Since the fateful events of 9/11 in New York, the phenomenon of investment repatriation by Gulf Arabs has accelerated significantly. Indeed, since 2002, Saudi investors are believed to have withdrawn more than $300 billion of investments from the US, while other Gulf countries are also said to have reeled-in roughly the same amount, if not more.
The record high price of oil has also contributed significantly towards this new prosperity and high level of liquidity in the Middle East. However, this liquidity has flooded a region that has been stagnating for the last decade in terms of investments, and has not been matched by a similar number of placement opportunities … until now that is.
Three years ago the return of Arab money prompted the launch of plans for a regional, modern and efficient financial exchange in Dubai. The result, rather predictably, is the Dubai International Financial Exchange (DIFX), which opened for business in September 2005, and which now gives international investors full access to Middle East companies.
It is part of the legally autonomous Dubai International Financial Centre (DIFC), a 110-acre “mini state,” which was also inaugurated in September, and which has, with the help of British and Australian regulators, established the Dubai Financial Services Authority (DFSA), a special capital markets authority to regulate the exchange and ensure it complies with international regulatory standards whilst supervising all capital market transactions that go through the DIFX. All successful exchanges traditionally set up a rigorously run capital markets authority to supervise capital markets transactions, and it is up to the DFSA to ensure that transparency is kept high at all times, and only suitable companies that fulfill investors’ needs get their securities listed on the exchange.
Taking it international
Thus the DIFX is unique, even by world standards, as it is a new financial exchange with a primarily international outlook. Most are usually set up as national exchanges, which become tied to the domestic economy for long periods of time. Some national exchanges, such as those in London or New York, have gradually developed into international exchanges, welcoming companies wishing to be listed from all over the world. However, the process is usually slow and it is clear that with the significant amount of liquidity available in the Gulf region, the DIFC felt it had no time to waste in making the DIFX into both a regional and international exchange from the beginning. While the old Dubai Stock Exchange has been kept operational by the Dubai government, the DIFX has been created and set up separately to cater for regional companies and to complement markets in the rest of the Middle East.
Until now, the various local exchanges of the Middle East have had limited success, as they all operate along national lines, with their potential being highly dependent on the way their national economies develop and prosper (the Beirut Stock Exchange (BSE) for example, doesn’t even have a capital markets authority in place). The exchanges stand out by their lack of attractiveness, given the dire state of their domestic economies, and a consequent lack of liquidity in secondary markets.
Another issue is that Middle Eastern equity markets have, for very long periods, been closed to foreigners, and have been operating under different rules from those established in other regions. While international investors have been limited in what regional securities they can buy and how they can buy them (settlements, currency, etc.), regional investors have been restricted as to where they can buy securities emanating from different parts of their own region. Most of the exchanges in the Gulf have, until now, been dependent on demand from oil-rich institutions and individuals, while exchanges in Lebanon, Egypt, Jordan and other non-oil Arab countries, have been relying on retail investors with traditionally limited capabilities.
Today, investors throughout the Middle East, particularly the cash-rich nations of the Gulf, are keen to diversify their investment interests beyond oil-related stocks and local real estate companies. Such desires for diversification and strong demand for securities issued regionally can only be met by international exchanges such as the DIFX. The latter is aiming to trade in US dollars and to place no limits on foreign ownership. The minimum listing requirements are expected to attract companies from throughout the region, as well as companies from Africa (demand from South African mining companies has been registered), Turkey, India and China (which interestingly are starting to use the DIFX option, even though they can use the Hong Kong and Singapore markets). According to the exchange’s officials, Egyptian and Lebanese companies have also shown interest in the DIFX, with the latest example being a potential listing of the recently much publicized and significantly over-subscribed IPO (Initial Public Offering) of Investcom, a telecommunications company owned and controlled by the Lebanese Mikati family (see pages 48 to 70).
The DIFX is ambitious. It is aiming for at least 15 IPOs and as many secondary listings in the next 18 months. This is more than just mere hype, as the recent IPOs that have already taken place and which got listed on the DIFX, such as ADDAR Real Estate ($225 million), the Saudi consumer dairy company Almarai, and the Saudi Dairy and Foodstuff Company (SADAFCO), were heavily over-subscribed. ADDAR was impressively 450 times covered, while Almarai and SADAFCO were respectively 3.5 times and 6.5 times oversubscribed. This severe over-subscription is a reflection of the heavy demand for too few investment opportunities, and the future looks bright for this new exchange, which is relying on its light but solid regulations and international outlook to attract companies from Asian and African markets.
Demand for newly issued regional securities is such that even the usual process of underwriting is often unnecessary. The high demand emanating from Gulf individual and institutional investors, as well as from Islamic banks – which are the fastest growing type of financial institution in the world (annual growth in both profits and assets is estimated to range between 10% to 15%) and which focus solely on placing cheap funding into non-interest paying assets such as shares – is such that all IPOs are pre-placed before the official date of their issue.
The DIFX is also looking to see listings across sectors, despite initial concerns that securities issued by the oil and gas sector would dominate. Currently, the DIFX includes companies with market capitalizations ranging from $100 million to $1.5 billion, reflecting the accessibility of this exchange. All kinds of securities are expected to be listed, including traditional equities, bonds, sukuks (Islamic bonds) and even Global Depositary Receipts, particularly those issued by Indian companies. Expansion of the exchange over time should add derivatives to this diversified pot of securities, as the high accessibility of capital through the DIFX is recognized in the medium-term.
The DIFX is also the first vehicle through which demand for capital would be optimized. No wonder Chinese, Indian and South African companies are feeling the necessity to launch their IPOs through this exchange, which finally offers our own Lebanese companies a real opportunity to go global, diversify funding and revenues, and gain substantially in terms of reputation. The massive success of the Investcom IPO (through both London and the DIFX) and the significant over-subscription (believed to have exceeded 10 times) is proof of the strong demand for Lebanese shares and securities that awaits any visionary Lebanon-based company in need of capital boosting.
With the Lebanese government planning to resume a much-awaited and overdue privatization program, the launch of the DIFX could not have been timelier. Before the opening of the DIFX, it was not clear whether Lebanese privatization would have been successful. However, the recent IPOs of Gulf companies, as well as Investcom, have proved many skeptics wrong, including this writer.
Although strategic institutional investors are still needed in the privatization of Lebanese public institutions (particularly the utilities such as EDL and water), the Lebanese government now has the added comfort of raising capital and urgent cash out of listing on the DIFX. Sadly, this could be bad news for the BSE, as Gulf and Lebanese investors find it more practical and transparent to buy Lebanese privatization shares directly through the DIFX.
Although some issues of corporate governance and interference from the DIFC’s top bosses remain, it is obvious that the creation of the DIFC and the DIFX is the step that will propel the Arab financial world forward into the 21st century. With such a tool paving the way for an explosion in Arab capital markets and consequent regional prosperity, it would be a shame if all of it were to collapse due to weak corporate governance and control freak behavior.