Asiamoney, December 2009

Dubai went to the brink – and it’s still there. Abu Dhabi’s decision in December to supply Dubai with $10 billion for debt repayment allowed it to forestall, at the very last moment, a default on the world’s largest ever sukuk – the $3.52 billion Nakheel Developments issue which matured on December 14. But it doesn’t repair Dubai’s tarnished reputation as a financial centre and issuer, or give any reason to suggest investors will rush back to help Dubai refinance the $100.6 billion of outstanding debt Moody’s believes Dubai Inc owes, $12.5 billion of it due next year. And it leaves significant questions unanswered about the credibility of the sukuk industry that has become a bedrock of global Islamic finance.

It is in some sense a shame that Nakheel didn’t enter formal default. While that sounds absurd, professionals across the Middle East and the Islamic finance industry globally had become increasingly sanguine about a potential Nakheel default, believing it would have answered vital questions about just what happens when a sukuk turns bad.

These, after all, have never been answered or tested satisfactorily. The sukuk market has grown with mercurial haste in the last 13 years: The UAE-based research group Zawya says there were $106.6 billion of sukuk raised in 747 issues between December 1996 and September 30 2009, most of it since 2002. But such is the sector’s youth, well over 90% of that total is still outstanding: to date only $12.6 billion has matured. Consequently, outside of Malaysia’s more mature domestic sukuk industry, there has been hardly any experience of default. Two did fall in the global financial crisis – Kuwait’s Investment Dar, and the US-based oil firm East Cameron Partners, which has a sukuk outstanding but has filed for Chapter 11 bankruptcy protection – but since they have yet to make it to court (and may never do so), it is hard to learn much from them yet.

There is a feeling, therefore, that this had to happen sooner or later, to answer that nagging question: what if? What happens when something goes wrong? For this reason, after the initial shock when Dubai announced a debt standstill and a $26 billion restructuring including the Dubai World state-owned holding company and its Nakheel Development subsidiary, market practitioners had started to look forward to a little clarity.

“In a sense, defaults in a type of transaction reveal the actual rights held by investors in that type of transaction,” says Ayman Adel Khaleq, partner at Vinson & Elkins in Dubai. “Pure economics aside, the defaults facing various sukuk in the current market are therefore not entirely negative occurrences.”

The same sentiment was echoed all over the world in the weeks up to Abu Dhabi’s intervention. “The sukuk market is growing up,” said Dino Kronfol, managing director at Algebra Capital in Dubai, one of the few Gulf asset managers to run a mutual fund investing exclusively in sukuk. “Nakheel will be an opportunity to set some important precedents. First and foremost, we are going to have a better understanding of what the path is going to be like post-default.” Three thousand miles east in Malaysia, Badlisyah Abdul Ghani, CEO of CIMB Islamic Bank, said: “There’s always a silver lining. What is happening now will make the market even stronger in future because it will cause people to build the necessary framework and infrastructure to make sure these things do not happen again.” Well, maybe now they won’t.

So what’s at issue here? Part of the uncertainty is structural. The principle of a sukuk is that it replicates the mechanics of a conventional bond in a Shariah-compliant way. In Islam, riba, or interest, is prohibited: money can’t just turn into more money without doing something else. So instead, sukuk use the cashflows of an underlying asset – typically a property – which pay out an income stream. In Nakheel’s case (there are actually three separate sukuk worth $5.25 billion maturing between December 2009 and January 2011), that’s a 50-year leasehold interest in two plots of land within Dubai Waterfront. In a sukuk, the return is a share of profits among the creditors.

But if it goes wrong, it’s not clear what the rights are of creditors to the underlying assets. Unless it’s specifically stated in the documentation, a creditor’s right is not typically to that cash-generating asset – which is there chiefly to ensure Shariah compliance – but to the obligor’s balance sheet, which can be a very different proposition. Also, the ethical stance of a sukuk is an equal sharing of profit and risk. Well, if it all goes sour, doesn’t this principle of equal sharing alleviate any obligation the issuer has to continue to pay out if it feels it can no longer do so?

