Today, the Dubai International Financial Centre (DIFC) is beginning to feel like a financial centre. It is not Wall Street, and it is not the City of London. But walking around the futuristic Gate building that forms the centrepiece of Dubai’s new finance zone feels a little like walking around London’s Canary Wharf in the early 1990s: very much a work in progress, but bags of potential.
The roll-call of financial institutions that have backed the DIFC speaks volumes. In April, Citigroup became the latest global institution to announce plans to open an office. Morgan Stanley, Merrill Lynch, Barclays Capital and Credit Suisse already have dozens of bankers working from the site, while others are waiting in the wings. Standard Chartered has bought an entire building, while HSBC will move in up to 300 bankers as soon as space is available.
“Business in the region is exploding,” said Robert Druskin, president and CEO of Citigroup’s Corporate and Investment Bank, during a visit to Dubai in April. “Citigroup is committed to developing the region’s capital and financial markets, and we are excited to be part of the DIFC.”
In common with most of its peers, Citigroup will base investment and private bankers in the centre, which only allows transactions in dollars. While the DIFC denies it is an offshore centre, it has many of the characteristics: it falls outside the remit of the UAE Central Bank, and no transactions will be allowed in UAE dirhams.
Central to the success of the DIFC is the Dubai International Financial Exchange (DIFX). The DIFX hopes to attract international issuers and investors by offering regulation on a par with markets in London, New York and Hong Kong. It allows unrestricted foreign ownership of shares and allows founders to retain majority control, in contrast to many domestic bourses in the Gulf Arab region.
Progress has been steady rather than spectacular since its launch in September 2005. By mid-April 2006, 13 securities were listed on the exchange. Most were certificates tracking major international indexes such as the Nikkei 225 and the S&P 500. The exchange also listed two depository receipts and one primary listing: Kingdom Hotel Investments. On April 18, no trades were executed on any of the 13 listed securities, according to official bourse data. That was a fairly typical day.
Ball rolling
However, there were signs in early 2006 that the DIFX was finally gathering momentum. The only initial public offering (IPO) on the exchange, Kingdom Hotel Investments, was a success, raising $397m. That raised hopes that more issuers would see the DIFX as a viable market and bring more issues to market.
In March, the DIFX announced that Per Larsson would take over as chief executive to drive that process. He admitted it would be challenging. “Liquidity doesn’t build overnight. At the moment we see a steady pace of new members as well as new products. There are no short cuts. Liquidity builds liquidity. We need more members, and more interesting products to trade.”
Those products are likely to include derivatives, which would be a first in a region that currently does not have any short selling. “Over time, maybe Nasdaq or other international exchanges could be partners.”
Mr Larsson and others within the DIFC hierarchy recognise that for the centre and the exchange to thrive, it is not enough to only attract international heavyweight banks. Local institutions are also vital, given their depth of contacts with Arab investors and potential issuers.
Local talent
Rasmala Investments, a boutique investment bank, was the first UAE investment banking firm to secure regulatory approval within the zone. CEO Ali Shihabi says the licence will help Rasmala win business in the neighbouring markets of Pakistan, India and Turkey, and form relationships with international institutions based in the DIFC.
“I think it will give us credibility in the region. We are looking very much also to the cluster of related entities in the DIFC. There are some very substantial investment banks coming in that we can work with. Having a proximity makes a difference.” Deutsche Bank has a 15% stake in Rasmala.
Indeed, Rasmala is also a potential issuer, and has announced plans to raise up to $300m through an IPO, probably before the end of 2006. “The DIFX will take time to get up and running. But I have no doubt that the DIFX will be the central stock market in the region,” says Mr Shihabi.
IPOs tend to grab the headlines, but some of the most interesting work is happening in the debt field. Barclays Capital was one of the first international banks to move into the DIFC. Regional head Nicholas Hegarty says the centre’s modern regulatory structure was the most significant reason for joining, as it offers a framework for structuring deals such as securitisation, which are new to the Middle East.
“The market is growing at an exponential rate. The key issue for all of us – issuers and arrangers – is to bring new products to the market.” Barclays has helped arrange two deals that have broken new ground. The first, an $800m securitisation of mortgages on Dubai’s Palm Jumeirah island, the second, a $3.5bn convertible sukuk for Dubai Ports, Customs and Free Zone Authority – the world’s largest Islamic bond. However, Mr Hegarty is realistic about the commercial potential of the new regulations, particularly relating to securitisation. “It is not tested,” he says.
Despite these reservations, he expects debt capital markets business to increase sharply in the region in 2006. The Middle East saw $3bn of transactions in 2003, rising to $8.4bn in 2004 and $15bn last year. “Already the number of transactions under review is significant.” As well as stronger regulations, competitive pricing is fuelling demand.
In December, National Bank of Abu Dhabi raised $800m through a bond priced at Libor plus 32 basis points, on the back of strong investor interest from the Middle East, Europe and Asia.
Reputational seesaw
The DIFC as a financial centre appears to have reached critical mass, having won backing from most of the leading regional and international banks. But this success was not always a foregone conclusion. In the summer of 2004, the centre was shrouded in controversy after it sacked its two most senior regulators. Ian Hay Davison, former head of Lloyd’s of London, was chairman of the Dubai Financial Services Authority (DFSA), while Phillip Thorpe was chief executive. Mr Thorpe previously worked as a managing director of the Financial Services Authority, the UK regulator, on which the DFSA was largely modelled.
They were drafted in to give the new centre a stamp of credibility: Dubai had long been regarded as a hub for money laundering. The 9/11 Commission in the US found that some of the funding for the 2001 terror attacks passed through Dubai’s banking system.
For a while, the attempt to build Dubai’s financial credibility worked, and banks such as Standard Chartered and Deutsche Bank announced their intention to apply for a DIFC licence. But when Mr Hay Davison and Mr Thorpe were dismissed – reportedly after raising concerns about transparency surrounding DIFC land sales – the centre’s reputation hit rock bottom.
However, a swift overhaul of the DIFC’s management – coupled with personal intervention from Dubai’s then Crown Prince (now ruler) Sheikh Mohammed – convinced the international financial community that the DIFC was serious about regulation.
Return to health
After a brief lull, banks began applying for licences again. David Knott, a former chairman of Australia’s national securities and companies regulator, was hired as the new head of the DFSA, and by the time The Gate opened its doors in September 2005, the turnaround was complete.
“The DIFC is creating a new centre of gravity for the region’s banking community which is attracting further international players to these dynamic markets,” says Stephen Green, CEO and chairman of HSBC.
Ten years since its birth, Canary Wharf is one of the world’s major financial centres; some would say it has eclipsed the City of London in importance. It may take more than a decade for the DIFC to reach that status but with high-level backing from regional and global institutions, it looks set to play a meaningful role in the global financial system.
