MENA ROUNDTABLE: ‘The story is about reforms’

Our cross-industry panel discuss the positive backdrop in Egypt, the Dana Gas controversy and the potential index upgrades of Saudi Arabia and Kuwait. Chaired by George Mitton in Dubai.

Jahangir Aka (managing director MEA, Neuberger Berman)
Akhilesh Baveja (lead equity portfolio manager, Arqaam Capital
Reda Gomaa (director and portfolio manager, equity funds, Mashreq)
Saleem Khokhar (head of equities, First Abu Dhabi Bank)
Salah Shamma (head of investment, MENA, Franklin Templeton Emerging Markets Equity)

Funds Global – Within the MENA region, which markets have the best prospects this year and which do you expect to face the greatest challenges?

Salah Shamma, Franklin Templeton – This year we’ve been most excited about Egypt. A significant currency devaluation has created a liquid FX rate and now dollar availability is back in the country. Inflation, which spiked almost at 33%, is back down, which has allowed the government to ease monetary policy.

The backdrop is positive for Egypt to take its GDP growth rates from 4.5% to maybe 6.5%, which is a strong underlying background for the market.

Reda Gomaa, Mashreq – We are positive on Saudi Arabia. FTSE and MSCI inclusion would be a boost for the market. Kuwait also is an attractive market. One big event for Kuwait is the MSCI review that may put them as an emerging market in May.

Oman and Qatar are less attractive markets. In Oman, the budget deficit is increasing as a percentage of GDP. In Qatar, the cost of doing business is increasing because there is a financial impact from the political problems.

Saleem Khokhar, First Abu Dhabi Bank – I would also say Saudi Arabia. The story is about reforms, such as the Saudization of various segments, which bodes well for the longer-term future of the market. There is also the planned IPO [initial public offering] of Aramco, which is another positive.

I admit that the anti-corruption drive in Saudi took us by surprise, but the resolution has been positive. Short-term, yes, there has been some pain, and the Saudi market reacted quite negatively, but the markets stabilised fairly quickly and, longer term, the government has sent a clear message as to what they are trying to achieve.

One market that’s not mentioned very often is Morocco, which has done well this year. Liquidity is the main issue there. On the negative side, Oman and Bahrain’s fiscal issues are well known.

Jahangir Aka, Neuberger Berman – The other side of it is the debt view. The evolution of debt markets in the region has been great over the last couple of years. The underlying driver is the need for debt, which in itself is not a great situation to be in, but, fundamentally, other than Bahrain and Oman, the countries in the region are in a good place – they still have low debt-to-GDP ratios.

We like Egypt on the debt side as well. It could become a “darling child of the IMF” story. It could head down the path that Ghana did to reform itself. We’re less positive in Bahrain, even on the debt side.

Akhilesh Baveja, Arqaam Capital – I agree with the panel on Egypt. Egypt has a demographic that is very similar to the Asian markets. The only thing which was pending for almost a decade was the currency rationalisation, which has happened, and therefore we are seeing the rationalisation of asset prices in Egypt. Foreign money is coming in.

I’d highlight Saudi Arabia again. It is the largest, most important market in the region and it’s a stock-picker’s paradise. Healthcare is the clearest story. Because the oil price is down, the government has no money to spend on healthcare.

The second most exciting sector would be motor insurance. We are seeing a sea change in the sector because of regulatory changes and compliance has gone up multiple-fold.

Third would be a theme of unorganised to organised. Lots of small businesses in Saudi are indirectly owned by expats. Because of the increasing cost of visa fees, utilities and Saudization, businesses are under pressure, and this has made the unorganised sector uneconomic to compete… [so] we are seeing market gains by the organised sector.

Funds Global – MSCI says it may add Saudi Arabia to its Emerging Markets index next year. What effects would this have on the regional markets?

Baveja – It’s highly likely that FTSE and MSCI want to upgrade Saudi this year, and we’re talking about $12-15 billion of passive flows. Active flows are three to four times that, so we’re talking about $40-60 billion of flows overall.

