A closer look at secret trading in the UAE

After this summer’s Arabtec saga, sources say that the UAE’s markets regulator will seek oversight of omnibus accounts, in which financial institutions trade on behalf of undisclosed investors.

Dubai’s equity index dropped more than 10 per cent in June after a turmoil in Arabtec caused its shares to freefall. Silvia Razgova / The National
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As a result of the market turmoil that followed the Arabtec saga, the UAE stock market regulator is shedding light on a practice that blurs the lines between traders and their clients.

The Securities and Commodities Authority (SCA) has appointed four financial institutions to put forward recommendations towards a regulatory reform that will distinguish trades made by banks on behalf of clients from trades made using the bank's own money.

The SCA has tasked EFG Hermes, HSBC, NBAD and Al Mal Capital with providing a report by the end of December, according to sources familiar with the matter. All four financial institutions declined to comment last week.

The SCA is “trying to regulate an unregulated type of activity here, which has been abused by some”, said one of the sources. “Especially the amounts of leverage which have exceeded the parameters allowed by the central bank and SCA.”

Analysts say the regulator’s move is meant to cast light on hidden financing outside the framework allowed by the SCA. Another reason is to ensure that the trading institution does not exchange buy and sell orders from its clients without having the trade mirrored in the actual market.

Finally, the framework is expected to resolve the legal shortfalls that could occur if the financial institution went bust – to ensure assets are under the names of the investors and not the institution.

The sources said the technical proposals provided by the lenders will shed light on how best to regulate financial institutions that are appointed as nominees on behalf of clients in an omnibus account.

An omnibus account is one in which a financial institution is appointed as a nominee and trades a pool of stocks on behalf of clients. In these accounts, the identities of the investors are concealed. At present, the UAE exchanges and regulator are unable to see which investors are making the trades and how much of it is leverage.

The regulator is looking to start licensing the omnibus practice for financial services firms – both banks and brokerages – that meet certain requirements.

The framework would allow for greater transparency and surveillance powers for the stock exchange and regulator.

“Among the ideas floated is a code for when an institution buys for clients and not for the institution itself, in which orders are mirrored in the market and the stock exchanges and the regulator will see who is buying or selling,” said another source.

The move by the regulator is in reaction to what it sees as abuse of omnibus account activity after Dubai's equity index dropped more than 10 per cent in June. The turmoil was triggered when the Dubai contractor Arabtec's chief executive, Hasan Ismaik, resigned and hundreds of staff were cut, provoking concern among investors.

At first, the regulator tried to divert the blame on the stockbrokerages for margin calls. It then turned its attention to financial institutions and said it needed to “review and amend regulations for lending by banks operating in the country against share guarantee”.

Since then, there has been greater cooperation between the Central Bank and the SCA on stock market activity.

“There’s omnibus, and then there’s direct financing of banks to clients trading in the market,” said Fathi Ben Grira, the chief executive at Abu Dhabi-based Mena Corp. “Today both are unregulated. The only aspect regulated is the leverage provided by brokerage houses to clients.”

Brokerage arms of banks cannot exceed the one-to-one leverage ratio, stipulated by the SCA, to their clients. However, clients can go to the mother company, the bank itself and access leverage that exceeds the one-to-one ratio, Mr Ben Grira said.

"That's a loophole in the SCA regulations," Mr Ben Grira added. Banks are not regulated by the SCA, as they fall under the Central Bank.

“Leverage more than one-to-one is not bad itself. You have it in markets elsewhere. But here in the local market it’s not a good idea because of relatively low volumes and high volatility. So the risk is amplified,” Mr Ben Grira said.

It’s important not to be too restrictive on omnibus accounts, which are used in markets abroad, he said, adding that the UAE should instead adopt international best practice.

Omnibus accounts are usually used by foreign investors who would like access to a certain market. Instead of being registered and having an investor number for each market or exchange on which they trade, they can avert the cumbersome process and create an omnibus account with a financial institution.

UAE shares were incorporated into MSCI's Emerging Markets Index in June this year. MSCI, whose indexes are tracked by investors managing about US$9 trillion in assets, upgraded the UAE to an emerging market from a frontier market the previous year.

The deadline for fund managers to replicate MSCI’s Emerging Markets Index with the new weightings of UAE companies this year coincided with the Arabtec and broader Dubai market turmoil.

Beyond regulation, there are commercial advantages for local stockbrokerages by the licensing of omnibus accounts.

This spring, the regulator introduced a two-tier system for brokerages. The first tier can trade directly with the exchange and have a bigger paid-up capital requirement. The second tier are brokerages that can execute trades on behalf of their clients via a first-tier trade.

The omnibus account removes concern from second-tier brokerages that they would have to disclose their clients’ information to the first-tier broker, and have that broker poach the clients from the second-tier broker, said Nabil Farhat, a partner at Al Fajer Securities.

Secondly, for a brokerage looking to expand its offering to international markets, it allows for the cutting of cumbersome regulation and red tape.

“This is very good for us,” Mr Farhat said. “We wanted to provide our clients access to trading US stocks. But the regulation requires due diligence on individual clients. If it’s, say, 500 clients, that’s not feasible. So they told us why don’t you open an omnibus account? But we couldn’t do that because it doesn’t make sense operating in a grey area and getting into issues with SCA.”

But still, there seem to be more questions that need answers.

“They’re looking to make the market more transparent,” said a stockbroker who spoke on conditions of anonymity. “I’m not sure how that’s going to work. What if you have a Swiss bank in Geneva looking to trade on behalf of clients? What happens then?”


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