We understand a capital markets system as combination of: (1) the platform for re-allocating capital from providers to users, providing a return on investment and facilitating the exchange of interests between market participants, and (2) the regulatory environment necessary to ensure the stability and efficient functioning of the platform.

From the viewpoint of governments, the establishment of objectives for a capital markets system is connected to broader macroeconomic and, in some instances, social goals. These macroeconomic goals may include specific aspirations such as to democratise the private sector economy by allowing the greater participation of the public in the country's investment opportunities (an important objective of the Saudi Government), increase the prestige of a country or city by developing a regional or international financial hub (an important objective in Dubai) or encourage sourcing alternatives for businesses requiring capital. But whatever the goals may be, all capital markets systems have in common the overarching goal of facilitating the movement of capital in order to promote its efficient application in the production of goods and services by the private or public sectors. The basic transaction behind this goal is the movement of cash from those who have a surplus of it (the investors) to those with capital requirements (the issuers of securities) in exchange for a participation in the profits and growth of the business (shares) or for a guaranteed rate of return (bonds) or, in the case of certain Islamic products, a return on income generated by a class of assets (sukuks).

The corollaries to this basic principle are that, in order to promote this basic exchange, it is necessary to ensure that those who propose to become issuers can in fact be trusted to make good use of the capital entrusted to them and that intermediaries who play a role in the movement of capital from investors to issuers do so efficiently, transparently and fairly. This is the function of capital markets regulation of primary issues, achieved through listing standards, disclosure rules, qualification and accountability requirements for intermediaries and the manner of offering principles, laws and regulation.

Beyond the initial allocation of capital, well-functioning capital markets systems promote, through the tradability of securities, the constant evaluation of a company's performance through the pricing mechanism. This is an important objective for all capital markets systems, with economic parallels to political democracy, since investors effectively vote through their investment decision on the soundness of a particular enterprise and its management. It is, in a sense, a privately led system of checks and balances on business power where capital is concentrated.

In order for the business performance evaluative objective to be realised, it is necessary that all relevant information be accessible to the economic voters and that markets have enough active participants to ensure the constant evaluation and disciplining of the management of a business. The first of these conditions, the provision of adequate information, is the function of secondary market regulation, including continual disclosure requirements imposed on issuers, while the second depends in part on the economic culture of a city or nation and its ability to either promote an active retail market or attract sufficient international investor interest in the local capital markets to ensure a liquid market with robust trading volumes, which is in turn partially a function of the confidence of investors in the capital markets system's transparency and fairness.

Middle East regulation

As would be expected, differing economic and social imperatives and states of development in the principal economies of the Middle East translate into widely disparate capital markets systems throughout the region, both in terms of the size of the markets, the composition of the investor base (retail versus institutional, foreign versus domestic) and the nature of the regulatory environment.

Saudi Arabia

The principal stock exchange of the Kingdom of Saudi Arabia is the Saudi Stock Exchange (Tadawul), with a market capitalisation of approximately $480.3 billion as of July 7 2008. The securities regulator is the Capital Markets Authority and the principal securities-related body of legislation or regulations is the Capital Markets Law. Some key capital markets transactions undertaken by Saudi Arabian issuers in the last two years include Riyad Bank's $3.5 billion offering of shares listed on the Tadawul and offered to retail and institutional investors and Al Inma Bank's $2.8 billion offering of shares listed on the Tadawul and offered to retail and institutional investors.

