Qatar and the UAE are still waiting for an upgrade in the status of their stock markets from “frontier” to “emerging”. It could still take a while…
On 15 December 2011, the online version of The Wall Street Journal included the following report: “Index compiler MSCI Inc. postponed a decision on whether to upgrade the status of stock markets in the United Arab Emirates (UAE) and Qatar for another six months, a blow to local investors who saw a promotion to emerging-market status as a way to reinvigorate lacklustre trading.” As Academic Director of the INSEAD Abu Dhabi campus and resident of the region over the last two and a half years, I found this representation of the facts quite interesting.
As far as I understand finance, and I want to be careful to emphasise the limits of that comprehension, a change to the index might have such an effect on investor sentiment for at least two reasons. The first is substantive and would result when an index upgrade reflects improvements in the underlying economic fundamentals; I have not seen the evidence to suggest that an upgrade in the MSCI global equity index accurately tracks improvements in the underlying economic fundamentals.
The second reason why an upgrade might induce more investment would be the self-fulfilling dynamic whereby investors enter the market after the upgrade based on the belief that others will enter. Presuming the disappointment of local investors is based on the hope that it would trigger this herd dynamic, I would like to suggest that this expectation is not well-founded. In short, I do not share their hope that this foreign certification would re-invigorate lacklustre trading.
To understand my scepticism on this issue, consider the following question: Can there be any serious hope of attracting foreign capital to financial markets that do not attract even a small portion of massive cash flows generated by energy exports? As you might guess, I believe the answer to this question is a resounding “no”.
At the same time, I do not wish to express pessimism about the value of hoping for MSCI certification without suggesting a constructive alternative. In particular, I advocate a process for re-designing market architecture that resolves competing interests effectively. In laying out this idea and in the interest of full disclosure, I hereby confess that I am an American. As I have lived outside the United States over the last years I have often been asked about the economic successes (and excesses, but I will ignore these for purposes of my essay) of my homeland. In talking about the successes, I have settled on a response that emphasises a single factor, a clause in the original constitution of the country stating that interstate commerce can only be regulated by the federal government. It is my belief that this provision created the world’s first mass market, triggering a process of economic integration that continues to this day and has expanded to a global scale.
Understanding the genesis of this provision brings me back to the value of a process that effectively resolves competing interests. Importantly, this clause was not enacted with foresight to create a large-scale market. Instead, it was enacted because New York refused to join a union where Pennsylvania could tax goods imported from New York, and Pennsylvania refused to join a union where New York could tax goods imported from Pennsylvania.
Apparently, a process of equal participation by representatives of 13 states in the context of a constitutional convention had some good outcomes. I say this not as a suggestion that the UAE or any other country should mimic what happened elsewhere. This would hardly be more useful than trying to attract foreign investment by obtaining a particular rating of the domestic stock market from an outside ratings agency. Instead, I urge local investors to design an exchange platform that surfaces and resolves competing interests; this is the surest route to success in creating domestic capital markets that attract the attention and money of local (and foreign) investors.
In that spirit, I want to close with a specific if somewhat far-fetched suggestion: the largest domestic firms in the UAE should exchange stakes in one another. The rules of this interchange should require that the only exit from these investments is an arm’s length sale on the local equity market. The result will be that all of the major stakeholders now have valuable ownership shares that must be traded on the local exchanges. A fair and participative process of developing rules and standards to govern these exchanges is most likely to result in a trading platform that facilitates transactions. I am confident that such a trading platform will attract the right kinds of investors and the right kinds of foreign investments to the local economy. I would suggest this is a far more promising strategy than hoping that MSCI certification will energise a financial market that is unable to attract (abundant) domestic capital.
Stephen Mezias is INSEAD Professor of Entrepreneurship and Family Enterprise, The Abu Dhabi Commercial Bank Chaired Professor in International Management, and the Academic Director, Abu Dhabi Campus.