Is the pattern towards more regulated structures playing out in the Mena region as it is elsewhere? The panel considers this and other topics, such as developments in the safekeeping of assets. Chaired by George Mitton.
Nicolas Angio, managing director, Apex Fund Services (Dubai)
Tarek Elrefai, head of global client management, Middle East & Africa, BNY Mellon Asset Servicing
Shikkoh Malik, regional head of products, investors and intermediaries, Standard Chartered Bank
Rod Ringrow, senior executive officer, State Street Mena
Richard Street, managing director, securities and fund services head, Middle East, Citi
Funds Global: There has been increasing demand for European Ucits-regulated products in preference to unregulated products from locations such as the Cayman Islands. Is this still the case or has investor demand changed?
Richard Street, Middle East Citi: Ucits products are distributed effectively across the world and are attractive for that reason. Most asset management in the Middle East is institutional, not retail. There is a place for Ucits funds, but also a place for Cayman funds. It comes down to what the asset class within the actual fund is and how attractive it is to the particular distributor. Firms pushing retail products will seek products that work on retail networks.
Rod Ringrow, State Street Mena: Luxembourg and Dublin funds have become more attractive to sophisticated investors, while the industry here has tried to move from a purely regional focus and into the international space. I think demand for Luxembourg and Dublin Ucits structures will increase and very large local players will be able to take advantage of that with structures set up in both jurisdictions.
Tarek Elrefai, BNY Mellon: With current oil prices the GCC [Gulf Co-operation Council] and Saudi Arabia have the muscles to grow. Spending domestically will filter all the way down to retail, which would be good for investors and for financial institutional investments and sovereign wealth funds, too. Countries within the GCC have very ambitious projects and plans to spend hundreds and hundreds of billions domestically.
Shikkoh Malik, Standard Chartered Bank: Ucits products have two elements: protection for investors; and liberty of distribution and product registration. In the Mena [Middle East and North Africa] region, do investors really look at those two elements? Less sophisticated investors do not look for that level of protection. In Mena, it is the more sophisticated investors, like sovereign wealth funds, that use Ucits structures.
Nicolas Angio, Apex Fund Services: I agree. When an investment manager sets up a new investment product, the best-case scenario is a product that has no boundaries as to where it can be marketed. Ucits is desirable because it is the product that is the closest to that ideal. But when investment managers look at costs of Ucits compared with Cayman products, they frequently and increasingly opt for a middle ground – a European product, but one that is less regulated than a Ucits.
Historically, in the Middle East, Cayman was, and still is to a certain extent, the first choice of investment managers, but today they are setting up a lot of funds in Europe, especially in the less regulated space such as Luxembourg SIF Sicavs or Sicars for private equity structures. However, when liquidity returns to the Middle East and assets under management pick up, I think we will see investment managers graduate to Ucits as the next step in the product chain.
Funds Global: Do local investors have a preference for products that are registered locally over international products?
Elrefai: It’s difficult to generalise. We see different behaviour in Saudi Arabia than in the United Arab Emirates (UAE). Qatar, for example, is active in locally and non-locally registered products. The Saudi retail market also looks at both.
Malik: People have no real confidence in or appetite for funds. This is because these funds in turn invest in assets within the Middle East itself. If people already have direct access to these markets then they prefer investing directly themselves instead of routing it through fund structures.
But for sophisticated institutional investors, as fund structures go offshore, so do their investments. For example, there is no real debt market in this region so investors and companies wanting to raise money are tapping international markets.
Angio: Sophisticated investors are used to investing into funds that are domiciled elsewhere and are quite happy with the framework and the controls that are there. I wouldn’t see that changing and I can’t see many high-net-worth individuals or institutions investing substantial sums into locally domiciled products. It will remain for quite a long time a game played just for international funds that are established elsewhere than here.
Elrefai: It is difficult for cross-border investors to invest in funds registered abroad if there is not the right legal infrastructure to protect them, and that is the case at present.
