Hardeep Dhillon, Global Investor/ISF Chair
David Marshall, senior executive officer, Emirates NBD Asset Management
Arindam Das, regional head of HSBC Securities Services, Middle East and North Africa
Richard Souri, vice president, MSCI
Robert Ansari, executive director, MSCI
Timothy Peters, managing director, JPMorgan
Mike Cowley, head of trust & securities services, Mena, global transaction banking, Deutsche Bank
Nigel Sillitoe, chief executive officer, Insight Discovery
Fadi Al Said, head of investment, ING Investment Management
Chair: How monumental is the MSCI upgrade of UAE and Qatar?
Robert Ansari: UAE and Qatar have been under review for potential reclassification since 2008 and five years on, we have reached a situation where investors in the MSCI indices are now comfortable with the steps those two countries had taken to open up to more foreign investment. The impact on the markets and overall benefit to the region are far more reaching than just the MSCI classification.
The move could also be a catalyst for other exchanges, regulators and market participants in the region to enhance their operational frameworks as a number seek potential reclassification by MSCI as well. In the wake of the announcements, more clients have asked us to explain the process of how we speak to institutional international investors and relay this feedback to UAE and Qatar exchanges and regulators.
Richard Souri: The MSCI developed, emerging and frontier categories are a reflection of institutional investors’ classifications and views of markets. There really has to be genuine market sentiment before any classification and we hold a series of consultations with institutional international investors and custodians, before any decision is made. Considering UAE and Qatar have been under review for reclassification by MSCI since 2008 both have achieved emerging market status in a fairly short period of time.
Fadi Al Said: The upgrades will increase inflows and though it is highly debatable by how much, the net impact will be positive. UAE and Qatar were previously momentum markets and an off-benchmark exposure for emerging market managers trying to generate excess return over the index.
However, this means that these managers do not have the patience or the risk appetite to hold on through any downturns in the market and naturally look to exit on any negative headline or underperformance. Whereas now the efficiency and the stickiness of the markets will increase as more institutional money is attracted to the underlying fundamentals of the region rather than just directional plays. Then you have the passive money that simply replicates the indices or goes through exchange-traded funds, which will also bring liquidity to the markets.
Arindam Das: The upgrade is significant not just because of the quantum of new money that will come in, but also the quality of money that these markets will now attract. Most of the concerns among investors that were impeding the upgrade earlier were on the post-trade clearing and custody model, and with these having been addressed now, the markets will now attract some of the risk-averse, long-term mutual funds and pension funds that the markets want to attract.
Also, in my opinion, the time it has taken for the two markets to get the upgrade, is an indication of the robustness of the process, and this will only increase the attractiveness of these markets in the eyes of the investors, because they know that the upgrade is a testament to real improvements in the market, and not just a tick in the box.
Ansari: It will be interesting to see how the weighting of those markets move over the course of time. We are in the process of analysing what the effect is on countries that transfer from one market classification to another.
Souri: The weightings for Qatar and the UAE will be roughly 0.45% each. Given that about $7trn tracks MSCI, roughly $1.5trn of which is emerging markets exposure, a fraction of a percentage is still quite a significant amount of money tracking these markets.
Nigel Sillitoe: An Insight Discovery survey on the MSCI upgrade showed that 96% of the 141 respondents envisaged positive incremental flows into Qatar and the UAE, with 23% anticipating between $500mn and $1bn, which tallies with some of the forecasts by US investment banks. The more optimistic 28% thought it would be above $1bn.
David Marshall: Undeniably, it is positive from a sentiment perspective. Domestic flows are still currently dominating, though this is the start of a positive trend of greater liquidity for the region. A secondary wave will probably only be felt when active managers enter in June next year, though many may sit on the sidelines watching developments.
Chair: Will this prompt Saudi Arabia to follow?
Al Said: MSCI’s re-classification could possibly accelerate efforts to open up the market in Saudi Arabia, which has the size, liquidity, depth, diversity and even the regulations to become an emerging market on the spot. Saudi represents roughly 70% of the liquidity of the Gulf Cooperation Council (GCC) region.
Although the Saudi economy is not as diverse as say, the Chinese, it is of similar size to Turkey and larger than South Africa, and could still easily qualify as an emerging market. Issues around custody, settlement and the value date have mainly been resolved, however, the market is still only T+0, which is an issue.
