Euromoney GCC asset management guide: regional centres

This is one of seven articles that made up the Euromoney Guide to Asset Management in the GCC, distributed June 2008 with Euromoney magazine

It has long been accepted that the Gulf needs a financial hub. It’s an increasingly important market on a world scale, oil and sovereign wealth make it more relevant than ever, and it fits naturally within the European and Asian trading blocs. But the Gulf has not one potential hub, but three.

For 30 years this was Bahrain’s unquestioned role. “When I worked in Bahrain in 1982 there was no question it was the centre of finance in the Middle East,” recalls Daniel Smaller of Algebra Capital. Linked to Saudi Arabia by a causeway, and barely an hour’s flight from Kuwait, it benefited from the relative difficulty of accessing those far bigger markets directly, and acted as a convenient and well regulated hub for those wanting to do business in or with the region. When turmoil hit Beirut in the 1970s, the business came to Bahrain and stayed.

It has been fashionable in recent years to suggest that Dubai in particular has wrested that title away, but the Bahrainis aren’t having a bit of it – and from the perspective of asset management, they have strong numbers on their side. As of December 31 there were US$15.6 billion of mutual funds registered in Bahrain, up from $9 billion the previous year – a 73% increase. There are 2,483 funds registered in the country, 124 of them local and the rest foreign.

Abdul Rahman  Al Baker, executive director of financial institutions supervision at the Central Bank of Bahrain, believes there are several reasons for the country’s popularity. “One is our legal framework: it has been in place for 15 years and has proven it is able to cope with changes in the market,” he says. “There is investor confidence in the system here. We have been a financial centre for 35 years. And the standards that we use in our regulations and legal framework for collective investment undertakings [CIUs, investment vehicles such as mutual funds] are in line with international standards.” The lack of any taxation on investment products also helps. “What you earn is what you get,” he says.

Last year Bahrain introduced a new and updated regulatory framework for its mutual fund industry including rules for CIUs targeting professional investors. For investors with enough assets, this has allowed for the arrival of hedge funds and other alternative investment vehicles in Bahrain. It also categorises investors by assets and experience, and allows different classes of products to be sold to each. This appears to have been a large part of the reason for the increase. “As a regulator you need to see what’s going on in the market, and try to revamp regulations to be in line with the changes,” Al Baker says. “We took the initiative by introducing these new categories. Previously most of these [hedge and alternative] funds were not registered in the region but outside. Our new regulations are attracting a lot of existing asset managers from the region to set up here instead.”

In some measure, Bahrain has also benefited from the lack of similar flexibility in other Gulf nations, notably Kuwait, which does not allow local fund managers to domicile dollar-denominated funds there. Consequently, managers simply set up their funds in Bahrain instead, enjoying the clear regulatory environment and swift efficiency of processes.

These measures have helped to cement Bahrain as a hub for distribution of funds in the region. It is also without doubt the regional centre for Shariah-compliant funds. Bahrain hosted 87 Islamic funds with US$1.3 billion invested in them at the end of 2007, a 78.5% increase on the previous year in terms of assets. They cover a range of asset classes from local and GCC index funds to property and, most recently, leasing. Bahrain is already home to many of the most important institutions and authorities in Islamic finance, such as the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), the body trying to standardise global Islamic finance in an accepted code; and the International Islamic Financial Market, mandated to develop the capital market and money market for Islamic banks. Bahrain has been involved in efforts to develop a trading platform for sukuk, to create master documentation for Islamic derivatives, and to develop qualifications for the industry, among other things. The product section of this guide talks about Islamic finance in more detail.

Bahrain, unlike newer competitors, operates under exactly the same legal code in its financial institutions as in the rest of the country. There is no designated plot of land in which separate laws and regulations apply (the Bahrain Financial Harbour, the gleaming centrepiece of the Manama waterfront, is simply landmark real estate rather than a separate regime), no separate regulator for the financial centre, and no common law jurisdiction. Bahrain presents this as an advantage, suggesting that having two legal codes in one location can only be problematic; the alternative view is that Islamic law is impractical for modern commerce.

While Bahrain had the market to itself for many years, it now has competitors. Dubai, like everything else in that city, has big ambitions as a financial centre: it wants nothing less than to be another London or New York, offering everything a financial centre would offer, as a global gateway for capital and investment.

DIFC is a 110-acre free zone in Dubai, formally opened in September 2004, in which this bold vision is taking place – quickly. Already 607 businesses are registered within its premises, almost 200 of them financial institutions of some description. They cannot get the buildings up quickly enough – literally.  “There’s still a huge waiting list for people to get property here,” says William Wells, relationship manager for the Middle East at Schroders, which set up in DIFC a year ago and has been in its permanent offices for three months.

The truly distinctive thing about DIFC is that within that 110-acre plot, the legal and regulatory systems of the rest of the United Arab Emirates do not apply. Instead, DIFC is overseen by a separate regulator, the Dubai Financial Services Authority, closely modelled on the UK’s FSA, under common law. The idea was that big global financial institutions had long had aspirations in the Middle East but had been put off by the lack of a legal code they could understand and trust, and a regulatory environment they were comfortable with. As with everything else in Dubai, the pace has been extraordinary: 30 pieces of legislation were enacted in the first three years, between them representing what one senior figure at DIFC calls “an entire body of Anglo-Saxon law.”

