UAE and Qatar set for a new challenge after MSCI markets upgrade

Both countries became the first to win an MSCI upgrade from frontier to emerging market last year and when that becomes operational, they will find themselves in very different waters.

Qatar's stock exchange will soon be listed alongside other emerging markets including Brazil, Russia, India and China. Fadi Al Assaad / Reuters

When it kicks in operationally in May, the upgrade of the stock exchanges of the UAE and Qatar to emerging market status will mark a long-awaited milestone for both nations - exposing them to billions of dollars of assets under management from across the world.
But it will also be a milestone for the listings body MSCI. This country and Qatar are the first markets to be upgraded from frontier to emerging since the former status was established in 2007. In this way, the Dubai Financial Market (DFM), Abu Dhabi Stock Exchange and Doha Securities Market are trailblazers.
There has been much speculation on how the upgrade will affect the markets of Dubai, Abu Dhabi and Doha but on the surface the numbers look good. While MSCI Frontier attracts US$2.7 billion worth of funds, MSCI Emerging tracks some $1.4 trillion and the UAE and Qatar will now be ranked alongside such economic giants as Brazil, Russia, India and China.
There has been no prior case of a frontier market (FM) being upgraded to emerging market status - making it difficult to predict the exact effect on the UAE and Qatar come May. However, some insight can be gleaned from examples of countries moving from emerging market (EM) status to developed market (DM) status, such as Greece and Portugal in 2000 and Israel in 2010.
"What we saw when Israel entered the market was that its volumes picked up 12 months before and there was a lot of trade and activity both around the date and after," says Vijay Sumon, the director of global equity quantitative research at HSBC in London.
With regard to the UAE and Qatar, it remains to be seen whether fund managers are positioning themselves now or are waiting until May to increase their allocation of UAE and Qatari stocks. In past cases of countries moving from EM and DM, says Mr Sumon, passive managers - bound by the weightings of MSCI - tend to move in first, but active fund managers, with more control, may wait and see.
"Historically, [an upgrade] may not be positive in terms of price movement," says Mr Sumon. "Even if there is more money tracking EM than FM, at the moment the UAE and Qatar make up around 30 per cent of FM, but when they enter EM they will be only 4 or 5 per cent. Although the pool of money is obviously much greater."
The current weighting of the UAE and Qatar in the allocations for EM fund managers is zero, but come May they will be expected to have 45 or 50 basis points - which means that of an US$100 million dollar portfolio, 0.45 per cent of the funds will be allocated to either the UAE or Qatar by passive managers.
"Active managers may take a different stance, they may decide that if they are at a half of a per cent weighting, it may be too small a market to focus on at this point in time in terms of an investment proposition," Mr Sumon says.
Indeed, there are many on the ground who do not expect a huge effect to be felt on the Dubai, Abu Dhabi and Doha markets in the short term.
"Yes, people are bullish about it, but a lot of the sentiment is already valued in. I don't expect that come May you are going to see a paradigm shift of any kind," says Adnan Fazil, the director of transaction services at Deloitte.
What we may see, Mr Fazil believes, is a directional shift towards enhanced regulation, more transparency and a lot more maturity in the way that the three markets expect issuers to behave.
"This will encourage investor confidence, both from global investors and from international and regional investors, that might add to the liquidity in Dubai, Abu Dhabi and Doha," Mr Fazil says.
"I think that is the key attraction, that the MSCI is validating or has validated that over the last 24 months, both the DFM and Qatar have taken positive steps towards addressing the gaps that they had identified and are on the right track. I think Abu Dhabi will follow suit, but it doesn't have such a big liquidity issue, relatively."
Israel, Greece and Portugal were very mature markets when they were upgraded to the developed market index, with little or no foreign ownership limits, so it is more difficult to predict what the effect of an upgrade will have on the UAE and Qatar - both of which restrict foreign ownership and remain heavily reliant on local retail investors.
But even the mere discussions around upgrading over the past three years have resulted in reform in opening up the Arabian Gulf markets, says Sebastien Lieblich, the executive director of the index department at MSCI, with both the UAE and Qatar taking "a big step" towards increasing foreign ownership - currently 49 per cent in the UAE and just over 25 per cent in Qatar.
"We are hopeful that we will see much more progress in the coming months," he adds.
But, in the end, as has been the case in Taiwan, South Korea and India, the inclusion of this country and Qatar in the EM index may force the authorities to open up local companies to overseas investors or risk being marginalised on the index. If the "foreign room level" - which is the amount of stock available to foreign investors of a given company on the index - becomes too low or drops to zero, MSCI has to reduce its weighting.
"It creates a problem for providers as their indexes are not fit for purpose any more," says Mr Sumon
"What tends to happen is if it is a chronic situation, that could prompt the index provider to reduce the exposure of that country in the index. This happened in India, where single stocks reached foreign ownership limits and the weighting was reduced.
"The UAE and Qatar may be prompted to increase their foreign ownership limit to allow investors greater access to the market and the freedom to enter the market," Mr Sumon adds.
"Taiwan and Korea gradually increased their free float [after being upgraded] but that took years."
Still, Jaap Meijer, the executive director of the equity research at Arqaam Capital, is bullish that the upgrade will be positive for the UAE and Qatar in terms of forcing their hand towards greater foreign ownership.
"We expect the MSCI inclusion of the UAE and Qatar to be a catalyst, improving the liquidity in these markets, and resulting in strong inflows as MSCI emerging market funds would need to recalibrate their exposure and as these countries start to show up on more investors' radars," he says.
"We expect many companies to raise their foreign ownership limits."
Mr Lieblich, however, is reluctant to speculate on when the true effects of the upgrade will be felt.
"We have only had a frontier market since 2007 so since the inception of the index we have never had an upgrade from FM to EM," he says.
"These are the first two. It is a pretty unique situation that we are facing."
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