* UAE allows short selling by market makers for now
* Traders, fund managers see wider short selling on way
* Seen boosting illiquid stocks, derivatives market
DUBAI, May 15 The United Arab Emirates (UAE) is likely to allow fully-fledged short selling of securities when it implements new trading rules in the coming months, local traders and fund managers said, in a move to encourage more money into its markets.
The UAE's market regulator, the Securities and Commodities Authority (SCA), has been liberalising securities rules since 2012, partly to secure an upgrade in its status to "emerging" from "frontier" market by equity benchmark provider MSCI, which is expected to trigger billions of dollars of foreign inflows.
But the main exchanges in Dubai and Abu Dhabi have been slow to change, in part due to concern about causing instability.
In January, the Dubai Financial Market (DFM), which takes its cue from the SCA, issued rules that permit lending and borrowing of securities. Approved agents had to be involved, it said, which seemed to stop short of allowing full short selling.
However, traders and fund managers said they did not think short selling would be limited to just the agents' own books.
"Designated market makers would enable short selling and in that respect theoretically should also be able to do so for their clients," said Amer Khan, senior executive officer at Dubai-based Shuaa Asset Management.
"It's not clear at this stage if that is so and it remains to be seen precisely how the regulation is implemented."
A trader at a Dubai-based brokerage, who could not be named under briefing rules, was more assertive: "Once they implement it and stock lending and borrowing is available then definitely you can go short selling for clients, not only for books."
The SCA had no immediate comment when approached by Reuters.
Short selling involves borrowing stocks and selling them, with the hope of buying them back at a lower price and making a profit. While blamed by critics for causing volatility, supporters see it as a vital way of increasing trading volumes, and thereby making markets more liquid and efficient.
National Bank of Abu Dhabi (NBAD), the UAE's top lender by assets and the first local bank to receive the market-making licence that allows short selling in April, is now taking steps to implement bourse regulations on short selling.
"We are in the process of putting down the mechanics how this actually happens so when we launch our market making at the end of the third quarter we can hedge our positions subject to any other regulatory approvals," Galen Moore, head of market making at NBAD, told Reuters. He declined to comment on whether the bank would also be able to short sell for clients.
So far, international banks have provided some customers with products allowing them to go short on UAE stocks, but these were not accessible to all investors, said the trader speaking on condition of anonymity. "Now, there will be more equality in the market when everyone has access to everything," he said.
Boosting liquidity would help to make investing in the UAE less risky, and could draw in money to help its oil-fuelled economy develop.
"Some stocks perhaps do not need liquidity ... but when you go down and look at how many stocks actually trade in the market, 10 stocks count for 80 percent of the volume," NBAD's Moore said.
Trading on UAE stock markets plunged along with equity prices from late 2008 as Dubai's debt crisis and a housing crash spooked both local and international investors, which caused many brokerages to close or scale back their operations.
But the markets have made a swaggering revival over the past 12 months, with Dubai's DFM stock index now trading at a near-six year high, while Abu Dhabi's ADX is at its highest level since 2006.
In Dubai, the value of traded securities jumped 429 percent to 110 billion dirhams ($30 billion) in the first quarter.
However, in Dubai and Abu Dhabi combined, 55 of the 92 listed stocks account for less than 1 percent of the traded volume. Five stocks have a market capitalisation greater than 5 billion dirhams but trade less than 1 million dirhams a day.
On NASDAQ Dubai, the only exchange in the UAE offering derivatives in addition to stocks and bonds, that trading activity has dried up in recent years as market makers were unable to hedge their exposure.
As the new trading rules are implemented over time, they have the potential to revive the stalled derivatives market, which offers index and single stock futures and options.
"By introducing the concept of short selling, institutions will now have access to additional derivative instruments that can be used for risk management purposes that were not previously available," NBAD's Moore said.
"If you are market maker on NASDAQ Dubai and you are a market maker on DFM and ADX then you can effectively hedge your derivatives positions on ADX and DFM," he said.
Shuaa Asset Management's Khan said the UAE's upgrade to emerging market status by MSCI in May, and S&P Dow Jones Indices in September, made implementing the new rules a priority to capitalise on an expected influx of foreign money.
"We wouldn't be surprised to see implementation over the coming two or three quarters," he said.
($1 = 3.673 UAE Dirhams) (Editing by Mark Potter)