Oliver Schutzmann examines the region’s path to developed market status amid rapid market reforms and growing investor interest in ESG
The combined market capitalization of the six Gulf Cooperation Council (GCC) countries is $4 tn. And with their earnings commanding investor attention amid a global maelstrom, companies in the Middle East are increasingly being compared with those in more developed markets. But are size and earnings of a high-enough quality to support an ambition to emerge from emerging market status?
The Gulf has been here before: as a succession of currency, energy and financial crises roiled the region in the first decade of the 21st century, a status upgrade for markets of ‘the Wild Middle East’ appeared wishful thinking. A few years later, in 2014, Qatar and the UAE ascended to emerging market status amid universal agreement. Saudi Arabia followed in 2019, and Kuwait in 2020.
Today, the prospect of reaching the next stage with a developed market classification may be more than wishful thinking. Just take a look at the evidence: among Saudi banks, Al Rajhi Bank has a larger market cap than Citigroup, the Saudi National Bank is worth more than three times as much as Barclays, and Alinma Bank is more valuable than Société Générale.
And Saudi Aramco, also listed on the Saudi exchange, is among the world’s largest companies and recently reported the biggest quarterly profit of any company. Ever.
Like so many other things in the region, the development of its companies and capital markets has happened at breakneck speed. Capital markets in the region were only formed in the 1990s. For most of the 1990s and 2000s, their light regulation in oil-dominated economies did not inspire confidence about the safety of assets and the sustainability of returns. The tendency to use PR in place of IR in messaging put many portfolio managers off, too. On the sell side, dealing with analysts was as uncommon as it was unfamiliar when companies went public.
Today, the region is unrecognizable. Market capitalization and liquidity are multiples of what they were just three years ago. And that has not happened by accident.
IR needs to be dispassionate and neutral and not try to present something in a particular light
The government imperativeGuided by plans drawn up at the turn of the millennium for a future without hydrocarbon revenue, governments in the Middle East worked hard to establish channels for the infrastructure finance they needed to accommodate their growing populations. Alongside privatization of state-held companies and increases in public borrowing, the new rules – and the stronger institutions they have created – are attracting sustainable flows of investment capital.
As a result, parts of the region have leapfrogged their developed market counterparts. Led by Saudi Aramco, a spate of IPOs and direct listings has seen capitalization of the Saudi Stock Exchange overtake that of markets in France, Germany and Switzerland, for example.
There is a growing belief that global index providers MSCI and FTSE Russell will need to start looking at the status of the region’s markets. Regulatory efforts have improved the quality of listings, which includes ensuring there is a more transparent, clear mechanism of communication and disclosure from the company to the investment community – and vice versa.
‘I think it will happen in the short term,’ says Ghida Obeid, head of IR at Saudi-listed Alhokair Fashion Retail and a former sell-side analyst, of a possible upgrade to developed market status.
As the capital markets have matured, so too has the role of IR. More than 200 IROs certified by the Middle East Investor Relations Association (MEIRA) now work in listed companies and this professionalization will have to continue if countries are to meet their long-term ambitions.
But some old habits linger. ‘Many companies pay lip service to IR because they still don’t understand the difference between IR and PR,’ says Ryan Ayache, head of IR at Banque Saudi Fransi. ‘They tend to get lumped together. Changing that will take some work. In simple terms, PR is about taking some information and packaging it with a bit of financial jargon, a sprinkle of ratios and a dash of something from the IMF. There is no real substance to this, and it doesn’t help investors or analysts understand what is happening in the company.
‘In contrast, IR needs to be dispassionate and neutral and not try to present something in a particular light. Instead, IR should be data-focused, show some real analysis of performance relative to an outlook and add substance to the relative positioning in the competitive landscape.’
Understanding disclosureIn many ways, IR in the Middle East is advancing at a much slower pace than market reforms. Even before Israel achieved developed market classification in 2008, governments from the Levant to the Gulf were creating independent companies to operate their securities markets and introducing electronic trading to facilitate liquidity. But in the few listed companies that bothered to issue regular reports for the region’s bases of largely retail shareholders, PR often masqueraded as IR.
There is still a misconception that financial communications and investor relations are partly selective disclosure. Companies struggle to understand how much to disclose and whether to omit the negative and only amplify positive news. The region’s best companies have made huge advances in disclosure in recent years but this trend has not been universal. While investor relations has grown more professional, a disconnect persists between country and exchange-level goals and investor communications.
