INVESTOR SERVICES The Pathway from Frontier to Emerging: Middle East Markets There is no official list which categorizes markets as developed, emerging and frontier. Having said that, the global marketplace generally recognizes the Morgan Stanley Capital Index (MSCI) as the benchmark, and markets strive to achieve their target status as recognition for improvements and ideally the increase in foreign investor flows which follow. With the recent MSCI upgrade of Qatar and U.A.E from Frontier Markets to Emerging Markets Index status, one can see evidence that certain Middle East capital markets made visible progress in making the improvements and changes to align with the views and practices of the international investment community. October 2013 J.P. Morgan 1 Alan Taylor Cluster Head for Middle East and Africa, J.P. Morgan Network Market Management
For a growing Frontier Market, acquiring the status of MSCI Emerging Market 1, could open doors to a larger investor base of not only the institutional pool of global assets, but also to other investors who might enter the market on the belief others will too. Whilst Saudi Arabia has a longer journey ahead particularly in respect to the market liberalization efforts, there are positive indicators suggesting it might follow suit. So how far each one of these markets has come, what is left to do, and what should a foreign investor keep in mind as key considerations when contemplating market entry? 1 Key MSCI upgrade criteria include: openness to foreign investment; ease of capital inflows/ outflows; efficiency of operational framework; and suitability of the institutional framework Qatar As noted by J.P. Morgan s Emerging Markets Research team, the approved FY2013/14 budget will be the largest in Qatar s history. The rapid increase in spending should reduce the fiscal surplus to QAR7.4 billion (1% of GDP) compared to a QAR27.6 billion (3.9% of GDP) the previous fiscal year. Public spending should continue to support domestic demand although the government expects real GDP growth to slow to 4% (in line with J.P. Morgan forecasts). The award of several projects related to the FIFA 2022 World Cup (for example the first phase of the metro) is expected to support non-hydrocarbon growth, especially in the construction sector. Qatar is well recognized as one of the fastest developing countries in the world. With the highest per capita income in the world, no income tax, free health care and education, growing ports, and the world s third largest natural gas reserves, there are lots for reasons to pay attention to this market. Locally much focus has been on obtaining the MSCI recognition as an Emerging market. As a result of the disappointing outcome of not receiving the MSCI status upgrade in 2012, and in conjunction with extensive consultation with market participants, including J.P. Morgan, the market quickly made two important changes. First, the Qatar Exchange (QE) introduced a false trade mechanism which reduced counterparty risk and enhanced the efficiency of settlements. Second, Qatar took steps to address the issue of low Foreign Ownership Limit ( FOL ) levels, and received the commitment of the Qatari authorities to increase the FOL levels applied by Qatari listed companies, which according to the local Decree No. 13 allows expatriates and non-residents to own shares in all QE listed companies up to an aggregate limit of at least 25% of available capital. This was initiated by several companies requesting the QE to modify the calculation of the FOL to their total market capitalization, instead of the free float market capitalization. These changes were received positively by the foreign investment community and in May 2013 MSCI upgraded Qatar to Emerging Market status with effect from May 2014. It is understood locally that developments must continue if Qatar wants to maintain their new status as an Emerging Market, and recent changes seem to indicate that the market is continuing to evolve. Qatar has recently expanded its sphere of trading instruments by introducing government bonds issued by Qatar Central Bank for trading on the exchange. This was in an effort to deepen the Gulf state s debt market and diversify investment tools for banks, institutions, and investors. There has also been an improvement in the dividend payment process. The market now provides direct dividend payment to custodians, and has moved away from the slow process of dealing with physical checks. Future developments that reinforce the view that Qatar will continue to develop and meet international standards include: the upcoming IBAN implementation by Qatar Central Bank; planned creation of Central Counterparty Clearing House (CCP); the move towards consolidating regulatory framework from currently three regulatory authorities (Qatar Central Bank, The Qatar Financial Markets Authority, and Qatar Financial Center Regulatory Authority) into a more efficient regime with the Qatar Central Bank acting as lead regulator. It is also anticipated that once Qatar expands down the path of allowing state owned companies to sell shares to the public over the coming years, foreign investors will benefit from the increased number of securities available to them in the secondary market. United Arab Emirates The bid for the 2020 World Expo is the most recent example of s continued focus on diversifying its economy and promoting foreign investment into the Emirates. The decision of the Bureau of International Expositions (BIE) to clear Dubai s bid to host the Expo could yield longer-lasting effects on the economy, should the Emirates win the bid. The World Expo represents the largest global event after the Olympic Games and the FIFA world cup, and unlike the other two events there is strong evidence suggesting it produces tangible impact on levels of spending, transport, and tourism for the host. 2 J.P. Morgan October 2013
