In August 2007, H.H. Sheikh Khalifa Bin Zayed Al Nahyan, President of the UAE, issued Federal Law No 10 for 2007, amending the Federal Law for 1984 on commercial companies. By Andrew Tarbuck, Partner, Corporate Finance, Norton Rose (Middle East) LLP.
The amendment to the commercial companies law allows local family-owned businesses that convert into public companies to list a minimum stake of 30% of their issued share capital of the company; other companies not falling within the definition of a local family-owned business must offer a free float of 55%. The result is that local family-owned businesses no longer need to cede equity control on a public float. A local family-owned business is defined as a company fully owned by members of one family extending up to the fourth generation, regardless of the nature of the company.
On first blush, it would seem that, because of the tight definition of a local family-owned business and the fact that there is no change for companies that fall outside the definition, this would have little impact. But this would be ignoring the fact that, according to an independent report in December 2007, 90% of commercial activity in the Gulf Co-operation Council countries (GCC) is controlled by family firms.
Further, family businesses in the GCC number over 5,000 and account for combined assets of more than US$500bn and employ 70% of the workforce. True, these businesses are prime targets for private equity firms running a more traditional private equity model of looking for value-add by inserting management but there has to be a greater likelihood that these businesses will seek an initial public offering (IPO) as an alternative.
Commentators may say that there has not been a rush to IPO family businesses but Rome was not built in a day. The equity capital markets in the Middle East have not suffered as much as their global counterparts but there is still uncertainty in the local markets, with upwards and downwards spikes that lead to apprehension over taking the decision to float for naturally risk-averse entities.
Coupled with the fact that potential IPOs may need to be accompanied by time-consuming restructuring, spin-outs and hive-offs for what can be exceedingly diversified companies (for example, the Al Habtoor Group, one of Dubai's leading family businesses, has interests ranging from construction to publishing and luxury cars) and that potential issuers must acknowledge internationally accepted principles of disclosure, risk management and corporate governance, it is no surprise that the change to the Federal Law is taking time to have an impact.
The Dubai International Financial Exchange (DIFX) is spearheading the encouragement of family companies to go public to give the local community the ability to take equity stakes in local issuers and therefore become stakeholders in the local economy and, in turn, boost the liquidity in the market. The DIFX has set up a separate family business unit and has also actively encouraged the new by-law to the Companies Law in August 2007 allowing DIFC holding companies to own operating UAE companies.
The DIFX has expended great effort to allow clearing and settlement on the DIFX to ensure that the 51/49% principle of local ownership is adhered to. The 51/49 principle is seen by some as an anachronistic, protectionist measure and certainly there are those including Tom Healy, CEO of the Abu Dhabi Securities Exchange (ADX), who believe that the greater freedom on share ownership allowing an increase in foreign investment could provide the boost to local market liquidity that everybody is seeking.
The latest success story with regard to local issuers is the listing on the DIFX of Damas International Ltd, a regional jewellery retailer, in July this year. The listing is of ordinary shares and there are mechanisms in place to ensure that the share register adheres to the ownership restrictions pursuant to which at least 51% of Damas's issued share capital must be owned at all times by UAE nationals.
There are specific provisions in the articles of association relating to "Required Transfers" that require shareholders to transfer their shares in the event that the minimum 51% UAE ownership required is breached. In order to maintain compliance with the Minimum National Ownership requirements, Damas created a special purpose company to which it transferred a percentage of shares in certain of the company's subsidiaries, jointly-controlled entities and associates incorporated in the GCC that is sufficient to prevent the breach of the requirements.
Damas implemented a trust arrangement whereby the Damas shares are held by the trustee for the benefit of Damas, as the issuer and holding company. Being a regional issuer, Damas has been a success story for the DIFX. The shares are currently trading marginally below float price, which is a good performance considering the battering received by the global markets during August and September. There is also daily trading in the shares with relatively good trading volumes and numbers of trades.
Liquidity is certainly an issue for the UAE capital markets but, although the number of trades may be lower than hoped for, there are significant numbers of shares being traded. Certainly, Jeff Singer, the new CEO of the DIFX, has targeted increased liquidity as his number one priority.
