Rules that say asset managers must appoint a third-party custodian are creating more business for asset servicers. But some participants in our panel say change is not happening quickly. Chaired by George Mitton in Duba.
Stewart Adams, regional head of investors and intermediaries, Middle East, North Africa and Pakistan (MENAP), Standard Chartered
Manoj Aidasani, head of direct securities and services, GCC, Deutsche Securities and Services
Arindam Das, regional head of Middle East and North Africa, HSBC Securities Services
Jonathan Titone, head of product innovation and expansion, custody department, National Bank of Abu Dhabi (NBAD)
Funds Global: How is your role as a service provider developing in the wake of investment fund regulations passed in parts of the region, including the UAE and Saudi Arabia? Do you now have more responsibilities than before?
Jonathan Titone, NBAD: There are opportunities and responsibilities. In the UAE, the requirement for new funds to have a third party custodian is positive. The Securities and Commodities Authority (SCA) in the UAE now has to approve funds before us offering them to our clients, and we must offer retail investors more awareness and transparency of the products we sell, like having to publish the prospectuses and all the fund information online. In Saudi Arabia, the rules have tried to clarify what was a grey area in terms of distribution.
Stewart Adams, Standard Chartered: The good thing is these are responsibilities we are already undertaking in other markets, so we can take the experiences from elsewhere and bring them to Mena. For the asset management industry these are more challenges to cross before they can launch a fund which can result in a longer lead time before they can secure assets and revenue. For the asset servicing providers it is a positive move as a third party custodian will be required and this should give foreign investors more confidence in the market. Along with the MSCI upgrade [of the UAE and Qatar to emerging market status] these changes should help bring foreign investors in.
Manoj Aidasani, Deutsche Bank: Our responsibility has increased, there’s no doubt. Board Decision 37 regarding the regulations on mutual funds in UAE [a resolution of the UAE Securities and Commodities Authority] has changed how we are operating. It’s an opportunity, because there are some services which only a professional or independent service provider can offer in a much more efficient manner. Bringing our global expertise to the region we need to apply our skills according to the local rules. We see it as a part and parcel of the industry evolving, and we are quite happy to work with the regulators to move forward.
Arindam Das, HSBC: I agree that the requirement to appoint a third party custodian is encouraging. However, the application of the rule has not been as far reaching as I would have liked. New funds coming in to the market are being asked to do it, but the existing funds industry has not been made to switch. I’m talking about both UAE and Saudi Arabia here, which is a very important part of this whole discussion, because that’s where the scale is. We would like to see the new rules and regulations being applied with a far broader scope.
While we appreciate the role regulators are playing in encouraging the appointment of independent custodians, we would like to see a similar proactive pull emerging from the clients side, evidencing the value they associate with this initiative, rather than just responding to a regulatory dictat.
Adams: It’s a good point, but we’ve got to walk before we run. It’s a big step to say that a third party custodian is mandatory in the market, though I’m sure we’d all like to see this regulation finalised. As per any new regulation it is the new asset managers which find it more difficult as they are at the forefront of the regulation. The established managers will have longer to take on board the changes, however this is usual in financial markets.
Funds Global: Do you see a rise in interest in sharia-compliant investing? What is your role as service providers to sharia-compliant funds?
Aidasani: If there’s any place in the world where sharia-compliant investments will grow it has to be the Middle East. This is where we see a constantly growing interest in sharia-compliant products and services from clients. We provide a full range of products and services, including sharia-compliant cash accounts. At Deutsche Bank we support different types of sharia instruments, such as wakalas, murahabas, sukuk etc. It’s an important and growing product offering for us,
Titone: It’s definitely growing in importance and we’re seeing more and more clients express sharia-related concerns in contractual matters and handling of cash. I think Dubai could become the Islamic financial hub of the world with the convergence here of some of the world’s top talent and financial firms. We are seeing significant asset growth at the sharia-compliant fund level and are ourselves looking to soon offer a more comprehensive and credible sharia-compliant custody product than exists in the market today.
Adams: I would like to see Dubai become the Islamic saving and investment global hub as the sector is so important on the global stage. There’s close to $2 trillion in Islamic assets which is a 20% compound growth over the last couple of years, and all economic indicators predict this will continue to grow.
Malaysia got a head start, however Dubai is catching up quickly. We have been approached by many asset managers who are looking to launch or have existing Islamic vehicles and we are working with them on a global basis from Dubai. It was announced last year that Dubai would strive to become the global Islamic financial hub and I am sure with the resource and infrastructure this will be achieved.
