With the MENA region at a tipping point, our panellists talk about economic diversification, the impact of regulation and the delayed Saudi Aramco listing. Chaired by Romil Patel in Dubai.
Saleem Khokhar (executive director – head of equities, First Abu Dhabi Bank)
Glyn Gibbs (regional head of business development – MENA, Apex)
Pierre Mengal (executive director, product management securities services, Africa & Middle East, Standard Chartered Bank)
Fadi Al Said (head of MENA, Lazard Asset Management)
Funds Global – Much of the MENA region has found itself under the international spotlight of late, from Turkey to Iran and Saudi Arabia. Which markets and asset classes have performed well this year?
Glyn Gibbs, Apex – Generally speaking it has not been a great year. In Egypt we have an element of stability in the government, recovery in the currency and a reduction in interest rates, leading to a more conducive investment environment. For those brave enough to step outside of GCC [Gulf Cooperation Council] investment, Egypt has been the market.
Saleem Khokhar, First Abu Dhabi Bank – Equities have performed quite well within the Middle East and North Africa (MENA) region. If you look at the S&P Pan Arab for instance, you are talking about a year-to-date return of about 14%. Saudi Arabia, Qatar and Abu Dhabi have been doing particularly well. Markets that have not done so well – Dubai is down about 17% on a year-to-date basis, with most of that coming from the real estate side of the equation. Equities in the region have done extremely well in a global context, and there is every possibility for that to continue into 2019 and beyond.
Pierre Mengal, Standard Chartered Bank – Egypt has been impacted by the broader emerging market sell-off as a result of the interest rate rise in the US. We have also seen some clients selling some of their Treasury Bills’ inventory due to the interest rate cut by the Central Bank of Egypt. As a result, the Egyptian government has delayed some of its privatisation plans.
Looking at Kuwait, we have seen increased volumes coming from the FTSE emerging market index inclusion. Likewise, some positive momentum was seen in Saudi Arabia with the MSCI emerging markets inclusion. In connection with the MSCI inclusion, there have been some positive reforms in the Saudi market in terms of liberalisation of the QFII [Qualified Foreign Institutional Investors Programme] which has brought additional volumes. Having said that, we have recently seen decreasing volumes from our clients in the Saudi market in line with the broader market trend.
When it comes to the UAE, I agree that Dubai had a lacklustre year. On the other hand, Abu Dhabi’s market has performed better.
From an Islamic banking perspective, Standard Chartered recently launched a Sharia-compliant fund administration to meet some of our clients’ interest in that space. This is also in line with Dubai’s efforts to promote itself as an Islamic financial centre. Although Islamic banking is still relatively small and limited to Malaysia and the UAE, we are confident that there will be a build-up in assets under management coming from that segment.
Lastly, we have seen real estate investment trusts (REITs) picking up in the UAE and that is perhaps because of reduced funding of some real estate companies by the banking sector. Hence, REITs provide another avenue for this sector to raise funding.
Fadi Al Said, Lazard Asset Management – Optically the markets have been doing well. Indices have been up, but if you look at the breadth, the index did not really represent what was really happening in the markets.
The markets this year have really been dominated, very mixed, by the story of inflows, increased foreign ownerships and, as a result, passive inflows which created a lot of dislocation. In the UAE for instance, the market in Dubai which was down 17%-20%, Abu Dhabi was up on the other side 15% or 14%, driven by the fact that two stocks have been receiving significant passive inflows. So, it shows you the kind of dislocation within the same country in terms of performance.
The index is up 12%-13%, but it is a very biased sample towards a basket that received a lot of inflows. It is heavily skewed towards large-caps, so in terms of representation it represents around 15%-20% of the market. If we look at the median and the mean of the performance of the market, it is down around 9%. Funnily enough, 90% or 80% of the companies are down on average 9%, while the benchmark names are up 20%-30%.
It has been a very challenging year especially for stock-pickers. Markets have, in my opinion, created this kind of liability for the future. Unfortunately, for long-term investors, usually you like to have sustainability, you do not want to have a short-term party that ends up in a very lousy after-party. We see what is happening in the market is creating a major dislocation between this MSCI basket or large-cap basket and the rest of the market.
Funds Global – Listed markets have been under pressure from private markets because people in the West have been chasing yield. Is there the same pressure here for private markets business, or are the stock markets holding their own at present?
Khokhar – We run a number of dividend-themed funds, so we are aware of the pressure that is coming in terms of lifting the yield, and even in our fixed income funds and sukuk funds where historically people were comfortable with that 4%-5% sort of range.
