Still hungry for a complete merger of exchanges

I made a wager about this time last year with a friend in the Dubai International Financial Centre that the Dubai Financial Market and NASDAQ Dubai would merge.

I made a wager about this time last year with a friend in the Dubai International Financial Centre that the Dubai Financial Market (DFM) and NASDAQ Dubai would be merged to produce a single, unified stock exchange in the emirate before the year was out. I forgot about it until, boarding a plane for London for the season's jollifications a couple of weeks ago, I got a mobile alert to the effect that DFM and NASDAQ Dubai had signed a deal that appeared to do just that.

For US$120 million (Dh439.5m), DFM was to buy out the 33 per cent NASDAQ Dubai stake held by New York's NASDAQ. The Americans received cash and a 1 per cent stake in DFM valued at $40m, and expressed their determination to continue working with the two exchanges to help make Dubai the premier financial market place of the Gulf. Through its holding company Borse Dubai, which owned the balance of NASDAQ Dubai shares, DFM would be the senior partner in the new company. Consolidation of the two exchanges was to proceed in the course of this year. "Linking" and "combination" were the phrases used by Dubai officials to describe the move.

I felt entirely vindicated and called my pal to claim my prize, a light lunch at Zuma. "Wait a minute," he said. "It's not done yet. I'll buy you lunch when it's really completed, and that could be a long time yet." I though he was just being a bad loser, but as I talked it through with him I realised he was right. There are so many loose ends and unanswered questions about the deal that it is by no means a shoo-in.

The principle has been agreed, though, which is important. It has been obvious to many observers of the Dubai financial scene for some time that the emirate could not really support two exchanges. Even on the more active DFM, daily traded volumes are tiny in comparison with the global markets that Dubai is supposed to be rivalling. At NASDAQ Dubai, daily business consisted almost entirely of trade in shares of DP World, which again was very small.

For a population of 1.5 million people, even if quite a large proportion are active retail traders, it made no sense to fund the expensive infrastructure of two markets. That was before adding the competitive lure of the Abu Dhabi Securities Exchange (ADX). So while the logic for merger was sound, there was a logic to the creation of NASDAQ Dubai in the first place which must not be overlooked. When it was launched in 2005 as the Dubai International Financial Exchange (DIFX), the aim was to attract big international stocks to Dubai, preferably as primary listings, but if not then as joint listings with the likes of London and New York.

For a whole stack of reasons, and apart from Dubai's very own DP World, that never happened. Although they would not admit it, I suspect there was an element of "build it and they will come" to the thinking of early exchange strategists, who with hindsight appear to have overestimated the attractions of the region and underestimated the competition. The big market, Saudi Arabia, has remained resolutely opposed to foreign involvement, even if channelled through Dubai.

The other argument for DIFX was that international investors needed certain standards of governance and regulatory guarantees before they would consider investing in the region. DIFX, with its own regulator - the Dubai Financial Securities Authority (DFSA) - and its own governance procedures was supposed to provide this. In the end it proved to be less than attractive for the big global funds. They wanted certain rules and standards, sure, but the thought of being "offshore", as DIFX was viewed, required a lighter regulatory hand.

Regulatory concerns, it seems to me, are at the crux of the obstacles to a truly unified Dubai stock exchange. DFM currently falls under the federal body, the Emirates Securities and Commodities Authority (ESCA), so some harmonisation of ESCA and DFSA is essential. But the two bodies come from very distinct investment cultures. The rationale for the merger is that NASDAQ Dubai needs the liquidity provided by DFM, but that liquidity also conceals a short-termist trader mentality that might not sit well with NASDAQ Dubai's ambitions to be a global centre.

Compared to this significant cultural difference, the practicalities of merging look comparatively simple. Trading platforms, settlement and back-office systems are all pretty much automated these days anyway and the new exchange should not be embarrassed at imitating the practices of NASDAQ in New York. It looks inevitable that we will lose the separate indexes operated by DFM and NASDAQ Dubai. The latter already runs a useful alternative index called the UAE 20, which is split roughly equally between Dubai and Abu Dhabi stocks. If that is formalised, it opens the possibility of a further merger with the ADX, which is a whole different question.

I have a feeling I will be waiting some time for my Zuma lunch.