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I am deputy editor at The Banker, a Financial Times publication. I joined the magazine in August 2015 as transaction banking and technology editor, which remain the beats I cover. Previously I was features editor at Profit & Loss, an FX and derivatives publication and events company. Before that I was editorial director of Treasury Today following a period as editor of gtnews.com. I also worked on Banking Technology, Computer Weekly, and IBM Computer Today. I have a BSc from the University of Victoria, Canada.

Friday, 24 July 2009

Desert blooms

Features

The Middle East financial services market is booming due to the high oil prices and emergent construction and real estate markets. Local exchanges and financial institutions are responding quickly and expanding their business in the region, as well as making advances internationally.

While the rest of the world has been rocked by the sub-prime crisis on one side and the fear of recession on the other, the majority of the Middle Eastern economies have been booming, fuelled mostly by the high oil prices that reached a record $100 a barrel at the beginning of January.Sovereign wealth funds, like the Abu Dhabi Investment Authority and the Kuwait Investment Authority, are using their billions to bail out big players like Citi and Merrill Lynch during these turbulent times.

Much of the money has stayed within the region after 9/11, when America took a harder stance towards the Arab countries. Many of the Middle East nations, especially in the Gulf, turned their investments inwards with massive expenditure in infrastructure, which in turn is fuelling a construction and real estate boom.

“What we are seeing is huge public expenditure in infrastructure, into diversification projects like tourism and into creating free trade zones. Plus there many Middle Eastern sovereign wealth funds that are investing all over the world,” says Kamran Butt, research analyst at Credit Suisse and author of an equity research paper,Gulf region: One of the most attractive investments for 2008.

“We’re seeing a strong economic basis that is driving the local markets with an influx of liquidity intra-regionally – this isn’t money that is coming from abroad but money that is generated locally within the region.” The creation of the Gulf common market on the 1 January this year has also helped to increase cross-border business opportunities between the Gulf States.

Although not all countries in the Middle East are as wealthy as the Gulf States, most are still seeing relatively strong growth, with the exception of countries bogged down in war or its aftershocks such as Iraq, Lebanon and Israel. Even Iran, in the face of US sanctions, is growing economically, benefiting from the high price of oil. And there is a trickle down effect that is being felt within the whole region.

“The infrastructure budgets in this region are among some of the highest in the world and that creates an economic driver and a feel-good factor within the whole region, whether you are looking at Bahrain, Oman, United Arab Emirates or Saudi Arabia,” adds Butt. “It is a feel-good factor led by the governments that are pumping money into the infrastructure into the non-oil sector of the economy.”

With the knowledge that the oil will not last forever, many of the Gulf States are increasingly looking to diversify their economies. Dubai, one of the emirates in the UAE which has almost no oil left, has led the region with theField of Dreams mantra: “build it and they will come”. Striving to oust Bahrain as the financial hub of the region and with hopes to play in the big league internationally, Dubai has developed a supply-led strategy through building the Dubai International Financial Centre in 2004 and enticing financial institutions to set up shop through attractive ownership structures, zero tax, etc.

Phil Knowles, partner at KPMG, explains: “The Dubai government built the DIFC and then incentivised people to come with 100% ownership and no restrictions around repatriation of profits and dividends; there is a guaranteed zero rate of tax for the next 50 years; and there are strong regulations – they brought in experienced people, from different regulators around the world who know what they are doing, to build a strong regulator to establish a reputation of trust.”

Now most of the big firms like Goldman Sachs, Morgan Stanley, Merrill Lynch, and Lehman Brothers have a presence there, and a lot of the middle tier firms are moving in, with a wave of smaller boutique-type operations expected to follow. “They all have to focus now on delivering a strategy for the region, which in the past was more fragmented,” says Knowles.

Dubai has also taken the initiative in driving international expansion in order to be a recognised financial centre like London or New York. In a high profile move, Borse Dubai has entered into a relationship with Nasdaq by bolstering Nasdaq’s holdings in the Swedish exchange technology firm OMX – now Borse Dubai has a stake in Nasdaq and the American exchange has invested in its Dubai International Financial Exchange. Within the deal, Borse Dubai also gained a chunk of the London Stock Exchange.

