ROUNDTABLE DISCUSSION: Inconsistent messages (part 1)

Clarity is key to the development of the Middle East region as a fund hub. In this roundtable discussion, senior executives outline the main challenges and their outlook for the industry. (part 1) Participants:
Stewart Adams
(head of investors & intermediaries, transaction banking, Mena, Standard Chartered Bank)

Mike Cowley (head of product & client management Mena, Deutsche Bank)
Glyn Gibbs (head of business development Mena, HSBC Securities Services)
James Martinson (senior vice president, Dubai, Maples Fund Services)
Richard Street (managing director, head of securities and fund services, Middle East and Pakistan, Citi) Mena-roundtable

Stewart Adams
(Standard Chartered Bank),
Mike Cowley (Deutsche Bank), Glyn Gibbs HSBC Securities Services)
James Martinson (Maples Fund Services), Richard Street Citi) Funds Global: Have regulators across the Middle East been successful in providing a more transparent regulatory framework or is there a danger that over regulation will stifle market growth? Richard Street, Citi: When it comes to fund regulation, we’re always keen to get more clarity. The regulations in the more recently formed domiciles, like the DIFC [Dubai International Financial Centre] and the QFC [Qatar Financial Centre], need to be aligned to their commercial ambitions within those areas and I think that’s been done reasonably well. Bahrain also has a good and clear set of regulations. Whilst considering the local regulatory environment it should be acknowledged that the majority of the activity we deal with is for offshore funds and if managers have a stable of Bahraini, or any other local, funds, it’s a small portion of their business. Many of those providers on the asset management side will already be considering going for Ucits solutions or already have other platforms, maybe Cayman or BVI [British Virgin Islands]. So, unless each of those domiciles [Dubai, Qatar, Bahrain] can find themselves a USP [unique selling point] and identify appropriate regulation against which they will be benchmarked, I don’t see a manager automatically choosing to domicile their funds in this region. Mike Cowley, Deutsche Bank: I think we have to remember the local markets/infrastructures are still very young. Many people come to the local markets in the Mena region and look for transparency and at the same time ask for things to be more regulated and more controlled so we now have an environment where we could possibly see some overregulation which could hinder growth. Things will continue to develop, regulation will continue to change but it would be better for all if there is a road map put in place on goals and objectives. We do sometimes seem to be a little reactive in the region. Funds Global: Is there a consistent message coming through from the regulators across the region? Cowley:    Unfortunately there isn’t a real consistent message emerging, however, we are beginning to see more cooperation between regulators which in such a relatively small region is be a huge plus. Martinson: The only constant message across the region is that there’s a significant amount of regulatory uncertainty, which curbs capital inflows from other parts of the world. We saw this happen in Qatar where there are three regulators and significant uncertainty as to which regulator is responsible for each respective sector.  More recently we saw the exact same thing in the UAE where it’s unclear what activities are overseen by the central bank and what will ultimately be regulated by Esca [Emirates Securities and Commodities Authority]. The regulators’ vision is commendable; they are aiming for greater transparency and trying to apply international best practice locally. However I think the ultimate goal has to be to eliminate regulatory uncertainty and establish clear regulations that attract foreign investment, especially in the wake of the financial crisis. The DIFC carried out a significant overhaul of its funds regulations last year, which is positive, but given the political climate, the UAE as a whole could benefit from a clear and concise regulatory policy going forward. Glyn Gibbs, HSBC: You also need to look at what’s driving regulation. Investor protection is the foundation of all this and therein lies the difficulty. In maximising investor protection, you increase costs because of the varying requirements between the different regulators which can lead to processes being duplicated and thus extra cost. This then comes back to the point as to whether this makes a local domicile uncompetitive from a distributor’s standpoint. If we compare local domiciles to international ones, it also affects the distribution of offshore funds into the region. The local regulators will be extremely careful about what they allow into the region because if you heavily regulate your own funds you’re not likely to allow unregulated or lightly regulated offshore funds to easily enter the market. That is the dichotomy and ultimately, as regulation evolves over time, that will bring the two closer together. Funds Global: The market is still in its infancy but a lot of good things have been done in that short period of time. So, are we being unduly harsh on these nascent markets? Street: Possibly we are, but for a fund management organisation choosing to enter a new domicile because there’s an opportunity to attract new investors and/or to enable investment to be made more effectively - it’s a commercial consideration. One of the considerations of the manager is the ability of the fund environment to enable managers to set up appropriately regulated funds with a quick turnaround - cost is obviously a primary consideration, ease of entry is another; these boxes need to be ticked to attract new funds to a fledgling domicile. But there are other ways to encourage more activity to the new fund markets. In fact, not only should we think about mutual funds, we should consider the broader pension fund industry as well.