Das: Dubai has expressed its ambition to become an Islamic finance hub, and from past experience we have seen that when Dubai expresses an ambition, they execute. But as of today, the key market for Islamic investments is Saudi Arabia. A significant part of their funds industry is in the Islamic space. About one-third of the Mena mutual fund industry is Islamic and that’s contributed largely by Saudi, so it’s a very important centre for us.
We will increase our sharia-compliant services but selectively, in centres like Saudi Arabia and Malaysia, and not across the board. We’re not going to expressly offer Islamic compliant services in the other centres where there is no significant demand.
Funds Global: Do you agree that GCC-wide passportability of funds will remain out of reach for some time yet? Is this still a desirable goal for the region?
Adams: It’s a desirable goal, but when will it happen is the key question. There were two meetings last October which developed the discussion around portability across the GCC. As far as I know, there wasn’t a defined agreement on what would classify as portable across the markets. There are other developments that are probably taking more priority, for instance merging the exchanges. Once that’s sorted, maybe we can get a unity across the fund management industry and “passporting” funds around the GCC.
Das: I personally think we should have two separate workstreams: integration of the exchanges and passportability of funds. The two should be separate and shouldn’t have to progress at the same pace.
Passportability would be a game changer, the European example tells us that. Some of the huge fund inflows in Europe are absolutely predicated on the concept of passportability. In this region, the individual countries are small – except for some like Saudi Arabia and Egypt – so unless you have passportability you won’t have scale.
Frankly speaking, it would be relatively easy to harmonise the fund regimes in this region and have passportability, but unfortunately, it seems we’re heading in the opposite direction at the moment. I actually see barriers being put up in marketing of funds.
Titone: We are a relatively small neighbourhood, and ultimately it would be better for the entire region to have passportability, but protectionism, linked to competition over which financial hub will lead the Middle East, seems to be preventing this. This attitude is not sustainable in the long term.
Das: Ironically, what is happening is that competition between the countries in the region is actually encouraging funds to set up completely outside the region. So the whole region is losing out because of the intra-regional rivalry.
Adams: We need to learn from other markets, Europe had unit trusts and investment trust regulations, then they brought out open-ended investment company (OIEC) regulations, which was the passport into Europe. This resulted in asset managers restructuring funds from unit trusts to OIECs, which was a costly and lengthy process.
The regulator then changed the rules for unit trusts, which resulted in that structure having a passport capability.
Aidasani: There are advantages for such a set up. There will be a larger investors base for fund managers to get, and investors will have larger funds to choose from. But what needs to be seen is how funds will be spread across the region in terms of domicile. Currently, it’s skewed toward Bahrain, and other countries need to catch up to be able to establish a meaningful dialogue. We should also not forget that even in Europe, Ucits underwent four amendments to be where it is today. Regulation is a time-consuming process.
Funds Global: Do you expect Bahrain will continue to be a popular domicile? What must other financial centres do to encourage asset managers to domicile funds in their country?
Titone: Bahrain was first in the region. They have a tested legal system that’s been built up over time in line with international best practices. The laws are consistent, people know what to expect and know what they’re getting. In other places, the systems are younger and less tested, though we are seeing strong fund regulations in many of the region’s offshore free zones.
Adams: Bahrain is well established, with some 2,800 funds listed, and despite some exits, from a regulatory perspective, it was a success. It was built around the knowledge of the fund industry, and the regulator is knowledgeable of the industry. That made a difference.
You asked, will it remain popular? Bahrain is facing some challenges and I hope it does come back. I know they have a good insurance industry, which helps support the financial sector.
If we’re asking, what are the lessons learned? I think it’s a case of looking at what the Bahrain regulator has done, what their promoters have done, and hopefully learning from it.
Das: Other countries need to do to come up with a regulatory framework that is at least as good, if not better than Bahrain’s. Some have done it. I think the DIFC [Dubai International Financial Centre] funds regulations are quite strong. However, it is still unclear what the DIFC’s status is. Is it in the GCC? This is important because only GCC funds can invest in Saudi Arabia. A Bahrain fund can invest in Saudi, but it’s not clear if a DIFC fund can. If these issues were clarified it might encourage the launch of more DIFC funds.
Funds Global: Do you see signs that Saudi Arabia will open up to direct equity investment from outside the GCC? How would this affect your businesses?