Liquidity should improve as more issuers list on the DIFX and institutional brokers become more active. There is also scope for an increase in detailed and reliable independent analysts' research, which can only help to encourage institutional buyers. Other factors that will encourage trading and market participation include the development of an equity derivatives trading platform on the DIFX, its having already launched the TraX platform for structured products in August 2007, and the encouragement of listing exchange-traded funds, particularly by the ADX.
The DIFX is also beginning to reap the benefits of its tie-up with Nasdaq and OMX; Netsol was the first Nasdaq listed company to seek a secondary listing on the DIFX and this could be the first of many others. Clearly, the expertise, experience and proprietary software of the OMX can only benefit clearing and settlement on the DIFX and the provision of market information.
There is also a realisation that greater transparency, increased disclosure and improved corporate governance will help market participation. The recent corruption investigations into individuals in several Dubai government entities such as Istithmar World clearly demonstrates that the region is very serious about proper corporate governance and risk management. It should be noted that Dubai boasts its own corporate governance think tank, the Hawkamah Institute (Hawkamah being an Arabic word roughly translated into the English equivalent of 'governance'). If local issuers including family companies can grasp the requirements for proper corporate governance then this will prove attractive to international institutional investors.
Not only are changes afoot in the UAE but throughout the GCC countries. The Tadawul in Saudi Arabia is particularly strong in terms of numbers of issuers and trading volumes and the Capital Markets Authority (CMA) is recognising that foreign investors wish to be a part of this. Currently, non-Saudi individuals or entities are prevented by law from owning Saudi-listed securities. There are various nominee structures used to assist investment but until there are changes in Saudi law the Tadawul will remain a closed, albeit successful market.
A positive sign is the fact that very recently, the CMA has allowed its regulated authorised members to offer equity swap transactions to foreign investors. What is different between the DIFX and the Tadawul, for example, is that there is a clear ambition of the DIFX to be an internationally recognised stock exchange. The Tadawul, being successful in its own right, has different objectives that may seem frustrating to overseas investors.
In terms of opening up the Tadawul, the Capital Markets Authority is fully aware of the potential of the market and the willingness of overseas investors to participate. The Bahrain Stock Exchange, a historical player in the region's capital markets, is a natural home for excess liquidity in Saudi Arabia and the Central Bank of Bahrain is not slow to see this. Qatar has promulgated a raft of new financial regulations and this led to the innovative IPO of Gulf International Services QSC and the IPO of Vodafone Qatar is in the pipeline. Kuwait and Oman are vibrant local markets with good liquidity that provide the potential for dual listings.
Coming full circle back to Dubai, there is tremendous scope for growth. With 15 equities listed on the DIFX, of which 10 are secondary listings, there is clearly a long way to go but when there are so many potential issuers in the region the achievement of the DIFX's vision in the timeframe expected is not so far fetched.
It should be remembered that mature exchanges, such as the London Stock Exchange, took centuries to develop into the sophisticated exchanges that they are and that the DIFX has come a long way in such a short time. It should not be forgotten that DP World raised proceeds of more than US$3bn in November 2007 and regularly has over 100 trades in its shares per day. This was a significant fundraising and was 15 times oversubscribed.
All that the DIFX needs is a regular flow of such floats and any criticism that it is a fledging market will be a thing of the past. What must be remembered is that it is, in fact, a nascent market having opened in September 2005 but it is highly regulated by the Dubai Financial Services Authority (the DFSA). The DFSA's offered securities rules and the DIFX listing rules ensure that the eligibility requirements for listing on the DIFX and the continuing obligations of issuers are as strict as on any other mature international exchange.
So, despite turmoil in Western capital markets, there is much to be optimistic about in the GCC region. There is enormous scope for development through changes to local legislation and the increased sophistication of the markets and issuers, and this is happening now. With regard to the DIFX, its success is integral to the vision of H.H. Sheikh Mohammad Bin Rashid Al Maktoum, Vice-President and Prime Minister of the UAE and Ruler of Dubai and, in no uncertain terms, you can be sure it will happen.