x Abu Dhabi, UAETuesday 25 July 2017

Blocked cash flow is in need of fiscal plumbing

While many markets around the world are thriving, the UAE is falling behind when it comes to attracting liquidity as company values start to suffer.

Gulf states are attracting only a small portion of renewed liquidity flow from investors. Nicole Hill / The National
Gulf states are attracting only a small portion of renewed liquidity flow from investors. Nicole Hill / The National

Trading volumes on the Abu Dhabi Securities Exchange (ADX) and the Dubai Financial Market (DFM) are at an all-time low. Companies' valuations are suffering. Stock brokerage houses are wringing their metaphorical hands. Aabar has decided to go private. Initial public offerings (IPOs) expected to return this year are yet to occur: the announced IPO of Axiom Telecom is a major test. If we wait longer, there will be no one around to celebrate if the rumoured merger between the ADX and the DFM/NASDAQ-Dubai comes off.

Is the problem restricted to the UAE and the Middle East? It appears so. Western markets are doing fine, while Hong Kong is booming and attracting new issuers every other week. Singapore has captured numerous pools of liquidity during the financial crisis; pools that were no longer comfortable in tax havens or old Europe or those that are being created in Asia, South America and in the Middle East. Unfortunately, the Gulf states are attracting only a small portion of this flow and when they do capture some of it, it is reinvested somewhere else.

The problem is, however, common to the MENA region at large and for both private and publicly listed companies. Over the past three years, investors' profiles have changed. Large investors (family offices, institutions or fund managers) have in general a shorter investment time horizon than before but, more importantly, need the ability to arbitrage their positions on a regular basis. This is also true for investors in private companies or private equity who are looking at a two to three-year exit horizon rather than five to seven years previously.

Small investors are more likely to invest via third parties' investment vehicles, especially those with downside protection and/or index tracking. Day traders will shy away from stocks where lack of liquidity is apparent. Foreign ownership limits remain a leading cause of lack of liquidity and transactions for both listed and private companies: foreign investors cannot track the index performance of the UAE as they are not allowed to own shares in the largest market capitalisation of the country, Etisalat.

Ad hoc solutions (swaps), which certain investors are considering to invest in Saudi Arabia, do not provide satisfaction today. For private companies in Algeria, following the imposition of a 49 per cent foreign ownership ceiling last year on all new companies to be set up or purchased, a large number of projects are stalled or have been abandoned, including those sponsored by UAE entities. There are several solutions that can be implemented rapidly to restore market liquidity for listed stocks in the Middle East.

One way would be to insert a Golden Share, a nominal share that is able to outvote all other shares in certain specified circumstances, for certain sensitive stocks, which should remain in the hands of a particular emirate or a particular family. The characteristics of the Golden Share must be precisely crafted to avoid legal challenge (as was just the case between Telefonica and the state of Portugal where the latter wants to block the company's takeover of a Brazilian subsidiary of Portugal Telecom, despite the approval of 74 per cent of Portugal Telecom shareholders in favour of the transaction).

The Golden Share mechanism was successfully applied in 2006 against a Dubai-based fund trying to buy a 20 per cent stake in the Greek-listed former state telecommunications monopoly operator OTE. The Golden Share may be customised to get investors comfortable about its application; it could have a limited lifespan, or not be applicable in certain cases (for example if a takeover premium is larger than a specified percentage).

In the case of government-owned or controlled stocks, in addition to inserting a Golden Share, the lifting of the foreign ownership limit can be gradual (parallel to the government ownership reduction in the stock so as to best monitor the stock liquidity and volatility). A fraction of the proceeds captured through this sales process can then be kept aside to be used to buy back shares at a discount of a particular stock in case foreign and/or local investors decided to off-load the stock at a pace that the government judged inadequate for the market.

Another option corresponds to the set-up of multiple voting shares for certain stocks, or the setting up of both a management company and an investment company, similar to the French legal corporate mechanism of "societe en commandite par actions", used by Lagardere and Michelin and which has successfully helped kept corporate empires in the hands of the founding families. A third option is to list investment certificates for a company: that corresponds to the economic value of a share and captures the whole dividend, without any voting right attached. There is thus no need to impose ownership limits on the investment certificate.

The issuer can decide to retain the voting rights and/or to list them separately. Depending upon the situation, the issuer can directly list investment certificates or the controlling shareholder could issue investment certificates giving rise to the economic rights of the underlying stock that the shareholder would retain. For large market capitalisations, trading of the investment certificates should enable a re-rating of the whole stock, as removing the current illiquidity discount increases the value more than the value attributed to the voting right (especially for an entity perceived as not available for a friendly or hostile takeover).

The listing of investment certificates could take place in the UAE or for large capitalisations on the London Stock Exchange, Hong Kong Stock Exchange or equivalent. Investment certificates have been used successfully in the past by governments looking to privatise assets and share the wealth with their population while achieving internationally benchmarked market value for their assets.

Alex Carre de Malberg is a senior adviser at The National Investor in Abu Dhabi