The end customer, whether institutional or retail, is demanding a higher yield, and that comes back to the environment we find ourselves in, which is a rising interest rate environment.
In terms of the yield that is being demanded, I am certainly feeling the pressure on that, and that sort of thing will be addressed going forward.
Funds Global – With rising oil prices, do you expect to see a slowdown in economic diversification efforts in the Gulf, as with so often in the past?
Al Said – Unfortunately, reforms usually come at times of distress. But the diversification efforts need to be launched and needed to be done yesterday.
We have been exposed to a major oil shock – and seen the repercussions of that. As economies we are heavily reliant on government spending and government agendas, and in terms of these ambitious plans we need to grow the private sector and focus on diversification. Unfortunately we have seen this kind of correlation where we have seen this increase in price with more reserves being built, the government in a better fiscal position, and we have seen the reforms have been in a way pushed [aside].
I hope that these are more structural reforms that are needed to be done regardless of the situation. No one wants to push major structural changes when things are volatile, but I am sensing this is something strategic, it is something that needs to be done regardless of the situation. The best way to do it is when things are good, because it gives you the ability to push certain changes without disrupting the balance or the social structure.
Gibbs – We are at a tipping point. The memory of $30 oil is still fresh amongst the leaders within the GCC economies and they are aware of the implications for oil prices if we are to wean the Earth away from being big oil consumers. With the discussion around the fourth industrial revolution, clean technologies, green technologies, there is a growing recognition from Gulf nations that they need to take action now.
We saw it with the 2030 initiative from Saudi Arabia, they have taken a number of measures there to move away from the public sector and try and move things into the private sector. Despite the political situation, I do not think that initiative will change, although it may slow a little bit, but the momentum is there and there is recognition that people will do it. So, succinctly, yes, we are going to see a change now.
Mengal – Lower price would not necessarily favour reforms either, so having a higher oil price may slow things down on certain initiatives that were driven specifically by the earlier distressed environment. We do not believe that governments will be backtracking on their reform agenda. It is more of a structural change that is on the cards across several countries in the region. A higher oil price may allow them to also adopt social measures to accompany their efforts towards economic diversification.
Khokhar – With the oil price likely to be stable over the next couple of years, it gives a window of opportunity to affect these reforms as such, because it makes it easier if you are in a slightly more comfortable position to tackle the mechanisms for the reforms and change.
We are now EM (emerging market)economies, and stability comes from diversification of the revenue stream, so to speak.
The introduction of value added tax (VAT) provides a level of income to the governments that they can spend over a period of time, and if that is spent in the correct manner, and I think it will be, then it is a source of revenue to be pushing through the reforms and the changes that are required in the real underlying economy. I do not think there’s going to be any backtracking at all in this space, regardless of where the oil price goes.
Funds Global – Which regulations are affecting you the most?
Al Said – Two things I would say is denying us participation in some of the opportunities is the initial public offering (IPO) market and some of the markets or jurisdictions which still are under very old regulation of the pre-funding IPOs.
For best international practices, for us for instance, we would never be able to participate in a pre-funded IPO because you are taking counterparty risk with our clients’ money. So, in a way we were denied participating in some of the IPOs in Kuwait, Bahrain, where you are required to pre-fund an IPO just without any contractual safekeeping for us.
On a broader basis, we have a lot of conflict between jurisdictions in the Middle East. There is a lack of clarity on some jurisdictions and your role in being part of a regional player, whether in the Dubai International Finance Centre (DIFC), whether in Saudi, what can you do in Saudi, what can you do onshore and offshore.
If we are keen on just putting this region as a financial centre, or Dubai or Saudi, the regulations need to be flexible, inclusive and unified, or at least complement rather than conflict with one another.
Gibbs – I have to applaud the regulators in the region from a financial regulatory perspective because they are trying to encourage change. You can see it primarily in Saudi Arabia with the move to the externalisation of custody and moving that function away from APs (asset managers), there is likely to be more new regulation that is going to come through next year. So, from an administrative perspective, we see a lot more opportunity in Saudi Arabia than ever before.
I then look at the UAE. The Abu Dhabi Global Market (ADGM), announced earlier this year its digital asset regulatory framework to try and encourage the digital asset community and exchanges to locate there. The Dubai Financial Services Authority (DFSA) is talking about the changes they are making, e.g. removing the minimum number of investors in fund structures. All of this leads to a greater business opportunity for us as service providers because it is encouraging more asset managers to establish businesses and launch more funds from the region, so we are happy about that.