According to the new Investment Attractiveness Index launched by the Arab Investment & Export Credit Guarantee Corporation, also known as Dhaman, U.A.E tops the list as the most attractive investment destination in the Middle East. Notably, the Emirates together with Saudi Arabia attracted the lion s share of Foreign Direct Investments (FDIs) out of the 20 Arab countries according to the Dhaman 2012 annual report. These top rankings are a testament to s focus on making further advancements down the pathway to market liberalization, and alignment to international standards and best practices. This pathway has not been without its setbacks. Similar to Qatar, the U.A.E also narrowly missed out on the MSCI status upgrade in 2012 due to concerns raised around the control of assets and in particular the lack of false trade mechanism which in turn forced investors to operate a dual account structure. Following extensive consultation with local market participants including J.P.Morgan, the Securities and Commodities Authority ( SCA ) amended the delivery versus payment ( DVP ) regulations for the U.A.E markets, creating a more favorable practice which aligns with industry standard. These procedures entered into force in May 2013. The changes were received positively by the foreign investment community and in June 2013 the MSCI upgraded to Emerging Market status with effect from May 2014. The upgrade is expected to attract initial inflows of US$0.5 billion with US$3-4 billion long term. Despite the advancements made with the DVP model, pre validation of securities remains a feature of the Dubai Financial Market ( DFM ) and Abu Dhabi Securities Exchange ( ADX ) markets whereby securities are required to be transferred into trading accounts under the control of the broker prior to trade execution. J.P. Morgan is continuing to work with its subcustodian and market participants to further improve this process. 2 Source: Tadawul, as at the end of June 2013 There are a number of future developments being reviewed by the U.A.E markets, one of which is the potential merger of the DFM and ADX to form a single exchange platform and single Central Securities Depository (CSD). Issues that may pose challenges relate to the differing ownership structures where ADX is government owned and DFM is a listed company, the location of the merged entity needs to be agreed, and operational technicalities like the current investor ID s require consolidation. Additional developments under consideration include securities lending and borrowing, short selling, market making, and liquidity providers. The SCA has now approved regulations for these product offerings and the exchanges are working on developing the mechanism for implementation likely to be in a phased approach beginning in Q4, 2013. Other initiatives of interest to foreign investors include the development of fixed income markets, further simplification of the account opening process, and enhancements to the announcement and collection of corporate actions. The Kingdom of Saudi Arabia With the recent S&P and Fitch ratings upgrade of Saudi Arabia s sovereign rating from stable to positive outlook, steady progress with diversification of the economy away from its oil dependency, and the region s most liquid stock market, the Kingdom has a lot going for it in terms of its attractiveness to the global institutional investor pool. The Kingdom has also ranked first across the Middle East and North Africa in the World Bank s 2013 doing business survey, outperforming its regional peers. Fast progress has been also evident in the sukuk market, as in 2012 the Kingdom was the second major global issuer of sukuk after Malaysia. There have been a number of positive developments in aligning the capital markets and local market infrastructure to regional as well as international best practices. While the progress might not have been as swift on certain issues (i.e. lack of the Qualified Foreign Investor (QFI) scheme), overall the most recent developments do suggest the Kingdom is making steady progress, taking it closer to the potential inclusion in the MSCI Frontier Market Index, and ultimately gaining the Emerging market status. Since 2011, the local stock exchange, Tadawul, and Saudi s Capital Market s Authority (CMA) have been reviewing alternatives to the current custody model. This involved engagement of the global consultancy firms to assist with the independent validation of the proposed model, as well as assessment of the requirements for a potential transition. The proposed solution Securities Independent Custody Model, announced by Tadawul in August 2013, will address a number of risks which exist today associated with exposure to local brokers during the pre-trade to settlement periods and will bring the market closer to international best practices. A viable custody model is essential for when the Kingdom s equity market opens its doors to the foreign investors and there is anticipation in the market place that the Kingdom is getting closer to introducing a QFI scheme in the near future, after considering this move for several years. Currently, foreigners have limited opportunities to invest through mutual funds, equity swaps, and exchangetraded funds. The public consultation on the QFI draft regulation circulated by CMA in October 2011 was subsequently concluded in January, 2012. Since this significant development, there has been little evidence of any further movement, however its is anticipated that following current focused review of the domestic capital markets framework, CMA will turn to the QFI regulation and see to its implementation potentially later in 2013/ early 2014. With Saudi Arabia s bourse market capitalization of more than US$399.23 billion 2, and more than 156 companies listed, QFI scheme will allow the Kingdom to broaden the spectrum of investors for its capital markets. Another positive development is the Kingdom s alignment of the workweek to that of the Gulf Cooperational Council (GCC) region effective June 30, 2013. Following this announcement, Tadawul, changed its trading days to Sunday-Thursday in line with the region. It is anticipated this change would facilitate greater governmental, capital markets and economic efficiencies between Saudi and its regional and international counterparts. October 2013 J.P. Morgan 3