Butt points out that beyond the integration agenda, there is a technology reason underpinning the interest in OMX. “In the Middle East there is a lack of domestic technology companies. One of their motives for buying assets is buying expertise or technologies. OMX is one of the most technology advanced exchanges within Europe – it may not be the biggest but it has one of the most advanced trading platforms. One of the reasons that Dubai looked at OMX is to buy in technology. This is why you are seeing that these wealth funds have the aim of buying technology, buying up companies that have expertise and also get exposure in the region. I think that is the primary reason for OMX deal.”

OMX is a main trading technology player in the Middle East partly through its 2006 acquisition of Computershare, which had previously acquired Canadian trading systems firm EFA Software, giving it a strong presence from the onset of exchanges in the region; and it has pushed forward its momentum with deals with the Egyptian Cairo & Alexandria Exchange and the Tadawul, the Saudi Arabian stock exchange. Atos Origin Middle East, sold off by Atos Origin in February 2006 and recently acquired by HP in November 2007, is the other large player, supplying trading platforms to Amman Stock Exchange, Muscat Securities Market and the Beirut Stock Exchange.

A strong exchange is part and parcel of the dream of becoming the logical financial centre in the Middle East, says Knowles. An exchange that includes “a good range of high quality listings of both equities and derivatives and potentially other instruments, backed up by good technology, creates a lot of opportunities, liquidity and volume to your financial market that you can exploit across the region,” he says. The listing of DP World, which debuted on the DIFX in late November, has given Dubai a centre stage position in global markets.

Dubai is facing a lot of competition, not just from Bahrain but also from Qatar, which is in the process of building its own financial centre and has a lot of cash to invest because of its gas reserves.

Plus the region’s “sleeping giant”, Saudi Arabia, is beginning to wake up. With Saudi Arabia’s economy flourishing and its Tadawul still the biggest stock exchange in the region, even after the correction in 2006 when the exchange’s value was nearly halved because of fears that the market was being manipulated by a few large investors. It will be hard for Dubai maintain the upper hand especially since Saudi Arabia has begun the process of opening up its markets to foreign investment and ownership as a result of joining the World Trade Organisation in 2005.

Krishan Soni, regional sales manager for capital markets, Tata Consultancy Services, explains: “The market crash resulted in the Capital Markets Authority waking up and implementing new regulations in Saudi Arabia. Now the brokerage divisions have to be spun off as a separate legal entity, so the commercial banks can not do investment banking anymore. This also resulted in CMA looking at options of creating licenses for new brokerage firms – these have gone from nine to 27 brokerage firms in 2007.”

The protectionism that has historically been a strong characteristic of the Middle Eastern countries is being broken down. With the advent of the Gulf common market, the walls are being torn down between the Gulf Co-operation Council nations, which include Saudi Arabia, UAE, Kuwait, Qatar, Oman and Bahrain. This change will make it more difficult for the other countries to maintain protectionist barriers.

The GCC is also talking about moving to a common currency by 2010, but with the pressure on many countries to de-peg their currencies from the dollar – which Kuwait has done already – the deadline is unlikely to be met. KPMG’s Knowles believes that there is still a long way to go before the central banks reach consensus about how to drive the common currency project forward.

Case study: Arab National Bank replaces treasury and risk systems

The Middle East has seen a huge growth in the banking market and a rise in the sophistication of the marketplace. Many of the traded instruments in the treasury space are more sophisticated compared to 10 years ago – now many people are trying to hedge their positions with complex structured products, credit derivatives and other instruments commonly seen in the West.

Roy Froud, Misys’ managing director in the Middle East, says that these developments are stretching the core banking systems. “Five or six years ago banks tried to solve their technology problem with a one-stop-shop by going to a vendor and buying just one core banking system which tried to address everything from the core retail banking, the wholesale banking, the trade finance, the treasury and syndicated lending, all in one piece of software. But now that concept has started to be tested.”

Due to this increase in complexity and the expansion of its treasury business, Saudi Arabia’s Arab National Bank, headquartered in Riyadh and with 117 branches including one in London, realised that it had outgrown its existing IT system. It required a modern integrated treasury and risk management system that would improve efficiency while reducing costs.

John Eldredge, general manager and head of treasury markets at the bank, says: “The system had done its job well, but it didn’t meet our developing needs, particularly the increasing range of products we wanted to introduce. For example, it didn’t support derivatives and would not enable us to comply with IAS 39. This is the new international standard relating to accounting for derivative financial instruments and hedging activities.”

