IPOs in the UAE: surely there has to be a better way!

The IPO system in the UAE is clearly in need of drastic reform. It a strange system that allows people to subscribe as much as they like to an IPO, and to borrow heavily from banks to do so.

What is needed is a system which still encourages investors to support IPO issues, but keeps the funds involved at more reasonable levels. Then there will not be the mass exodus of funds from the stock market to buy IPOs that is one of the explanations for the UAE share crash of the past couple of weeks.

Why not put some restriction on the size of subscriptions: an upper and minimum limit? Bank borrowing would then also be reduced pro rata, but further limits here might also be considered.

IPO pricing

The setting of IPO pricing is also something that the UAE Ministry of Economy and Finance ought to review. The Dubai International Financial Exchange has just put a different system in place for IPO pricing, in line with world standards, and the rest of the UAE could consider following this example.

The basic principle is that investment advisors determine an IPO issue price that just slightly exceeds market demand for the new issue. That way the company owners get a fair price for their stock, and the buyers obtain a small risk premium. And an orderly market is maintained at the same time.

For the fundamental reason that so many people apply for IPOs in the UAE is that they think this is a guaranteed way to make money. Indeed, it was until so many started to make applications that the returns became smaller and smaller, and with bank borrowing virtually nothing.

Stop new IPOs?

This week the secretary-general of the GCC Secretariat called for a halt to all IPOs until reforms were put in place. But many financial institutions are profiting from the present IPO system, in fact they may be the main beneficiaries right now, and so the pressure for reform is not from all the parties involved.

But logic suggests that reform of the IPO system is overdue, and the stock market crash should be a serious reminder that the flow of funds concerned is enough to cause systemic damage.

This is a more realistic suggestion than expecting IPO investors to take more interest in what they are buying. UAE investors, for example, seem unable to distinguish between a start-up company and a company with an established track record of delivering profits, let alone reading the prospectus.

But get the IPO system right and there is a healthy market for floating new companies in the UAE on the back of a dynamic local economy.