It is not surprising that the Kingdom of Saudi Arabia, which has by far the largest economy in the Middle East, with a gross domestic product of $376 billion, also has the largest stock exchange in the Tadawul. It has a market capitalisation of $480.3 billion, compared to only $253.5 billion of combined market capitalisation for the three exchanges in the United Arab Emirates, its closest rival in combined stock exchange market capitalisation, or $206.3 billion for the Kuwait Stock Exchange, its next rival on an exchange-to-exchange basis. The reason for the overwhelming dominance of the Tadawul is not only the size of the Saudi economy relative to its peers but also the successful initiatives of the Saudi Government to encourage the greater participation of the general population in the capital markets. According to a report by the Oxford Business Group, between 2003 and 2006 the annual number of trades on the Tadawul increased from 3.8 million to more than 96 million, while the number of listed companies increased from 69 to 85. Several market developments are responsible for this growth, including regulatory changes coinciding with political and economic events favouring such growth. The regulatory changes consist primarily of the introduction the Capital Market Law of 2003 and the creation of the Capital Market Authority in 2004, providing a sound regulatory regime with all of the principal characteristics of effective primary and secondary market regulation as outlined above, including listing standards, continual disclosure obligations and market conduct standards.

The events of September 11 2001 or, more accurately, the American reaction to September 11, resulted in the curtailment of capital expatriation by Saudi nationals, which, combined with rising oil prices, provided tremendous impetus to local investment. However, the regulatory authorities in Saudi Arabia appear to have been so focused on the laudable goal of democratising the economy that the capital market system that has developed is almost entirely a local retail market, which has resulted in greater volatility than would probably have been the case if institutional investors, including international institutional investors, had played a greater role in its development. By early 2006, average P/E ratios for Tadawul-listed stocks had reached the mid forties, compared to the average emerging market P/E ratio of 15, according to the Oxford Business Group.

In the period from February 25 to March 14, probably triggered by a series of incidents and allegations of insider trading, the Tadawul lost more than 25% of its market capitalisation value. During 2007, the Tadawul recovered moderately when several more companies came to market, including the new mobile telecom operator Zain. According to Hasan Al-Jabri of the National Commercial Bank, up to 40 Saudi companies may effect IPOs in 2008, raising up to $8 billion, compared to approximately 25 companies in 2007 raising $2 billion. However, the market continues to be overexposed to the retail segment.

The principal challenge for Saudi Arabia is to overcome overexposure to the retail investor base by encouraging the greater participation of institutional investors, who can bring discipline into the market through appropriate risk analysis and research publication and provide the longer view that the market needs. This may be achieved by changing the following aspects of the Capital Market Law: (i) eliminating the requirement that shares issued in an IPO must be issued at par value, enabling pricing through the book-building method; and (ii) allowing non-Gulf Cooperation Council (GCC) investors, and in particular non-GCC institutional investors, to participate in the primary and secondary market.

The CMA has just announced its approval for "authorised persons" to enter into swap agreements with non-resident institutional and individual investors in order to enable these to have indirect participation in the economic substance of an investment in Saudi stocks (under the new rule, legal ownership and voting rights remain with Saudi entities). This new rule may partially redress the market's overexposure to retail Saudi investors but, more importantly, it may signal a change of policy towards a gradual relaxation of the foreign ownership restrictions. The change would indeed make sense: the Saudi government has certainly succeeded in achieving its goal of democratising listed equity among the Saudi people and could now take advantage of the liquidity in its market to develop its stock exchange into a regional, and maybe international, powerhouse.

United Arab Emirates

The United Arab Emirates (UAE) has three principal stock exchanges: the Abu Dhabi Securities Exchange (ADX), the Dubai Financial Market (DFM) and the Dubai International Financial Exchange (DIFX). The three have a combined market capitalisation of approximately $253.4 billion as of July 7 2008, based on Zawya.com. The securities regulator for the ADX and the DFM is the Securities and Commodities Authority (SCA), and the principal securities-related body of legislation or regulations is the Emirates Securities and Commodities Authority and Market Law and regulations promulgated pursuant to it by the SCA and the UAE Council of Ministers. In addition, the UAE Central Bank has promulgated a number of regulations in respect of the UAE capital markets, as it regulated these markets before the establishment of the SCA.

