Within one week in September, the world’s financial markets were turned upside down with many of the greatest virtues of capitalism labeled as the reincarnation of evil, as investors ran for cover and governments across the world stepped in to stem the rot.
Terms like short-selling, derivatives and deregulation became dirty words and were trooped around as criminals in a police line-up. So what does it mean for the regional markets that have been looking to emulate the pits of the New York Stock Exchange and the City of London?
“The single most important lesson to learn from the crisis is that markets must have effective risk management. Managing and mitigation of risk must be paramount and the system should not be overexposed to any one sector,” says Bryan D’Aguiar, head of research at NCB Capital. That ship may have already sailed as banks in much of the Gulf are already heavily exposed to construction and related sectors, some of which looks very vulnerable right now.
On a wider scale, the Western financial market model was going to be the great template for regional authorities to follow, but that blind faith in the system has now been shaken.
Short selling, for example, which is illegal in regional markets, was being tolerated by the authorities as they were looking to introduce it at some point in the future. Not anymore. That instrument may be mothballed for some time to come, as regional regulators look for stability rather than fancy financial wizardry from opportunistic traders. Some might argue that’s not a bad thing, but proponents of short selling say that it allows investors to act on stocks they feel are overvalued.
Regulation resurgence?
There is a danger that the current crisis will hamper liberalization and innovation as regional regulators are concerned that markets are not ready to manage derivatives and other newfangled financial instruments.
“Absolutely, I think regulators in the Gulf and across the world are cautiously looking at all these complicated products that have caused havoc on Wall Street — they are going to be cautious going forward,” says Shahid Hameed, head of asset management GCC, at Global Investment House. “They will be taking smaller steps to improve the market at the expense of some of the more sophisticated products — which does makes sense.”
The ‘re’-regulation could impact regulators such as Dubai Financial Services Authority and Qatar Financial Services Authority, which closely track the regulatory environments of the United Kingdom and other international markets that are going through a regulatory resurgence.
“The tighter regulations in international markets will flow back into the region as well,” says Haroon Ahmed, head of business development at EIS Asset Management.
While some sectors such as banking and real estate will likely see a slowdown as a direct result of the global crisis, other areas may also see growth dry up.
Sukuk market for example, which was thriving on innovation from international and regional banks, had been experimenting with clever products such as Islamic credit swaps. That kind of innovation will be pushed back as “issuers go back-to-basics, and shun the more sophisticated instruments,” says Sean Daykin, head of investments at EIS Asset Management. International banks were behind much of these innovations, but as they face the wrath of regulations on their home turf, they are less likely to push new products in the region. In any case, Gulf regulators may not be too enamored with them either at this stage.
Another key lesson that regulators must take to heart is corporate governance, transparency and the protection of shareholder interest. According to corporate governance watchdog Hawakamah, Gulf companies could improve their combined market cap by about 15-30 percent if they apply more stringent transparency rules. Otherwise, opacity will lead to depressed markets, as has been seen in Dubai lately.
Many senior industry observers have also called on regulators to encourage regional fund managers to focus more on domestic investors, rather than international hedge fund managers.
Although retail investors dominate the regional stock markets, they have received poor treatment from both fund managers and regulators to date. Encouraging smaller shareholders to enter the market through professionally managed funds will take the financial market industry forward and move away from the disease of chronic day trading.
There have also been calls to discourage international hedge fund managers from investing in regional funds. “I would support that. As a fund manager we don’t want an investor who comes in only to leave in a few months and destabilize the fund,” says Hameed. “But at the same time we cannot block short- term investors to enter the market directly as they bring liquidity.” It is going to be a crazy ride for the next few months, but the true test of regulators always comes during tough times. And that could ultimately determine which of the Gulf’s financial hubs is first among equals.
(Yadullah Ijtehadi is managing editor of Zawya.com, Dubai.)