The recent and planned market developments have been significant in setting the foundation for the transformation and improved stability in each of these markets. The improvements to post trading infrastructures and alignment with international standards have led the way for each market to draw more attention from the global investment community and the commitment towards future enhancements from each market indicates there are still more changes to come. So watch this space, not only for the future developments of Qatar, and Saudi Arabia, but for other markets within the Middle East and neighboring regions that will use the roadmap already established for developing and aligning themselves with the views and best practices of the international investment community. TIMELINE Pathway from Frontier to Emerging Conversion of Tadawul into joint stock company Non Resident Investors allowed to invest through Swap Agreements Tadawul launches order driven Sukuk and Bonds market ETFs launched in Tadawul Introduction of DVP CMA issues draft QFI regulation, and public consultation is concluded Tadawul changes trading days in line with the region CMA publishes amended Investment Fund regulation Tadawul announces Securities Independent Custody Model Potential implementation of QFI Scheme Pending approval of the new custody model by CMA 2007 2008 2009 2010 2011 2012 2013 in progress DFM launches new trading system OMX X-Stream Introduction of new ISIN codes for ADX and DFM by ANNA Outsourcing of the NASDAQ Dubai settlement function for equities to the DFM New Law relaxes Foreign Ownership Limits in some Economic Sectors Introduction of DVP CMA approved trading of Rights Entitlements in Tadawul MSCI relaunched its Saudi indices Introduction of a false trading mechanism and buyer trade compensation Buyer Cash Compensation introduced New regulations announced on short selling, liquidity management, SBL, and market making MSCI upgrade from Frontier to Emerging Markets Index Introduction of electronic connectivity between market participants for trade pre matching Potential merger of ADX and DFM and single CSD Implementation of securities lending and borrowing, short selling, market making, and liquidity providers. Enhancements to the announcement and collection of corporate actions Qatar Exchange implements NYSE Universal Trading Platform Agreement signed between QE and Qatar Exchange Bank (QCB)for QCB to perform all cash settlement services (Central Bank Money) QCB introduces new automated payment clearing system Launch of Government bonds market Improvement in dividend payment process New regulations announced on short selling, liquidity management, SBL, and market making Introduction of electronic connectivity between market participants for trade pre matching Planned launch of Direct Market Access (DMA) services IBAN implementation by QCB Planned creation of CCP Consolidation of regulatory framework ACROSS THE REGION: Development of fixed income markets MSCI upgrade from Frontier to Emerging Markets Index Simplification of the account opening process Continued development of post trade infrastructure (CCP; separation of CSD from stock exchange) 4 J.P. Morgan October 2013
ANALYST CERTIFICATION: The research analyst certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. LEGAL ENTITIES DISCLOSURES ARABIA: J.P. Morgan Saudi Arabia Ltd. is authorized by the Capital Market Authority of the Kingdom of Saudi Arabia (CMA) to carry out dealing as an agent, arranging, advising and custody, with respect to securities business under license number 35-07079 and its registered address is at 8th Floor, Al-Faisaliyah Tower, King Fahad Road, P.O. Box 51907, Riyadh 11553, Kingdom of Saudi Arabia. DUBAI: JPMorgan Chase Bank, N.A., Dubai Branch is regulated by the Dubai Financial Services Authority (DFSA) and its registered address is Dubai International Financial Centre - Building 3, Level 7, PO Box 506551, Dubai, UAE. COUNTRY AND REGION SPECIFIC DISCLOSURES DUBAI: This report has been issued to persons regarded as professional clients as defined under the DFSA rules. Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively J.P. Morgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMS and/or its affiliates and the analyst s involvement with the issuer that is the subject of the research. All pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. JPMS distributes in the U.S. research published by non-u.s. affiliates and accepts responsibility for its contents. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise. 2013 JPMorgan Chase & Co. All rights reserved. The products and services featured above are offered by JPMorgan Chase Bank, N.A., a subsidiary of JPMorgan Chase & Co. JPMorgan Chase Bank, N.A., is authorised by the Office of the Comptroller of the Currency in the jurisdiction of the U.S.A. Authorised by the Prudential Regulation Authority in the jurisdiction of the UK. Subject to regulation by the Financial Conduct Authority and to limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. J.P. Morgan is a marketing name for businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. 5 J.P. Morgan October 2013