An Emerging Middle East

Ahmed Tabaqchali, CIO of Iraq Investments, Asia Frontier Capital looks at the economic history of, and changing market conditions in the Middle East
When people think of the Middle East, they think of it as one homogenous place. The Middle East should be looked at as broad, distinct areas with different dynamics regarding populations, history, especially recent history, and other factors. On the one hand there is the Gulf Cooperation Council (GCC) which comprises Kuwait, Saudi Arabia, UAE, Qatar, Oman and Bahrain. They are incredibly rich nations; rich in oil and resource, but relative newcomers to the world stage. They also have very small populations.
On the other hand you have Egypt, with a massive population but poor resources; similarly lacking in resources are Jordan and Syria. Countries such as Iraq and Iran fall between the two; they were established well before the oil boom with a long history of urban development and share the incredible oil wealth that the GCC has.
In stock market terms, most of the Middle East is retail driven, where retail accounts for around 80% of the market in some places. The occupation of Iraq in 2003 saw rapid growth in western interest in Middle Eastern markets as the Iraq risk premium was mostly removed. If you examine the stock charts, you’ll see from 2004 onward, enormous growth in the Saudi market in terms of market capitalisation. Kuwait and the UAE were similar. Eventually they all peaked at about 2006 after the strong bull markets.
Now they are a major asset class, with Egypt, the UAE and Qatar as part of the emerging market index. And the frontier market index also has major regional representation. The GCC is one of the biggest components in the MSCI frontier market.
A False Economy?
Within the Middle East, the real economy is not well represented in the stock markets. The GCC’s biggest driver is oil and petrochemicals. Now, with the exception of Saudi Arabia, none of the other markets i.e. Kuwait, UAE, Qatar, have an oil company represented on their markets because the oil companies are government owned.
Saudi Arabia is an exception because Saudi Aramco is majority government owned but is listed. It is one of the biggest components in the index, but still nowhere near a true representation of the of the oil sector in the economy. The Middle East is primarily made up of family businesses which are massive players in the economy but very few are listed in the market. The markets are composed mostly of banks, telecoms and real estate.
Market technology
In terms of technology, most of the exchanges use modern systems. NASDAQ-OMX systems are  widespread across much of the region. Egypt was one of the first to use NASDAQ with the UAE and Qatar having the same technology. Kuwait moved to NASDAQ-OMX latest system Xtreme in 2012 and Iraq converted in October of last year.
In the Middle East every investor has a unique National Investor Number, whether an individual investor or institutional investor. In the case of an institutional investor the NIN is attributable to the individual fund/account; for example, in a typical asset management firm the Growth Fund or the Small Cap Fund for example will each have a separate NIN.
Furthermore, trading is done in the NIN’s name; for example, a trader cannot aggregate orders and offer 20,000 shares for sale for four people and allocate afterwards. A firm has to put in the four separate orders at the same time using the individual account NIN number for each order. Moreover, each NIN number is linked to a unique settlement account.
At an institutional level this becomes very difficult; for example, where an institution has ten funds and one is a growth fund, one is a pension fund, etc. If the firm wants to buy a million shares of Alpha Beta Gama Company for instance, the order has to be placed/traded individually, X in this account, Y that account which complicates the execution process.
The other element which differentiates the Middle East stock markets is that there isn’t a specialist or market making function. There is no specialist book, all orders in the order book are customer orders and as such volatility can be high as there is no specialist/market maker to ensure a fair and orderly market. This is especially the case when a larger order is placed; it can take out all offers or hit all bids and as such the price can swing a great deal.
For all these and other reasons that complicate trading systems in the Middle East, technology firms have to think “outside the box” when developing new technology for the region.
Iraq focus
Using Iraq as an example as it is my focus; as a major economy with estimated 2014 GDP of USD 230 billion, the economy will only contract by half a percent this year despite ISIS occupation and plunging oil prices according the IMF’s latest figures. The stock market, as a percentage of the economy is less than 4% of GDP. The region as a whole is in the 50s and in more developed stock markets, that figure is substantially higher.
If you believe the estimates, based on the latest available full IMF figures (Jan 2015) Iraq will start growing again by 2.5% in 2015 and by over 7% until 2018. These figures haven’t factored in future lower prices. However, Iraq will still likely grow strongly paced by increased oil production. A stock market at under 4% of GDP is unsustainable with this economy and with such growth.
The major obstacle facing the great majority of institutional investors entering Iraq is the lack of a global custodian. Iraq has custody laws and infrastructure to allow the entry of a global custodian, however, a major obstacle is the size of the market. The whole market cap right now is USD 8 billion with an average daily trading of USD 1 million which doesn’t leave room for any custodian to operate profitably. And without global custody most foreign funds cannot operate.
The wider future
There is much talk of the need for unity across the the region’s stock markets. Finally the preparations are underway about opening up the Saudi market to foreign investors, and I believe they will use the Indian system of the qualified investors.
In terms of international institutional presence, the UAE has the largest because it has been open earlier and easier. It’s a fast growing region. The companies are developing pretty quickly. There is enormous potential for growth in the markets.
Most of the regulators see themselves as comparable to other emerging markets, but technology is a constantly changing challenge that pushes their ability to catch up. The speed of technology advances and the speed of the transformation of the economy is outstripping the capacity of regulators and the law to catch up. That is where the opportunity is because these markets as they develop will become major global markets.
With a long term average oil price of USD 70 per barrel, the GCC will be a significant force. Quite a few countries in the region need to diversify their economies, and they’re using the sovereign wealth funds to build assets overseas, but they are also using them to develop their local economies.
A lot of the family businesses will come to the stock market because like all family businesses, when they reach the second or third generation, family members who either want to monetise their assets or start their own projects, move to listings. That’s how almost all major international family companies became public companies.
As that happens the markets will start to resemble the real economy, and they will start to move from frontier to emerging and they will be major asset classes.
One of the major drivers for uniformity in the Western markets is the growth of institutional investors as a force in the market i.e. other pension funds, insurance funds and ultimately down the road, mutual funds. In the Middle East, that is at a very small scale and almost non-existent. For example, insurance companies are not players in the stock market. Most of their assets are in fixed income and even the fixed income markets of the GCC are hardly developed. So there is not that big force which is needed to drive the market: retail is non-homogenous in behaviour and driving needs.
These markets are developing very rapidly in terms of technology, lifestyle, influence, institutions etc. in line with a society chasing technological and social economic developments. The system itself has to catch up with all of that: how the markets work and how the investment culture and business culture develop, will ultimately drive this region. It will either make or break these markets.