Optimism about Securities Lending in the Middle East
16 November 2010 London
Image: Shutterstock
The climax to the Formula 1 season in Abu Dhabi was preceded by the 2010 Middle East Securities Finance Forum in Dubai. The recent announcement from the Qatar and UAE Stock Exchanges that they would attempt to introduce securities lending and short selling regulations in 2011 provided the backdrop for the debate. Those present felt there was a new degree of momentum behind the plans of these exchanges to open up securities lending. Companies covered are Emaar Properties (DFM:EMAAR) and Dubai Electricity and Water Authority (DEWAT).
An active market for short selling and securities lending represent two of the six criteria required by MSCI to gain emerging market rather than frontier market status. Panelists believed this combination would aid capital flows in region, as well as increasing price transparency and liquidity in the region. MSCI’s last index rebalance was just recently and there was no change to the 21 countries defined as “emerging markets”. However, Trinidad & Tobago was mentioned as a possible future drop out due to poor liquidity so perhaps that makes way for a Middle Eastern country when the next review takes place next February?
For an example of how inhibitive it is to have no short selling was given as follows, evidence was heard that Dubai listed Emaar Properties (DFM:EMAAR) had a tough time issuing some debt to raise money. Their USD 500m of convertible bonds had incurred costs of an estimated US$50m over a five year period because of the high coupon (7.5%) the company had to pay to investors since they could not hedge the convertible bond position by selling the equity short. This bond was effectively priced like a corporate not a convertible, with the equity option given away for free. It is no surprise that we cannot find any institutional ownership of it right now in lending programs. Imagine the total benefit short selling and securities lending could bring for companies, investors and traders in the region.
Other Dubai issued debt with similar yields and popular with institutional investors are various bonds from Dubai Electricity and Water Authority (DEWAT). For example, the bond maturing in Oct 2020 and paying a 7.375% annual yield sees 20% of the issue value in lending programs (if the issue value is USD 161m). A small amount is on loan (8m). Some delegates expressed concern that the regulatory regime in the region could develop in disparate ways and that competing exchanges could challenge the building of consensus. In addition, regulators were urged to construct an environment that facilitated the participation of the local retail investors and for a sensible level of transparency that would create a level playing field between funds going long and going short.
Following the anticipated introduction of securities lending and short selling regulations, panelists believed activity would initially be pioneered in the regions by the international investor community with local lenders expected to follow. The first lenders were expected to engage in synthetic transactions rather than stock loans – mirroring the experience in Asia. Over time the international investor community, encouraged if the Middle East secured emerging market status, will provide more supply via experienced global custodians. Attractive fees will attract local lenders once the market is established.
Other important points made on the day:
• Panelists felt that short selling was permissible under Sharia Law.
• Fixed Income represents only 6% of securities lending volume in the region, growing strongly and with good spreads.
• Restrictions on foreign ownership need to be repealed in order for the market to mature.
• Regulators in the market are as sophisticated as their European counterparts.
• Many in the region have multiple custodians and have decoupled lending from custody.
• Cash collateral down to 50% from a peak of 95%.
• GCC region needs its own industry association – any volunteers?
More information about the Middle East Securities Financing Forum, including the results of interactive voting, can be found at: www.dataexplorers.com/dubai
An active market for short selling and securities lending represent two of the six criteria required by MSCI to gain emerging market rather than frontier market status. Panelists believed this combination would aid capital flows in region, as well as increasing price transparency and liquidity in the region. MSCI’s last index rebalance was just recently and there was no change to the 21 countries defined as “emerging markets”. However, Trinidad & Tobago was mentioned as a possible future drop out due to poor liquidity so perhaps that makes way for a Middle Eastern country when the next review takes place next February?
For an example of how inhibitive it is to have no short selling was given as follows, evidence was heard that Dubai listed Emaar Properties (DFM:EMAAR) had a tough time issuing some debt to raise money. Their USD 500m of convertible bonds had incurred costs of an estimated US$50m over a five year period because of the high coupon (7.5%) the company had to pay to investors since they could not hedge the convertible bond position by selling the equity short. This bond was effectively priced like a corporate not a convertible, with the equity option given away for free. It is no surprise that we cannot find any institutional ownership of it right now in lending programs. Imagine the total benefit short selling and securities lending could bring for companies, investors and traders in the region.
Other Dubai issued debt with similar yields and popular with institutional investors are various bonds from Dubai Electricity and Water Authority (DEWAT). For example, the bond maturing in Oct 2020 and paying a 7.375% annual yield sees 20% of the issue value in lending programs (if the issue value is USD 161m). A small amount is on loan (8m). Some delegates expressed concern that the regulatory regime in the region could develop in disparate ways and that competing exchanges could challenge the building of consensus. In addition, regulators were urged to construct an environment that facilitated the participation of the local retail investors and for a sensible level of transparency that would create a level playing field between funds going long and going short.
Following the anticipated introduction of securities lending and short selling regulations, panelists believed activity would initially be pioneered in the regions by the international investor community with local lenders expected to follow. The first lenders were expected to engage in synthetic transactions rather than stock loans – mirroring the experience in Asia. Over time the international investor community, encouraged if the Middle East secured emerging market status, will provide more supply via experienced global custodians. Attractive fees will attract local lenders once the market is established.
Other important points made on the day:
• Panelists felt that short selling was permissible under Sharia Law.
• Fixed Income represents only 6% of securities lending volume in the region, growing strongly and with good spreads.
• Restrictions on foreign ownership need to be repealed in order for the market to mature.
• Regulators in the market are as sophisticated as their European counterparts.
• Many in the region have multiple custodians and have decoupled lending from custody.
• Cash collateral down to 50% from a peak of 95%.
• GCC region needs its own industry association – any volunteers?
More information about the Middle East Securities Financing Forum, including the results of interactive voting, can be found at: www.dataexplorers.com/dubai
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