As world events knock the gloss off the world’s important financial centres, Dubai sees an opportunity to realise its aspiration to become a financial hub.

It would be untrue to say that the United Arab Emirates (UAE) has been unaffected by the chilly winds blowing through global financial markets in the past few years, but it has been better insulated than many regions in the world. Earlier this year, an annual survey of the region’s banks by Gulf Business magazine noted the “increasing presence of UAE banks in the top 50, [many of which] registered above average growth rates during the year”.

Sixteen UAE banks featured in the top 50 in 2002. The net profits of National Bank of Dubai (NBD), the largest of the Dubai-based banks, rose by 26% to $155m in 2002.

There is plenty of local business these days to keep Dubai’s banks on a steady upward profit curve. Compared with widespread gloom in the financial sector across many parts of the globe, “the business environment here is very benign”, according to Stephen Freeman, HSBC’s regional chief operating officer. “In infrastructural projects and tourism in particular, there are a lot of opportunities.”

Despite perennial mutterings about consolidation of UAE’s domestic banks, at the moment, Dubai’s overall economic growth is providing the 19 UAE banks operating there with lucrative business. Emirates Bank International, placed right behind the NBD in terms of profitability in the recent survey, was created more than 12 years ago, from the consolidation of three local banks. But that was the last significant merger among Dubai’s banks.

With fears of terrorism and then the bear market taking some of the gloss off New York and London as financial centres, some locals believe global diversification will be inevitable and that it will benefit Dubai’s aspirations as a financial centre. “Particularly post-9/11, there has been a trend of funds from Europe and the US coming back into the Middle East,” says James Hume, executive vice-president of the Dubai International Financial Centre (DIFC), Dubai’s new finance initiative.

“As we move out of the bear market, there is a far less automatic assumption that in order to have an investment portfolio, it needs to be in Western instruments.” Mr Hume and others in Dubai’s banking community hope that the creation of the DIFC and events like the World Bank/IMF meeting in September will act as a catalyst for more banks to enter the emirate.

Dreams

Still, there are some prickly issues that need to be resolved before this dream scenario comes true. One is the restriction on the number of branches that a foreign bank can operate in Dubai: eight. For HSBC, which has had a presence in Dubai since 1946 and at one point had 28 branches across the UAE, this is a frustrating brake on local expansion. “We would like to see a relaxation of that rule,” says Mr Freeman.

Another local requirement is on hiring. All banks, local and foreign, must increase their hiring of locals by 4% annually, with a targeted aim of 40% of local staff. At the moment, most bankers agree that 4% annual growth is not an unreasonable figure.

“NBD is currently at 30% [local hires] and aims to reach 40% by 2005,” says Douglas Dowie, general manager of NBD. But in the same breath, he admits that local hiring does pose a challenge. “Although the quality of the graduates is high and their number is growing, the market still suffers from a shortage of experience.” It is not so much the education, but the experience that comes from working abroad, he says, that is critical. Perhaps, inevitably for a entrepôt economy like Dubai’s, going abroad for a few years will continue to be important for ambitious young bankers.

Contradictions

Recruiting talent is tricky for any business and restrictions on hiring and local branches may make that task more difficult, but the broader concern is that such restrictions will appear increasingly anachronistic with the creation of the DIFC. The centre, like other free zones, is designed to create as free an operating environment as possible. It will also be difficult for the government to address the apparent strategic contradiction demonstrated by the difficulty that foreign banks wanting to open in Dubai have in obtaining an operating licence, on the one hand, and the DIFC’s expressed aim to create a world-class financial hub, on the other.

“Without naming names, there are quite a few potential new entrants queuing up, waiting to come in,” says one local Dubai banker.

The answer may be partly out of Dubai’s hands. Federal approval for the DIFC’s new laws is held up in Abu Dhabi. “No doubt, the delay in legislation has not helped Dubai’s case,” says Mr Freeman.

