Pressures for Increased Transparency resulting from MSCI’s Reclassification of UAE from Frontier to Emerging Market
Written by Zachary Cefaratti, Risk Officer at Dalma Capital Management Limited
Analysis by Ryan Mahoney, Portfolio Manager at Dalma Capital Management Limited
Dalma Capital Management Limited is a DFSA regulated asset manager operating in the DIFC; the company’s core business is hedge fund management.
MSCI (Morgan Stanley Capital International Indices) is no longer part of Morgan Stanley but is a worldwide, influential and leading provider of investment decision support tools.
On 14 May 2014 MSCI announced the results of its semi-annual review meeting. As expected, the UAE and Qatar indices were reclassified from Frontier Markets to Emerging Markets.
This brings positive news to the market in terms of increased investor confidence, greater visibility of UAE companies to sophisticated investors worldwide, increase in foreign portfolio investment directed towards the UAE and improvement in overall market efficiency. The upgrade and the assets that come with it are also likely to lead to pressures for increased transparency in order to achieve consistency with the market accessibility criteria set forth by MSCI for constituents of its Emerging Markets Index.
A country’s market accessibility is judged on the basis of four factors that include: openness to foreign ownership; ease of capital inflows and outflows; efficiency of the operational framework, and stability of the institutional framework. “To remain consistent with the Emerging Markets criterion and gradually move towards the ultimate goal of being classified as a Developed Market, the UAE and Qatar will need to deliver the required improvements in all four factors assessing market accessibility,” concludes Elliot Carol, portfolio strategist at Dalma Capital Management Limited.
With regard to openness to foreign ownership, the MSCI upgrade will require local markets to have an increased focus on providing a level playing field for both international and local investors. Foreign ownership limit levels will inevitably need to be enhanced, with equal economic and voting rights being provided to foreign investors. In addition, the upgrade will necessitate that equal rights are provided to all minority shareholders.
The UAE is largely compliant with the ease of capital inflows and outflows factor; the country has already implemented a high degree of foreign exchange market liberalisation due to the existence of a developed onshore and offshore forex market. There are also no restrictions, as such, on inflows and outflows of foreign capital to and from the local stock market. Minimal restrictions are applicable to repatriation of foreign direct investment as well.
The key challenge will be improving efficiency of the operational framework and, just as importantly, maintaining it. Barriers to entry for investors will need to be lowered significantly, by minimizing the registration requirements for international investors as well as documentation/approvals required for setting up local accounts in order to decrease the overall time required for opening and funding an account. The legal and regulatory framework governing the financial market, stock exchanges and the various other financial markets participants will need to be improved, including ease of access to information (particularly in English), reduction of ambiguity and prompt enforcement of laws and regulations, as well as consistency amongst all of these factors over time.
A competitive landscape that encourages unrestricted investor access to derived stock market information, data and investment products will also be required; for example the provision of independently calculated indices or the creation of baskets of securities used in the creation of financial products. Likely the most important factor in improving transparency will be increased pressure for the timely disclosure of complete stock market information in English and under reasonable commercial terms to all market participants as well as the robustness and enforcement of accounting standards. These improvements will likely lead to reduced information asymmetry amongst investors and other market participants.
Constant improvements will be considered necessary in the market infrastructure as the UAE continues its path to “developed market” status. A well-functioning clearing and settlement system, based on international standards including delivery versus payment, the absence of pre-funding requirements and the possibility to use overdrafts will need to be in place. Availability of omnibus structures will be a key consideration. An efficient mechanism that prevents brokers from having unlimited access to an investor’s accounts, in order to guarantee the safe keeping of its assets will in all likelihood become mandatory and would require competition amongst local custodian banks as well as the presence of global custodian banks.
In addition, to ensure high quality of services offered to investors – such as cost efficient trading and ability to execute block trades at the same price for the various accounts of a fund manager – steps to increase competition amongst brokers will be inevitable. A framework for off-exchange transactions and in-kind transfers will likely be needed. Finally, there will be pressures to put in place an efficient mechanism to allow short selling as well as extensive use of stock lending, along with a robust but practical regulatory framework governing those activities.
Concerning the stability of the institutional framework – which deals with basic institutional principles such as the rule of law and its enforcement, the stability of the "free-market" economic system and track record of government intervention with regards to foreign investors – the requirements remain modest for countries classified as both Emerging and Frontier Markets.
Any country aiming to acquire the Developed Market status in the long term inevitably needs to focus on improving the stability of its institutional framework as well.