Funds Global: There has been much talk about securities lending, exchange-traded funds (ETFs) and over-the-counter derivatives coming to the Mena region. Is the region’s infrastructure ready and how do you think regulators feel?
Malik: In terms of trading platforms, yes. But for the day-to-day handling of those products, no. The regulatory framework is not ready, meaning day-to-day procedures cannot be designed by the market infrastructure companies and the market players themselves. There is a lot of talk about it, but in terms of real action, apart from UAE, and to a certain extent Qatar, we’ve not seen real tangible moves in terms of markets and regulatory authorities preparing themselves for these specific products.
Street: Let’s look at the three products mentioned. The first ETF was actually launched in Saudi Arabia about two years ago, though it was not a runaway success. Quick on its heels came one in Abu Dhabi.
Securities lending is here, but it is not about speculative securities lending to support short-selling like we know in Western markets. I don’t see regulators allowing this for some time. Here it is about having a fails coverage programme to support the newly implemented DVP [delivery versus payment] model to make sure there’s an avenue to settle those transactions.
Derivatives on the onshore markets are a still some way off. NASDAQ Dubai is well placed to move into an exchange-traded derivatives environment and has some contracts up and running but volumes are still limited.
Ringrow: The problem is that these are developed market products, but markets in this region have been developing for just ten to 15 years, hence the imbalance.
Angio: An ETF has to be a certain size for it to make sense, so although the idea of having ETFs listed in London that track the stock markets in the GCC or Mena is interesting, the ETFs probably won’t have more than $100 million, and no one is going to make money off of that. I think the time will come but we are not there yet.
Elrefai: I agree. The market is not deep enough and I see family business as an obstacle. If they are growing they do not see the need to float. They would rather keep the business for their children. This concept really needs a generation or two to evolve. Because the market is young and the country is young, the older generation which established these companies, or the first generation who picked up the company, are still in control.
Until we see the generation that received a Western education come back to run businesses and take control, then we will not have deep capital market.
Ringrow: The single biggest bright spot on the horizon is the QFII [qualified foreign institutional investor] route in Saudi Arabia. It’s been much talked about and various dates have been put forward for its launch. It would be a catalyst event for the whole region if
the Saudi market is able to leapfrog frontier market status to emerging market status.
Street: I’m hopeful Saudi Arabia will be a 2012 event. They don’t need foreign investors right now as there is enough liquidity in the market, so it’s worth them getting this right for everybody.
Funds Global: In the past, brokers have often provided custody for clients. However, the Emirates Securities and Commodities Authority (Esca) has required the use of independent third-party custodians. How has this been received at the market level? Is there a need for education?
Malik: We need to segregate markets but there is definitely a need for investor education. Investors need to understand why custody is required. Esca bought into this idea some time back, that ring-fencing assets brings an element of protection for investors.
Traditionally, investors in the region have always entrusted their investments with brokers who they know on a personal and professional level.
Due to this historic business culture, it is difficult for domestic investors to adapt to an idea that could cost them more and would mitigate a risk that, to a certain extent, is not recognised as that high a risk by them.
So would introducing custody bring additional cost to the investor base? If the answer is yes, then there is an issue with it, especially if the investor base is 80% retail.
This service would be hard to sell as it adds to the costs incurred by investors and reduces their returns.
Ringrow: When you’re used to getting something for free, it’s hard to then have to pay for it. This relates directly to investor education and being able to understand the whole asset management process, such as clearing and settlement.
Street: But there’s also market structure. The depository function within the market is considered by many investors to be the de facto custodian. Also, people understand the word ‘custody’ differently depending on the market you’re in. A lot of people believe the market is their custodian. If 80% of the market is retail, then I don’t see many providers standing up to offer custody at that level.
But education is critical across the board to get people up to speed on why this is an important function.
