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A Gulf Struggle to Emerge from Frontier Status

Why Qatar and the UAE can’t seem to hit it off with MSCI.

The biannual review of the United Arab Emirates and Qatar capital markets by MSCI — a New York–based index provider that tracks economic development, trading volumes and market accessibility to assess market classifications — had increasingly become a running joke on the desks of Gulf business-news outlets.

Every six months, in the run-up to the decision on whether the Dubai Financial Market, Abu Dhabi Securities Exchange and Doha Securities Market would be upgraded to “emerging” from “frontier” markets, news features and special reports would be rolled out, experts consulted and daily updates published — and one lucky markets reporter would stay up until 1:00 in the morning to hear the decision live from New York.

And then the anticlimax, because for the last four years — including most recently June 2012 — the decision has been the same: no dice. The exchanges of the UAE and Qatar remain frontier markets, experts go quiet, and the features go back in the bag to be rolled out six months down the line. The sleep-deprived markets reporter, inevitably, quietly broods at the next day’s news meeting. “I told you so” doesn’t need to be said.

However, some market watchers in the Gulf feel that at least something has changed in 2012. While in previous years the run-up to MSCI decisions were accompanied by surges on Dubai’s and Abu Dhabi’s exchanges (although not Qatar’s, but more on that later), this June saw little reaction during the buildup to the decision or after the announcement.

This year traders saw the decision coming, argues Sébastien Hénin, portfolio manager at the National Investor, an Abu Dhabi–based investment research group. “It’s interesting to note that both markets didn’t react to the announcement — [the decision] was widely expected by the financial community,” he says.

Tarek Lotfy, managing director of capital markets at Dubai-based Arqaam Capital, adds: “The MSCI provided very tangible feedback and requirements for inclusion, and those had not been met. This, combined with the lack of market activity and liquidity, led us to expect the outcome.”

It is that lack of liquidity that makes the upgrades so important for the UAE and Qatari markets. An upgrade would bring in funds from emerging markets such as Brazil, Russia, India and China, according to MSCI, whose Emerging Markets Index tracks bourses with a combined market capitalization of $3.2 trillion.

In its June statement, MSCI said that while the UAE and Qatar had made progress in fulfilling its requirements, “hurdles remain.”

It is on the subject of these hurdles that Qatar and the UAE diverge. However, Qatar’s hurdles are different from those of the UAE. The markets of Dubai and Abu Dhabi are far more advanced than are those of their northern neighbor Qatar. New laws allowing limited foreign ownership have gradually opened the exchange, as required by MSCI, but it is mainly technical issues with the DFM and Abu Dhabi that are holding them back.

“The reason the UAE was not upgraded was due to a delay in the implementation of a proper false-trade mechanism,” says Lofty. The absence of such a mechanism means that international institutions still need two accounts in order to trade. “Both exchanges have been working closely with MSCI to ensure that a properly functioning system is in place,” he adds. “It is our expectation that once this has been done, the UAE will be upgraded.”

In Qatar the issue is political, relating to the amount of shares a foreign investor can own in a company, currently capped at 25 percent and far below the mandatory 50 percent preferred by MSCI. The UAE currently allows 49 percent, but experts expect a new law to raise this further. “The decision to raise foreign ownership levels has to be taken at a very high level. It is a sensitive question across the whole region,” says Hénin. “MSCI has suggested introducing new mechanisms, such as nonvoting shares, but these solutions have not yet been introduced.”

Analysts are largely bullish on what the MSCI upgrade — should it finally be approved in the next review in 2013 — would mean for the markets of the UAE and Qatar. All three exchanges struggle with a lack of depth and a reliance on retail day traders — two problems that the presence of funds and major institutional clients are likely to alleviate or even rectify. “It would improve sentiment toward the markets and the broader region, which we expect would result in an immediate reaction from international investors,” says Lofty. “In the long term it would open the countries to significant and sustainable capital inflows from emerging markets investors.”

“It can certainly be considered as a marketing tool,” adds a slightly more skeptical Hénin. “But market participation might not evolve that much.”

The expected combined weight for both countries in the MSCI Emerging Markets Index could be as low as 1 percent, Hénin points out, so while MSCI may boast of its $3.3 trillion market, the proportion going to the markets of the Gulf could end up at around $350 million.

“And that’s if investors mirror the weight of these new entrants in their portfolio, but this allocation is difficult to assess due to its small weight,” he says. “Foreign investors could just decide to avoid these countries.”

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