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Capital markets in the MENA region: a conversation with the OECD’s Alissa Amico

04 December 2015
Giada Vercelli

Levels of foreign portfolio investment in equity markets in the Middle East remain low as a result of restrictions on investment, but also due to concerns of foreign institutional investors and asset managers regarding the quality of governance. Alissa Amico, Project Manager, Middle East and North Africa, OECD shares her views on the development of capital markets in the region with Euromoney Conferences’ Giada Vercelli.

EC: What is the role of the MENA region in the emerging markets space and how has it changed in recent years?
The region is certainly attracting greater attention in the equity markets space since the re-classification of the UAE and Qatar to the emerging market status last year. No market in the Arab world is currently classified as developed and until this re-classification, only Egypt and Morocco were considered as emerging markets, a status Morocco lost recently and Egypt also risked losing following the revolution. These re-classifications, as well as the anticipated classification of the Saudi Stock Exchange (Tadawul) - by far the largest and most liquid market in the region - as an emerging market, has certainly attracted interest. The recent roadshow of the Saudi Stock Exchange supported by Euromoney was a clear sign of this. 

EC: Levels of foreign portfolio investment in equity markets in the Middle East remain low...

Apart from Turkey and to a lesser extent Egypt, it is true that levels of foreign portfolio investment in equity markets in the Middle East remain relatively low. This is not only as a result of restrictions on investment but also due to concerns of foreign institutional investors and asset managers regarding the quality of governance and transparency in particular. Certainly, a part of this story is the availability and quality of disclosures of listed companies in English (e.g. 40% in Saudi Arabia provide disclosure in English). While significant progress in the region has been made over the past decade in the development of governance codes and securities regulations, cross-border investment flows are low and foreign investors still allocate less to the region than to other emerging market regions in relative terms and most of these allocations are passive.

EC: Is the competition between Arab financial centres intensifying and what are the outcomes so far?
As I arguein a recent article on financial centres in the region, the quest for the establishment of financial centres in the region continues unabated. While the Bahrain Financial Harbour is the oldest financial centre in the region, competition among financial centres has intensified significantly especially since the establishment of the Dubai International Financial Centre (DIFC) ten years ago but also the launch of other centres including the Casablanca Finance City, the King Abdullah Financial District and last but not least the Abu Dhabi Global Market. This competition is based on the historical strength of MENA countries in finance, especially in banking, but also on the desire to attract financial market participants and capital to the region.

The latter has become increasingly crucial in light of budget deficits forecasted in oil-exporting and oil-importing countries alike. Ultimately, the litmus test of the success of these initiatives will be the ability of the region’s financial centres to compete with global emerging markets such as Hong Kong. This, in turn, will be determined by the value proposition of financial centres notably in the capital markets space. Attracting wealth and asset management industry to the region without providing them with adequate opportunities to invest in local equities effectively does not facilitate the development of local capital markets. Experience shows that today’s leading financial centres such as London or New York have at their core deep and liquid capital markets.

Are equity markets in the region supporting growth companies?

While there is a significant variance in the level of development of local exchanges, from large markets such as Tadawul in Saudi Arabia to nascent markets in Algeria and Lebanon, I would argue that regional markets are generally not serving growth companies. One reason for this is the overall slowdown in the IPO space in the region. 2013 saw 23 IPOs for the entire MENA region raising $3 billion, a figure that grew to 27 IPOs raising almost $12 billion by 2014.  To put these figures in perspective, the OECD area had an annual average of 1170 IPOs raising on average $133 billion annually between 1993 and 2000, falling to 670 IPOs raising $70 billion annually between 2001 and 2011.

These figures are testament to the fact that while equity markets in the region are generally considered pillars of local financial centres, they are not significantly contributing to financial intermediation between investors and firms seeking equity capital. In fact, Arab equity markets have been developed over the past 20 years primarily through the disposal of government stakes in privatisations and to a lesser extent, through listings of large family firms. Both are currently on the decline.

At the same time, the launch of dedicated SME markets and listing tiers in Egypt, Qatar and Dubai has not been followed by notable listing of growth companies. This merits further investigation, especially considering that the region has a very low rate of new firm formation and that bank financing is ill-suited to firms which are characterised by high intangible assets, high levels of innovation and low stock of physical assets/inventory. Ultimately, there are significant linkages between equity financing and corporate sustainability on the one hand, and rates of innovation and employment creation on the other.

What challenges are institutional investors facing when investing in the Middle East and are those similar to other emerging markets?

The level of institutional investment in the region remains low despite recent market re-classifications due to limitations on foreign portfolio investment, but also due to perceptions of international investors around the quality of governance and transparency in the region. Few foreign pension funds or insurance companies have major allocations to the region’s equity markets. A handful of foreign investors such as Passport Capital are active equity investors in the region.

For foreign institutional investors who have little knowledge of the region’s markets and their dynamics, greater information on the structure of equity markets, the quality of investor protection frameworks alongside better disclosure by individual companies is crucial. A number of exchanges in the region are now looking at developing tools and research for investors, especially as some (e.g. the Kuwait Stock Exchange) are transitioning to private ownership and seeking to establish self-regulatory powers.

The other challenge for foreign institutional investors is that most MENA equity markets are retail driven and that local institutional investors –sovereign investors and family offices – tend to be passive. There is an urgent need for a dialogue among progressive foreign and domestic investors to create a demand for better governance and this should be a mutually beneficial exercise. Local institutional investors could gather useful experience from engaged investors such as Norwegian and Canadian pension funds, while foreign investors can glean better insight into the operation of local equity markets. Beyond dialogue, developing stewardship responsibilities for local sovereign investors such as pension funds and insurance companies could also stimulate reflection on the fiduciary responsibilities of these actors as investors in equity markets.

EC: How has the regulatory framework been evolving to address investor priorities and needs?

Regulators in the region, especially in the Gulf, where capital markets have been relatively closed to foreign investors until recently, have been preparing the ground for the opening of these markets for almost a decade now, notably by introducing corporate governance codes and securities regulations dealing with insider trading and market manipulation. In parallel, the evolution of Companies Laws in countries such as Kuwait and Saudi Arabia provides an arsenal of investor protections to investors in private companies, in addition to those available to investors in listed equity.

Observing these markets for a decade now, it is clear that the regulatory framework has evolved significantly and the priority now is improving the implementation and enforcement of these regulations. As I explored in a recent report on corporate governance enforcement, few regulators in the region resort to enforcement actions and they are mainly focused on penalties for late or inadequate disclosure. There are a number of areas which regulators still need to consider such as the ability to support investor actions through derivative or class action suits or other, less litigious mechanisms. Issues relating to the competency and expediency of courts to deal with financial disputes need to be addressed in parallel as they are part and parcel of building an efficient regulatory framework, not only for investors but also for other market participants.

Note: the views expressed herein are those of the author and do not reflect the official views of the OECD or its member countries.


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