Laying the infrastructural foundations for future growth

Until recently the Middle East was still seen as the world’s El Dorado, its economies fuelled by the reserves of black gold that underpin the region’s financial strength. Some of that gilded vision has melted away though as oil prices have sunk and consumption been reined back, and the region’s attempts at diversification into tourism, real estate, manufacturing and services have been hit by the global downturn.

Dubai has come to symbolise the region’s perceived fluctuating fortunes. With its comparatively small oil and gas reserves, Dubai’s government has sought to diversify its economy, notably into real estate and construction, trade, tourism and financial services, with notable success.

The Dubai International Financial Centre (DIFC), which opened in 2004, quickly gained a reputation as a leading financial hub in the region, attracting a host of international financial institutions. Meanwhile, the booming economic growth enjoyed by the city-state in recent years was visibly demonstrated by its changing skyline, as one new building project after another rose into the desert sky.

However, Dubai’s developers financed much of the investment with international borrowing. And as the economic situation soured it has left them staggering under a heavy debt load. As a result, in February the Dubai government announced it would issue $20 billion of long-term bonds, with the federal government of the United Arab Emirates (UAE) coming to the rescue by taking on the first $10 billion tranche.

Its stock market, the Dubai Financial Market (DFM), has been hit hard too in the current crisis, with the DFM Index down from 5,931.95 at the end of 2007 to 1,636.29 a year later, with modest falls since.

Nevertheless, while Dubai’s boom and subsequent woes have attracted much of the international attention, the picture is somewhat different elsewhere in the region.

For example, the Qatari capital Doha likewise has been transformed in recent years by a wealth of building projects. But unlike Dubai, Qatar’s economy is underpinned by massive hydrocarbon reserves.

As was noted by the International Monetary Fund’s Country Report, published in January, Qatar has the fastest growing economy in the six nation Gulf Cooperation Council (GCC) region, with real GDP growth estimated at 16 percent in 2008 thanks to high and expanding production of oil, liquefied natural gas and condensates, and strong performance in the manufacturing, construction and financial services sectors. And that is set to continue, with the IMF report predicting real GDP growth of 29 percent in 2009, and 12 percent a year average growth through 2013.

And while the Doha Securities Market has plummeted in the last year – as indeed have all the GCC stock markets – the IMF report noted that underlying market fundamentals in Qatar remain strong. In addition, it concluded that Qatari banks are profitable and adequately capitalized, and that overall the banking system appears to be sound.

Meanwhile, the other oil-producing countries in the Middle East are expected to see a slowdown in their rate of economic growth for the coming year at least, thanks in part to declining oil revenues. Nevertheless, real GDP among the Middle East, North Africa, Afghanistan and Pakistan (MENAP) oil exporters is still forecast to grow by 3.6 percent in 2009, with the GCC nations of Saudi Arabia, Kuwait, Bahrain, Qatar, Oman and the UAE seeing 3.5 percent growth, according to a presentation in February by IMF Middle East and Central Asia Department director Masood Ahmed . That is much more attractive than the 0.5 percent projection for global growth, and the GDP declines expected across the developed countries.

And despite the cuts in revenue from lower oil export receipts, Mr Ahmed said governments in the region, especially in the GCC, are expected to maintain their ambitious spending and investment plans as they draw on the large reserves they have accumulated. As a result, this spending will cushion the impact of the global financial crisis on the region.

As for the financial services sector specifically, the current problems present both challenges and longer-term opportunities.

To date, there has been considerable emphasis in many states – not least the UAE, Qatar and Bahrain – on bringing in foreign financial institutions to set up local operations, and attracting foreign institutional investment flows. But with many Western banks and investment managers struggling, their investment and expansion plans for the markets are either being reassessed or reversed.

Last year, for example, a number of fund managers had ambitious plans to launch funds and raise assets, but those have since been scaled back or put on ice. And while it is said to be more a question of time before those plans are dusted off, with so much bad news still coming out of the industry there is no telling how firms’ businesses will look a year from now.

Still, that the pace of activity in the region has calmed gives everyone involved time to draw breath and assess their future strategic direction. For regulators, the exchanges and market participants it is an opportunity to discuss how the markets operate and investigate ways to ease access for investors and improve liquidity. And for domestic and foreign banks and asset managers it is a chance to invest in their infrastructures, and so be better positioned for the growth to come.

On the regulatory front, a range of initiatives have been implemented or are underway as nations take further steps to strengthen their investment environments.

In Qatar, for instance, the project to unify the three existing financial regulators into a single body – the Financial Regulatory Authority – is continuing, with the IMF report noting steady progress on agreeing the proposed policy and legal framework, information sharing and convergence of their rulebooks. However, the transition date is expected to slip from its initial 2010 timeframe.

And if Qatar, and Kuwait, can address the transparency and regulation issues that recently prevented MSCI Barra from upgrading them from frontier to emerging markets then they will stand to gain from the passive money manager investment flows that inclusion in the index provides. Hopes that the UAE will soon be upgraded to emerging market status remain though, with MSCI’s consultation due to be concluded in June.

For its part, the Abu Dhabi Securities Exchange has been working with the Securities and Commodities Authority to implement a new Corporate Governance Code, which may go some way towards improving transparency. In addition, it said it will list its first exchange traded funds this month, and offer derivatives contracts by year-end.