The Saudi market cap is around $500 billion. Out of that, around 45% is free float, so we are talking about $230 or $240 billion of free float, plus inflows of $40-50 billion. You are going to see 20%-25% of free float change hands from locals to foreigners.

Shamma – It’s a milestone event – something that has been in the making for more than ten years and one that is essential in the development of the region’s capital markets.

I pulled out some numbers on Qatar and UAE, which were added to the emerging markets index in 2013. Since then, we’ve seen almost $11-12 billion of inflows over the past five years. We’ve never had a negative net inflow year in both of these countries since their inclusion.

Gomaa – We have seen encouraging signs that the inclusion will happen, such as Saudi Arabia introducing a T+2 settlement cycle and easing conditions for qualified financial investors from $5 billion to $1 billion. Looking at the Saudi market, it’s mostly retail-driven, and if the MSCI inclusion brings in more institutional investors, that will be good for the market.

There are external political risks, such as the war with Yemen and the war in Syria. There are domestic political issues as well, however I think MBS [Mohammad bin Salman, the crown prince of Saudi Arabia] is doing good stuff by consolidating power and removing corruption from the system. He’s taking from the rich and giving to the poor, allowing women to drive and giving more freedom to the people, so that now they are allowed to attend entertainment and watch football matches. He will receive good support from the commoners vis-à-vis the high-net-worth individuals.

Saudi still has a budget deficit but I think foreign investors will come. It is one of the last untouched territories of the G20.

Khokhar – Focus and attention from global investors is important. People from various parts of the world are going to start honing in on the GCC [Gulf Cooperation Council]. It’s a meaningful step – a 3%-plus index weighting is my guess. We’ve seen precedents. When the UAE and Qatar were upgraded, it had a positive impact on the markets – the same happened with Argentina and Pakistan. All of them went through a sharp increase prior to inclusion.

There will be challenges for other GCC markets because Saudi might draw liquidity away. But generally what tends to happen is that you get a bigger flow into the wider GCC region, not just Saudi.

Aka – There is lots of excitement, and I don’t want to mute that, but on the active side, let’s not forget it’s all about valuations and forward-looking macro views. What we’ve seen in the past is that active flows are not necessarily as dramatic as initially anticipated, because the domestic market runs up, and global managers decide the market is no longer attractively valued. Yes, the Saudi inclusion would be positive for the reputation of the region, but let’s not assume 25% extra flows, because that will depend on a relative value process.

Funds Global – After a seven-month rally, the oil price saw significant volatility in February. What is your outlook for oil in the year ahead?

Khokhar – Global growth seems to be fairly strong and this should translate to robust demand for oil. The supply side of the equation is what’s been hampering things, and that’s because of shale oil producers, US self-sufficiency and changing US regulations. Shale oil producers seem to have come back into control somewhat, with the shale companies being sensible in terms of the way they’re growing their rig counts and their production levels, leveraged players have also been reined in. Providing shale oil producers remain sensible, we have a picture where the Opec plus non-Opec major oil producers are also moving into supply control, and that has worked fairly well over the last year or so. Saudi Arabia will try very hard to keep a positive stance on the oil price, especially if they’re bringing an Aramco IPO to the table.

Gomaa – Shale is the swing producer. The oil price will be decided by the production level of shale, and Opec/non-Opec producers will respond to the volatility of production from the swing producer until global demand is absorbed. Overall, we think the market is approaching balance. Both sides, even the swing producer, are happy with a level of about $60 a barrel. It’s not great, but it’s an OK level for stabilisation.

In addition to that, the political risk might add another $5 to it. Europe has imposed more sanctions in Iran, which should be encouraging for the oil price, and we are waiting for a big event very soon – the US saying if it will continue its agreement with G5 and Iran or not. That might change the oil price.

