ROUNDTABLE: Back of house (part 2)

As asset management plays an ever greater role in the Gulf states, asset servicers discuss the evolution of operational and regulatory processes. (part 2)

mena roundtable 2

Craig Roberts (CEO, Apex Fund Services)
Andrew Polley (senior executive officer, RBC Dexia)
James Martinson (senior vice president, Maples Finance)
Richard Street (director, head of Middle East securities and fund services, Citi)
Glyn Gibbs (head of business development, HSBC Securities Services Mena)

Funds Global: What kind of funds are pushed out to the market? Are they predominantly Gulf equity funds or are there more complex products? Will ETFs pick up in this region?

Martinson: When we’re talking about institutional or high-net-worths, infrastructure is expected to remain one of the key areas. Investors from outside the region are getting more comfortable with products offered from here, and at the same time investors in the region are getting more comfortable with investing outside the region. I think we’ve now seen a definite increase in interest for investing in China and India, investing outward from this region. But I think it’s very diverse and it’s very difficult to generalise.

Gibbs: I certainly think large private investors are beginning to turn from just looking at this region.  From the conversations that we have now, there’s a far greater number of them that revolve around emerging markets in general. If you look at what’s happening in Europe, or even the US to a slightly lesser degree, it’s not necessarily an attractive place to put your money. Investors are looking for returns, so they’re looking at perhaps Asia as emerging markets, or even Latin America for the bolder investors.

Looking at sovereign wealth funds and where they are seeking exposure, strategically again it’s from anywhere that is developed. You can see that through what Qatar Holdings has done in Brazil, for example, and the deals that some of the UAE funds have been doing. I think you also go through trends of fashion.

Real estate is popular because of the opportunities thrown up by the dislocation in the property markets here in this region, and certainly a lot more inquiries are starting to come through for those. We see a lot more cash-type products through the private banking arms of institutions looking to generate yield for their investors, and similarly private equity because of the investment opportunities that are here. It is becoming an asset class within this region in a bigger way than it ever has done in the past.

A comment I’ve heard is that people see much more opportunity in that area because with credit availability being restricted or much reduced, many family firms or private firms have had the same ability to finance all their plans, and therefore have to consider whether they keep the family silver that’s been generating a good return for the past 20 years, or do they actually cash in that investment to invest in another project that will generate double the return? So there may well be two assets that are coming onto the market for private investment that previously weren’t available.

Polley: My general view of real estate funds is actually reflective of what the retail investors see or do.

Most of the transactions on the local stock markets are dictated by retail activity through their brokerage accounts, and one of the things that we’d like to see is obviously more of that activity moving to the funds area, and I see something very similar in real estate.

When I talk to potential clients here they’re all buying real estate directly, either doing it through their advisors in London, or local real estate agents, and it’s never entered their mind that maybe they should have a real estate fund. I think they just like the touch and feel of buying and owning directly. It’s the nature of the beast here that people who have a decent amount of money – and I’m not talking the mega-high-net-worth – but people who have a good level of savings, actually just like to buy things directly.

Martinson: I think it’s quite true that in the region investors are inclined to invest in things that are tangible, things that they are accustomed to and things that they can see and touch. As investors are becoming more comfortable with the funds structure or a collective investment vehicle, we have seen quite an interest again recently in property funds and, as I said earlier, infrastructure. But investors are still very reluctant to look at funds that invest in financial instruments that are somewhat foreign in nature.

Funds Global: And do you think that’s because traditionally they’ve invested in property, so there was no need for them to invest in funds?

Roberts: Regional investors have a characteristic of wanting to invest in something tangible. They see it as prudent. Traditionally there is a background of trading, the region has evolved from a trading community. The range of funds that have been available to them has been relatively small, particularly over the last five to ten-year period, so it’s all a relatively new thing for them and they have to develop their trust. As soon as you start seeing fees attached to someone making the same decision that they think they can make, they think why should they pay for it? It’s a new thing for them, so it’s going to take time. Mutual funds in the US have a long-established history, but it took a little bit of time for them to really develop.