Nobody is entirely sure. “Until recently the growth of the sukuk market has been driven more by an abundance of financial resources than by, for example, regulatory or legal considerations,” says Khaleq. “In conventional finance and investment markets, the post-default path is well worn.” Consequently when you structure and document a new conventional bond, you take into account a worst case scenario like a default or insolvency, based on what you’ve seen happen before. “Precedents indicating what such a scenario may entail are readily accessible. The same cannot yet be said for Islamic transactions, particularly in debt capital markets.”

Abdul Ghani says in Malaysia, through experience, these things are understood and therefore practised. “The majority of sukuk are unsecured paper, and there is no expectation whatsoever on the part of the creditors for using the underlying asset to get back their money,” he says. “That asset is just there in a transaction to make it Shariah compliant, it is never intended to be collateral.” Instead, creditors can seek a liquidation of a sukuk, in a process well established over the years in Malaysia’s courts. And this, really, is the difference: experience. “One of the major things that is missing in the Gulf is the bankruptcy law,” he says. “That’s not fully tested.”

One other area Nakheel could have shed some light is the issue of multiple jurisdictions. There are major challenges with different bits of a sukuk being covered by different laws and codes. Khalid Howladar, an analyst specialising in sukuk for Moody’s, says that the declaration of trust, the transaction administration deed, agency agreement, certificates, co-obligor guarantee and the Dubai World guarantee are governed by English law. The purchase agreement, lease, mortgages and the share pledge, among other things, are under UAE laws – which are Islamic. “This complicates issues such as enforcement of rights,” he says. “Ultimately, even an English judgment will need to be enforced locally, and given the conflict of government ownership of the entities involved, as well as the immaturity of the legal environment, it’s not clear how transparent or fair local courts would be.”

In truth, nobody in their right mind would have taken Nakheel’s backers – ultimately, Sheikh Mohammed bin Rashid Al Maktoum, emir of Dubai – to court in the United Arab Emirates. “It’s a brave person who stands up in court and says to him: ‘that’s mine, not yours’,” says one banker. “When you go to court in Dubai, there’s a symbol of the ruler behind the judge. Are you going to go into that court and ask for the ruler’s assets?”

Kronfol also doubts the point of going to court. “It’s never helpful. And even if you got the court to give you access to the asset, why would you? It will be complicated – you won’t own the land, you’ll own a lease, and that land is just desert with a fence around it. You’re much better off with a planned restructuring.”

The sukuk market has a host of other challenges to deal with besides: a lack of secondary market liquidity anywhere outside Malaysia; the damning remarks recently by leading scholar Sheikh Taqi Usmani from Pakistan, who said 85% of non-ijarah sukuk issues were not in compliance with Shariah law, undermining the credibility of the entire industry; and divergent standards on compliance between the Middle East and southeast Asia. Issuance more than halved between 2007 and 2008, to $15.4 billion, although it did rebound to $16.2 billion in the first three quarters of 2009; issuance is driven by southeast Asia rather than the Middle East, with the Gulf nations accounting for only 16% of issuance in the first half of 2009.

But despite this continuing lack of clarity about rights and processes, the market itself will no doubt persevere. In particular, few in Malaysia – whose US$66 billion of outstanding public and private sukuk at the end of June 2009 accounted for 62% of the total outstanding sukuk globally, according to Bank Negara Malaysia – feared much contagion even when a default was on the cards. “The Malaysian ringgit sukuk market will be isolated from this incident,” says Abdul Ghani. “It’s a domestic market with its own framework, its own infrastructure, its own investor base. It’s the most mature sukuk market and its activities have been tested in court, in restructurings and reschedulings since 1990.” He did, though, expect dollar sukuk issued from Malaysia to struggle to tap Gulf investors “as most of them have been affected by Nakheel.” For its part, Bank Negara Malaysia told Asiamoney a default, if it came, would be “a credit issue on a particular issuer” with “no systemic impact on the Islamic capital market” and “no adverse impact on the overall sukuk market in the long run.”

That said, the market will evolve. Ernst & Young expects more sovereign issuance, including European and Asian issuers such as the UK and South Korea; others say investors are likely to show a preference for those from wealthy companies with assets to back them – such as oil for Abu Dhabi, and gas for Qatar. Efforts are likely to increase to build secondary market trading in sukuk – Saudi Arabia is already trying this by introducing sukuk trading on the Tadawul stock exchange, and the Islamic Development Bank proposes to launch an investment bank to create an Islamic interbank market. And, more than anything, even if Nakheel’s survival has deprived the market of a chance to learn more about creditor rights, the future must involve an evolution of structures that makes these things more clear. “There is going to be an increased push for transparency and better governance,” says Kronfol.