Aidasani: I wish I had a crystal ball. There were some strong signs last year, but it has not yet happened. When it will happen we don’t know, but international banks will be prepared to invest in their local trading and brokerage capabilities to cater to this business segment. We set up in Saudi Arabia seven years ago because we were convinced very early that Saudi Arabia will become an important market. We’re here to stay.
Titone: It’s very important for our business as well, and we’re doing a lot of business there today with our local and regional client base, although we’re not in the market as a CMA-licensed bank yet. In the near term that’s something we’re looking at very seriously.
We’ve all talked to the Saudis’ consultants, and there are signs that it’s going to open, but there’s also the realisation that the Saudis were generally isolated from the financial crisis, so at what cost do you open your market?
If you look at what happened in Dubai, the boom and bust, and then the new boom, with the turmoil in the region and signs of local dissent, they are likely asking whether they can afford to expose themselves to that.
Das: I would advocate the opposite view. In 2005 the Gulf went through a huge boom in the stock market. It was not a boom driven by foreign institutional investors. In 2006 the whole market crashed, which again foreign investors had nothing to do with. So, boom and bust is not something that you bring to a market because of foreign institutions.
I think foreign institutional investors provide more diversity for a market dominated by a very retail investor base, and therefore brings in more liquidity and stability. In the short-term, yes, what happens in Europe or the US will impact your country far more if you open up, but, empirically, there’s evidence to show that large foreign investors lead to net inflows over time and not net outflows.
While we don’t know when Saudi would open up to foreign investors, or even if it will at all, frankly, I don’t think the amount of work that has happened in Saudi Arabia to set up some form of an operational framework to open up the market could have happened if there was no sign from the top that they’re considering it seriously.
If it happens will it be a game changer? We believe it absolutely will. A lot of investors currently don’t look at the Middle East because the largest investment case is out of bounds. We can’t look at the swap programme as a proxy for what can happen if the market opens up, because it’s an expensive product. A lot of institutional investors want direct access.
Titone: I didn’t say that foreign investors caused the boom and bust cycles in the region. Foreign investment would create more interconnectedness of Western financial systems with Saudi’s financial systems, which are largely isolated today. The risk is in the tie-in to the greater world economy, and the potential for a local perception that external forces have negatively affected their local situation.
Adams: There’s no doubt it will happen, but no one knows when. The new regulations coming in during the second quarter for an independent custodian to be used in Saudi are a big positive for the foreign investor looking in. But the other question everybody raises is, does Saudi Arabia really need to open up? Probably not. This could change depending on oil prices and demand.
Funds Global: What are the main regulatory issues that concern you at the moment? Are there questions that still need to be ironed out with regulators or have the various consultation periods been broadly successful?
Aidasani: During the consultations we had during the draft stages of the fund regulations, there was a lot of accessibility to the regulators and the regulators were positively surprised by the huge feedback they got. The effort was fruitful as it helped our clients and asset managers by bringing in a clear-cut view of what we want to do and how it should be done.
In the UAE, we are expecting some more rules to be added to the fund regulations, regarding the service provider responsibilities, obligations, etc. We are awaiting some more developments. On the Saudi front, we are still in consultation stages. It’s not yet finalised. It’s an ongoing process.
Titone: For a lot of the regulatory issues that we’re facing in the region, we’ve been able to drive the consultation here, and the regulators are very open to constructive feedback. This is critically important to the development of our markets, and they are very receptive. The fund managers have adjusted and have prepared, and do have strong compliance regimes in place. We have made progress.
Adams: There’s a lot of consultation with the regulators and that is very positive. One of the issues we all had were some unclear areas in the UAE fund regulations that came out last year. The consultation has helped crystallise that. It’s a big step forward in the industry that the regulators will happily sit and listen to a diverse group, whether it be global custodians, regional custodians, local banks or any other concerned party. They will take the feedback, listen, and hopefully consolidate it and make the rules better for the region.
Das: We just need to accept the regulations and see how we deal with it. There are a lot of gripes that people have about regulations, and part of it is justifiable, but the thing is, regulation is there for a reason. The financial crisis was an extremely difficult period, as an industry. A lot of people suffered as a result of that, and regulators have a job to do. There are some unintended consequences of regulations, but we should accept there was a need for regulatory overhaul. In fact, I believe that regulations often offer opportunities more than challenges.
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