In June this year, Qatar and the United Arab Emirates (UAE) were upgraded from frontier to emerging market status by index provider Morgan Stanley Capital International (MSCI). This elevation, which had been under review since 2008, is a significant boon for both countries’ economic trajectories. Not only has it opened up their respective exchanges to a new investment universe, it will substantially increase liquidity in these markets over the coming months and years. Moreover, the prospects for increased transparency and corporate governance in both jurisdictions are now brighter.
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However, the upgrade will also present challenges. Both countries are now competing against larger and potentially more attractive emerging market economies, including India and Brazil, in a more competitive investment space. Moreover, the demands for widespread regulatory and institutional reform will increase as this international investor base becomes more sophisticated. Meeting these challenges will be demanding over the medium term. However, if this opportunity can be seized, the development opportunities will be significant.
Stepping up
Both countries were initially placed under consideration for an upgrade in 2008. Regulatory conditions hindered their progress until 2013, when MSCI finally announced their promotion to emerging markets status for June 2014. In its 2012 Annual Market Classification Review, MSCI noted: “The issue around the very low foreign ownership levels imposed on Qatari companies is expected to be the only impediment to the reclassification of the MSCI Qatar Index to emerging markets status.” During the review period, Qatar’s 25% limit on foreign ownership of listed companies remained the key impediment to an upgrade. As part of the country’s transition, foreign ownership levels were increased to 49%.
In the case of the UAE, which had an existing 49% foreign ownership limit, concerns over the structure of its exchanges, and the trading mechanisms in place, were the primary obstacle. In particular, the efficiency of the emirates’ delivery versus payment systems required improvement, through the implementation of a cash compensation structure. To address this, the UAE applied the structure to its exchanges, whereby cash would be offered when securities were unavailable for delivery on the scheduled settlement date.
That both jurisdictions met their regulatory obligations in a relatively short time frame is encouraging. As MSCI announced their inclusion in the emerging markets category in June 2013, to take effect one year later, the news was welcomed as a sign of their closer alignment to international trading norms. For Qatar's and the UAE’s constituent stock exchanges, the announcement had huge implications. From June 2013, active or non-constrained investors secured massive stakes in these markets in preparation for the arrival of passive funds upon the implementation of the upgrade on June 1, 2014.
“This phenomenon is pretty typical when you see an index change. There are a lot of passive investors that are forced by their mandates to buy positions in a newly upgraded market. In response, you have unconstrained investors who go in and buy ahead of the upgrade, inflate the price, and then sell it back to the passive funds as they enter on a specific date,” says Danat Abdrakhmanov, senior Europe, Middle East and Africa analyst and portfolio manager at Eaton Vance, an investment management group.
For both countries, these trends were the source of immense volatility during the first month of trading. The Abu Dhabi and Dubai stock markets fell by close to 13% and 21%, respectively, while Qatar’s QE Index fell by 10%. Though these figures also include domestic factors, as well as a wider regional sell-off in the equity markets, the MSCI upgrade was a salient feature of these sell-offs. "The month of June was particularly volatile in terms of market performance, as local investors sold their stakes as the upgrade took effect, while the security situation in Iraq also took its toll,” says Jubin Jose, an investment adviser to the Qatar Investment Fund.
Broader appeal
July saw a process of market rebalancing as market fluctuations levelled and the upgrade was priced in. For Qatar and the UAE, the priority will now be the management of massive portfolio inflows from foreign institutional investors over the coming years. As MSCI emerging markets are tracked by investors with about $8000bn in assets, the scope of the potential investment universe has expanded substantially. This, in turn, has raised the investment profiles of both countries across the highly liquid developed markets.
"Foreign investors who never used to look at Qatar or even the region are now showing an interest. For example, Qatar has received about $1.8bn foreign investment in the year to date, compared to $700m at the same time last year," says Mr Jose. Notably, the depth and sophistication of international investment is also expected to improve, as investors and fund managers with longer term strategies weigh in against the presence of more volatile hedge funds.
Accordingly, this process of improving international investor sentiment and awareness of these markets will be important. At present, volatility in one part of the Middle East can negatively impact the domestic market dynamics of countries such as Qatar, which remain insulated both politically and economically, from the turmoil. As investors become more aware of the region, it is hoped that the tendency of aggregating events in the Middle East will diminish.
Beyond this, regional institutional investment in Qatar and the UAE will also be an important, if unexpected, component of their development. “The real surprise has been that the upgrade has stimulated a lot of additional regional institutional investment in the equity markets in addition to drawing the expected foreign institutional investment. This dynamic has been driven by the likes of family offices, as well as regional financial companies, and is a very positive development because it should really support liquidity levels,” says Amer Khan, senior executive officer at Shuaa Capital, one of the region’s oldest investment banks.
Collectively, these developments are expected to improve liquidity levels in the Qatari and Emirati markets. As these levels increase, there is an expectation that the number and frequency of initial public offerings (IPOs) in these jurisdictions will also grow. “From a liquidity perspective, volumes have been very encouraging so far. This is likely to improve further as a number of IPOs are scheduled for the third and fourth quarters,” says Mr Khan.
A clearer picture
Aside from these wider investment trends, the other significant change will be an anticipated improvement to levels of transparency, corporate governance and investor relations in these markets. For years, both the UAE and Qatar have suffered from relatively opaque business environments in which the domestic business community has failed to develop advanced reporting standards. This partly reflects a supervisory deficiency, yet it is largely attributable to a lack of demand for these measures from the investment community, which has traditionally been dominated by the domestic retail sector. With the MSCI upgrade, this environment is set to change.
"The upgrade significantly increases the number of potential investors that companies can talk to. That of course has a major impact because – in the case of the active managers who are looking at this market – they are used to high disclosure, transparency and investor relations standards elsewhere. As such, the UAE and Qatar are now being compared to other emerging markets, such as Brazil and India. So there is a need to continually improve these standards and develop these markets in line with international norms," says Oliver Schutzmann, vice-chair of the Middle East Investor Relations Society.
Even in the short time since both countries were upgraded, measures have been taken to improve the investor relations environment. In March, the Securities and Commodities Authority of the UAE approved a proposal to compel all listed companies in the country to develop an investor relations department. As foreign investors pile into the market, companies that have clear reporting procedures stand to gain the lion’s share of the capital inflows. “I think it’s quite visionary for a regulator to come out and compel companies to set up an investor relations programme. You don’t really find that in many other jurisdictions,” says Mr Schutzmann.
The MSCI upgrade will usher in a period of transition for both the UAE and Qatar. For markets that have, to an extent, been traditionally insulated from global markets, this change may take time. Increased competition and greater international scrutiny will be a price worth paying when balanced against the longer term benefits on offer.
More encouragingly, this transition process will have positive implications for the wider region, as other countries incrementally move towards a potential upgrade. “There will be a significant impact on other regional markets looking for a similar upgrade. In particular, it puts the spotlight on Saudi Arabia and its timeline for potentially opening up the market to foreign investors. If this happens, it will take the Middle East and north African investment landscape to the next level,” says Mr Khan.