On the flipside, yes we see the ripples coming from the GDPR regulation coming from Europe, which has caused us to make a number of changes and has been quite a big project for the compliance teams of asset managers and service support providers to deal with across the world.
Mengal – Most of the regulatory burden has come more from the US and Europe than from this region.
We have seen the Saudi regulators being more open, more responsive. We have, for example, seen the liberalisation of the rules around the QFII status, whereas traditionally investors would access the market via swaps. The liberalisation of the QFII creates opportunities for us as a custodian and as a fund administrator. Similarly, the recent Independent Custody Model, which allows to safekeep assets with a custodian, previously held with brokers, opens the door to opportunities for our Securities Services business.
There may be a tendency for some regulators in the region to confuse the role of a clearing institution on an exchange with the role of a custodian. Some countries have been trying to hold custodians responsible for the clearing activity performed by brokers, which would result in increased financial participation to guarantee funds by the custodian community.
There are also some discussions in Qatar about potentially changing the trading and custody account structure at the central securities depositary level. We are closely monitoring this development and investors’ protection remains our main focus in those discussions.
Funds Global – The UN warned that we have just 12 years to curb climate change. What can the funds industry in this region do to make a positive impact, and what are the challenges?
Al Said – We are a very conscious house when it comes to environmental and social governance (ESG). The problem is that we do not have a reliable independent third party that can give us any data for us to judge whether a company is doing a great job or a bad job when it comes to environmental issues. We have also a lot of clients who are very conscious about that, and they want us to include that in our process when we meet the companies and when they have made an effort to try to make them disclose. Unfortunately, the companies are usually very politically right when it comes to disclosures about environment, and that is why we require bodies or third-party bodies who can give you this.
If there is something that we can rely on, this could be something that would stop us from investing in a company, because we believe everyone has a duty towards society and to other stakeholders. It is not only about making money, you have to optimise your profits, not maximise your profits, in a way that is sustainable with society.
Mengal – The biggest impact we have is through the businesses we finance. By providing finance efficiently and responsibly, we generate value for our shareholders while creating value more broadly for the society.
The emerging markets need reliable and accessible energy to support economic growth and this needs to be balanced by mitigating the environmental impacts of power generation and consistent with the Paris agreement on climate change.
We will introduce over time new assessment criteria relating to climate risks for our energy industry clients, in order to promote alignment with a 1.5 degrees climate scenario.
Khokhar – This is an area which is definitely gaining pace in terms of importance. There is a lot of strategy that is focusing on this area [ESG] and a lot of platforms that are out there in terms of being able to assess whether a company is ticking the right boxes in this space. There are a few that have been launched out in Dubai, and there are all the investment platforms as well, screens which are there which you can actually pull up fairly easily to see what efforts are being made by companies and how those are progressing.
Gibbs – People have increasingly become aware of this as a pressing issue and it is only going to increase going forward. At the end of the day, industry reacts to the demands placed on it, so the companies reacting to the demands that investment managers are making on them in terms of clarity, information-sharing and having specific policies can only be a positive. Over time we are going to see this evolving.
An element of regulation may be required to just increase that pace of change. I am referring to audited financial statements, annual reports having to have specific sections which reference what the company is doing, the actions taken and the key metrics.
Funds Global – Saudi Arabia is under intense international scrutiny after a spate of high-profile incidents. Do you expect this to have an impact on investments, particularly if new developments come to light or any fallout deepens?
Al Said – We look at it as part of the fact that the region is known to have a lot of political risks, every year we have multiple issues and it is coming from different parts of the region.
From our perspective, we focus on businesses we invest in and we always take into consideration the political volatility – the potential political volatility and the current political volatility, our required return, and we price our investments accordingly. From our approach nothing is going to impact what we are doing, how we do it, because it takes into consideration not any specific event, but always the potential of events happening, whether in Saudi or other places. The geopolitical risks are in the DNA of this region, and if you think you are in this part of the world doing business expecting an easy ride and no headlines, you are either going to be disappointed, or have a significantly lower required return which might result in losing money.
Funds Global – A number of personalities avoided Davos in the Desert to avoid publicity, but many of their companies were still there, and so it was trying to take the heat out and saying: ‘business in Saudi still goes along and you adjust and look at pricing in the market accordingly.’
Gibbs – That is absolutely correct because strategic investment decisions are made over a long period, and once they are made, they are followed through over a period of time. If you take the big banks, HSBC for example in Saudi have just gone through a major merger with a large institution, increasing its exposure and investment in Saudi Arabia, Citi is increasing investment there, as I am sure Standard Chartered, JP Morgan, Northern Trust and others are.