Shamma – I slightly disagree with Saleem on the sensitivity of shale. It’s a fragmented industry that is commercially driven, so they’ll pump up as much as they can as long as it’s commercially viable for them. I don’t see them stopping. Where I see the difference is that Opec is committed to maintaining or stabilising oil prices. The level of quota compliance has been unprecedented, and it makes a lot of sense for Saudi and the GCC countries to maintain these levels of $60-$70 per barrel, given where they are and how they’re trying to reform their economies. A price of $60-$70 is manageable, especially for Saudi. It’s close to where their budget should break even.

Aka – The reason shale producers became more sensible was that pricing didn’t make it commercially viable to put more rigs online. Lack of investment drove that process.

I’m a little nervous around Opec. As they become a smaller proportion of production, are they really going to apply much power? Maybe this reflects my British connection, but let’s not forget Russia is looking vulnerable at the moment, so let’s see where that plays out in terms of sanctions. Another thing that worries me for this region is we don’t seem to be bringing the break-even point down. In Saudi, we haven’t seen the daily spends come down in a material way. The only reason the deficit has tightened is because oil prices are up.

Baveja – Every year, we consume 5% of the oil reserves. Every year, industry needs to make approximately $300 billion of investment into exploration and production to bring back oil levels. Only national oil companies are investing, not the private sector, which has no funding. This has been happening for the last three years and if it continues, there will be a deficit somewhere, because we are not seeing any demand destruction yet. In fact, demand is going up in Asia and India. There is a long-term bearish trend because of electric vehicles, and the short-term bearish trend because of shale, but in between there’s a scenario developing which could be quite benign for the oil price.

Funds Global – What are your views on the Islamic finance market? Has there been a knock to confidence in this sector due to the dispute over sukuk issued by Dana Gas?

Gomaa – Those events won’t affect Islamic finance on a big scale. We’re tracking Islamic issuance for the last few years and it has doubled from almost $15 billion in 2015 to $30 billion in 2017.

Despite a premium for sukuk over the conventional instruments, we’re still seeing good appetite. In the long term, there is lots of potential for sukuk because project finance will be big in this region, if oil stays at this level. A low interest rate environment also encourages issuers to issue sukuk. Dana Gas will only have a minor effect.

Shamma – In terms of the mudaraba structure, has it come into question? Yes. People now want more legal safeguards, but is it coming at a detriment to the entire industry? If anything, this will help the push for standardisation and a more level playing field.

Khokhar – Dana Gas is a special case. We’ve had successful issuances since the dispute and in the short-term they’ve been taken fairly well. I don’t think it’s knocked the market too far off course, but it has highlighted a desire for more standardised documentation.

Aka – Agreed. It’s a documentation thing, not a structural thing. In any case, Islamic finance is broader than just the GCC. We’ve seen a number of African sovereigns issue sukuk as well. The instrument is getting picked up by other parts of the world, who see it as a way to diversify their investor base.

Funds Global – Do you see greater fund domiciliation within the region, for instance in the DIFC [Dubai International Financial Centre], ADGM [Abu Dhabi Global Market] or Bahrain, or will established jurisdictions such as the Cayman Islands continue to attract business from Middle Eastern fund managers?

Gomaa – We have a sukuk fund which is domiciled out of DIFC, and currently we are launching an equity fund domiciled out of DIFC. One reason we chose DIFC instead of Ucits is that Ucits is getting more complicated because of MiFID II and other regulations. They are making our life hell and increasing the cost of the investment, so we decided to shift from Ucits to DIFC. The competition between DIFC and a cheap jurisdiction like the Cayman Islands will continue, because the regulation there is more loose. I think the DIFC is trying to be something in between the two: they are not very strict like Ucits nor very loose like Cayman.

Bahrain used to be the main financial hub in the region but after the introduction of DIFC, ADGM and the Qatar Financial Market, they lost ground.

Baveja – In terms of DIFC and ADGM, a lot of progress has been made. You are talking about standardisation of regulations across the board. But I would say that Luxembourg and Dublin remain the main centres.

