Funding future development

By Mats Berggren, Advent Software EMEA

With their bulging oil-fed coffers, Gulf-based investors have been making a big splash on the global financial stage. Reports of Borse Dubai and Qatar Investment Authority’s stakes in the London Stock Exchange and OMX, and that a tenth of banking giant Citi is now in Middle Eastern hands pay testimony to the importance of the region in the international arena.

But the changing investing environments at home are making big news too. For example, this December the Dubai Financial Services Authority became the first regulator to issue a code of practice for hedge funds. The code – which focuses on nine key principles around areas such as assets, back-office functions and trading risks – comes into effect on Jan. 20, with the goal of promoting a vibrant hedge funds industry in Dubai.

The move is the latest in a string of initiatives undertaken by the emirate as it seeks to position itself as the region’s financial hub, and spur development in the United Arab Emirates and wider region. The focal point of that strategy is the Dubai International Financial Centre, a 110-acre free zone that is seeking to build a world-class presence across banking services, capital markets, wealth management, reinsurance and Islamic finance, while attracting the ancillary service providers to support them.

Its success is evident in the roll call of institutions that have set up shop there. Since its launch in September 2004, more than 400 companies have joined the centre, a figure that is expected to top 550 by year-end, making it the most popular location in the region for western companies. Among them are behemoths of the global financial world such as Goldman Sachs, Citi, Merrill Lynch, Morgan Stanley, Deutsche Bank, Mellon Global Investments and IXIS Asset Management. The first hedge fund to be domiciled in DIFC, Argent Financial Group International, was authorised in March 2006.

But Dubai is not the only one. The crown of leading financial centre is hotly contested among its neighbours in the region, many of whose governments are undertaking similar programmes in an effort to diversify their economies away from their past reliance on oil and gas.

Since the 1970s Bahrain has been the region’s financial capital, when it supplanted Beirut following Lebanon’s descent into civil war. It is now seeking to build on that with the $1.5 billion Bahrain Financial Harbour development. Its centrepiece, the Financial Centre, was formally opened in May, with Dexia Asset Management and BNP Paribas among those already signed up.

As with its peers, the Qatar Financial Centre (QFC), established in March 2005, aims to be the Middle East’s financial centre of choice. It too is seeking to attract international financial institutions and multinational corporates, as Qatar seeks to develop both its local and the region’s markets in the wake of its burgeoning economy. To date, Goldman Sachs, Lehman Brothers, Morgan Stanley, Barclays Bank, Credit Suisse and Swiss asset manager Union Bancaire Privée are among those granted authorisation to operate in the QFC.

Meanwhile, Saudi Arabia is building King Abdullah Economic City, a multi-billion new metropolis north of Jeddah that will feature a central business district (including a Financial Island that it hopes will attract the world’s premier banks and investment institutions), industrial zone and residential districts that are forecast to be home to two million people.

In addition, plans for a Financial City in Ras Al Khaimah, which will form the centrepiece of the RAK Offshore project, a free zone financial hub under development by the RAK Investment Authority, were unveiled in June.

The pace and scale of development of such centres attest to the dynamic growth these markets are experiencing, and their ambitions for the future. And their effects are being felt in particular in the private banking and wealth management arenas.

Evidence of that can be found in an Economist Intelligence Unit (EIU) white paper, Asset management in the Middle East: The prospects for global financial institutions, which was sponsored by the Qatar Financial Centre Authority and released in September. In it, the EIU pointed to how the growing ranks of high net worth individuals, plus developments in the region’s capital markets are spurring demand for private banking and wealth management services. And included in that is growing interest in sophisticated investment products, such as derivatives, hedge funds and exchange traded funds.

But while traditionally the market has revolved around institutional investors and ultra high net worth individuals, the countries’ booming economies – buoyed by a series of record oil price highs – mean the ensuing wealth is spreading deeper and wider. And that is bringing a changing customer demographic.

For one, there is a more pronounced mass affluent investor market developing. In addition, we are seeing the emergence of budding retail sectors. This interest in the capital markets is driven in part by oil-fed wealth. But it also reflects the fact that alternatives such as real estate and fixed deposits are becoming riskier and more costly, that the region’s markets have recently opened up to foreign retail investors, that there is a shift of assets from other markets, for instance the US and Lebanon, and that various regulatory initiatives are fostering greater transparency.

Given these shifting asset management sands, it’s no surprise to find more and more foreign-based financial institutions are being drawn to the region. A recent EIU survey of 180 senior executives at financial services firms that either already have or plan to develop an asset management business in the Middle East found more than 80 percent expect to increase their investment in the region over the next three years.

And they are not alone. For while the private banking arms of international banks may dominate the market at present, there has also been tremendous growth recently in the number and size of local providers, as they too seek to tap into the rich field of opportunity.