But today, the whole market looks tarnished. As Asiamoney went to press, the great and the good of the Islamic finance industry were meeting in Bahrain for the landmark annual World Islamic Banking Conference. “We were expecting to be able to celebrate the triumph of Islamic finance over conventional,” says one person in attendance. “In the last year most Islamic bankers have been saying: ‘look at us, if people had worked with us they wouldn’t have lost any money’. Well, nobody is saying that right now.”

BOX: Dubai

Sheikh Ahmad Bin Saeed Al Maktoum, the chairman of the Dubai Supreme Fiscal Committee and uncle of Dubai’s ruler, had some soothing words to say when he announced the $10 billion bailout of Dubai World on December 14. There was talk of “our strong commitment as a global financial leader to transparency, good governance, and market principles.” He wanted to “reassure investors, financial and trade creditors, employees and our citizens that are government will act at all times in accordance with market principles”. And he promised: “Our best days are yet to come.”

It is to be hoped so, because the two weeks prior to his statement are never going to appear in any précis of Dubai’s best days. Credit and stock markets worldwide were delighted at the news, but that doesn’t mean are going to forgive Dubai’s conduct in a hurry. That’s going to matter when Dubai comes to refinance its other debt.

One of the biggest complaints that came after the announcement of the standstill was that people felt misled: that they had assumed the state would stand behind its subsidiary companies. Nakheel – “where vision inspires humanity”, as its tagline continues to trumpet – is the backer of the vast palm-shaped property developments that are sprouting into the Gulf, among the most iconic projects in this most ambitious of cities. Nakheel, in ownership and symbolism, is Dubai.

In fact, the 237 page prospectus for the sukuk itself contains no mention of state backing, which has led some to question the wisdom of investors and rating agencies in their approach to assets like the Nakheel issue. “As there were various risk factors listed in the Nakheel sukuk prospectus, a clear statement that Dubai World depends on its subsidiaries, and none actually giving any indication that the Emirate of Dubai would pay for Nakheel in case of insolvency, the original rating based on implicit sovereign support seems to be exaggerated, and not really wise,” says Michael Salah Gassner, a banker and founder of the website islamicfinance.de.

On paper, that’s clearly true, but what muddied the waters was the apparent statement of support from Dubai’s leadership – right up to Sheikh Mohammed – in the weeks and months before the standstill announcement. “A few weeks ago Sheikh Mohammed publicly said the Dubai economy was in good shape and he didn’t expect any more problems for it,” says Douglas Hansen-Luke, CEO for the Middle East at Robeco in Bahrain. “I am sure there are no records anywhere of him explicitly guaranteeing the debt of companies in which he is the largest shareholder. But at the same time there are no explicit statements until these last two weeks that he would not stand by them. And it would certainly be true to say that the vast majority of the investment community thought they were almost pari passu.” And, in the end, it appears it was.

Hansen-Luke stresses there is another side to the coin. “The ruler in Dubai has got the opportunity to show two things – one, that Dubai is a normal economy, where companies that invest soundly and are in the right markets will do well, and companies that don’t will become smaller, restructure or close – that’s the nature of capitalism. It’s good for people to see this is a capitalist economy and nothing is too big to fail: that is a positive message. The other is that Sheikh Mohammed will not tolerate corruption or wrong-doing. That’s also very positive for the long term future of Dubai. But to get that right in the near term, a third element is needed, which is transparency.” And this is really where the greatest hand-wringing is taking place: the sense of being surprised, of being in the dark.

This is only the first stage of Dubai World’s restructuring so there is much to be worked out. “This really is a key moment in Dubai’s evolution,” says Khalid Howladar at Moody’s. “If it hopes to retain and improve its position as a financial centre it needs to show fairness and transparency in its restructuring.”

One thing in particular infuriates foreign investors: that the standstill was announced immediately before a four-day public holiday, letting uncertainty and rumour drive world markets until Dubai got back to work. And the bailout, when it came, was a matter of hours before the sukuk would have entered technical default. Investors don’t like a white knuckle ride like that, particularly on what they thought was state-backed paper; many will doubtless think twice before rushing back to Dubai.