Angio: I came to the Middle East very early in 2008 and I was surprised at how often I had to explain what fund administration was to fund managers. I think that has changed significantly since then – it’s not a question I get asked very often anymore. But even today if you ask a fund manager who is their custodian or what their custodian is doing, I don’t think they are always 100% sure. That shows that education is not only required for the investor base but other segments of industry participants. I’ve come across many investment managers who think that their brokers are providing custody without that being the case.
Funds Global: Has ESCA set industry standards for the Mena region? Are other regulators setting the same standards and is there consultation across the region between regulators?
Ringrow: At the top level there is consultation across the regions between regulators, and also competition to see who can be seen to be the toughest. A slightly different approach is needed to attract more funds to list in the region
Angio: I look at it primarily on the regulation of funds side more than capital markets and from that perspective, I don’t think ESCA is setting new or higher standards than what is already available in certain other jurisdictions in the region.
I think the Central Bank of Bahrain has the most advanced framework for funds. The DFSA [Dubai Financial Services Authority] is also making inroads after they agreed to revise its regulation closer to international standards.
Specifically for the UAE, if you look at the rather small number of funds that are domiciled in the UAE compared with the relatively large number of funds that are sponsored by UAE asset managers but who opt to domicile their funds elsewhere, it highlights certain limitations on locally domiciled funds.
Malik: There certainly is collaboration at the top end though it’s extremely macro level collaboration. With a relatively common culture and a common language there needs to be further collaboration where regulators take action and verify how other markets handle ETFs, for example. I really believe there needs to be a bit more co-ordination at the real working level between the regulators.
Funds Global: Looking forward over the next two to three years, what changes do you see taking place in the market? Do you see the market growing? Will the Middle East become a hub for African investments which are seeing a lot more interest? Is direct investment from Asian companies and institutions becoming a reality? Will the domestic banks establish local custody operations as China has been doing? And will retails funds start to see growth in the region, or is it likely to be more about infrastructure and private equity?
Ringrow: Domestic banks establishing custody in the region, my question is why would they? It’s a high volume, low margin business, given the relatively small scale of each of the markets. In terms of market development, given the strong historical bias for real estate, the development of some kind of local Reit [real estate investment trusts] structure to be launched. The other major development is a 401k-type pensions product.
I think we are beginning to see some developments in various markets, which would be very beneficial for all.
Street: A mandatory pension structure is the sort of thing that is needed. The concern I have is how is this best implemented. At the outside, UK pension funds mandated domestic investment concentrations – it had to be 70/30 domestic, or thereabouts.
Transpose this to the Middle East and consider the people who would invest, the transitory population – certainly in the UAE – who would see their money tied up in this, would probably not be happy to invest 70% of domestic or regional markets. I think the potential for leakage cross-border is enormous, which again reduces the multiplier effect.
I don’t believe it’s appropriate in this day and age to direct local pension vehicles to invest into domestic markets, but I do believe there’s a huge opportunity to develop a whole asset management and asset servicing industry around what’s being considered.
To the final point in the question, I do think that it will be more a matter of infrastructure and private equity investment for the medium term. The local markets will continue their steady progress to greater maturity. I expect this to be catalysed by the evolutions of a local pension fund industry, by an increase in IPO [initial public offering] activity and particularly privatisation of public assets. But this will all take time.
Angio: I agree that we still have more waiting to do before we see the markets significantly change. I think it’s also closely related to the fact that global financial markets are so highly correlated these days. As a result, the GCC gets affected by global events and risks which counter the local fundamentals and limit the upside.
These days, I think the name of the game for managers is to wait and get ready for when the GCC becomes interesting for global investors again. Those who are ready will benefit most.
Malik: Despite the financial crisis and Arab Spring, people still tend to make money in the markets, so there is some resilience.
The issue I see is that the Arab region needs to stabilise as soon as possible. And I’m saying that because most of the countries have already started looking inwardly. Thus, all projects and investments, to a certain extent, are now focused on internal social programmes.
The earlier the social and political situation in the region stabilises, the better it will be for the markets.
©2012 funds global