DIFC : MANAGING EXUBERANCE & EXPECTATIONS

Now that the Federal financial free zone law has been passed, the stage is now set for the Government of Dubai to issue its own decree to formally launch the operations of the Dubai International Financial Centre (DIFC) and at a later stage, the Dubai International Financial Exchange (DIFE). Much has been written about DIFC in the local press and copious coverage given in the media to the recent announcement about the new federal law that has been welcomed by one and all; from issuers of debt and equity, to insurance companies.  DIFC and DIFE’s enormous potential have been recognized  by many corporations as a vital ingredient for their global business growth.

It is also about time that DIFC, having been in the ‘works’ for such a long while, is restoring credibility to the concept . By meticulously making the preparations needed for a robust regulatory environment and conforming to international best practices, DIFC will have regained lost time and initiative and redeemed its original promise to the world at large.

This is indeed what is reassuring about DIFC, when contrasted / vis-à-vis the aborted Saadiyat financial island experiment i.e. the exceptionally experienced (naturally expensive!) and talented team of experts that DIFC began to recruit and put in place, from day one, to prepare and be in readiness, to launch. They have been waiting in the wings for a while, and must heave a huge sigh of relief, now that the federal legislation is firmly in place.

Herein perhaps lie a few cautionary road bumps! Just as there are gushes of enthusiasm expressed through the media and in the cocktail circuits, the hype and the positive glow that the DIFC will gain from being constantly in the public eye, will underscore a need to manage expectations and exuberance. Greenspan’s immortal words a few years ago, in the wake of the Nasdaq vertigo about “irrational exuberance” in the market place, is a real risk in this part of the world. The senior DIFC officials that I have met, do recognize and realise that building up bubbles of expectations and exuberance ill-serve the market place and undermine investor confidence. The regional players may face disappointment; if they do not get approved or fail to conform to the standards and the jurisdictional requirements for passporting themselves into phase one of the DIFC. It is likely that in the first instance, only the top international institutions will easily ‘migrate’ into DIFC and be allowed to establish entities or offices that are subject to the DIFC regime. They may well operate outside the financial zone for a few years, in the physical sense, until such time as the infrastructure and the Gate are ready for occupation.  Therefore, regional financial institutions, particularly banks, or smaller reinsurance companies may not gain quick entry. If they thought and applied on the basis that the DIFC will give them a “laissez-faire” operating freedom, not obtainable from their own regulators, then they could be deluding themselves. While the Bahrain Monetary Agency has been operated like a financial free zone, its offshore banking regime and capital market / investment institutions have a good regulatory oversight.  Other central banks in the region, particularly SAMA, have been less enthusiastic about financial engineering or innovation. This is exactly where I think that there is need for some management expectations by the DIFC, and this can be achieved through clarity in articulation of the eligibility criteria and ‘passporting’ processes. 

As far as the Dubai International Financial Exchange is concerned, it will need a whole host of broker intermediaries and ‘market makers’. Here, the regional corporations that will raise equity and debt, will prefer to deal with regional / merchant banks and capital market players with powerful placement capabilities.  The latter’s track records, even if small by global standards, will add to their adaptability to easily conform to best practices. Therefore, the DIFC must set its sights on not just bringing in marquee names but regional institutions that make markets.

Taxation is not such a disincentive, because it is either non-existent or low for the heavy weights such as the commercial banks and GCC reinsurance companies (if they operate outside their home countries).  There will be regulatory costs / burden in terms of reporting and staffing, that may well offset some of the tax advantages. Arguably, it remains to be seen as to what the costs are, and here again, the DIFC can display greater transparency on its fee structure, and in publication of the various licensing requirements. This will remove ambiguity; thus not to give rise to misplaced expectations.

This is the next task that DIFC must engage itself in; in my view. The exuberance will bubble  up during DIFC’s operating activities. For instance, if private banking entities go overboard, in reaching out and trespassing into the domestic retail segments, there will be necessarily some strong reactions; not just from competitors but from the people / customers that have grievances in dealing with DIFC-regulated banks. Soon they will deflect the blame onto the new jurisdiction of choice i.e. the DIFC. Here again, some ring-fencing may need to be vigorously monitored and considerable arms-length distances maintained from what can and not be done by entities located in the DIFC.

The other forms of irrational exuberance will come in when the DIFC comes into play. While I may have reiterated time and again in this column, it bears repetition to say that good documentation, disclosure as well as international quality information memoranda etc. are pre-requisites.  It is in this context, that flimsy few-pages offering circulars, as have been seen in some of the highly successful and oversubscribed IPOs, should not and will not stand upto scrutiny in DIFC. It is a pity that even globally recognized accounting and law firms look the other way and sign off on such IPO documentation in the UAE and this cannot but be to the detriment of the investor base. In all these issues (sic), the come-uppance comes when the inherently cyclical markets turn adverse. Then the blame-game starts, but worse, as a wag put it, investor confidence is dented. Market confidence is the elusive will-o’-the-wisp, but the enduring cementing force, and once damaged, will take a long time to recover. This is the irrational exuberance that Greenspan and others have been cautioning against, as markets literally try to overreach themselves as a matter of course, during boom times and when the feel-good factors are around.

The UAE stock market authorities (ECSA etc.) will, no doubt, work closely with the DIFC officials. Those in charge of the stock exchanges in the country can develop a regulatory collegiate environment. Similar to the police and the Interpol, where there is good exchange of information, alerts to ensure that no one exploits the weaknesses or information gaps or gains any material advantage, will need constant and close surveillance. Arbitraging will inevitably take place in one form or the other, and not just in price / value terms.

In the final analysis, DIFC’s regulations, if found to be vigorous and vibrant, can in turn, be reflected upon soberly by the national and regional authorities; so as to bring up their own standards and to give DIFC some healthy competition. Ultimately, the success of the DIFC is critical for all in the region, especially if it assumes the form of a financial life-line in this key time zone, within an eight hour travel reach to the major financial markets and with a 24x7 capability. 

All of Dubai’s “hub” aspirations, whether in communication, infrastructure, aviation etc. have always been launched with great fan fare and realised very rapidly in terms of returns and potential. There is no reason why the results of the DIFC initiative, with such a fine team assemble, should be any different. It augurs well for the future of capital markets and would be a matter of great pride, if the DIFC will benchmark against the ringing words that “in the race for excellence, there are no finishing lines”.

Back

Top