“The direct impact of the standstill and the relatively small amount of money involved,” says Hansen-Luke, “is much less important than the impact on perception and credibility.”

Viewed from a distance, the Middle Eastern property industry is symbolised by Dubai. That’s the place with the fastest pace of development, the tallest buildings, the wackiest plans for world-shaped islands and underwater hotels. It may be as brash and bold as Las Vegas, but it’s not the whole story. Outside Dubai, and even beyond the booming cities of Abu Dhabi, Doha, Kuwait City and Manama, there are other interesting real estate stories. With concern growing about overheating in Dubai property, they’re starting to look like more attractive propositions.

At the heart of this momentum is money from the Gulf itself. For some time, Gulf developers have been looking for new opportunities. Jordan, Oman and Egypt have captured particular attention, with some looking as far afield as Lebanon, Morocco, Tunisia and Syria. All the big names in Gulf property development – Dubai’s Emaar and Damac, Qatari Diar, Bahrain’s Gulf Finance House as well as the big Saudi and Kuwaiti conglomerates – are aware of the risks of concentration in one market and, more importantly, see great long-term gains to be had in less well-trodden locations. The only question now is: in the new, more frugal environment that must follow the credit crunch, can they all be funded?

“You cannot invest your whole capital in GCC, because the economy is not so large,” says Faisal Hasan, head of research at Global Investment House in Kuwait. “With the liquidity GCC has, even with the decline in oil prices, they are still looking at investing their surpluses outside. The MENA region is one they understand and you can also see substantial appreciation in it: the latest IMF report says MENA will grow at 5.5% at a time when other markets are in recession.”

It’s natural that developers are looking beyond their home markets. Whether or not you think Dubai and other centres are bubbles waiting to burst [and see the news story on page xx for a discussion of falling prices in the luxury residential sector], nobody could claim they are cheap. “Prime rents continue to demonstrate unprecedented increases,” says Mohammed Faheem at CB Richard Ellis in a third quarter 2008 review of Dubai’s office market. Prime office rents are going for between AED5650 and 5920 per square metre, a 38% year on year increase, and are unlikely to fall any time soon: “With no new office supply anticipated, prime CBD rents are likely to appreciate further during the remainder of 2008.” Renting or purchasing prime office space or land has become prohibitive in Kuwait City, Abu Dhabi and Doha as well. And, while Gulf investors are historically quite happy to invest in the US, UK and Europe, they are increasingly happy to invest in their own region too – a trend seen all the way from the high-net-worth individual to corporates and sovereign wealth funds.

The problem is that this expansion into overseas markets has come at exactly the same time that sources of wealth for the big developers are drying up. The credit crunch took a while to arrive in the Gulf, but it has certainly turned up now: for the first time, the Dubai government, and others in the region, are talking about scaling back their construction ambitions. That suggests a rather less rosy underside to some of the brochure pictures of soaring blocks in azure skies.

“Most of the market in GCC is in flux now,” says Bikash Rout, senior financial analyst at Global. “People are really scrabbling for liquidity, not looking for new investments. It’s not that they’re exiting Dubai and going to Oman, they’re selling in Dubai and trying to preserve their capital. You won’t see people taking much interest in new projects, as most of them are facing some kind of liquidity crunch.”

After all, it’s not as if these new projects in Egypt and Oman have suddenly sprung up overnight. The landmark developments in these countries long predate the price dynamics of Dubai or Kuwait. “These are developments which started a few years back driven mostly by demand for real estate facilities on the back of growing economies and strong demographics, as well as opening up to tourism,” says Bassam Al Othman, senior vice president at Markaz in Kuwait. “I don’t see developers from the Gulf investing new capital in these countries.” Instead, he feels developers are more likely to take their next step into deeper markets such as Abu Dhabi, Qatar and Saudi Arabia if correcting prices reveal new opportunities. “Real estate investors are in a wait and see mode, trying to play it safe until the dust of the global financial crisis has cleared,” he says. “Would we see investors migrating to areas which had lower attention in the past few years? That is doubtful. I would assume that investors will become more risk averse and will focus on places with the strongest fundamentals.”