Street: Historically there’s been a huge movement of hot money. Hedge funds have been in vogue, but if they stop returning and if the local markets are returning higher than hedge funds, then investors’ money moves into the local markets.

Money is constantly moving to the next good thing. This has been particularly true in the local markets, which are still dominated by retail investors. But it will be the institutional investors that will drive market maturity, and I think over time that will result in more benefits to the private investor.

In all of the mature markets around the world there’s plenty of people who will invest in the markets themselves rather than through a vehicle. The higher their wealth the more likely it is that they’re going to go direct. But as you see greater institutional activity in the Middle East coming from international investors, and critically the pension and sovereign funds within the region which are beginning to take a medium and longer term view on portfolio investments into the region, we will see the maturing of these markets.

There’s nothing to say there’s anything wrong with these markets today, this is how they operate, these markets evolve for the reasons that they’ve evolved, but I think that we will stop experiencing the extreme volatility when enough professional investors coming in with true value-based management techniques, which means you’re not going to get an emotive falling off a cliff at certain points in the year.

I know we’ve had extraordinary markets over the last two years, not just here, across the entire planet, but I think there is value in a lot of the stocks here that sometimes gets eroded through pure retail reaction, or just the movement of hot money. For example, the volumes on the markets over the last couple of weeks have been very, very light and this time a year ago the volumes were much higher.

Funds Global: Do you treat the market – the local investors and international investors – as one in your asset service offering?

Street: We all have building blocks which we deliver in different combinations to different types of clients, and it depends which building blocks you happen to have. At Citi we’re developing more building blocks at the local custody level as quickly as we can, and then we glue that together with our investor services capability… In some instances we’ll insist on doing these functions ourselves; in other instances we’ll partner with other people to deliver that service if we need to have more of a local touch.

But you have to take bets on certain markets. Bahrain is a very mature environment and is onshore, whereas DIFC [Dubai] is a very good regulatory environment but doesn’t have the level of funds activity that even Bahrain has.  Qatar’s the same. The onshore domiciles in UAE, Kuwait and Saudi have fund regulation but it may not be recognisable to a Western investor.

Funds Global: Obviously the different regions have their own identity and there’s a competition element between them. But is there more cooperation?

Gibbs: I think that in the UAE, between Abu Dhabi and Dubai, there is some cooperation, but otherwise no.

Funds Global: How likely is a common currency?

Gibbs: I think because fixed exchange rates have come down, you’ve almost got a quasi-common currency already in place. But even with the common currency initiative you already have two GCC [Gulf Cooperation Countries] countries that aren’t participating at this moment in time.

People want to establish their own centres because that’s what attracts employment. If, just for argument’s sake, Oman gave up its exchange and merged into the UAE, all jobs probably would then come here to the UAE, so it would be a big loss to the Omani economy. From their perspective they wouldn’t really get very much out of that particular proposition. Does it makes sense for them to come together to have GCC-wide fund passports? Of course it does because it makes it that much easier for distributors across the region to get funds with a much greater scale than what we’re seeing at the moment.

Martinson: Each region is trying to develop its own financial centre but we have seen a little bit of pragmatism in trying to establish closer connections and working with each other. This can be seen in the number of memorandums of understanding that they’ve entered into. So we are seeing that they are taking a much more logical approach to the asset management industry and corporate governance generally.

The DIFC and the DFSA have worked on their new funds regime. Similarly, the central bank of the UAE is working on entering into memorandums of understanding in terms of anti-money laundering and counter-terrorist financing. These are all positive, proactive developments.

Roberts: While the establishment of regional centres may seem to be competitive and disruptive, if the standards do rise and lead to the centre sending out a greater level of acceptance in terms of its passport, this would be welcomed. For example, right now the DIFC does not accept a Saudi fund to be distributed into the  DIFC. But if the Saudi centre raised their standard procedure and regulations, then the other half a dozen centres would possibly develop in the same way.

Funds Global: Presumably the European firms looking to set up here would want that passporting ability?

