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Circle in the sand
The Middle Eastern markets are diverse in many ways, and they’re focusing on themselves before they look to harmonise settlement cycles within the wider region
In investment terms, the Middle East region is often lumped in with North Africa and Europe, but, even in itself, this is a vast and diverse area with different countries facing different economic challenges.

The six countries of the Gulf Cooperation Council (GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE)—each have their own market quirks and influences. They’re different sizes, have financial sectors at various stages of development, and they feature in multiple market indices. However, there are also certain trends that span all of them, and indeed, that mirror those in the more ‘mainstream’ markets in Europe, Asia and North America, as well.

Robert Frazer, senior vice president at Northern Trust, who is based in Abu Dhabi, suggests that, across the GCC region, government institutions are moving towards building in-house investment management capabilities.

He says: “To a certain extent this is being driven by cost consideration as investors seek to reduce the amounts paid in external manager fees. However, it also reflects a growing sophistication within the investment community and a willingness to recruit market-leading talent and develop front and middle office investment platforms.”

With regards to investment strategies, Frazer notes that, over the past five years, there has been increasing commitment to passive investment, with strategic allocations becoming more weighted in this direction.

“Like markets in Europe and North America, there has been closer scrutiny of the value added by active managers and a consequential shift towards beta-focused strategies,” Frazer adds.

But this is still a region of emerging and frontier markets, and this is also reflected in the strategies seen. According to Fadi Al Said, director and portfolio manager for the Middle East and North Africa strategy at Lazard Asset Management, Saudi Arabia represents a significant proportion of the investment universe of the region.

Here, investors tend to focus on the petrochemical industry, which is export-oriented and unique to this market. However, there is also interest in healthcare and insurance due to low penetration.

Al Said notes: “There is a very undeveloped market in insurance in Saudi Arabia, and that’s something that investors are taking advantage of, positioning themselves in light of the favourable trends seen in the insurance sector.”

The UAE is more developed in its infrastructure, with a diversified and developed economy that could potentially prove resilient to softer commodities prices.

But, Al Said says, its very openness also serves to leave it more exposed. “It’s a more open economy, and it relies heavily on sectors that are not seen in other economies—particularly trade, logistics and, most importantly, tourism.” This is something that global investors will take into account.

Finally, Al Said draws attention to Kuwait, which he calls an “under-owned” market with “increasing importance in the context of frontier markets”.

An anticipation of inflows from frontier market participants draws the attention of investors, which in turn could lead to more inflows from liquidity-driven investors.

He says: “There might be some structural changes in the market, plus new tools, pricing mechanisms or regulations that will increase the appeal for investors.”

With an unprecedented political shift in the US, and uncertainty remaining in Europe, the Middle East is not immune. Unsurprisingly, the effects of falling oil prices are felt particularly hard in GCC states, which are oil-producing countries.

Frazer says: “The low yield investment environment, along with the impact of falling oil prices, is compelling institutional investors to focus more attention on operational costs and efficiencies.”

“Service delivery models are coming under increasing scrutiny in a bid to ensure data delivery and transaction processing platforms are eliminating or driving down costs.”

He suggests that service providers such as Northern Trust are being asked to build and support sophisticated middle- and back-office solutions that can support more governance and more diversification.

“While many investors already manage highly diversified portfolios across all asset classes, others are at an earlier stage of their journey in diversifying into alternative investments,” Frazer says.

“These changes often bring with them the challenges of data integration, limited transparency and more onerous oversight requirements. There is a growing demand for service partners who are able to deliver sophisticated and bespoke governance tools.”
Also noting the direct impacts of commodity prices, Al Said suggests that the correlation can be viewed in both economic and market terms. Commodity price softening may affect some markets more than others. For example, global economic issues will affect Saudi Arabia’s petrochemical industry, while less demand for travel and tourism is more likely to affect the UAE.

“Indirectly, this impacts consumers and the corporate sector as it puts pressure on some of these states to restructure some of the subsidised sectors,” Al Said says.

He does concede, however, that there is a flip side to this, and when commodities and oil prices are strong, these markets will benefit accordingly. While this is not an exact science, “it is related in a sense”.

The financial markets are a little more complex in their correlations. Al Said suggests that, as more markets are considered essential in the emerging market indices, they “become direct beneficiaries of passive inflows into them, and of increasing liquidity”.

“The opposite is also true especially when there are emerging markets outflows”.

Both the UAE and Qatar were upgraded to emerging market status in 2014, a move that, by all accounts, led to a positive impact on both markets, and an increase in flows that is expected to continue. Certainly, Frazer notes that since the markets were upgraded, Northern Trust has seen its assets increase in both.

Despite accounting for such a large slice of the investment landscape, Saudi Arabia still stands as a frontier market. However, Frazer suggests that the Saudi Capital Market Authority and its stock exchange, Tadawul, are focusing their efforts on securing emerging market status as soon as possible.

Frazer says: “The dynamics of Saudi Arabia being included into the emerging market status will allow the market to attract global investments. To fully achieve emerging status, the government has a detailed plan that focuses on market operations, governance and regulatory oversight.”

It is widely expected that Saudi Arabia will be granted this upgrade in 2019, which would require a decision to be made in 2018. And it’s not far off meeting the criteria.

Al Said says: “There is not a specific formula that means a country will be automatically upgraded, but there are guidelines related to some factors like settlement, foreign ownership, liquidity and regulations, as well as the opinion of investors into other emerging markets. Investibility is key. Market access is key.”

He suggests that the UAE and Qatar were more forthcoming in restructuring for the requirements, and that, in his opinion, other GCC regions should follow suit.

But Saudi Arabia is something of an anomaly in that it only opened to foreign investment in 2015. Since then, unclear regulations have been straightened out, and the T+0 settlement cycle has been pushed back to T+2. These are all steps that should lend themselves to a status upgrade.

Al Said says: “Tadawul considers this a high priority and, based on the announcements we’re hearing, it’s not a matter of whether it will be upgraded, it’s a matter of when.”

He adds: “This will have a significant impact into the markets. If liquidity is higher than expected, this will push prices higher.”

Further, in the medium- to long-term, Kuwait could be a frontier market poised to make the leap to emerging. Al Said suggests that, aside from Saudi Arabia, this is the only market large enough, both in terms of market and liquidity, to be considered. He adds that market restructuring here is already underway.

So, as different countries grow and develop at different paces, how important is it for their financial markets to harmonise their clearing and settlement cycles? For asset managers in the region, at least, it could serve to make life a little easier.

According to Al Said, harmonisation for clearing and settlement between the GCC states could be beneficial as it unifies the settlement cycles across the region, and reduces some costs. He notes that the market regulators have been discussing this topic for a long time, however, he says it is not a requirement and it is not indispensable for the GCC markets. Even broader emerging markets are not necessarily fully synchronised, he says.

Frazer adds to this, noting that, although changes may be happening in that direction, harmonisation would be more of a nice-to-have than a necessity.

“Changes to the clearing and settlement infrastructure, such as Saudi Arabia’s migration to a T+2 settlement cycle, are essentially taking place within markets,” he says. “There is no immediate priority to invest resources in harmonising the investment infrastructure between GCC states.”

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