In the Middle East there is a huge polarisation among the investing public. You have significant wealth in the public and private sectors where investors would rarely consider going for a fund solution. At the other end you have the emerging middle classes who want to start investing. This group may already be remitting significant sums of money back to their home countries or even investing into their own domestic funds markets. These new investors and the established middle class will also be attracted to invest in funds domiciled in the more established international markets. Gibbs: The other problem is that most funds in the region don’t have scale and therefore they aren’t large enough to sustain certain levels of overhead costs, unless the sponsor is willing to subsidise the fund from its own pocket to develop its brand. Funds Global: Asset service providers talk about bringing automated processes to Middle East banks in order to help them sell funds. But how easy is it for local banks and fund managers to plug-in to straight-through processing? Is there an interest to do so and are they willing to incur any associated costs? Street: Asset managers are investing in relationships with the consumer banks in the region for distribution. They rely on those banks to do the appropriate level of KYC [know your client] and AML [anti money laundering] work.  Automation between the distributor and the fund administrator is then a bilateral agreement between the parties. The non-institutional investor community will use their banks and financial advisors to access insurance and investment products. Even the life companies use the banks to distribute their insurance products, most of which are funds-backed. This is a trend I believe will continue.
As the international names look to broaden their distribution channels in the region there is potential for asset servicing providers to deliver a product alongside them, running sub registers and taking on the KYC/AML. This would be attractive to the asset manager and provide comfort to the home regulator of the fund.  Asset managers will look at the best solutions to achieve their distribution ambitions while preserving their good name by ensuring that their distribution is absolutely clean.
Gibbs: STP [straight-through-processing] is definitely something we have seen more of in the past 18 months. There are two reasons for this. The more business you can STP, the more you can automate and therefore the cheaper and quicker the process. Who’s going to pay the cost for the system development required is always the issue.
We have also seen the rise of fund platforms, like Fidelity Funds’ network in Europe. You have the likes of Allfunds pushing into the Middle East whilst we are promoting our platform as well, HSBCfast. Skandia is also being mentioned.
When looking to link to this type of platform, the KYC issue Richard mentioned is the first question we ask. Anybody entering this kind of arrangement has to make sure that procedures and processes are followed to market standard. Another driver is that a platform makes things easier for whoever is buying or selling the fund because it helps reduce paperwork. Stuart Adams, Standard Chartered: It’s completely dependent on the target investors. Local investors really want to invest through a platform that will take them somewhere else.
I chaired a post-trade optimisation conference earlier this year around STP and everyone in the region seems to be looking towards London and Europe and how well that has performed.
They have to realise that it took about 400 years to get where they are and it’s still not perfect.
The cost of getting onto these platforms can be quite punitive, especially in Europe. You have to pay unless your assets are a certain size or unless there’s certain demand for your product. Therefore, will funds with smaller assets under management want to take on the extra cost of getting their products onto a platform? It depends on what it will give them in terms of distribution. If they can get distribution through some other networks and banks then that will be the way forward for them. But regardless, STP seems to be very high on the agenda. Funds Global: There has been more talk of the growth of securities lending, exchange-traded funds and OTC derivatives in the Mena region. Is this something you have witnessed or are these services still in their infancy? Cowley: I feel they are a long way away and that is not necessarily a bad thing.. For these activities/products to take off in this region, we need to have an equity market that has the liquidity and depth which enables the  products mentioned to succeed, maybe only a handful of local stocks would currently benefit. You mentioned ETFs. We have seen in Abu Dhabi and Saudi that ETFs at present and in their current form don’t work in these markets, at least for now. If you can’t lend stock and you can’t short stock then it’s difficult to get these products moving. The same goes for derivatives.
So they’re all good ideas and they may all possibly become a reality at some point. But for that to happen, you need to go back to the fundamentals and create an equity market with decent liquidity, volume and depth before you can move to the next level of products. Adams: A good step forward would be if the exchanges could interface with each other so investors could trade across exchanges. This could then potentially lead to a consolidated exchange network. Cowley: I agree but I don’t think it will happen for a quite some time at exchange level, each country will want to keep its own trading platform for a while yet. We might find a CSD platform could be more attainable at a regional level. Martinson: The positive thing is that the regulators are recognising that they need to make some changes to market practices in order for countries such as the UAE, Qatar and Saudi Arabia to be upgraded from frontier market status to emerging market status by MSCI.  This appears to be given the utmost importance and inclusion in the MSCI Emerging Market Index is what everybody’s aiming for rather than focusing on the fundamental building blocks of the market that would ultimately achieve this goal.

