DUBAI, June 5 Investors are betting that the United Arab Emirates will finally be elevated to emerging market status in a review of MSCI indexes next week, but expect Qatar to miss out due to still stringent foreign ownership limits.
After being repeatedly overlooked by MSCI for an upgrade since 2009, UAE's efforts to improve market technology and transparency may be rewarded, analysts say. However, there is still a risk that some of the adjustments may have come too late for this year's index review on June 11.
Index compiler Morgan Stanley Capital International (MSCI) has UAE and Qatar under review for an upgrade to emerging market (EM) from frontier status, a move that could open up their bourses to millions of dollars of inflows from funds that are mandated to invest only in emerging markets.
Qatar appeared to make a last-minute push to help its chances of an upgrade on Wednesday, announcing that two of its biggest banks have asked the Qatar Exchange to increase the number of shares available to foreign investors.
Whether that will affect MSCI's decision remains to be seen.
Investors say UAE is more likely to gain emerging market status, a view which, along with improving economic fundamentals, has helped push Dubai's stock market. up 47 percent this year. That makes it the best-performing of all markets covered by MSCI, including developed markets.
"UAE does deserve to be upgraded," said Julie Dickson, head of equities at emerging market fund manager Ashmore. "It has been on the radar for a long time."
UAE missed out on an upgrade last year due to MSCI requirements related to custody, clearing and settlement.
Two of the UAE's three stock exchanges, Dubai Financial Market and the Abu Dhabi stock exchange, have since addressed the issues.
They have introduced a delivery versus payment (DvP) model and a so-called "false trading mechanism" that removes the requirement for international investors to have a cumbersome dual-account structure to limit local brokerages' access to their trading accounts.
Early last month, Abu Dhabi's exchange also put in place buyer cash compensation (BCC), an enhancement to its DvP process that allows an investor to be paid cash compensation in the event of securities being unavailable for delivery on settlement date.
If UAE is not upgraded this time, it could be because these enhancements were not made in time.
"UAE has only recently introduced BCC - our concern is that there isn't sufficient time for the market to fully test this enhancement," said Vijay Sumon, an analyst at HSBC in London. "They might have satisfied it now but the question investors may raise is: have they had sufficient time to test it?"
HSBC estimates that an upgrade would see UAE attract an additional $370 million in inflows from global funds that track the MSCI emerging market index. Qatar would draw $430 million if it is upgraded, HSBC says.
As UAE and Qatar would have a weighting of less than 1 percent combined in the MSCI emerging market index only passive funds, which try to track the benchmark returns, would re-balance their portfolios to accommodate the new entrants. The weightings would be too small to matter for most active funds, which aim to beat the benchmark performance, analysts said.
Still, even if UAE loses out again on being upgraded the rally in Dubai stocks could continue.
"Whether an upgrade for UAE or Qatar happens or not, we're here to stay," said Fadi Said, head of investments at ING Investments in Dubai. "If it happens, it will increase the amount of committed funds to the countries."
The rally is supported by a partial recovery in Dubai property prices in recent months following a 50 percent-plus slump from their 2008 peak.
Dubai also still offers attractive valuations and dividend yields and banks have reported better earnings as provisions declined.
"An MSCI upgrade will not be a game changer," said Sebastien Henin, UAE-based portfolio manager at The National Investor. "Due to the fact that we have a strong rally in the market, people are looking at other things. Volumes picked up dramatically so the likely impact will be even less."
Qatar's stock market is up about 11 percent this year but restrictions on foreign ownership remain a concern for international investors.
Foreign ownership limits (FOLs) on Doha's bourse are capped at 25 percent for most stocks. MSCI said last year that this was an issue that could disqualify the country from its review.
Some companies have increased their free float, which has helped to attract more liquidity to the market, but progress may be too slow.
"Foreign institutional investor feedback may indicate that they are still too low and may look for commitments from more Qatari companies to increase their FOLs," HSBC said in a report.
(Additional reporting by Carolyn Cohn in London; Editing by Susan Fenton)