Tuesday, August 17, 2010

Even if the volume goes to zero we can still hang out here right? I mean, we don't want to let these awesome leather couches go empty...

There have been some articles recently about the plight of brokers in both Dubai and Abu Dhabi. Initially these were reports of how volumes were tapering off as we move into Ramadan. While business networking takes off during the Iftar hopping season (I wish there was an analog to this in the West) trading on the regions exchanges tends to slack off. This volume decline and the economic effect it is having on the brokerage industry in the Emirates has attracted the attention of both Bloomberg and The National as well it should because it says something about Ramadan, more about the brokerage industry in Dubai and a great deal about what the function of equity markets in the region is and what it could be.

There are any number of reasons why people would want to scale back their trading during Ramadan. Perhaps in the same way that you shouldn’t go grocery shopping while you’re hungry maybe you shouldn’t go stock shopping while you are denying yourself basic sustenance. Maybe that dry feeling you get in your mouth when you’re betting the ranch on Saudi Livestock is particularly arid when you can’t drink anything till sundown. Or maybe people feel closer to Islam generally and so are less comfortable making or taking non-Sharia compliant margin loans. Perhaps the speculative nature of trading GCC shares seems a little too close to gambling for people to be comfortable during Ramadan. Perhaps the generally higher level of sobriety keeps people away from buying shares. Or maybe this year as Ramadan falls in August everyone is simply in Marbella or the Cote ‘d Azure or Geneva so no one is around. It’s been interesting to watch the number of people logging onto my blog from the marina in Monaco spike. Whatever the reason, volumes are seasonally light.

The articles in the press don’t stop there. Volumes in the Emirates have fallen off a cliff putting an extremely serious squeeze on the brokers forcing a great many of them to close their doors. Personally I have mixed emotions about this. I think I met with 80%-90% of the brokerages in existence between 2005 and 2008. The market structure was extremely fragmented, there were something like 95 brokers registered on the DFM and the largest one had a market share of under 15% the top ten were less than 30%. As a person trying to sell connectivity to the DIFX in November of 2005 this was deeply tragic because it meant I literally had to meet with everyone.

Things got better once my firm established our own market access business which we used to connect international investors to local markets channeling billions of dollars from abroad into local markets (this ended in tears I'm afraid.) At our peak we were trading between 10-15% of the daily volume in Dubai, Abu Dhabi, Qatar and Bahrain. It sounds crazy I know, but we were. International investors could not get enough of the place once upon a time. Naturally we became an extremely large brokerage client and that made the meetings a lot easier. They got easier still in the run up to the DPW IPO. It’s always easy to have a meeting with someone when you’re paying 10% of the brokerage in the entire market and you are handing out IPO candy.

So in this way I became acquainted with the entire brokerage industry in Dubai and Abu Dhabi and let me tell you there was quite a variety. There were several which operate efficiently with a wide range of services and had moved from being mere brokerages to full service local investment banks. There were some firms which focused on electronic execution of their client orders some of which had developed surprisingly sophisticated technology in house and which we viewed as potential partners. There were of course the brokerage arms of the large banks which thanks to their huge distribution networks were printing money. We had such confidence in these firms that we were able to put them together into a retail syndicate for the DPW IPO which in all operational respects was handled as if it were a major market IPO. Though these firms were pleasant to work with they were not the most interesting stars in the UAE brokerage constellation. Those were the bucket shops.

One of the trading classics is a book called “Reminiscences of a Stock Operator” a thinly disguised autobiography of Jesse Livermore. He began his career in bucket shops. Bucket shops purported to be brokerages but never actually executed client orders on the exchanges. Rather they operated as casinos where the “house” took the other side of every trade and the margin rules were such that the clients were systematically wiped out. Despite or perhaps because of this the bucket shops became a place where local men would come to socialize and talk about stocks cheer each other on and share their sorrows. Like a casino it was as much a social activity as an economic one. Eventually in the US the authorities caught on that these were merely casinos operating incognito and shut them down. Not so in Dubai. In Dubai they multiplied like rabbits.

I must have visited several dozen during my time there. Occasionally they would be in office parks but my favourites were the ones in out of the way places: above an auto-repair shop, in the back room of an auto-dealership, behind a narrow door in a rabbit warren of alleyways in Bur Dubai or Deira. The kinds of places that when you ask the cab driver for them you get that Pakistani look of bewilderment, followed by desperation, followed by resignation that these foreign idiots have asked for yet another non-existent address and are going to go ballistic when the meter runs out of digits because it cannot be found. When you finally did find the place it was always the same thing.