Cowley: Agreed; my worry is that we tick all the boxes to get onto the MSCI and then we’ll see very little change after that at the Exchange/CSD level. Maybe now would be a good time to step back and consider what the market model should/could look like in five years’ time. I think, otherwise we  may miss a good opportunity here. Martinson: Everybody thinks achieving this goal will attract a significant amount of foreign investment, but how do we expect to see such flows being invested?  Will allocations to locally domiciled funds that are subject to a degree of regulatory uncertainty really increase significantly? To achieve sustainability, I think that regulators need to continue to consider the basics and attempt to stimulate the market from a grass roots level up, rather than aiming to achieve emerging market status in the first instance. Street: Good progress has been made around corporate governance and all companies are posting financials periodically. Kuwait, for example, suspended many companies that were late. This is the basis of a robust capital market. We need to make sure that we have good quality companies carrying out the correct activities on the corporate governance side. This way, people know what they’re buying into and they’re prepared to invest in these markets.
We need to have more stocks listed on local exchanges and therefore they [the local exchanges] need to be more attractive to compete with other listing venues. We also need to defend all of the issuance that has already come to the regional markets.
I’m extremely encouraged by the idea of some level of privatisation across the region. The one reason you’ll never have unity across the region is because they each want to make sure they push all activity through their own exchanges and create a more diverse economy. That’s healthy. We wouldn’t have expected the Western countries to merge their exchanges in the days of mass privatisation.
But first of all, we need to consider the fundamentals, the building blocks that make a market attractive. Investors are attracted to a particular market because it’s selling a good product, it’s transparent and there’s a demand for that product. These are the things we should be focusing on. Funds Global: Do local fund managers understand what custody is or is there still a need for more education around why they should trust you with their assets? Street: Many fund managers, even some quite sizeable ones, leave all their assets with a broker. Many people believe that the exchange is the depository or custodian, and to an extent it is. This is not unique to this part of the world. What we’re doing is introducing improved controls and quality asset servicing as a local custodian in these markets and helping to drive the entire market infrastructure forward toward greater maturity. It’s definitely beneficial for the asset managers that have funds domiciled in the region and also have international ambitions. They know it’s the right way to be successful as an international player. Cowley: Things have improved. For example in the UAE they are pushing for more transparency between fund managers and post trade services associated with funds. This type of thinking and subsequent regulation means that people start to look at custodians in a different light and see the value added they can bring. . If we also look at what has changed since custodians got involved in the markets I think people have started to see some benefits. More needs to be done on the education of what we do but local fund managers have now started to see the added value.
We have seen movement away from having dividend payments made by cheque. These are basic things that may seem prehistoric to those outside the local industry, but there have been changes in the last 24 to 36 months which although they haven’t been massively significant on there own, represent when combined, a reasonably impressive move in a short period of time. Adams: I feel that education is required, around how a custodian can help automation and provide asset security. It is very encouraging to be involved in conversations where organisations are open to change and they see the benefit of a service solution. The market had developed in the past few years; however further development is required and desired by the financial organisations in the region. Gibbs: This is a long journey and you have to start with the small things but we are moving forward. To go back to the original question; I think securities lending and ETFs will happen. Whether these things are going to happen for the right reasons is another story. I think that ultimately it will be successful in helping to develop and expand the market.
Furthermore, moves like inclusion in the MSCI Emerging Markets Index will attract more money and encourage market values to rise. That in turn will create more liquidity as people look to sell into that market and get out of positions they were locked into.
There is potential for a virtuous circle but it’s not going to be immediate.
Regarding custody, I don’t think it is a matter of education. People know full well that if they leave assets with brokers there is a clear risk as assets are not necessarily segregated in a watertight manner.  Moreover the broker can access the assets and use them intra day should they so wish.  More positively, I’m glad to say that we are seeing quite a few companies beginning to use a custodian where they haven’t used one before. Generally, they would do this if they’ve invested in their domestic market and they’re looking at an asset allocation strategy that will take them elsewhere in the region where, perhaps, they are not as sure of the market from a structural standpoint. I wouldn’t say it’s a trend but it’s something we are seeing among the clients I deal with. There are more new clients this year than last year and these are new clients that never used a custodian before. That’s encouraging for all of us because it should lead to opportunity. Martinson: Since I’ve been in the region there’s been consistent progress, although not necessarily always at a fast pace. The markets are evolving. Asset managers were traditionally doing all their administration in-house. But now it’s no longer a question of trying to convince managers that outsourcing their administration to a third party is best practice. We’re finding that there is also a big shift in mindset towards separating custody and administration and managers are more dedicated to applying international best practice. We’ve seen consistent progress in this regard and hopefully the market will continue to evolve in this way. End of part 1 ©2011 funds global

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