Aka – This is about scale and distribution. Your foreign investor who would potentially want a fund vehicle, wants the Ucits comfort. Your local investor, frankly, is a direct securities selector. One of the challenges is, do you have the scale and reach from these markets in terms of where the client base is? If your investor base is either in Saudi or in foreign markets, what does the DIFC or ADGM give you in terms of access? If you’re marketing a MENA fund in Hong Kong, I’m not sure a DIFC or ADGM fund is going to work.

Gomaa – That’s a good point. One of the disadvantages of domiciling a fund in UAE is distribution, because even after launching the fund, you still have to get approval from Esca [the Emirates Securities and Commodities Authority] to distribute it. I don’t see any need for this step. How can you attract foreign investors to place their funds in DIFC if you still have to do this routine to get your fund approved for distribution from Esca?

Funds Global – What are the main regulatory issues affecting your organisation at the moment?

Gomaa – For a Middle Eastern fund manager, MiFID II is not a big hassle compared to the European-domiciled fund manager, but like I said before, we used to have a fund in Ireland which was a Ucits product and after MiFID II, we decided to go out, because this would have increased our cost by double.

Shamma – Most of our funds are retail-driven funds based in Luxembourg, however our company is based in the Middle East. Our company has taken a comprehensive approach to quantifying and applying MiFID II and we are now compliant. The more important things are the longer-term effects of MiFID II, for instance on the sell side. It’s still in flux.

Khokhar – We’re out of scope when it comes to MiFID II, but again, feedback coming from research providers and our brokers is that it’s impacting their business models quite dramatically, and the question is, how much of our research access continues and how much becomes separated? This is something that we’re watching quite closely.

Aka – Do not always bash the regulator. All those points are valid, but the impact of regulation has been positive on the asset management industry. We have created a deepening private debt market and a speciality finance market as a result of banking regulation, hence created an opportunity in the industry.

Investor education on the tightening of KYC and AML processes continues to be an issue. We spend more and more time talking to client custodians around the need to make sure that we have standard documentation ready for clients to onboard them more effectively.

Baveja – All in agreement, and regulatory convergence is a given. We are not untouched. We have some European clients, so we have to be prepared. It’s better to take it as an opportunity rather than a threat or a hazard.

Funds Global – What are your main objectives this year, both at an industry level and for your organisation?

Shamma – We’ve got several strategies operating on the investment side: frontier strategies, MENA strategies, global sukuk and GCC bonds. We hope to improve or increase these. Also, we’ve got a large sales presence here that’s marketing global products in the region, and we want to promote that.

Gomaa – I hope we see more participation from institutional investors in the MENA region. At the moment, it’s still a retail-driven market. The authorities need to encourage market-maker activity that can introduce more liquidity.

The second point again is investor education. At the moment, we see family offices who have one investment specialist running billions of dollars for them. They still have the mindset of managing their own assets themselves.

Of course, our main aim is to increase our assets by introducing more products.

Khokhar – Diversification. We’ve come through a couple of difficult years, and we’re now at the cusp of something exciting, with Saudi leading the charge. We need diversification not only within the region itself and our own home markets, but also at an organisational level, with diversified funds and portfolios. My firm would like to push more towards the emerging market space, perhaps deeper into global and frontier markets.

Geographically, we sit in a unique region between the east and west. That has the potential to benefit the local asset management industry.

Aka – We define our main objective as “look after client money”. There are a few facets to it. One is increased engagement, the second is client education and the third is innovation. From an engagement perspective, we are focusing on concentrated relationships on the active side with institutional investors. On the education side, we continue to deliver new training programmes, white papers and bespoke stuff for our clients. On innovation, we are creating new strategies and products.

Baveja – From the company perspective: generating returns – that’s the easy answer. But with regards to the industry, our asset class is going mainstream with this upgrade, and this is a sea change. As an industry, we have to bring ourselves up to global standards in terms of regulation, disclosures and practices. We need to attract the foreign flows.

©2018 funds global mena

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