A year ago it was claimed that Gulf economies were so uncorrelated to those of the rest of the world that they had little to fear from the credit crunch. No more: stock markets have plunged with the worst of them, and now even Dubai – which for so long has seemed to operate under different economic forces from the rest of the planet – is facing a property crash.

And in November, the United Arab Emirates (in which Dubai is one of seven emirates) witnessed that most Western of modern phenomena: the state-sponsored bank merger. Specifically, two large Dubai mortgage companies, Amlak Finance and Tamweel, were merged with a UAE government-owned bank, Real Estate Bank, which will then be put into a new, state-owned and federally funded bank called Emirates Development Bank.

These are big entities by local standards: Amlak is the largest publicly held Islamic finance company in the UAE and had AED14.2 billion in assets in the first half of 2008, while Tamweel had AED10.8 billion, according to the companies themselves. Real Estate Bank is little-known – it has just 7,000 customers – and is seen as a vehicle to house the other two assets.

A Ministry of Finance statement called the merger “a milestone development for the UAE financial sector” and said the bank would “provide a strong growth platform the real estate financing in the UAE, and will serve as the cornerstone of the mortgage market, which has significant growth potential.” But locally it is being seen as a bailout, and a clear acknowledgement of the pressures in Dubai’s property market. The week before the announcement, Amlak had suspended new loans; some new luxury accommodation is reportedly being advertised at half the levels it was previously offered at; and big construction projects are being delayed, with developer Nakheel confirming in Dubai it was slowing the dredging work on its Palm Deira project.

Just as closely watched as the merger announcement was a speech by Mohamed Alabbar, the chairman of Emaar Properties, on November 24. Alabbar is also a member of Dubai’s ruling council, and his comments on construction were strikingly direct: “We have made a decision to pull back on supply,” he said, and: “if you have to pull something, you have to pull something.”

Up the Shaikh Zayed Road in Abu Dhabi, similar measures are being taken to those in Dubai. Abu Dhabi Finance was formed in late November as a joint venture between five big UAE companies, including Abu Dhabi Commercial Bank and the Mubadala sovereign fund. The new company will offer financing to buyers of properties from three Abu Dhabi developers, and later to other UAE developers. The measure reflects the lack of liquidity at a time when new supply is heading rapidly for a swamped market.

Still, although the new measures send worrying signals, fund managers believe they are sensible. “I see that [the mergers and new company] as a positive trend,” says Harshendu Bindal, director for CEEMEA at Franklin Templeton Asset Management in Dubai. “It’s making sure liquidity is available to the market. Let’s assume prices come off and you want end users to step in and buy: unfortunately there are no mortgages available currently. Making sure that key mortgage companies are adequately capitalised and able to lend is a good sign.”

It has long been accepted that the Gulf needs a financial hub. It’s an increasingly important market on a world scale, oil and sovereign wealth make it more relevant than ever, and it fits naturally within the European and Asian trading blocs. But the Gulf has not one potential hub, but three.

For 30 years this was Bahrain’s unquestioned role. “When I worked in Bahrain in 1982 there was no question it was the centre of finance in the Middle East,” recalls Daniel Smaller of Algebra Capital. Linked to Saudi Arabia by a causeway, and barely an hour’s flight from Kuwait, it benefited from the relative difficulty of accessing those far bigger markets directly, and acted as a convenient and well regulated hub for those wanting to do business in or with the region. When turmoil hit Beirut in the 1970s, the business came to Bahrain and stayed.

It has been fashionable in recent years to suggest that Dubai in particular has wrested that title away, but the Bahrainis aren’t having a bit of it – and from the perspective of asset management, they have strong numbers on their side. As of December 31 there were US$15.6 billion of mutual funds registered in Bahrain, up from $9 billion the previous year – a 73% increase. There are 2,483 funds registered in the country, 124 of them local and the rest foreign.

Abdul Rahman  Al Baker, executive director of financial institutions supervision at the Central Bank of Bahrain, believes there are several reasons for the country’s popularity. “One is our legal framework: it has been in place for 15 years and has proven it is able to cope with changes in the market,” he says. “There is investor confidence in the system here. We have been a financial centre for 35 years. And the standards that we use in our regulations and legal framework for collective investment undertakings [CIUs, investment vehicles such as mutual funds] are in line with international standards.” The lack of any taxation on investment products also helps. “What you earn is what you get,” he says.