The authorities have made it clear that it is their intention to open up the market and it is understandable that Saudi is taking its time to mitigate many of the risks. If it happens, then this will naturally have a positive impact. However, we have to differentiate between seeing the MSCI upgrade as a catalyst for the region and a reason to invest.
You invest in a region, country or company because you like the mathematics, the fundamentals and valuations. Ultimately, it is because you feel that your money might appreciate and you can generate income from your investments.
Timothy Peters: Saudi Arabia has introduced a number of practical and tangible steps over the past 12 months, with laws being passed to change the weekend, greater transparency, potentially improving the settlement cycle and introducing a true custody model. However, other elements are uncertain and certain expectations may be too far too soon. For instance, would short selling be part of the criteria for inclusion considering where that sits with sharia principles?
Das: Saudi is possibly too large a market to be pressurised into following suit, but the upgrade of UAE and Qatar will encourage them to review their market in terms of how closely they are aligned with the standards that MSCI sets for emerging markets. However, this is possibly something they would do once they open up the market for foreign investors.
Mike Cowley: Saudi’s weighting would completely change the game for most emerging markets players, if estimates are correct that it is near the 2% bracket, that means potentially billions of dollars of investment. Saudi could be the one that really drives the region and really gets the investment community focusing. If we combine that with UAE and Qatar, and possibly Kuwait, then the region would become very attractive in terms of size in an MSCI index and cannot be ignored.
Marshall: If you look from a market capitalisation basis, Saudi is the one that becomes more of a structural play if it constitutes 2% to 3% of the index. An economy, which is built on massive government finances, huge services and strong internal demand, intuitively, feels attractive.
Chair: Will international or local players benefit?
Marshall: There are some overriding structural reasons why emerging market managers should allocate more of their portfolios to the region because current account deficits, fiscal deficits and currency devaluation—all the issues that are causing investor nervousness at the moment—do not apply here.
However, it will take time for them to make that move. As a regional manager, we now need to look at not only comparing sectors across the countries in the Middle East region, but also Brazil, Russia and emerging Asia. That is a huge mind shift, and I think that takes time to build into anyone’s practices. Therefore, if these countries are on the radar, then valuation metrics on certain companies, which should look quite attractive versus emerging market peers, will start to come to the fore.
Sillitoe: The upgrades will be beneficial to a range of both domestic and international players. There are fourteen local funds in the UAE, three of which are passive, and ten in Qatar.
Therefore, the initial beneficiaries could be these funds that specialise in those two countries. However, the greater focus may rest with the larger players, such as Franklin Templeton, National Bank of Abu Dhabi and Emirates NBD Asset Management, which can provide greater comfort due to having robust due diligence procedures in place and quicker request-for-proposal processes.
Das: Having more institutional investors coming in will challenge the local companies to become more transparent, provide better information, be more investor friendly, and that will benefit both the local and international asset managers, and in due course, retail investors as well. Better corporate governance is valuable for every class of investor.
Positive developments such as the MSCI upgrade and the interest that it generates among foreign institutional investors also leads issuer companies to become more outwardly focussed.
The Dubai Financial Market and 20 of the exchange’s listed companies recently conducted a roadshow in New York on September 24 and 25, which naturally suggests that they are keen to attract international investors, and are willing to meet the enhanced transparency standards that these investors expect.
If the MSCI upgrade had not occurred and if foreign investors were not looking at these markets, then I doubt the roadshow would have taken place at this time.
Peters: Global managers will insist on having a lot more procedures in place, such as better due diligence, research and execution. It will be interesting to gauge how these firms differentiate themselves and what they promote as their value added services.
You might just find that local institutions looking to get greater exposure in the region will go with the local managers and the outside investors could simply ally with global managers that have a better focus on execution and international common practices.
Generally, we are seeing large institutional fund managers from across the globe showing a greater interest in the Middle East, which will result in a more diversified pool of non-speculative and fundamentally driven investors, bringing greater stability and liquidity to the regional markets.
Sillitoe: Interest in the region is growing apace. Anecdotally I hear that four or five international firms are looking to set up a local presence, including one very large emerging market debt manager. The only issue is the cost to do business here.