ANB needed the platform to be comprehensive, meeting all existing capital market requirements and still have the inbuilt flexibility to support and enable its growth agenda. The bank also wanted to automate its back office processes.

Eldredge adds: “We decided we wanted a complete front, middle and back office system with full reconciliation and support for trading across a wide range of products and real-time risk management. The old treasury system did not interface with the bank’s main accounting system, so we definitely wanted to change that. The old system only supported ‘vanilla’ functions and we needed one that could support some of the Islamic products we were introducing, which have very specific and often complex requirements, such as foreign exchange delayed delivery features.”

ANB chose Misys Opics out of a field of 15 competitors because of its open, flexible framework for rapidly introducing new products in the future. With Opics, ANB benefits from more efficient risk management and straight through processing capability across all of its treasury businesses and product lines. Opics was implemented in phases during an 18 month period, starting with derivatives, which were the most pressing requirement due to the imminent introduction of IAS 39, and ending with foreign exchange, the largest area by volume of transactions per day.

Egypt

▪ Population: 80,335,036 (July 2007 est.)*

▪ Egyptian pound floats again the US dollar.

▪ GDP growth rate at factor cost markedly increased from 4.6% during FY 2004/2005 to 6.9% during FY 2005/2006 (source: Central Bank of Egypt Annual Report 2005/6).

▪The Central Bank of Egypt is implementing reform based on four pillars: privatisation and consolidation of the banking sector; financial and managerial restructuring of the state-owned banks; solution of the problem of non-performing loans; and upgrading of the supervision sector at the CBE.

▪The Cairo and Alexandria Stock Exchanges and Misr for Clearing, Settlement and Central Depository signed an agreement with Abu Dhabi Securities Market, allowing dual listing and trading of the securities listed in both markets in accordance with their relevant trading systems. CASE has signed MOUs with Shanghai Stock Exchange and Korea Exchange, as well as teaming up with the Swedish IT company OMX to establish a capital market IT company. CASE has launched a mid and small cap market NILEX.

Israel

▪ Population: 6,426,679 note: includes about 187,000 Israeli settlers in the West Bank, about 20,000 in the Israeli-occupied Golan Heights, and fewer than 177,000 in East Jerusalem (July 2007 est.)*

▪ Israeli shekel.

▪ Economic activity continued expanding throughout the year, extending the trend that started three years ago, following the deep recession of 2001 and 2002. The recovery persisted, even though the rate of growth slowed in the third quarter of 2006, due to the Second Lebanon War. GDP increased by 5.1%. (source: Bank of Israel)

▪Tel Aviv Stock Exchange has four international financial institutions as members of the TASE – Citibank, which joined the exchange and the clearing house during 2006, and HSBC, UBS and Deutsche Bank, which joined earlier. TASE has signed agreements with Nasdaq and with the London Stock Exchange.

Lebanon

▪ Population: 3,925,502 (July 2007 est.)*

▪ Lebanese lira pegged to US dollar.

▪ Beirut Stock Exchange successfully implemented the remote trading system in December 2006. In 2007 the BSE launched a new real time website which provides data on live trading, news digest, listed companies’ performance and maintains the flow of information to the public. In addition, the stock exchange plans to upgrade the NSC-UNIX trading system, with a new version that will add more features to the existing system.

Palestinian Territories

▪ EFA Software Services, a Canadian company, provided both the trading and settlement & clearing systems for the Palestine Securities Exchange in Nablus, which was established in 1995 as part of the Oslo Accords.

▪The Palestinian Authority is now in the process of establishing an embryonic central bank.

▪The Palestine Monetary Authority is mandated to manage a Palestinian currency once a state is established. Palestinians in the West Bank and Gaza now use Israeli shekels, US dollars and Jordanian dinars.

Saudi Arabia

▪ Population: 27,601,038 note: includes 5,576,076 non-nationals (July 2007 est.)*

▪ Saudi riyal pegged to US dollar.

▪The growth rate of GDP (at current prices) rose by 10.6% (source: Saudi Arabian Monetary Agency Annual Report 2006).

▪Tadawul, the Saudi Arabia stock exchange, is the eleventh largest exchange in the world and is supervised by the Capital Market Authority. In 2006 the Tadawul signed a contract with OMX for the design, supply and implementation of trading, information dissemination, surveillance and depository and settlement systems. The new infrastructure will support Tadawul’s plans for expanding its business and product offerings.