The securities regulator for the DIFX, which operates in the semi-autonomous free zone jurisdiction of the Dubai International Financial Centre (DIFC), is the Dubai Financial Services Authority (DFSA) and the principal securities-related body of legislation or regulations are the DIFC Markets Law, the DFSA Offered Securities Rules and the DIFX Listing Rules. Some key capital markets transactions undertaken by issuers in the last two years on DIFX include DP World's $4.96 billion offering of shares listed on the DIFX and offered to retail and institutional investors, Depa's $432 million offering of shares listed on the DIFX and offered to retail and institutional investors and Damas' $270.6 million offering of shares listed on the DIFX and offered to retail and institutional investors.

Since its launch in 2005, the growth of the DIFX has been restricted by legislation preventing UAE retail investors from investing in DIFX-listed securities and UAE-incorporated entities from issuing securities on that exchange without having effected prior offerings on the ADX or the DFM. Recent legislative amendments have resolved both issues. Depa and Damas were the first companies to be established as special purpose vehicles to hold the assets of UAE companies and to avail themselves of such legislative changes. Both companies listed their shares on the DIFX without their UAE subsidiaries having first listed their securities on the ADX or the DFM. It is expected that the DIFX will prove an attractive alternative market to UAE issuers, albeit through the establishment of a holding structure. In addition, UAE retail investors are now able to invest in DIFX-listed securities through UAE brokers, providing an investment alternative to the ADX and DFM-listed securities and an opportunity to invest in securities of issuers from beyond the GCC.

The main challenge of the capital markets in the UAE is their fragmentation, which prevents the development, principally, of the DIFX. While the ADX and the DFM are both securities markets suited to their purpose of serving the retail investor segment of the market, the DIFX is struggling to become the regional securities powerhouse that it aspires to become, at least as far as equities are concerned. This is a problem that is difficult to resolve through regulatory intervention, for its roots lie in the spirit of competition for regional financial supremacy prevalent in the GCC, with both Qatar and, to a less successful extent, Bahrain still vying to promote their exchanges as the international markets for the region.

At the very least, the consolidation of the DFM and the DIFX, not just as two markets held under the umbrella of Bourse Dubai but operating as a single exchange (albeit with differing listing standards) is the step needed to provide the DIFX with the impulse it needs. Moreover, quirks in the regulatory process for listing a company on the DIFX should be clarified. Under the existing framework, for example, while it is technically possible under the DIFC Offered Securities Rules and the DIFX Listing Rules to achieve a listing through an exempt offer statement if the initial placement of securities is only to institutional investors, in practice the DIFX requires a full prospectus compliant with the otherwise inapplicable disclosure requirements of the Listing Rules.

Egypt

In Egypt, the securities regulator is the Capital Markets Authority (CMA) and the principal securities-related body of legislation or regulations is the Capital Markets Law (CML). Some key capital markets transactions undertaken by Egyptian issuers in the last three years include Telecom Egypt's $891 million offering of shares listed on the Cairo and Alexandria Stock Exchange and offered to retail and institutional investors and Talaat Mostafa Group's $800 million offering of shares listed on the Cairo and Alexandria Stock Exchange and offered to retail and institutional investors.

The regulatory framework of the Egyptian capital markets is one of the most advanced in the Middle East. The Egyptian CMA was established in 1979 under Presidential Decree 520 and is responsible for regulating the securities market, issuing licences for financial intermediary businesses (including brokerage, venture capital, mutual fund and securities portfolio management). The CML comprehensively covers areas such as disclosure requirements for primary issues and continual disclosure requirements for listed companies, market conduct standards for market participants and clear guidelines for conducting exempt offerings. The privatisation programme of the nineties provided the CMA with the opportunity to test the CML and obtain the requisite experience in its interpretation.

Kuwait

The principal stock exchange of the State of Kuwait is the Kuwait Stock Exchange, with a market capitalisation of approximately $206.3 billion as of July 7 2008. The securities regulator is the Ministry of Commerce and Industry. Some key capital markets transactions undertaken by Kuwaiti issuers in the last two years include the National Bank of Kuwait's $1.5 billion offering of shares listed on the Kuwait Stock Exchange and offered to retail and institutional investors and Noortel's $203.6 million offering of shares listed on the Kuwait Stock Exchange and offered to retail and institutional investors.