Last year Bahrain introduced a new and updated regulatory framework for its mutual fund industry including rules for CIUs targeting professional investors. For investors with enough assets, this has allowed for the arrival of hedge funds and other alternative investment vehicles in Bahrain. It also categorises investors by assets and experience, and allows different classes of products to be sold to each. This appears to have been a large part of the reason for the increase. “As a regulator you need to see what’s going on in the market, and try to revamp regulations to be in line with the changes,” Al Baker says. “We took the initiative by introducing these new categories. Previously most of these [hedge and alternative] funds were not registered in the region but outside. Our new regulations are attracting a lot of existing asset managers from the region to set up here instead.”

In some measure, Bahrain has also benefited from the lack of similar flexibility in other Gulf nations, notably Kuwait, which does not allow local fund managers to domicile dollar-denominated funds there. Consequently, managers simply set up their funds in Bahrain instead, enjoying the clear regulatory environment and swift efficiency of processes.

These measures have helped to cement Bahrain as a hub for distribution of funds in the region. It is also without doubt the regional centre for Shariah-compliant funds. Bahrain hosted 87 Islamic funds with US$1.3 billion invested in them at the end of 2007, a 78.5% increase on the previous year in terms of assets. They cover a range of asset classes from local and GCC index funds to property and, most recently, leasing. Bahrain is already home to many of the most important institutions and authorities in Islamic finance, such as the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), the body trying to standardise global Islamic finance in an accepted code; and the International Islamic Financial Market, mandated to develop the capital market and money market for Islamic banks. Bahrain has been involved in efforts to develop a trading platform for sukuk, to create master documentation for Islamic derivatives, and to develop qualifications for the industry, among other things. The product section of this guide talks about Islamic finance in more detail.

Bahrain, unlike newer competitors, operates under exactly the same legal code in its financial institutions as in the rest of the country. There is no designated plot of land in which separate laws and regulations apply (the Bahrain Financial Harbour, the gleaming centrepiece of the Manama waterfront, is simply landmark real estate rather than a separate regime), no separate regulator for the financial centre, and no common law jurisdiction. Bahrain presents this as an advantage, suggesting that having two legal codes in one location can only be problematic; the alternative view is that Islamic law is impractical for modern commerce.

While Bahrain had the market to itself for many years, it now has competitors. Dubai, like everything else in that city, has big ambitions as a financial centre: it wants nothing less than to be another London or New York, offering everything a financial centre would offer, as a global gateway for capital and investment.

DIFC is a 110-acre free zone in Dubai, formally opened in September 2004, in which this bold vision is taking place – quickly. Already 607 businesses are registered within its premises, almost 200 of them financial institutions of some description. They cannot get the buildings up quickly enough – literally.  “There’s still a huge waiting list for people to get property here,” says William Wells, relationship manager for the Middle East at Schroders, which set up in DIFC a year ago and has been in its permanent offices for three months.

The truly distinctive thing about DIFC is that within that 110-acre plot, the legal and regulatory systems of the rest of the United Arab Emirates do not apply. Instead, DIFC is overseen by a separate regulator, the Dubai Financial Services Authority, closely modelled on the UK’s FSA, under common law. The idea was that big global financial institutions had long had aspirations in the Middle East but had been put off by the lack of a legal code they could understand and trust, and a regulatory environment they were comfortable with. As with everything else in Dubai, the pace has been extraordinary: 30 pieces of legislation were enacted in the first three years, between them representing what one senior figure at DIFC calls “an entire body of Anglo-Saxon law.”

This has been a big appeal for foreign managers. “When we looked at going into the region, we wanted to be there on a basis that minimised operational risk and reputational risk for ourselves and our clients,” says Nick Tolchard, managing director of the international development division at Invesco, which is licensed within the DIFC. “We actually welcome a strong regulator, and that’s what we see in the DFSA.”