Funds not only have to consider paying registration fees for being housed in the Dubai International Financial Centre (DIFC) or another financial centre, additional costs could arise from the Emirates Securities and Commodities Authority (SCA) plans to introduce a series of fees for the registration of mutual funds and a license to distribute them.
This may decide the fate of some international asset management companies because many of those retailoriented managers will have to pay the fees of the distributors marketing their funds, which is about AED35000 ($9500) per fund. So some may question whether they even want to remain or come here compared to London or the US.
Marshall: It is ironic, that you probably need an on-the-ground presence more for the retail business than for the institutional business where you’ve got large clients that maybe trade three or four times per year. There are a number of asset managers wanting to set up in the region and are choosing the UAE as a base.
That may be to service institutional and retail markets but SCA has certainly caused an issue, which could help local asset managers. In the short term, I do not think the business will be big enough to justify the cost of setup for many foreign firms. My expectation is that certainly in the next two to five years, there will be a smaller number of larger players, rather than a large number of small players.
Das: What SCA is doing in the UAE is similar to what is happening in other countries in the region. Kuwait has increased the licensing fees to market offshore funds in Kuwait. So, many of the Kuwaiti funds which were earlier domiciling themselves in Bahrain and other jurisdictions may now choose to domicile themselves in Kuwait.
Peters: There could come a point where there is a license or physical presence in every country that international firms want to do business in. If that happens then it does not make sense for a lot of asset management companies to consider full distribution in the region.
Ansari: That is very true of the direct fund business. Most distributors are saying that the cost of registration will be in excess of the fees they generate from offering that fund through a shop window.
Sillitoe: A lot of asset management companies generate their fund sales through life company platforms, which will be exempt. Therefore, it could just mean that the flows will be more through life platforms and also fund platforms, such as Allfunds, instead of through direct business.
Chair: Will European regulations make it more attractive for funds to set up here?
Marshall: If funds still want to use Europe or Asia, they are not going to set up in the DIFC but simply use the usual Sicav structure. If a lot of the regional business is put through life insurance platforms, it may not actually make a difference. Although some funds that conduct business in the Middle East and North Africa region may still have to be approved by the relevant life company, which could also be a barrier.
I do not think it will and do not expect it to have a material increase in the number of funds setting up here. What will perhaps help is the appetite for real estate and the DIFC has some interesting trust and ownership structures, which you do not have offshore.
That would be a bigger catalyst. Most investors are agnostic as to where the assets are custodised, whether here or in Luxembourg, provided the correct rules, controls and the governance are in place. The DIFC could compete with the larger recognised offshore centres by setting up as a portal to the region.
Peters: Dublin and Luxembourg have been incredibly successful and offer such a wide regulated distribution base but I think that the Dubai Financial Services Authority will attract more international managers to set up here after allowing fund managers in the DIFC to market alternative investment funds to investors in 26 European countries.
This may not necessarily be to create domiciled funds but to cover regional interest and investors. You could see more hedge fund and boutique managers setting up in Abu Dhabi, Qatar or Dubai, as an alternative option or in tandem with other traditional locations like London, Geneva or Zurich.
Chair: Will a local pensions industry help boost the local asset management industry?
Sillitoe: We have conducted a number of roundtables on gratuity and the feedback we received seems to suggest that it could be interesting for the pensions industry. Companies like the National Bank of Abu Dhabi and Takaud in Bahrain, which is part of Kipco, are now launching offshore retirement schemes as an alternative to gratuity. It is well known that Emirates Group is one of the big players that allow some, but not all, members of its staff to enter the offshore scheme, as long as they are no worse off than if they were still in gratuity.
The way forward is to take a more corporate look at taking the liabilities off their balance sheets and actually set up an offshore scheme, which is a great way of retaining staff. There is a shift now towards looking at ways of retaining staff, which has really never happened in the past. Instead of just keeping increasing people’s salaries, which increases the gratuity liability, firms might as well look at other ways of keeping staff on board. Pension reforms are definitely coming but, obviously, it takes a long time in this part of the world.
Peters: This is the whole defined benefit (DB) versus defined contribution argument. The end of service gratuity is on a DB basis and looking forward, more expats will continue to come into the region and perhaps the duration of their stay will arguably become longer than perhaps it was ten years ago. In that scenario, I agree with Nigel on the liability aspect, which will drive the demand for more local pension vehicles that, in turn, could be beneficial for the local markets.