Dubai-based SHUAA Capital, for example, started life in 1979, but since 1998 has sought to branch out from its original private equity focus into other financial service areas, including asset management and investment banking. In 2006 it launched a three-year growth plan that includes opening physical offices across the region, making strategic acquisitions and investments in investment management, banking and brokerage firms operating in India and the Gulf Cooperation Council (GCC) countries, and developing new offerings in areas such as alternative investments, structured products and Shariah-compliant investments.

Meanwhile, Ahli United Bank – a Bahrain-based commercial and investment banking group, one of the largest in the Middle East – has taken an alternative approach. While its business spans the wealth management, private banking, retail, corporate and treasury areas, it has chosen to partner with BNY Mellon Asset Management International for the investment management services it offers to clients. In this way, it focuses on the client relationship side, while clients get access to BNY Mellon’s broad array of funds.

Alongside these changes in the region’s investor and provider profiles, there is a steady evolution in the structure of the market too. For a while it has always been a large offshore market, increasingly funds – in particular Shariah-compliant ones – are moving onshore. For example, more than 100 funds are already domiciled in Bahrain thus far. And that trend will continue.

And as the EIU report noted, demand for Islamic finance products is forecast to become an ever more important part of the asset management offering. As a result, many of the respondents to its survey expect at least some of their products to be Shariah-compliant.

Greater market maturity is also evident in the array of regulatory developments that have taken place to date, and that are earmarked for the future. Major initiatives by the Central Bank of Bahrain, the UAE’s Emirates Securities and Commodities Authority, the Dubai Financial Services Authority, the Capital Market Authority in Saudi Arabia and Qatar Central Bank have resulted in strict guidelines and reporting requirements when it comes to outsourcing and market validations for the respective markets.

And these developments are having a significant impact. The fact the underlying funds are now being monitored means managers must ensure they have stringent risk management controls, compliance and reporting frameworks in place, which in turn is inciting them to upgrade their reporting, analysis and decision supporting system architectures. And with this greater need for transparency, in order to provide accurate numbers to both investors and regulators, comes higher levels of confidence among international institutional investors to invest in the markets.

Nevertheless, despite the progress made and the bright future that beckons for the region’s asset management industries, the EIU report identified several issues that continue to cause unease and militate against investment in the region. In particular, it highlights fears about the Middle Eastern geopolitical environment, a factor cited as significant by 71 percent of the survey respondents. Meanwhile, nearly two-thirds pointed to a lack of transparency and poor standards of the regulatory regime as being a deterrent to further investment.

Aside from such geopolitical and regulatory concerns, there are also several business-oriented challenges to be borne by any asset management organisations seeking to build their businesses.

Distribution is one. At present, many new banks wanting to establish themselves to target the burgeoning mass affluent sector don’t have the retail office networks in place. As a result, distribution can be a headache.

Another priority for firms is the implementation of appropriate technology infrastructures, and that they leverage the system capabilities on offer to fully tap the market’s potential.

The fast and far-reaching changes we are witnessing across the markets means organisations are having to change the way they work, to join up parts of their businesses that hitherto have not been connected, to automate business processes, and improve their levels of service across the board. This is particularly crucial when firms move into a retail environment, where the onus is on automation, efficiency, data mining and utilisation, and better all round organisation.

Customer relationship management (CRM) technology is a case in point. Despite the number of banks and financial institutions with a market presence, only a small percentage of their customer bases are asset management clients. The wealth management divisions therefore have a huge opportunity to up-sell to their organisation’s existing clients and thus increase their wallet share of what should be a captive audience.

At the same time though the investment environment is becoming increasingly sophisticated. Having a large potential client base is one thing. Converting them into actual customers, and keeping them for the long haul, also means being able to offer access to a broad array of product sets, not simply international equities. For example, private equity, commodities, fixed income products including traditional bonds and Sukuk, and sovereign funds are all becoming more popular. It is therefore crucial that firms have a multi-asset class technology platform in place that is able to handle discretionary assets, mutual funds, private equity, and real estate.

In addition, there is a strong argument in favour of implementing a comprehensive, front-to-back solution able to handle all functions throughout the transaction chain.

A best-of-breed approach to technology selection – whereby a firm picks systems that offer task-specific functionality – can result in products strong on industry best practices and features. It also mitigates the possible risks that come from relying on a single vendor.

Nevertheless, opting for a single vendor relationship helps avoid the implementation risks, delays, complications and ownership issues that can arise when attempting to integrate multiple systems and components. In addition, the user ends up with a single point of contact for overall systems integration and for future support. The overall result is tighter business integration, more process automation and thus reduced operating expenses, and the potential for improved customer service, leading to enhanced revenue generation.

But the choice of provider should not be one of pure technical facility in terms of, for instance, portfolio modelling capabilities, or accounting robustness. Yes, being able to tick all the functionality boxes is imperative. But an understanding of, and capability to meet, local market regulatory idiosyncrasies and business opportunities is essential too.

Get the right technology foundation in place though and the exciting work of building a strong asset management business in these most vibrant of markets will be considerably easier to accomplish.