Qatar and UAE make MSCI upgrade at last

Euromoney, July 2013 

In recent years a familiar pattern had emerged around the United Arab Emirates and Qatar’s possible reclassification as MSCI Emerging Markets Index constituents, rather than the less-watched frontier index. Expectation of an upgrade early in the year; disappointment each June with MSCI’s annual market classification review. But finally, after five years on review, both markets will join the emerging markets index in May 2014.

It was June 2008 when MSCI Barra (as it then was) announced a consultation to reclassify the two markets – plus Kuwait, which didn’t go far – from frontier to emerging markets. Getting there has required a number of changes in both markets: in Qatar’s case, around operational efficiency, delivery, custody and foreign ownership limits, and in the UAE’s case around a proper false trade mechanism and a move away from dual account structures.

So now that it’s happened, what does it mean? HSBC expects that $430 million will flow into Qatar and $370 million into the UAE from passive index investors who track the MSCI Emerging Markets Index over the next year. Small amounts, but perhaps catalytic: HSBC also estimates an additional $4 billion in actively managed funds could be available for investment in those markets, if they can attract it.

“We are hoping this will bring in the liquidity that has been lacking in the local markets,” says Sandeep Nanda, who is executive vice president at Qatar Insurance Company in Doha and investment advisor to the Qatar Investment Fund. “When we meet investors, in London for example, a lot of them are constrained by not being allowed to take positions in frontier markets. A lot of investment managers will now be able to allocate serious money to these countries.”

Others say the fact that MSCI required the markets to make significant operational changes is clearly good for investors. “Although it has been a cautious process, it has resulted in material benefits to investors in public markets,” says Daniel Broby, CIO of Silk Invest, which invests in public and private markets in the Middle East, Africa and frontier Asia.

It should also add impetus to capital raising. “It’s a very significant step,” says Chris Laing, managing director, emerging market equity capital markets at Deutsche Bank. “One challenge we have had when we do transactions in these countries is they are off-index. That was a big hurdle for many investors and issuers to overcome. Having that hurdle removed will make transactions an awful lot easier to do.”

But perhaps the key question is whether other, bigger Gulf markets, having seen UAE and Qatar make the step, feel inspired to do the same.

Saudi Arabia is the one everyone wants to see. Although today it has 100% restrictions on direct foreign ownership of stocks, “at some stage that will be relaxed and you will be looking at 40% of the Arab market moving” to the emerging market index, Broby says. There have, in recent years, been several moments of modest liberalization in Saudi, such as allowing other Gulf state mutual funds to take positions in Saudi stocks, but as one banker says: “expectations have been raised too many times over the last five years, and we have been disappointed many times too.”

Some think Kuwait is a more likely next candidate, having originally been part of the 2008 consultation for Gulf market reclassification. “Kuwait would be the most likely next country, I would think,” says Laing. “It’s a decent sized market as well.”

At the same time as Gulf markets have ascended to global investor awareness, North African markets have been heading the other way. Morocco was downgraded in the same review, with MSCI saying the country’s index “has failed the emerging market liquidity criteria for several years and this downward trend in liquidity has shown no sign of reversal.” MSCI also said it “may be forced to” launch a public consultation on excluding Egypt from the index too because of the shortage of foreign currency on the domestic forex market, which impedes repatriation of funds by foreign investors.

Few were surprised by the Morocco downgrade. “Morocco is attractive and has good returns but the locals have been buying the investment opportunities more than the internationals, restricting what’s available,” Broby says. “That’s why they’ve dropped off the international radar screen.”

While the reclassification of Gulf markets is encouraging, it was sobering to note the pricing of Al Noor Hospitals on June 21 in London, valuing the company at £672 million ($1.04 billion). A company as big as this, and with as much potential, is still unlikely to choose the UAE as its listing venue and it will be some time before the country can attract such capital raisings to stay home.

Correcting that will take time and effort – further reducing foreign ownership levels (Qatar’s still stands at 25% on most companies, and the UAE’s 49%), removing withholding taxes on dividends in places like Kuwait, and most of all opening Saudi. That’s when big institutional investors will no longer be able to ignore the region.