Differing ambitions for centres

IFR Middle East Report 2008
17 min read

More than other regions, for companies serious about doing business in the Gulf it is vital to have a presence on the ground. By Solomon Teague.

The world is currently experiencing a unique set of economic circumstances: the high prices of oil and gas, combined with a credit crunch, have conspired to create an especially favourable environment for the Middle East, which has the capital reserves to move forward without debt financing. But from the Arab perspective, the region's growth is about much more than oil.

"The region is in the middle of an economic renaissance," said Nasser Al Shaali, CEO at the Dubai International Financial Centre (DIFC), a renaissance that is underpinned not just by oil but by demographics and a vibrant services sector.

A Chatham House (CH) study titled "The Gulf as a Global Financial Centre – Growing Opportunities and International Influence", reports that, including immigration, annual population growth varies from 1.3% in Bahrain to as high as 3.8% in the UAE, compared with 0.9% for the US and 0.3% for the UK. With SABIC acquiring GE Plastics, Dubai Ports buying P&O and Zain's expansion into Africa, the region's economic activity is clearly not confined to oil.

Neither has the credit crunch done much to deter businesses from looking at the Middle East as a route to growth: write-offs in the region for CDO and RMBS contracts have been minimal. The cost of funding has risen and spreads have widened, but this has not stopped the private sector from expanding, said Al Shaali. If anything, he added, the rate of businesses setting up in Dubai has accelerated in the past year.

Companies come to the Middle East from all over the world. It has always been popular with Europeans, for which the Middle East is geographically convenient. Recently it also seems to have seen an uptick in business from the Far East, said Al Shaali.

On one level, the territories in the Middle East are competing for foreign firms to settle. However, there is also a widespread recognition of the "GCC Brand" and the benefits brought to the whole area by the achievements of individual entities within the region. According to the CH report: "Using the GCC's economic power and brand as an umbrella should enable the region's financial centres to move more quickly up the IFC [International Finance Corporation] rankings."

The rising tide lifts all boats, and the success of the Dubai Stock Exchange, for example, is good news for businesses in its proximity, even if they are not in Dubai itself. Yet there is definitely more than a whiff of competition between the states.

"Regional rivalry, acting as a spur to competition, has also broken out in terms of the development, and redevelopment, of property and financial centres," said CH. "As Dubai and Qatar have unveiled new-build projects, this has started to make the older centres in Bahrain and also Abu Dhabi appear in need of rebuilding and refurbishment work."

Ambition

The jurisdictions within the GCC have different ambitions for their financial centres, and have taken different routes in creating them. Dubai is probably the most ambitious member of the GCC in terms of its commitment to creating a world class financial centre. It aims to become a regional centre to rival Tokyo, London or New York, and, according to City of London data, is by far the most successful centre in the region, "largely a consequence of its higher investment levels", CH said.

The City of London found Dubai to be "number one among financial centres that 'might become significantly more important over the next two to three years', as well as ranking number one as a destination where businesses are thinking of opening in the next few years – an indication of how much momentum it has built up," CH reported.

To achieve this growth it developed the DIFC, a financial free zone designed to attract businesses into the country at the expense of generating revenue directly for the state treasury. In 1999, it set out a three-stage plan to create a knowledge economy by 2010 – a goal it has arguably achieved with two years to spare.

The first stage was the development of its infrastructure. Its airport strategy illustrates its ambition: in 2007 its airport saw 27m passengers pass through, and by 2015 it plans to have completed a second airport with traffic of around 135m people annually.

The second stage saw the development of competencies in core sectors, of which finance was just one, alongside media, technology, healthcare and others. Each sector has been developed along equivalent lines to the DIFC, for example the media sector's Dubai Media City. The final stage of the plan will see these sectors reach targets for their respective input into the economy: the DIFC should be delivering 15% of GDP by 2015. According to Abdullah Al Awar, managing director at the DIFC, the centre is past the half way point in achieving its goals.