Syria

▪Population: 19,314,747 note: in addition, about 40,000 people live in the Israeli-occupied Golan Heights – 20,000 Arabs and about 20,000 Israeli settlers (July 2007 est.)*

▪Damascus Stock Exchange to open early in 2008 and Sweden’s OMX will provide the technology.

Jordan

▪ Population: 6,053,193 (July 2007 est.)*

▪ Jordanian dinar pegged to the US dollar.

▪ GDP, at constant market prices, increased by 6.4% in comparison with 7.2% in 2005 (source: Central Bank of Jordan Annual Report 2006).

▪Amman Stock Exchange, like other regional markets, witnessed a broad correction movement during 2006 that led to a significant decline in stock prices in contrast to the marked increase recorded in 2005.

Oman

▪ Population: Pop 3,204,897 note: includes 577,293 non-nationals (July 2007 est.)*

▪ Oman rial is pegged to the US dollar.

▪ GDP grew by 15.6%, in 2006, representing the third consecutive year of strong economic growth (source:Central Bank of Oman Annual Report 2006).

▪The Omani banking system has gone through several rounds of mergers since the 1990s and as at the end of 2006, the number of commercial banks stood at 14, of which 5 are locally incorporated and 9 are branches of foreign banks.

▪ Muscat Securities Market implemented an advanced electronic trading system, as well as a financial settlement system for trading among brokerage companies. Internet-based trading was launched in the first quarter of 2007. The second milestone in the Payment System Strategy Roadmap was reached on 6 September 2006 with the launch of an automated clearing house.

Iraq

▪ Population: 27,499,638 (July 2007 est.) *

▪ Iraqi dinar.

▪Iraq Stock Exchange was established 18 April 2004 and began trading on 24 June 2004. It operates under the oversight of the Iraq Securities Commission, an independent commission modelled after the US Securities and Exchange Commission. The ISX opened to foreign investors on 2 August 2007.

Yemen

▪ Population: 22,230,531 (July 2007 est.)*

▪ GDP growth accelerated from 3.9% in 2004 to 4.6% in 2005 (source: Central Bank of Yemen Annual Report 2005).

▪ No stock exchange.

Iran

▪ Population: 65,397,521 (July 2007 est.)*

▪ Iranian rial.

▪Despite regional and international tensions during 1384 (2005/06) GDP registered a growth rate of 5.4%.

▪The Tehran Stock Exchange experienced a dramatic fall in the second half of 1383. The slump continued in 1384 and bottomed out by the end of the year against the backdrop of bubble market.

▪ TSE established seven new stock exchanges in various regions. (source: Central Bank of the Islamic Republic of Iran Annual Report 2005/6)

Bahrain

▪ Population: 742,561 note: includes 283,549 non-nationals

▪ Bahrain dinar is pegged to US dollar.

▪ GDP grew by 19.7% at current prices and 7.8% at constant prices in 2005 (source: Central Bank of Bahrain Annual Report 2006).

▪ Central Bank of Bahrain has implemented an RTGS system from Singaporean firm BCSIS, which also developed a securities settlement system to handle government securities. The CBB has recently moved to new premises in the Bahrain Financial Harbour.

▪ Bahrain Stock Exchange has recently approved a project to replace its existing trading, clearing, settlement and central depository servers. In May last year it signed an MOU with Abu Dhabi Securities Market and followed that in June with a cooperation agreement with LSE.

Kuwait

▪ Population: 2,505,559 note: includes 1,291,354 non-nationals (July 2007 est.)*

▪ Kuwaiti dinar unpegged from US dollar.

▪ GDP at current prices continued to grow during 2006 up 20.8% on 2005 (source: Central Bank of Kuwait Economic Report 2006).

▪The main trading indices of the Kuwait Stock Exchange followed a downtrend during 2006. The OECD reports that a new capital market regulatory authority is being established in Kuwait.

▪ On 28 January 2003 the Kuwaiti Ladies Trading Hall was opened with the aim of creating an adequate environment for business women to trade their investment.

Qatar

▪ Population: 907,229 (July 2007 est.)*

▪ Qatari riyal fixed rate against the US dollar.

▪ GDP continued its vigour in 2005, albeit at slower pace than that of 2004, reaching 33.8% in 2005 compared to 34.8% in 2004 (source: Qatar Central Bank Annual Report 2005).