The most notable feature of the Kuwaiti capital markets regulatory framework is the absence of one. This is surprising for a country boasting a stock exchange that is second in market capitalisation only to Saudi Arabia's Tadawul. The Kuwait Stock Exchange is a self-regulating entity, while regulatory oversight of both primary and secondary market activity is the responsibility of the Kuwaiti Ministry of Commerce and Industry. While the creation of a Capital Market Authority was greenlighted by the Kuwaiti Parliament in May 2006, the relevant capital markets laws creating it and providing it with a regulatory remit have yet to be introduced.

Morocco

The principal stock exchange of the Kingdom of Morocco is the Casablanca Stock Exchange, with a market capitalisation of approximately $89.7 billion as of July 7 2008, based on Zawya.com. The securities regulator is the Conseil Déontologique des Valeurs Mobilières and the principal securities-related body of legislation or regulations is the Stock Exchange Law. Some key capital markets transactions undertaken by Moroccan issuers in the last two years include Itissalat Al Maghrib's $560.3 million offering of shares listed on the Casablanca Stock Exchange and offered to retail and institutional investors and Compagnie Generale Immobiliere's $432.4 million offering of shares listed on the Casablanca Stock Exchange and offered to retail and institutional investors.

Region-wide challenges

On a regional basis, the principal shortcoming of the capital markets is the lack of harmonisation between the different regulatory systems. This is largely the result of significant variation in the levels of economic development, political systems and social and economic objectives of the countries of the Middle East. While it is not likely that a harmonisation project involving the entire region will develop, it may not be too much to hope for harmonisation at least between the countries of the GCC, which includes four of the five largest economies of the Middle East. The immediate work for any harmonisation project, if it is to be effective, must involve the adoption of similar disclosure requirements across the region with the ultimate objective of creating a passporting system throughout the GCC similar to that created by the EU Prospectus Directive and the adoption of clear categories of exempt offerings premised on the level of sophistication and economic power of the investor, the number of offerees and the manner of conducting offering activities. It is not possible, for example, for legal advisers to provide underwriters and issuers of securities with clear guidelines as to how they may conduct exempt offering activities in the various countries of the GCC, with the exception of Saudi Arabia and the DIFC, which have clear exemptions from registration.

Regulatory fragmentation and the uneven quality of regulation in the GCC is therefore a real hindrance to capital flows through the capital markets in the region. The removal of these uncertainties is an imperative for the efficient allocation of capital in the region. Just as in the economic sphere cooperation is necessary if the GCC is to have a viable international stock exchange, on the regulatory side the creation of an organisation of the securities regulators of the GCC, similar to the International Organisation of Securities Commissions and possibly in affiliation with it, is a necessity for the achievement of a regionally integrated system of capital markets that will promote the objective of the efficient, transparent and fair re-allocation of capital, as well as the disciplining of business power through the share pricing mechanism of the secondary market.

Author biographies

Federico Salinas Dewey & LeBoeuf Federico Salinas is a UK and US-qualified partner at Dewey & LeBoeuf's Dubai office. He regularly represents issuers and underwriters in debt and equity capital markets transactions, as well as targets and acquirers in M&A, principally in the emerging markets. His most recent completed transaction was the DIFX-listed $300 million initial public offering of Damas International Limited, the Middle East's leading retail jewellery chain. Salinas has extensive experience in listings on many of the world's leading stock exchanges, including the NYSE, Nasdaq, London Stock Exchange, Euronext and the DIFX. Before his relocation to Dubai in January 2008 to open Dewey & LeBoeuf's office there, he was based in London, where he was involved in Middle East and CIS debt and equity capital markets transactions. Before that, he was based in New York for several years, where the focus of his practice was debt and equity capital markets transactions involving primarily Latin American issuers. He has authored many articles relating to capital markets in the emerging markets.