Abu Dhabi stock market revives derivatives plan

The Abu Dhabi Securities Exchange is dusting off derivatives plans first hatched in 2005. Delores Johnson / The National

Stock market officials are reviving plans for a Gulf Derivatives Exchange capable of trading the most sophisticated financial products.

The Abu Dhabi Securities Exchange is dusting off plans first mooted in 2005 but shelved after the eruption of the financial crisis, itself brought about by derivative bets gone wrong.

"What stopped us was the crisis. Immediately we said 'let's reprioritise', and we put it on the shelf," Rashed Al Baloushi, the ADX's chief executive, told The National.

"Now we're looking for the right time. If the players are demanding to have derivatives available, then we'll shift up the gears to put the rules and regulations together."

The exchange is currently taking views from custodian banks and others in the financial services industry and would need the support of authorities before any move could be taken, Mr Al Baloushi added.

Industry practitioners recognise that the reputation of the derivatives industry has been tarnished as a result of the financial crisis, when lacklustre regulation and risk management practices from financial firms - especially for credit derivatives - led to trillion-dollar taxpayer-funded bailouts and capital injections from central banks.

In the region, firms including Abu Dhabi Commercial Bank, Dubai's Mashreq and Kuwait's National Industries Group have all lost hundreds of millions of dollars on derivative bets, some of which are still being fought over in lawsuits.

But some analysts argue that since banks already make extensive use of derivatives anyway, having a regional derivatives exchange would reduce risk.

In the Arabian Gulf, most derivatives are traded "over the counter", or directly between banks. This raises risks and makes banks more difficult to regulate, although whether exchange-trading solves the issue was still a matter of debate, said Philippe Carre, the global head of connectivity for SunGard's capital markets business. "OTC/bilateral transactions have been viewed as containing significant risk, which usually remains in the banking system, if not directly on the bank's balance sheet," he said.

"There is a pent-up demand for hedging using on-exchange derivatives instruments, such as equity derivatives or index futures, which would allow market players to better manage their risk."

The UAE's upgrade to "emerging markets" status by the index provider MSCI along with Qatar this month has left exchange officials plotting the next course of growth. The ADX is also currently studying whether it can provide more derivative products including futures contracts, alongside depositary receipts and exchange-traded funds, in an effort to develop the sophistication of local markets, Mr Al Baloushi said.

Following the MSCI upgrade, increased use of derivatives would cement the place of Arabian Gulf financial firms among international markets, said Riad Meliti, the chief executive of Arqaam Capital, the Dubai-based investment bank.

"Derivatives would accelerate the amount of time it takes for the regional markets to be better integrated into international markets. We're already seeing very positive signs in the progress of that by virtue of the upgrade of the UAE and Qatari stock markets," he said.

"It's important that the instrument develops in the Middle East from a risk management perspective."

Arqaam is one of the few local firms that structures and trades foreign exchange, commodity and equity derivatives. Much of this business is done by international lenders such as Standard Chartered and Deutsche Bank.

Mr Meliti said reviving the Gulf Derivatives Exchange was a "great idea" and added that using an existing platform where the technology is in place, such as Nasdaq Dubai, would be preferable to starting from scratch.

Other hurdles remain, however. The UAE lacks a legal framework to develop a home-grown derivatives industry, mostly as a consequence of outdated bankruptcy laws, bankers said.

The Securities and Commodities Authority, the market regulator, last year approved laws for short-selling, securities borrowing and lending, market making and liquidity providers, giving financial firms additional sophisticated tools for use on the UAE's markets.