These stages have not run sequentially, and the infrastructure development characterising the early stages of the plan continue. There are more than US$300bn worth of projects still outstanding that were started in 2007, said Al Awar; for the wider GCC the figure is about US$1.5trn – or around US$2trn including completed projects.

"That is more than the BRIC countries combined, but with a population of less than 1%, so it is hard for the capital markets to keep up," said Al Shaali.

Overall, the emirate wants to increase its GDP at a rate of 11% annually, in addition to a per capital GDP of US$44,000 by 2015. “We need to transform the region, not just ourselves,” said Al Awar.

To ensure the growth of the corporate financial services industry, DIFC imposed certain boundaries on what businesses could be brought in: no direct insurance activities are accommodated in the DIFC, and financial transactions of regulated institutions are not allowed to be in the UAE local currency. At the same time, however, The DIFC’s appeal is not limited to financial companies: global Fortune 500 companies have started to set up their treasury functions there too, to leverage from the proximity to the financial institutions, with which they have close relationships globally and hence raise funding for their worldwide activities.

"Bahrain and Qatar may be starting from a lower base [relative to Dubai] but they are moving rapidly upwards," CH said in its report on Gulf financial centres. "They are among the most significant upward movers in the latest report." Like Dubai, Bahrain has come a long way in recent years in diversifying its economy and embracing financial services. One decade ago 18% its GDP was derived from financial services. Today the figure is around 27%.

Its regulatory environment has been the key to achieving this, said Abdul Rahman Mohammed Al-Baker, executive director of financial institutions supervision at the Central Bank of Bahrain (CBB), adding: "It has been an enabler for innovation." Its development of the first financial statements for Islamic banks was perhaps one of the most important examples of this, as it helped facilitate the growth of Bahrain as an important Islamic Finance centre.

It considers itself, alongside Malaysia, to be the global capital of Islamic Finance. Its appeal has also been strong for asset management and insurance companies. Overall, it is home to 410 financial institutions and about 2,600 funds – the largest concentration of funds in the Middle East.

Qatar acknowledges that it started its financial centre after Bahrain and Dubai, but it has a very different model and has very different ambitions to the other two centres in the region. For Qatar, the QFC is just one part of a broader effort to develop the country. High oil prices have ensured the whole region is awash with cash, but this is not the first time Gulf states have seen their treasuries overflowing, so governments know it will not last forever.

This time, Qatar wants to ensure the money is spent wisely for the benefit of future generations and is investing much of its current wealth in infrastructure projects. Therefore, the diversification of the economy is just one of a broader set of projects, alongside, for example, the development of better transport infrastructure. It is in effect a "future-proofing fund" worth US$140bn, said Steve Martin, director of marketing and corporate communications at the QFC. "We are not just trying to build up a centre. We are building a world class sector," he added.

Businesses do not have tax breaks dangled in front of them to entice them into the country. Instead, it helps to integrate foreign businesses into the local economy, and has the flexibility to allow any firm to settle there, regardless of the business it is in so long as it directly or indirectly supports the financial sector. And a big part of this is the insurance industry – in which, luckily, it does not have to compete with Dubai. Qatar sees itself as a potential insurance hub for the region, and has already attracted a some of the top global insurance and reinsurance firms and brokerages, such as AXA, Zurich, AIG, Alico, Marsh and Aon, and most recently HSBC Insurance Brokers.

Qatar has singled out the asset management industry as a potential area for growth, but here is has more competition, with Bahrain already having made a name for itself as a centre for buyside companies as well as administrators and other service providers.

"To reach the top rankings of global financial centres requires the financial sector [of the GCC] to move up the skills curve and into higher value-added activities," concluded CH's report, fostering franchises in fund management, foreign exchange, securities trading, IPO management and M&A. Much of this is under way, and the three centres, and others following a similar path, can continue what they are doing.

Other aspects of the development prescribed by CH would require more of a rethink of government principles and a departure from the current plan.