This has been a big appeal for foreign managers. “When we looked at going into the region, we wanted to be there on a basis that minimised operational risk and reputational risk for ourselves and our clients,” says Nick Tolchard, managing director of the international development division at Invesco, which is licensed within the DIFC. “We actually welcome a strong regulator, and that’s what we see in the DFSA.”

From an asset management perspective, many of the world’s biggest names are registered and set up within DIFC already, among them Franklin Templeton, Permal, Invesco, Man, Prudential and Schroders, and the asset management arms of international banks such as Deutsche Bank, UBS, ING and Barclays. However, very few funds are actually domiciled within the DIFC – the figure was just nine in late 2007 – which has led critics to suggest that all the DIFC has really done is become a conduit for money to leave the UAE, with foreigners simply posting sales staff in their offices rather than any manufacturing presence. In fairness, the collective fund law governing domestically domiciled funds only came into effect in mid-2006, and it will take time, and the arrival of custodial and fund administration services in Dubai, before it will make sense for many groups to domicile funds there. At the moment, there is no obligation for foreigners active in Dubai to domicile funds there, so most instead keep their funds in the Cayman Islands, Channel Islands or Bermuda as they always have done. There is some speculation, though, that in time foreign groups will be required to domicile feeder funds locally which then feed into offshore products.

From the outset the DIFC has been designed to offer domicile to a wide range of products, including mutual funds, exchange traded funds, listed investment companies, hedge funds (and fund of funds), and Shariah-compliant funds. The regulatory package allows for 100% foreign ownership of the funds, no tax, no restrictions on foreign exchange or profit repatriation, and of course the world class level of supervision and regulation from the DFSA.

It is important to noted tha the DIFC does not cover retail financial services, nor transactions in dirhams; those are covered by the central bank in Abu Dhabi.

Qatar has its own highly ambitious program to build a financial centre, though its aim is rather different from that of Dubai. Its intentions are to build a centre that is very much onshore: it wants international financial institutions to establish operations on the ground in Qatar. In the Qatar Financial Centre’s own words, it wants them “to participate in long-term and mutually beneficial partnership with Qatar.” It is often explained in terms like these: that Qatar is not explicitly aiming to become a regional financial hub, but if its domestic efforts cause it to become one, so much the better.

The legislation to establish the QFC was enacted in March 2005. There are four distinct components to the Qatar model: the QFC Authority, which is responsible for commercial strategy and for developing relationships with the global financial community, among other groups; the QFC Regulatory Authority, which supervises financial services firms and financial institutions operating in or from the QFC; a civil and commercial court; and a dispute resolution body.

Initially, the legal model was similar to that in Dubai: the QFC operated on common law principles while the rest of the country had its previous, Islamic legal code. Also as in Dubai, the QFCRA tried to adopt best practice from regulatory authorities elsewhere in the world, and again bears a lot of similarity to the UK’s FSA. However in July 2007 it was announced that a single financial regulatory body would be established, bringing together the regulatory functions of the stock exchange, central bank, and QFC Regulatory Authority, and some regulatory responsibility for insurers that had resided within the Ministry of Economy and Commerce. A chairman and board for this new body should be announced soon.

The QFC aims to foster a number of centres of excellence, hoping that clusters of firms will develop in those areas, which in turn may develop into a regional hub. Insurance is one example, and another is asset management. Collective investment regulations for wholesale and retail funds have been enacted over the last 12 months. It is hoped that managers will domicile their funds locally, which has not happened at this early stage, but a new tax regime that comes into effect on May 1 may help: it exempts any locally domiciled funds from tax. Many fund managers have in any event chosen to set up in Qatar. Among them are Axa Investment Management, Global Investment House, EFG-Hermes, and Kuwait Financial Centre.

Axa was already in the region through the insurance arms of its business before selecting Qatar as the centre of its investment management advisory and client services for the region. Axa, like many others in the region, had historically managed its Middle Eastern business from London and Paris, and had reached a point where it made sense to be on the ground. “Location was not the only issue;  we did want to feel comfortable with a strong regulatory environment and we were very impressed by the QFCRA,” says Scott Callander, director, Middle East, at Axa Investment Management. “The logistics of moving around the region are very good, and by the nature and dispersion of our clients we’re not tied to any one city in the GCC.”

Some homegrown institutions are appearing too. One example is Qatar Capital Partners, formed last year with a focus on venture capital. “The opportunities are huge in Qatar,” says Mikko Suonenlathi general manager at Qatar Capital Partners. “The things QFC are driving are corporate governance and transparency, and I think that’s exactly the right agenda. Once you get to the highest possible international standards it will make it into an even better investment environment.”

Qatar’s regulatory environment is still coming together, though much of the most important legislation is now in place. For example, the regulations for limited partnerships – vital for any private equity and venture capital business. “That’s a significant step forward,” says Mikko. But every step forward is a new one. “It’s pioneer steps that I’m taking,” says Mikko. “But with the overall environment here it’s a good time to take those steps. Three years ago it was too early; three years later is too late. Now is the time to enter a new market.”