Marshall: There is a need for a sharia compliant pension solution, which is not readily available with, say, offshore providers. It is an area where you might find a niche.
Chair: Is greater diversity and liquidity of regional markets still required?
Cowley: We certainly need more issuances in the region and obviously more diversification is definitely required. The education and healthcare sectors are potentially the most promising sectors that can drive diversity unless we look at the government-owned businesses.
Das: There is not a huge amount of local currency debt that is traded on the local markets. Much of the debt issued from the region is on Euroclear and Clearstream and is dollar denominated. Qatar has made an initial start in trying to develop a local currency debt market but it is still relatively nascent. Development of local currency debt markets is not just important for issuers to raise money, but is also very important to build a yield curve because, otherwise, you really do not have any monetary policy tools.
On the equities side, the UAE market is performing very well but it is still not representative of the whole economy. Property and financial sectors dominate the market, but what about retail, education, tourism and so many other sectors? The tourism sector in the UAE is booming, retail is doing very well, but those stocks are just not available. The market still does not reflect the economy and I think that correlation needs to be strengthened.
Marshall: Although there is still a heavy concentration of financials, they currently look interesting given they will reflect the wider improving economic situation. Healthcare is becoming more appealing and that sector is being referenced more in our portfolios.
Chair: Does it matter where companies are listed?
Marshall: If a company’s operations have a certain perentage sourced or derived from the region then we view it as a regional position. If that company decides to list elsewhere with better liquidity, then that can actually be quite a good thing for investors.
Peters: Where the earnings are being generated is certainly important for international investors and liquidity obviously is a key driver. If you look at the listing particulars and requirements in the GCC region, it can actually be fairly onerous.
Das: The markets here have to be fundamentally more attractive than the overseas exchanges to position themselves as compelling listing venues for the issuers, who will otherwise flock to London or elsewhere because that is where the liquidity is. For example, in UAE, companies need to list at least 55% of their capital, which is an entry barrier for family-owned companies who are concerned about losing control. The proposed Companies Act in UAE could change this dynamic but one needs to wait and see.
Chair: Is custody and outsourcing becoming more important?
Das: The custody function is not getting as much traction among local institutional investors as it should. Many custodians still have a greater share of their client base coming in from the foreign institutional investment side. More local asset managers need to believe that custody services can actually help mitigate risk and help generate operational efficiencies. They have to believe in the value of outsourcing and not consider it as a burden that is imposed by regulators.
Cowley: It is important that companies evaluate their risk and the more they do so, the more value they will find in using a custodian for outsourcing. What is slightly frustrating is that many firms use a custodian for their international but not their local business because local custody is just seen as an additional cost. There is still an educational process to go through with a lot of local players - whether they are fund managers, local companies or family offices - on how they can benefit. I think it is getting better, but there is still more to do.
Peters: Trust is key because the local institutions need to be comfortable with the data share between different organisations. That is one hurdle, which needs to be overcome, while another barrier is efficiency and scale. Banks that are in the business of supporting outsourcing do not necessarily want to inherit one headache from another institution. It needs to be scalable and of such a size that it can be efficient enough to take on any level of activity versus the inherent risks.
The new managers coming into the region do not want to have the operational burden, so, a partnering solution will be very healthy for the industry. Abu Dhabi has taken some unique steps to develop its custody sector and focus more activity on trading, the physical storage of commodities, foreign exchange and prime brokerage.
The regulators are looking at special purpose custodians that have increased rights of enforceability in order to protect both parties in a transaction. In addition, there are changes to some of the regulations governing collateral, thus building a legal framework that offers international investors and trading counterparties greater confidence.
Das: Currently there is no scale on the local asset management business, so costs for servicing that sector remain high. There is scale in countries like Saudi Arabia, where the asset management industry is large enough, but the asset servicing is all done by the banks internally.
In addition to the mutual funds sector, there is a huge amount of money that asset managers manage through discretionary portfolio management and on the managed accounts side. However, they also often do not outsource their custody or administration. So, although that market exists it is very difficult for a custodian to tap into.
Marshall: Custodial services can be expensive. From a customer’s perspective, and particularly with really price sensitive discretionary money, which is paying 1% all in, if 50bp of that goes on custody, people will start to question why they need to pay these additional costs and what is the added value.
Middle East roundtable