Roberts: Yes, it’s no good setting up a fund here that you can only distribute in one specific place and you can’t try and attract different parts of the market. The market has to be seen as one, not just Saudi or a UAE concentration.

Polley: They are trying to create finance industries within their countries in exactly the same way that Dublin and Luxembourg did. I’d say that it is a core revenue area, so regulation is not driving it; it’s the economics of the individual country that’s driving that. Saudi is almost unique in that it has a large domestic financial services fund management industry it would like to protect. I don’t think it wants to open it out to the world as quickly as, maybe, UAE or Qatar do. They don’t really have a big financial industry of scale to protect, and they actually want to draw in international activity.

Gibbs: Each centre will try and assess what benefits to bring. If you look at the European Union, prior to Ucits being established, you had 15 individual different countries each with their own regulation, so it’s hardly surprising that the Gulf countries haven’t yet got that far in the development of the market, and nor do you see it really in Asia where everything is still individual, although they have brought a lot of Ucits-type regulations in.

Street: It’s going to be very interesting. Yes, I agree that Tadawul [the Saudi exchange] is a significantly larger exchange than anything else in the region, but I equally understand why each of the countries wants to have its own exchange and will continue with its own exchange. I think that there’s a chance that there’ll be some sort of merger in some future time around the clearing and the back end, provided the countries get together and talk it through appropriately.

I think things like the single currency might help to drive that. But for the time being I think you’ve got to assume it is going to go it alone.
All of them are looking to add more instruments and according to the press recently, the Kuwaitis are now ready to start privatising. International exchanges like Nasdaq Dubai are looking to put more derivatives on there to attract the bigger markets within the region, like Egypt. All of the exchanges you’ll talk to are talking about ETFs, every single one of them, and that’s an appropriate thing to be talking about.

All of them are talking about stock borrowing and lending, short selling, and moving into the derivatives environment.

These are healthy and normal things to talk about, but what’s really going to change those markets is when the state starts privatising things and listing them on local markets. This is especially important for an exchange like Bahrain. Like many of these exchanges, it has a fantastic set-up. They just need to see more flow through that capital market.

They need to attract it initially from their domestic draw and they won’t have any problems doing that. But will there be cross listing? We have dual listing of some securities now, but I don’t see the primary listings of Saudi entities in Bahrain, so my guess is that it’s going to be around the privatisation story. This has been put on the back burner for the last few years because of the financial crisis, but if that starts to speed up I think that will help to drive these markets, like it did in Europe.

The world expects these markets to mature and to quickly arrive at Asian or even European standards – but it has taken tens of years for those markets to get to their current state of maturity. We should not forget that, and given the relatively early stage we are at, we have very mature regional markets.

The regional markets don’t make decisions quickly, they consider everything very carefully before implementing change. In terms of the equities markets, each country has its own quirks and different systems, but fundamentally they’ve got the same structural building blocks in each of them. We are representing institutional investors so we are keen to push the market into more of an institutional environment, a move to deliver versus payment and a nominee – all the things that we see as the natural evolution. But it takes time to get to that point.

Funds Global: How open are the regulators to sitting down and talking about driving change? How willing are they to listen to the large global players in terms of making small changes?

Street: The only way you can measure success of negotiation is if anything is actually implemented. Certainly, like anything in this part of the world you don’t do it in the first meeting. It takes time to build trust; it’s exactly the same as all the other things we’ve said, it’s a consensus of opinion and then it’s the process, and it’s their process.

The Kuwaiti market, with government changes they’ve seen over the last three years, makes it a little bit more difficult, but we will sit and lobby in conjunction with our partners and competitors to make sure we put our thoughts forward. How quickly they deliver depends on the infrastructure, so I’m very excited in Kuwait about the idea that an SEC is going to be put in place. That should help modernise all of these things. They’ve got clear direction, they’ve taken consultation from very professional people and they’ve put it into a law. Now they mean to take that law and put it into practice, and that’s really where the practitioners come in – on the lobbying side.

Funds Global: Do locally based managers that you provide services for have aspirations to be international players? Or are they happy to stay within the Mena market?