‘There is often a gap between a country’s aspiration and what flows through to the corporate level,’ explains Colin Milton, listing specialist at the Qatar Stock Exchange, which rose in status from frontier to emerging market in 2014. ‘On inclusion, not all constituents were at the same level in terms of preparedness, and it took a few years of honest conversations with fund managers to get to the stage where both were talking the same language. I’m sure that will be the same with any proposed move to developed market status. In fact, those conversations will be even more challenging.’
Many regional companies continue to rely on traditional sources of financing after they list, a fact that also holds back efforts to improve disclosure. Paying dividends to ministries or paying down loans to banks lessens the demand for meaningful analysis of results as they relate to business strategy.
But Obeid sees reasons for optimism that positive change is coming, and coming soon. ‘When there is limited capital to deploy, and everyone is trying to get a chunk of that capital, giving corporate access to these funds and asset managers becomes an imperative,’ she says. ‘Listed companies are starting to understand this better and, as such, they are focusing more on the need to analyze their share register and the need to have a bigger portion of their share register owned by institutional investors rather than retail investors. Corporations are slowly but surely comprehending that and working toward it.’
It took a few years of honest conversations with fund managers to get to the stage where both were talking the same language
ESG factorsThe rise of ESG as an investor theme also provides a headwind: managers of foreign capital eyeing regional markets increasingly have to adhere to ESG rules when investing in listed equities, and the easy option for an ESG portfolio manager is to simply exclude a region whose economy is dominated by oil.
Once again, however, things are moving fast. Saudi Aramco set the regional bar high when it included a deep dive into ESG initiatives reaching back almost two decades in the 656-page prospectus for its 2019 IPO. It followed that with detailing Covid-19 contingencies that consumed a quarter of the debut earnings report the company issued at the start of the pandemic.
Because few companies in the region possess similar reporting capabilities, ESG is a competitor for resources as IR professionals go about the business of compiling quarterly financials and conducting earnings calls.
‘The touch point between institutional investors and ESG weighs more on IR than it did 10 years ago,’ says Milton. ‘ESG is not something the industry is blindly making up. It’s actually what institutional investors need to make their decisions. Some people still think of it as an IR-compliance matter, but I think boards and management feel more pressure around ESG because institutional investors and their trustees are under more pressure.’
Sources of flexible, non-bank financing will become thinner on the ground as governments continue to privatize assets. The shifting away from oil revenues to fund infrastructure projects looks to make governments de facto competitors for private capital investment, just as rising interest rates and growing numbers of borrowers increase the cost of bank finance. It will be incumbent on senior managers to court more reliable sources of capital to expand operations and grow their business.
Slowly but surely, companies are beginning to understand the need to be owned by institutional investors in order to have a stable shareholder base. And with that trend comes a requirement for higher standards of investor relations.
‘Rather than forcing companies to invest in IR, governments are compelling them to adhere to certain disclosure requirements, standards and timelines,’ says Ayache. ‘So a kind of standardization of expectations around financial communication is seeping into IR as opposed to what used to be mainly a PR function.’
A kind of standardization of expectations around financial communication is seeping into IR
Speed of government action is keyOn one point, however, market participants in the region agree: the speed at which regional governments can move is astonishing. Without the burden of unions, democratic representation or a welfare state, the GCC region’s rulers can take decisive action, knowing it will be carried out. Qatar hosting the World Cup, the UAE running a space program, Saudi’s stock market being home to the world’s most valuable company – all these began with decisions taken by rulers.
In just two decades, the region has gone from unclassified or frontier market status for only the bravest investors to top of mind in global emerging markets. In the early 2000s, commentators laughed at the notion of emerging market status. Twenty years later, several countries have achieved it.
Of course, there is a long way to go: current standards of IR will be a drag on the reforms the region must undertake to be considered for elevation to developed market status.
Among them are lifting limits on foreign ownership, lowering barriers to capital flows, improving the stability of market institutions and increasing the number and types of investment instruments available to investors, including securities lending and short-selling.
As regulators tick those boxes, it is incumbent on IR professionals and the senior executives they serve to ensure companies realize more value from their investment in IR. That will require an understanding of the true value of the IR function, as well as the adoption of a wider range of tools and techniques to increase the depth and frequency of analyst and investor engagement.
But the stage is set for further rapid and fundamental change. Investors are increasingly comfortable dealing with the region, and the gap between the Gulf and other emerging markets is palpably closing.
The current economic backdrop provides even more evidence of the region’s maturity, as the Gulf becomes a haven from the Covid and war-induced turmoil we see around the world. And the standards of investor relations are rising to pave the way for the next generation of companies. Developed market status a fantasy? Don’t bet on it.
Oliver Schutzmann is CEO of Iridium Advisors