From an asset management perspective, many of the world’s biggest names are registered and set up within DIFC already, among them Franklin Templeton, Permal, Invesco, Man, Prudential and Schroders, and the asset management arms of international banks such as Deutsche Bank, UBS, ING and Barclays. However, very few funds are actually domiciled within the DIFC – the figure was just nine in late 2007 – which has led critics to suggest that all the DIFC has really done is become a conduit for money to leave the UAE, with foreigners simply posting sales staff in their offices rather than any manufacturing presence. In fairness, the collective fund law governing domestically domiciled funds only came into effect in mid-2006, and it will take time, and the arrival of custodial and fund administration services in Dubai, before it will make sense for many groups to domicile funds there. At the moment, there is no obligation for foreigners active in Dubai to domicile funds there, so most instead keep their funds in the Cayman Islands, Channel Islands or Bermuda as they always have done. There is some speculation, though, that in time foreign groups will be required to domicile feeder funds locally which then feed into offshore products.

From the outset the DIFC has been designed to offer domicile to a wide range of products, including mutual funds, exchange traded funds, listed investment companies, hedge funds (and fund of funds), and Shariah-compliant funds. The regulatory package allows for 100% foreign ownership of the funds, no tax, no restrictions on foreign exchange or profit repatriation, and of course the world class level of supervision and regulation from the DFSA.

It is important to noted tha the DIFC does not cover retail financial services, nor transactions in dirhams; those are covered by the central bank in Abu Dhabi.

Qatar has its own highly ambitious program to build a financial centre, though its aim is rather different from that of Dubai. Its intentions are to build a centre that is very much onshore: it wants international financial institutions to establish operations on the ground in Qatar. In the Qatar Financial Centre’s own words, it wants them “to participate in long-term and mutually beneficial partnership with Qatar.” It is often explained in terms like these: that Qatar is not explicitly aiming to become a regional financial hub, but if its domestic efforts cause it to become one, so much the better.

The legislation to establish the QFC was enacted in March 2005. There are four distinct components to the Qatar model: the QFC Authority, which is responsible for commercial strategy and for developing relationships with the global financial community, among other groups; the QFC Regulatory Authority, which supervises financial services firms and financial institutions operating in or from the QFC; a civil and commercial court; and a dispute resolution body.

Initially, the legal model was similar to that in Dubai: the QFC operated on common law principles while the rest of the country had its previous, Islamic legal code. Also as in Dubai, the QFCRA tried to adopt best practice from regulatory authorities elsewhere in the world, and again bears a lot of similarity to the UK’s FSA. However in July 2007 it was announced that a single financial regulatory body would be established, bringing together the regulatory functions of the stock exchange, central bank, and QFC Regulatory Authority, and some regulatory responsibility for insurers that had resided within the Ministry of Economy and Commerce. A chairman and board for this new body should be announced soon.

The QFC aims to foster a number of centres of excellence, hoping that clusters of firms will develop in those areas, which in turn may develop into a regional hub. Insurance is one example, and another is asset management. Collective investment regulations for wholesale and retail funds have been enacted over the last 12 months. It is hoped that managers will domicile their funds locally, which has not happened at this early stage, but a new tax regime that comes into effect on May 1 may help: it exempts any locally domiciled funds from tax. Many fund managers have in any event chosen to set up in Qatar. Among them are Axa Investment Management, Global Investment House, EFG-Hermes, and Kuwait Financial Centre.

Axa was already in the region through the insurance arms of its business before selecting Qatar as the centre of its investment management advisory and client services for the region. Axa, like many others in the region, had historically managed its Middle Eastern business from London and Paris, and had reached a point where it made sense to be on the ground. “Location was not the only issue;  we did want to feel comfortable with a strong regulatory environment and we were very impressed by the QFCRA,” says Scott Callander, director, Middle East, at Axa Investment Management. “The logistics of moving around the region are very good, and by the nature and dispersion of our clients we’re not tied to any one city in the GCC.”

Some homegrown institutions are appearing too. One example is Qatar Capital Partners, formed last year with a focus on venture capital. “The opportunities are huge in Qatar,” says Mikko Suonenlathi general manager at Qatar Capital Partners. “The things QFC are driving are corporate governance and transparency, and I think that’s exactly the right agenda. Once you get to the highest possible international standards it will make it into an even better investment environment.”

Qatar’s regulatory environment is still coming together, though much of the most important legislation is now in place. For example, the regulations for limited partnerships – vital for any private equity and venture capital business. “That’s a significant step forward,” says Mikko. But every step forward is a new one. “It’s pioneer steps that I’m taking,” says Mikko. “But with the overall environment here it’s a good time to take those steps. Three years ago it was too early; three years later is too late. Now is the time to enter a new market.”