Street: I haven’t seen that sort of grand ambition but I think that all of them would have it in the back of their mind.

Polley: I think they want to sell their product, but if you’re just talking about the fund managers I think they’ve realised what their specialisation is – they know this territory and they are happy to sell that expertise to the outside world and to be a Mena sub-advisor if applicable. They certainly aren’t looking currently to have established operations in other international markets.

Martinson: We’ve found that a lot of the regional players are partnering with international players and forming joint ventures. This way they gain exposure and get their names out there for more international-based work, but they are still within their comfort zone in the region.

Funds Global: How do you see the market developing over the next few years? Does the future look steady and stable? Or is there anything that could disrupt future progress in the region?

Roberts: Well you’ve got things like the European Union’s Alternative Investment Fund Management (AIFM) Directive and similar US proposals that could disrupt the whole funds industry globally. So it’s difficult to say how regional managers are going to be able to adapt to this uncertain climate because we don’t know what the new rules are. And obviously the markets need to mature. Privatisation will play a big role as will other operational aspects that are developing. These are all going to be key drivers but they’re going to take time.

Polley: In my personal view, the way that Europe has evolved is that there are two big fund administration centres in Dublin and Luxembourg. There is not room or scale to have three separate financial centres unless each of them specialise in their own way, so in the future there will be one location in the Gulf which will be a specialist fund administration centre. Now there happens to be three that are vying for it, but in ten years time there will just be one centre that will really have the scale and the regulation and the people to actually be successful, and the other two will find their own niche. This is sort of happening in Doha now where the Qatar authorities are reshaping their strategy and are focusing on very specific areas. Essentially there is not enough business in the Mena region for all countries to be involved in everything.

Funds Global: Is it inevitable that there will be consolidation further down the line, whether of fund administration centres or exchanges? In seven or eight years’ time will we see one exchange used as the gateway to the Middle East?

Street: In my personal view, I think that you can see them like flag carrying airlines. I think they would be loss-leading for a long while before you see consolidation. By country I think in spite of whatever’s mentioned, there’s still a lot of upside to a consolidation within the UAE specifically. There are some associations developing between say the DFM in Dubai and the ADX in Abu Dhabi. Whether that formulates into something concrete remains to be seen but I think everyone will benefit from the UAE acting as one market.

Gibbs: There are some very deep pockets in this region.

Street: Yes, that’s exactly right, they can, if they choose, keep going for a long time without making money.

Roberts: And it may not be a formal consolidation process but it may be just a bank or a financial centre stepping back and realigning its objectives, or maybe one or two centres consolidating without being competitive about it.

Street: I think that what could potentially derail the Mena region’s development from the perspective of the regional markets is if corporate governance and transparency isn’t implemented as planned. I think that a fraud case or a major implosion in a listed corporate entity where investors from within the region or beyond the region get burnt would be very disruptive to this industry. So I applaud and encourage all of the work that’s been done on the corporate governance side, such as the restricting or temporary blocking of securities which haven’t filed their financials on time. All of those things drive this to be a much more transparent market and help underpin the actual building blocks of this industry here.

These corporate governance measures are taken as read in most markets. This is just part of the evolution process, so it’s important to make sure there are no issues around that and then the confidence will come. If there are no failures, then I think what will happen in a few years is that some of these specialist players in the asset management field will start to get snapped up like they were in Asia and Europe. They will become part of a bigger fund house, as a joint venture to start with maybe, then a full takeover, and I think then you’ll start to see more and more of the international asset management organisations on the ground here, not just distributing but managing money, having acquired expert local teams. But I think that time horizon is very much in the medium term.

Gibbs: The key to improving everything, generating scale and persuading local investors to invest in funds, is education.

Roberts: Obviously the developments between different financial centres and the very healthy market competition between them all are all driven by economics. The upside for the industry is that we’re gaining a lot of ground on corporate governance; the different centres are accepting more standardised regulations because they need to compete with each other as the domicile of choice or the centre of choice.

©2010 funds global

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