▪ In February 2005, QCB instructed the commercial banks to provide the new Islamic financing services through a unit (or a division) inside the bank or through an independent branch. In the second half of March 2005, QCB allowed banks to open accounts for foreign companies which do not operate in Qatar.

▪ Doha Securities Market

▪ Qatar Holding, part of the state-owned Qatar Investment Authority, withdrew its bid for Nordic Exchange OMX to focus instead on a potential deal to become the biggest shareholder in the London Stock Exchange.

▪ Qatar has plans for free trade zones and is building a large financial centre.

United Arab Emirates

(Abu Dhabi, Dubai, Sharjah, Ajman, Umm Al Qaiwain, Ras Al Khaimah, Fujairah)

▪ Population: 4,444,011 (July 2007 est.)*

▪ UAE diram fixed peg to the US dollar.

▪ GDP grew 23.4% in 2006, compared to 2005 (source: Central Bank of the United Arab Emirates Annual Report 2006).

▪ Dubai International Financial Centre is a “financial free zone,” a separate legal, geographic and judicial jurisdiction established in 2004.

▪ Dubai International Financial Exchange, Abu Dhabi Securities Market, and Dubai Gold & Commodities Exchange. The Dubai Mercantile Exchange will soon be launched, following a joint venture with the New York Mercantile Exchange.

▪ Borse Dubai, the holding company for DIFX and Dubai Financial Market, has entered a complex deal to buy shares in OMX and then transfer these stocks to Nasdaq. At the same time, Borse Dubai will make a minority investment in Nasdaq which in turn will take a minority holding in DIFX.

Tech spend rising due to regulatory change

The Middle East countries have created a more favourable financial services regulatory environment, which in turn is driving technology spend, according to the Tower Group research note Bright Spots in the Desert: Governance Takes Center Stage in Financial Services in the Gulf Region (see graph). Changes in the region include the opening up of the markets to foreign investment, the implementation of Basel II and the rise of Islamic products.

The central banks across the Middle East decided to implement Basel II in the agreed international timeframe of the 1 January 2008. But for many banks looking to compete on an international level, the technology expenditure has been driven more through the desire to implement best practices across their business.

Andreas Hug, solution leader for risk management, SunGard, says: “We see a lot of banks in the region investing in risk management solutions. One of the key drivers, besides the fact that right now they have a lot of money, is that they want to be prepared and credible in the international banking market – and to basically have international banking activities you have to prove that you have your risks under control. The other driver is a straight regulatory driver because the banks in the Middle East are also implementing Basel II.”

Waleed Abdullah Rashdan, executive manager at Kuwait Finance House (Bahrain), agrees that Basel II was a secondary reason – primarily the bank wanted a good risk management system for better risk practices. In 2006 it began by implementing SunGard’s asset liability management technology and then Basel II to meet the Central Bank of Bahrain’s deadline of 2008.

“We knew that it is difficult to generate the capital adequacy report required for Basel II using manual calculations – we had to automate the process. The problem was to map the Islamic banking products with Basel II products. This was the challenge and it took time for us and SunGard to sit together and map all these products to Basel II,” says Rashdan.

Islamic banking is an increasingly important part of the Middle East financial terrain and is growing by close to 15% each year – this growth rate is expected to continue at least until 2010. Nick Brewer, group strategy manager, Temenos, says: “Rather than being a specialised function, Islamic banking has moved into the mainstream. I would be now surprised if you came across a new bank or a bank expanding that didn’t have plans to offer some type of Islamic window. Four or five years ago it wasn’t the case; it was a growing sector but it tended to be more specialised banks or experiments.”

Andrew Jackson, chief executive of the KPMG Saudi Arabia practice, agrees: “Islamic banking is becoming increasingly important – a lot of the banks have refocused their Islamic banking strategy. If you look at National Commercial Bank, over the last 24 months it has gone through the process of converting all its banks to Islamic banks. All major players in Saudi are increasingly reliant on their Islamic banking strategy.

“Plus they are looking at expanding regionally and further afield – like the Al Raji Bank which has set of operations in Malaysia and is expanding those operations. There are all sorts of things that spring up from that, like efficiency of operations and consistency of systems and platforms. When these national banks become regional and international, they have got to face all sorts of governance issues as well.”

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