetite for foreign investment. That’s natural for diversification. By substraction it does imply that a very large amount of the investable assets remain in the region and we have to take note of what these investors want to do with their money in the region.
Asset managers had become concerned about dwindling stock market volumes but it seems to be coming back. Over the last few years we’ve seen significant interest from regional investors into the fixed income markets, which have developed very nicely, and the sukuk market.
Srivastava: GCC investors do so globally because the investment classes and opportunities in the region are still developing. But the legal system is important. In the West, investors’ investments can get frozen at the whim of authorities. When they look at the global legal regulatory environment they don’t like what they see. They will still invest but want it to be done from here.
Vernooy: The whole regulatory environment has tightened significantly over the last few years for investors placing money elsewhere in the world. It does play a role when investors decide where to domicile their investments.
Srivastava: Dubai World was locked out of US strategic asset markets purely on the basis of politics. What about the strategic assets of the GCC? These are oil and gas related and there is foreign participation.
Kanawati: The region has not witnessed the financial scandals and securities fraud seen in international markets and as such regional investors have a greater level of comfort investing in the region. The degree of trust not only in terms of managing money but financial reporting scandals, has helped maintain a greater level of trust in the local financial services industry, where integrity is valued just as much as returns.
Mujtaba: Qatar has been the best performing market in the MENA region for the last two years as government spending has helped local banks and corporates post profits above estimates. The concern I have is about the state of the asset management industry. If all GCC capital invested in Europe or the US came back, would we have sufficient assets to invest in? Are we at the risk of creating a bubble?
Chair: What about infrastructure projects?
Srivastava: From a macroeconomic perspective the governments have surpluses and can finance all infrastructure spending. Public private partnerships (PPPs) create local opportunities for local investors. The driver for PPPs is different to the driver in countries short of capital. The driver is to introduce private sector discipline – executing a project on time and on budget – and creating a new asset class.
Chair: The Dubai crisis of a few years ago is now barely mentioned. How much of a lasting effect has it had?
Srivastava: The financial crisis was 2008, the Dubai crisis started immediately after, and in 2009 a Qatar sovereign issue was 50 times oversubscribed. That sort of answers your question.
Khan: For investors who truly understand the region, it was a phenomenal opportunity as decisions to sell aggressively were made on a top-down basis which made no sense in many cases. We look forward to this happening again. It took time for the blind panic to ease and investors to realise the region is not simply one country.
Today Dubai is not even in crisis. The non-real estate economy - the sectors where Dubai has a competitive advantage - have probably never been in better shape. Retail, hospitality, transport, logistics and tourism have been breaking new records. The UAE is a country of six million, yet 54 million people visited Dubai Mall last year. Jebel Ali port has not been busier. The same goes for Jebel Ali Free Zone and the airport. Interestingly, prices of some prime real estate properties have actually seen modest increases in the last few months.
Vernooy: There were difficult days for Dubai in 2009, let’s not underestimate the issues that were faced at that time. But it was dealt with efficiently. Real estate went through a significant downturn, but even that is working its way through the system and prices are stabilising. The macroeconomic numbers are mostly positive. Anecdotally, we are seeing traffic congestion again in Dubai, something not seen since the days of 2007. Dubai is on its way back.
Kanawati: Significant global attention has been focused on the debt in Dubai, eg Dubai World. However, all obligations have been met, issues have been restructured and since then debt has been successfully re-issued at competitive rates. Dubai has also made a clear statement that there will be zero default.
Dubai banks have never been stronger with Tier one and Tier two capital 18-19% across the board. Most banks have written down real estate loans based on market fluctuations while customers continue to make payments just in case people walk out on their mortgages.
We’ve had some very successful debt-capital market issues with Dubai Electricity and Water Authority and Emirates airlines issuing $1bn each and Emaar $500m, notably amidst the turmoil seen overseas with European banks needing to focus on their own domestic issues. Dubai has $100bn to work its way through over the next ten years. The challenge of matching inflows and outflows looks very positive.
Abeysekera: The publicity around it could sometimes be seen as unfair? Default on debts can happen and in most stacases they are restructured. This would not be the first or the last.
Vernooy: The balance sheet of the UAE is very strong. When Dubai needed capital it was supplied by the federal and the Abu Dhabi governments. The governments have the firepower to deal with these problems when they come up.
Khan: What you don’t see in the headlines was that Dubai was the best performing stock market in the world in February.
Chair: What effect is the Arab Spring having on the GCC? Are there both positive and negative effects?
Abeysekera: If you look back four or five years, international investors wouldn’t differentiate between countries in the Middle East, most would consider the Middle East as a single entity. One good thing that transpired is a result of the Arab Spring is that most international investors are aware of each country and understand the dynamics of each market.
Khan: Political change in the Arab world was actually a very good catalyst for the GCC investment case. The GCC has two major long term problems. Firstly, a very young and very rapidly growing population. One third of the people are below the age of 15 and will need jobs over the next ten years – without these opportunities the so-called Arab Spring may look like a walk in the park.
The second issue is an extreme shortage of infrastructure across most sectors, be that transport - in all modes - residential for Saudi in particular, health, education, tourism, power generation, sewage, desalination, leisure facilities - you name it. This picture is similar to many emerging markets but GCC governments have ample resources to actually do something about it.
The Arab Spring put an afterburner on governments’ decision-making processes and the speed they will implement solutions, which essentially means aggressive spending. Last year the Saudi King announced $70bn of measures for housing alone - no doubt more will follow.
Freeling: The need for infrastructure investment is probably nowhere greater than in the countries at the heart of the Arab Spring, like Libya and Egypt. After conflicts like these there’s probably no greater time to start thinking about investment. Historically, countries in that position have the greatest opportunities. What’s really interesting is the flow of money from Qatar and Europe into places such as Libya.
Kanawati: Five years ago the average GCC fiscal breakeven oil price was close to $40 and now it’s close to $70. Any blip in the global economy and oil prices come down. This could create significant budgetary issues.
Chair: Are stable places such as Qatar experiencing inflows from countries affected by the Arab Spring?
Srivastava: The development of the financial services industry is based on the fundamentals of Qatar, as a politically stable and economically growing country – rather than being based upon troubles in other places.
Kanawati: Following the Arab Spring, money coming out of the troubled areas would initially flow into housing, bank deposits and only at some point trickle into the financial market. We are seeing that effect in Dubai more than anywhere else, where housing prices have seen an upward trend. The same goes for money supply with M3
Khan: Dubai saw approximately $25bn of bank deposits come in during H1 2011, but then leave, underlining its safe-haven status in the region. In general these funds originated from Arab countries seeing the greatest political upheaval.
Chair: How concerned is Qatar about rising tensions between the US and Iran?
Mutjaba: If you look at the recent past, Qatar has been an extremely important player in the region when it comes to regional and global politics. Not only for Iran but Egypt, Libya, Lebanon and Sudan. It has provided leadership and has the mindset to mediate where necessary. Relations with Iran have been dealt with very pragmatically and Qatar is not an ally of anybody but has its own position. The financial firepower provides Qatar with the standing that it has today.
Vernooy: There is no doubt that the Iranian situation is creating anxiety. It’s hard to know where this will end but to some extent markets are pricing in an ongoing level of uncertainty. If you look at it from a positive perspective, if these issues get resolved, Iran can play a very positive role in the region.
Kanawati: We hear from the GCC leadership that there is definitely a call for engaging Iran as opposed to raising the drums of war.