There would be an extremely affable GM who would be calling you “habibi” before even shaking your hand. He would talk about the massive expansion he was planning, about how his firm would be the next EFG, Rasmala, you name it. These people drank the Dubai cool-ade by the gallon. Dubai would be the next Singapore and after that New York and it would be done by firms like his led by men like him. He’d introduce you to a few clients all of whom he assured you may not look like much but this was because they were overly modest in keeping with the tenets of Islam. This one here owns 3% of Emaar, that man in the shabby dishdash negotiating with the teaboy routinely flips millions of shares of Arabtec. Unbable to contain himself he’d insist on giving you the grand tour and show you what luxury you yourself might be able to trade in if you became a customer.

There would be at least one, often several strikingly beautiful receptionists, Arab girls from Morocco or Lebanon. I remember thinking that the Niqab made some sense because if Arab women were all like this it would be understandable that Arab men would be perpetually at war with each other over them. You would then go into the main room which would have plush carpeting and huge comfy leather sofas, a lot of fancy trading screens and TVs tuned to CNBC Arabia or Bloomberg TV. There would be tea boys and waiters aplenty to bring you some coffee or a snack to maintain that trading stamina. Some were built like nightclubs with an exclusive VIP area for the “whales” with even comfier sofas, more tea boys and gaudier decoration. There was even one, now defunct, that had a shark tank in the middle. “Our clients are the sharks of the market.” Said the GM. That may be, but they were sheep for the shearing for the brokerage.

These weren’t bucket shops in the traditional sense where house bet against the customers and rigged the leverage to blow them out. They did however achieve largely the same effect with high fees and by using the rumour mill to generate high trading volumes. My first boss on the Merc floor had a saying which seemed to me pretty useless at the time: “Bulls and bears make money, sheep get sheared, and pigs get slaughtered.” If the customers were the sheep the brokers themselves were the pigs. They ground up the clients and now the clients are gone and with them the volumes. But this is a tiny part of the story. The bankruptcies of the bucket shops and the demise of their denizens are merely a symptom of the deeper illness that afflicts the equity markets in the GCC. The real problem is not that a few impresarios have perverted the capital markets in order to separate a lot of fools from their money. The problem is that economically that is the only function they perform.

As I have written before the IPO market is a rigged game designed to spread the wealth of the business owning class to the masses. As a result all the IPOs are systematically underpriced and thus no rational business person would voluntarily sell equity in a profitable business via that method. This reinforces a cultural aversion to surrendering control or giving up equity, particularly among the merchant families. As a result the public equity markets in the UAE do not perform the important capital raising function that they perform elsewhere with massively negative consequences for the economy of the Gulf as a whole. It is impossible to exaggerate the degree to which this weakens the economy of the gulf because it forces all the merchant families to fund themselves with debt or with retained earnings. To some extent this is offset with government largesse but that creates a dependence of the merchant families on the ruling family. This suits the ruling family just fine but helps explain why there are so few globally competitive firms which originate in the Arab world.

Even once corporations are public GCC equity markets don’t provide a decent valuation function. There is no operational capacity to borrow or lend shares so it is impossible to short them. What you get as a result are a string of euphoric manias followed by buyers strikes which lead to collapse. This is why you can have things like Aabar and Kingdom trade so far away from the value of the underlying assets they own. They don’t function as a market for control either. Especially where the state takes a view as to what the outcome should be. Think of the decision of Sheikh Mohammed to form a national champion with the forced merger of National Bank of Dubai and Emirates Bank. The merger was announced before the terms were decided. The shareholders? No say. The original Arabtec merger? Abu Dhabi decides it wants something, it gets it. The shareholders? No say. The Aabar delisting? IPIC and then ESCA make arbitrary decisions, the shareholders? No say. Want to try to take out a local company as an international player? Forget it.

So the macro bulls and the bears are kept out of the equity markets in the GCC. This leaves pigs and sheep for the sharing and the slaughter. And maybe, before long, not even them.


Laocowboy2 said...

There is a (duration limited) Western equivalent to the Iftar hopping season. And it happens at about the same time in the evening in Washington DC. Think about the cocktail party circuit at the IMF-World Bank meetings. Only three/four days or so but i remember averaging at least four parties a night in my banking days.

Ken said...

Yes, I've written on that. It's similar but I found the pace much more rushed, I'd liken it to speed dating rather than Iftar/Sohour hopping. I've written about it in a previous post: http://www.wallstwtf.com/2010/01/david-jackson-casualty-of-hubris-though.html

Farmer Joe said...

great read!
cool-ade = kool-aid

This leaves pigs and sheep for the sharing and the slaughter.
sheep/shearing & pigs/slaughter

sheep sharing is for generous welsh and kiwis!!

Ken said...

Farmer Joe, you're right but you're killing me. Looks like I need to hire an editor. -KM