Can the DIFX save Gulf capital markets?

The danger of small, illiquid capital markets is that they tend to overheat, and then crash to earth, burning the participants' cash in the process.

Any disinterested analyst looking at the share charts of the GCC countries over the past few months would conclude that there has been a massive spike in share prices, driven by investor overconfidence, which peaked on May 2.

Since then markets like the UAE have attempted to recover losses, though not quite made it. Others like Qatar have seen a definite reversal of the original vertical upward movement into a strong downward direction. At best then it would be reasonable to conclude that markets have entered a 'correction phase', particularly as oil prices now seem to be falling.

Into this awkward conjuncture of circumstances steps the new Dubai International Financial Exchange on September 26. The aim is the right one: create a larger regional bourse with a deeper pool of capital that will not be as subject to the madness of crowds in terms of swings of investor sentiment.

Then local companies - and not just start-ups with ill-specified business plans - can raise capital without the threat of a sudden downturn in share values hanging over them.

In the case of the UAE, the DIFX will also be something of a competitor for the existing two bourses whose restrictions on IPO pricing and 55% minimum flotation rule remove the attractiveness of public listing for many local companies.

The DIFX will also offer regional companies - albeit obviously only those whose shares can be owned by foreigners - the ability to tap into the huge wealth of the UAE. The minimum flotation will be an attractive 25% of capital, and IPO share valuations free from government interference.

However, if the individual bourses of the GCC are all in negative territory by this autumn then the DIFX is going to have a much harder job getting off the ground. Investors whose fingers have been burned become cautious folk.

What can the DIFX do about this? First, it can focus on non-equity asset classes, and the announcements about oil and gold exchanges suggest the authorities are on the right path.

Secondly, the Dubai Government should consider floating some of its most prized assets on the DIFX. Investors, for example, would probably flock to buy shares in Emirates Airline, whatever the stock market conditions.

On the other hand, setting up the DIFX just after a downturn in the fragmented, illiquid and poorly regulated GCC bourses could be just the thing to get a new exchange going. The flight from one set of capital markets to a single new one might be very quick.