QFC head analyses regional capital markets (page 3 of 3)

In conversation with one banker the other day, I was told that there are no more than 50 Middle Eastern issues of bonds currently traded and these came from as few as just two dozen names.

This reflects a serious lack of depth for a region that is in such need for debt. Pressing his point, my source complained that only 20% of the financing he had undertaken recently was going to the bond market, with 80% being made through bank loans. Shouldn't these proportions really be the other way round?

Systemic risk

Such distortions have not gone unnoticed by the credit rating agencies. In May this year, Moody's warned of a build-up of systemic risk in banks operating in the Gulf as a result of rapid loan growth and what the Financial Times called: "possible asset bubbles".

Central to the evolution of a long-term bond market, say our banking colleagues, is the creation of a sovereign yield curve as a bench mark. They need this to be able to confidently price other securities, and they feel governments have been slow to act upon this either to avoid harming their otherwise healthy credit ratings, or have simply relied upon local liquidity for their funding.

This is changing, however, and the realisation that such structures are required for the healthy functioning of our capital markets - rather than for the creation of government debt for its own sake - is being noted at governmental level across the region.

This was evidenced in September this year when Standard Chartered reported that the Central Bank in the UAE has been in negotiations earlier in the year with several institutions in order to create an active debt market.

Private liquidity

A report, published last month by Global Research and based upon UN figures, claimed that private liquidity in the Gulf has leapt to $1.5 trillion - accounting for 60% of the $2.3 trillion of Arab capital available for investment.

Moreover, the report went on to suggest that by 2015, 60% of this will be retained in the region as opposed to the 20-25% currently invested here now. But while these instruments such as private equity funds act as effective locators of value, there remain few domestic or cross-border opportunities to be had regionally, and the growth of the industry in the region is dependent on the evolution of the equity and debt markets.

What we are seeing is the growing fire-power of Gulf capital being deployed overseas and investing in industries in developed markets across the globe.

Private equity funds

Private equity funds raised in the GCC have grown at a compound rate of 41% per year over the past five years and are set to continue at around 25% for the next three. This would explain the estimated $50 billion in overseas acquisitions made by Gulf investors in the course of this year.

So are we nearing some sort of tipping point in the development of capital markets? Well, the answer is yes and no. Undoubtedly, the region has the world's attention purely by virtue of the enormous potential that exists here. But the remaining obstacles to development range from the structural to the cultural and political.

Structurally, we have surveyed the barriers to development that exist in the equity and debt markets - ranging from the relative shortage of foreign capital, to the need for greater transparency and liquidity in the stock markets and a reliable index in the bond markets.

But there are also indirect structural issues that organisations such as the QFC can address directly. Primary among these is the looming problem of finding a financially skilled labour force with which to facilitate the growth of the capital markets.

As for the cultural and political obstacles to market development, it is my belief that these are disappearing. While pessimists might point to the continued pursuit of national interests rather than regional or international engagement amid the GCC countries, change is definitely afoot.

Over the past year or so, market authorities and legal authorities in Qatar, Dubai and Saudi Arabia have all demonstrated a refreshing diligence to investigate and prosecute recent incidents of malpractice.

Justice is therefore increasingly being seen to be done and this can only erode the current imbalance in regulatory practice between the region's new financial centres and the broader capital markets of the Middle East. Moreover, if the commitment is made at a national level, then a regional change in attitude will certainly not be far behind.