These decisions were taken two years ago, and they are now being implemented. They will not be paused immediately, but I agree that when a serious geopolitical event occurs, you may not want your chief executive attending such a high-profile event.
Institutions that have already made the decision to invest in Saudi will do so and that investment process will continue. Maybe some who were about to make a decision might defer it for a short period.
Mengal – We have seen it drop a bit in volumes and assets in Saudi Arabia from our clients, but we believe that the structural changes envisioned by Saudi Arabia and laid out in Vision 2030 will be taking place. Not being in Saudi in the Middle East is like being in Asia without being in China, so I think it is still central to most of our clients’ plans and I do not think it will change in the long term.
Funds Global – The Saudi Aramco flotation has been pushed back with no fixed date. What are your expectations for the listing of the state oil company, and where do you think Riyadh could find this type of funding if the IPO does not go through for its economic diversification efforts?
Gibbs – Well, the kingdom has been given breathing space by rising oil prices, so to go from $30 to $80, and now $65, has removed the urgent need to find the financial resources. Thus we may see it deferred even beyond 2019. It is a big thing for external investors to be allowed to invest in Aramco, so, given recent events, maybe that will be something that will just move a bit further forward.
Mengal – The rise in oil prices has eased pressure on policy-makers. The authorities recently said that the long-awaited Saudi Aramco IPO had been put on hold. Markets had seen the IPO as central to plans to transform the Public Investment Fund (PIF) into a sovereign wealth fund. Policy-makers now appear to be working on plans to raise debt to substitute for the FX proceeds that would have been raised from the IPO.
There are also other companies that could maybe be privatised first and to set the pattern for the privatisation, as opposed to starting with Aramco.
Al Said – If you look at the transformation plan of Saudi Arabia, the IPO of Aramco is instrumentally important because its proceeds are supposed to be used to seed the initiative of the sovereign wealth fund, and that is vital. It is something important that should not be correlated with oil prices.
There are two main complexities: the first is a company of this size needs to be listed on an international market and that requires certain levels of openness. It is not an easy job to transfer a company overnight, or even in one or two years, from such a structure to an open structure. There are specific requirements of disclosures and identifying certain things that we need time to structure properly to meet these requirements.
Funds Global – Looking ahead to the next 12 months, are you optimistic or pessimistic about the asset management industry’s prospects in the MENA region? Where do you expect the biggest challenges to come from?
Khokhar – I genuinely am optimistic on the region. The focus has to be on growth and if the reforms continue, the growth push continues. There are really good valuations in many parts of our region which can be taken advantage of – the UAE is a prime example of that. The emerging market status that we have gained for much of the region is very positive in terms of the changes that we have seen across our systems and regulation.
The challenge is to increase and maintain the consumer demand levels. That has slowed a little bit given the oil prices and slightly weaker growth rates in the last couple of years.
Gibbs – The first answer is I am pessimistic because we are hooked to the global caravan, and what happens in the trade war that may or may not occur between China and the US, what happens with Brexit, the interest rate environment and elements elsewhere in the world will have a ripple effect into this region. There are so many uncertainties that you do worry one is actually going to be quite bad.
If we temporarily disconnect ourselves from the global caravan, then I am optimistic in the sense that I think next year we will see a stabilisation in, for example, the Dubai real estate market, which will provide a more solid grounding for markets to actually rise. I am an optimist concerning Saudi Arabia and the changes taking place, and I think we will get through the current turbulence. There is going to be positive momentum there, but the big caveat is what is happening in the big, wide world.
Mengal – I am cautiously optimistic. We just mentioned the US-China trade war, Brexit, the interest rate environment.
Standard Chartered’s expectation on the interest rate is that there is going to be a monetary tightening in this part of the world in sync with the US trend, which may be a bit counter-cyclical for the Middle East. We still believe that there will be no backtracking on the reform agenda.
On the custody and fund administration side, if the privatisation movement is happening, it will generate investment flows out of the region, creating opportunities for us in the cash management, custody and FX space. At the same time, additional listings on the various stock exchanges will also create local custody, FX and cash management opportunities in our Middle East footprint markets.
Al Said – Talking about the MENA asset management industry, there are some specific themes and trends that are very interesting. A lot of institutional allocators are finding it tough to allocate money to the region through what I would call the institutional managers space, because they are at capacity or close to capacity.
Consolidation is also a theme, so some of the boutique managers are being acquired by the bigger names and this could be something to watch.
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