"A critically important development to meet both investor needs and the GCC's financial market aspirations would be the creation of a larger, deeper debt market, whether based on Western-style bonds or the Sharia model, building on the region's strength in Islamic finance," CH said. "This will require a radical departure for the GCC authorities in terms of how they view the role of government debt and project finance, its potential in promulgating activity and broadening the base of the financial sector and asset management activities."

This development would, ideally, come as part of a much broader co-operation between the region's states in setting up a single, integrated framework, which would give it a realistic chance of competing with the likes of London, New York and Hong Kong, CH said. The model it should pursue, the report concluded, is "co-opetition" – or "selective co-operation" – combined with leaving markets free to compete.

Comparing the particulars

Dubai’s aim when developing its regulatory regime was to create an environment that was eminently familiar to the foreign players it sought to attract. “The institutions we attract do not need to adapt to a new foreign regulatory and legal framework as they will operate in an environment similar to that of established jurisdictions,” said Abdullah Al Awar, managing director at the DIFC.

Qatar Financial Centre (QFC) operates under English common law and a principles-based regulatory regime, comparable with that operated by the UK's FSA, and as such is also easy to understand for most international institutions.

The CBB's Al-Baker agreed that the regulatory regime is vitally important in enticing foreign institutions to come to Bahrain. The country has a mixed legal code, incorporating elements of English common law, local laws and Islamic law, meaning it does not score well for simplicity. But it does boast a 35-year track record, in which time it has been stress-tested in both bull and bear markets. A World Bank report, Doing Business in 2009, put Bahrain at 18th for ease of doing business, comfortably ahead of Qatar at 37th and the United Arab Emirates at 46th – as well as Switzerland and Germany.

"The CBB generally does not allow aggressive growth and puts limits on banks holding certain asset classes, like real estate," said Ijlal Ahmed Alvi, CEO of the Bahrain-based International Islamic Financial Market. It is symptomatic of its conservative nature, and the relative importance it places on the quality of the business it attracts over the quantity.

Bahrain prides itself on the responsiveness of its regulation. The regime is reviewed quarterly to check all provisions are relevant as the markets evolve, with the close co-operation of its financial community.

"The market changes every minute, so regulation needs to change too," said Al-Baker. This keeps local regulation in line with international standards, he explained. For example, it recently updated regulation of the insurance industry's insolvency ratios, and in concentration limits for bank loans to individual sectors. "You need to be proactive, not reactive. You need to regulate without over-regulating and killing business," he said.

Not everyone is satisfied that the region's various regulators have created the perfect robust and responsive environment, however. CH refers to the "weaknesses in regulatory and supervisory systems" that prevails in the region, predicting that these need to be addressed before any of the centres can realise their ambitions of climbing to the top tier, alongside London and New York. Yet GCC apologists could easily counter that recent troubles in London and New York indicate that there is always room for improvement in regulation, and in fact recent evidence might suggest GCC regulators compare quite favourably.

Inflation makes the region a relatively expensive one to do business in, but from a tax perspective the jurisdictions are distinct. Qatar operates a flat tax system. The costs of setting up are variable, depending on a range of factors, such as the size of the company, its regulatory status and where its office is.

Other jurisdictions may appear cheaper at first glance because they do not charge tax. The QFC's strength is its transparency, argues Martin at the QFC, saying: "The QFC's construct is very transparent, whereas firms face many hidden costs in other centres in the region."

The World Bank report found that of Middle Eastern and African countries, Qatar required the fewest annual payments for tax – just one, compared with 14 in the UAE and 25 in Bahrain. Qatari tax also amounted to the lowest proportion of overall profit, at 11.3%, compared with 14.4% in the UAE and 15% in Bahrain.

While some companies are only likely to open one office in the region, others establish significant operations there, necessitating more than one office. In such situations Dubai and Qatar, for example, might prove complementary: one offers international banking facilities and a global exchange, while the other allows for local money transactions. According to Martin, there are some 30 companies currently operating in both the Dubai International Financial Centre and the Qatar Financial Centre.