Meanwhile, the DIFC announced last September new regulations designed to attract family-run institutions to establish Single Family Offices there. At the time of the announcement the DIFC noted that more than 75 percent of firms in the Middle East are family-run businesses, with assets totalling over $1 trillion. And the fruits of that initiative were in evidence with the news in February that Novaar Limited, the private investment office of His Royal Highness Prince Saud bin Mansour, has begun operations in the DIFC.

As for Bahrain, it has a long-developed reputation as a business-friendly jurisdiction, backed by a well-regarded regulatory authority. More recently it has been focused on developing its Islamic banking sector into a world leader, and is also emerging as a regional funds domicile and administration hub.

All eyes though remain on Saudi Arabia. Changing regulation has fostered growth in its investment management market, with the granting of more banking licenses enabling the creation of investment houses to manage the wealth its large pool of high net worth individuals.

And last August the kingdom’s Capital Markets Authority introduced new rules to allow foreign investors to enter into swap agreements with authorised intermediaries. For the first time that has enabled them to buy shares listed on its Tadawul stock market, albeit indirectly, since prior to that non-GCC residents could only access the exchange through the undeveloped mutual fund sector. And the hope is that further steps towards market development and investor openness will be forthcoming.

As for the investment climate as a whole, the region’s continued economic growth, low levels of debt compared to other developed and emerging nations, a growing pool of high and ultra high net worth investors, and the fact that local retail populations have not been as affected by the downturn in the funds sector as those in Europe and Asia because of their lower exposure means the prospects for a strong and rapid investment industry recovery look good.

All of which makes it critical that both domestic and foreign investment managers operating in the region have a robust, scalable and functionally-rich technology infrastructure in place.

In today’s environment, cost control and operational efficiency are omnipresent themes. But the only way to achieve those imperatives is to eliminate manual intervention and replace it with end-to-end automation.

That means not only having systems to provide the necessary portfolio modelling and trade order management, portfolio management, accounting, performance analytics, reporting and client relationship management capabilities, but ensuring they are seamlessly integrated to plug any gaps in the process through which trade data can fall.

And while such an advanced and comprehensive technology infrastructure brings evident cost advantages, there are risk management benefits too.

Minimising firms’ exposure to operational risk – where losses result from employee mistakes, malicious or criminal activity, systems failures or natural disasters – is one obvious area where the right infrastructure will help.

Legal risk, such as the threat of fines or penalties from supervisory actions, also comes under the broad heading of operational risk. And firms’ compliance responsibilities are becoming more complicated all the time.

Lack of market standardisation across the region is one factor, with the UAE alone featuring three different markets on three different models. And as authorities pursue further development of their markets the slew of legal and regulatory requirements fund managers have to meet will continue to change too. For example, regulatory initiatives across the GCC region are already leading to stricter guidelines and requirements around outsourcing and market validations.

Meanwhile, the intense self-examination that has been going on in the wake of the credit crisis means many institutions are reviewing their internal investment policies and restrictions as they seek to exert better control over their businesses. And this is adding extra rigour to the compliance burden many firm’s face.

And the price to pay for compliance breaches comes not only in the shape of fines or penalties from supervisory bodies, but in the less tangible, yet potentially costlier and longer-lasting form of reputation risk. Here, the whiff of unwitting or intentional lack of control and mismanagement can lead to an exodus of existing clients and impact an organisation’s ability to attract new assets.

And given investors’ understandable wariness in the face of almost universally disappointing asset returns, restoring customers’ trust and confidence is a priority for asset managers of all descriptions.

In part that can be achieved by firms’ improving their risk-adjusted performance. Ways to do that include being able to report on firm-wide positions across asset classes so as to view the firm’s total risk position rather than it being segregated by asset silos; obtaining accurate valuations for illiquid securities and portfolios; monitoring counterparty risk; and having accurate and timely data from counterparties for reconciliation purposes.

Such capabilities require a portfolio management/accounting platform that supports the gamut of financial instruments, and features cross-asset class risk tracking and reporting, including an ability to track exposure by name or issuer across asset classes. The platform should allow for the breakdown of sources of risk in a portfolio by factors such as style, sector, interest rate, country and currency as well.

An effective risk system will also allow for accurate monitoring of manager thresholds and fund concentration limits, to guard against overexposure to particular positions, industries, economic sectors or geographies, and so avoid style drift. And by feeding portfolio managers with accurate reports that provide an aggregated view of client holdings and positions they can make better informed asset allocation decisions.

Of course money – in the shape of investment performance – will do a lot of the talking. But strengthening customer relationships also requires firms to up their game when it comes to client reporting and servicing.

Having an integrated systems environment provides users with the ability to capture and collate portfolio data and feed it into reporting engines that generate information-rich and customisable reports. What is more, by automating the process the reports can be sent to clients much sooner after period end.

And integrating the portfolio management/accounting and reporting platform with a client relationship management system enables managers to track and personalise their communications with customers, making firms more responsive to and proactive in meeting their clients’ requirements, and better placed to cross-sell to them.

This kind of sophisticated technology infrastructure then – offering cost savings, automated compliance monitoring, improved performance and better client servicing – can help investment managers to weather this difficult period.

But crucially, the investment in such a best-of-breed framework will give organisations the stability and scalability to grow their businesses, and not their cost base, when the boom times return – as they surely will. Better then to be prepared.

Advent Software | www.advent.com | Tel: +971 4 3199 089