Aside from making the DIFC a rigorous, transparent financial centre, the government also wants to make it the centre for the massive region sandwiched between Europe and east Asia. The area, which the DIFC defines as “the GCC [Gulf Co-operation Council], northern Gulf, the Caspian states, the Levant, north and east Africa”, has a population of about 1.6 billion. At present, financial markets across the region are fragmented and enjoy none of the economy-of-scale benefits that London, New York or Hong Kong have.

Competition

“We are sitting on a huge pool of liquidity,” says Essa Kazim, director-general of the Dubai Financial Market. But, the liquidity is not being tapped, he says. “Competition is usually a healthy thing in economic terms, but not for stock exchanges.”

Mr Kazim believes that regional competition rather than co-operation makes it harder to generate the critical mass that attracts brokerage houses and asset management business. One estimate from SHUAA Capital, a Dubai-based asset management firm, puts the whole GCC asset management industry at just $10.5bn.

Moreover an estimated $1300bn in Arab money is held abroad that could, some argue, be invested in the region if the more attractive investment opportunities became available.

“Certain of our markets are very thin. Our IPO [initial public offering] market has not grown and there are limited innovative financial products and services,” Esam Janahi, CEO of Bahrain-based Gulf Finance House, said at the International Investment Summit held in Dubai in May. “Instead of developing parallel markets throughout the Gulf, we should [be developing] integrated markets.”

Dubai financial market

The Dubai Financial Market, the emirate’s securities market, is not quite a buzzing hive of activity. Its trading floor opens at 10.30am each day and closes just two hours later. But Essa Kazim, the DFM’s director-general, admits that the market is in the early stages of development.

The exchange was set up in 1998 but the emerging markets crash that year delayed its growth. “Only now is the confidence coming back to the market,” says Mr Kazim. Bond trading values last year stood at 277m Dirham ($75.4m), up from 220m Dirham in 2001. Trading volumes also rose noticeably, from 2150 units two years ago to 2770 last year. The exchange’s total market value was just under 35bn Dirham in September 2002 – up almost 4bn Dirham or 13% from 2001.

Bond issues

As further evidence of the DFM’s resurgence, Mr Kazim points to the 250m Dirham corporate bond recently issued by the Emirates Group, which was heavily oversubscribed, and which eventually raised 1.5bn Dirham from bondholders. And in mid-May, the Dubai government began a roadshow for its 1.5bn Dirham bond, the first ever issued by the government. The bond is being underwritten by lead local players Emirates Bank International, HSBC, National Bank of Dubai, National Bank of Abu Dhabi and Standard Chartered Bank. According to Ibrahim Belselah, director of finance of the Dubai Municipality and the bond’s co-ordinator, the five-year, fixed-rate bond is being issued to provide an alternative to investors when short-term interest rates are at an historic low.

But five years after inception, it remains early days for the DFM. There are just 19 companies listed on the exchange: five banks, three insurance companies, six from the service sector and five mutual funds.

“Dubai is booming but that is not reflected in the capital markets,” says Mr Kazim. By that he means that the exchange is disproportionately weighted towards banking, and does not accurately reflect the emirate’s economic boom – much of which is due to trade (re-exporting) and property development. Bank shares account for the lion’s share of the exchange’s value (73%), followed by services companies (23%). “Tourism is booming here, but not a single hotel is listed. Trading is very well-established here, but we don’t have a single trading company [on the exchange].

Hopes for growth

One of Mr Kazim’s hopes for the exchange is that it becomes an institution through which smaller companies can grow. At the moment, he says, expanding companies tend to look to banks as the primary source of capital they need to grow. “Traditionally, you have to be big or have government support to think of listing,” he says.

Instead, he would like to see companies come to the capital markets, if nothing else to counter the growing dependence on the banking sector. Stephen Freeman, HSBC’s regional chief operating officer, says: “We are starting to see a move away from strategic bank lending to bonds in the government and corporate sector but it is still early days yet.”

As for the long-term, Mr Kazim believes there is a lot of untapped potential. “There is huge potential for the capital market to grow when the government decides to cash in on some of its assets,” he says. He cites as examples aluminium smelting business Dubal, the airport and other assets in the Jebel Ali free zone.