Amid the dramatic changes in the post-financial crisis world, there are high expectations of essential changes in the stock market industry around the world and this will have strong impact on local markets, according to a research study on the outlook of UAE stock markets.
The main impact is predicted to be the need to consolidate and merge between Dubai Financial Market (DFM) and Abu Dhabi Securities Exchange (ADX) to create a stronger entity in the country, according to Wafa Sherif, a UAE-based researcher in stock markets.
The study is part of a PhD thesis on the impact of the financial crisis on stock markets and the outlook of global markets, taking UAE stock markets as an example of the new trend. "Global financial markets are growing and innovating rapidly.
"Physical trading floors have been replaced by electronic trading systems and the internet is playing a crucial role in the globalisation of markets. There is an increasing trend worldwide towards mergers of exchanges in order to mobilise resources and efforts to follow such rapid changes, as the forces of globalisation is making change inevitable and the status-quo is not an option. Thus, if exchanges are to survive, merger is the only way," Sherif told Emirates Business.
"The advance in information, institutionalisation, and the growing competition in the rise of alternative trading systems has put more increasing emphasis on the need for stock exchanges to be more cost efficient, transparent and more widely accountable.
"Accordingly, traders and investment firms no longer confine themselves to their domestic markets or their immediate homeland, but can reach out to pools of liquidity in other countries and route their orders whenever they choose seeking the best price for securities across a number of different exchanges," she added.
Wafa said in order to survive in this highly competitive environment, stock exchanges need to concentrate on a number of critical success factors as there are high expectations that a lot of markets will not survive and only few exchanges will survive in the long run.
Recently, the DFM acquired Nasdaq Dubai in a move to consolidate and integrate the two markets in one platform and the process is witnessing continuous progress to achieve full integration of the two markets by the third quarter this year. This trend came with expectations of the study that exchanges should merge and consolidate to create stronger and more cost efficient ones.
Strategy needed
"UAE stock exchanges need to have a strategy to compete in this global marketplace, and should prepare for these changes and the expected coming developments, which will be driven by mega stock markets, that accelerate the rate of developments in industry architecture," she said.
"The DFM and ADX as separate exchanges in the UAE have no choice but to prepare for the changes taking place in the securities industry, which its cumulative effects pose fundamental challenges and threats to continuance as separate exchanges. Hence, merger is the necessary step in order to survive and compete in the globalisation area."
According to the study, such proposed merger will lead to create a unified stock exchange in UAE that would help build strong credibility in world-class financial markets. It will create added value for merged markets, together with the economy. Merger will also clearly place the new entity in a better position to forge ties with other international entities, explore new markets, and attract international investors and strategic partners.
"Therefore, given the competitive forces that play on the international stock markets, I believe the merger between DFM and ADX is entirely justified and potentially advantageous," Wafa said.
She said it is just a matter of time before decision makers in the country would decide on a merger plan.
"The logic supporting this initiative is compelling as the businesses uniquely complement each other. This merger is a sensible business decision since there is no need for two exchanges in UAE.
"Combination of ADX and DFM will create a leading, diversified, and integrated stock exchange that is able to punch above its weight in the global capital markets. Such merger no doubts will be a great opportunity to enhance UAE capital market, and will have significant benefits for both sets of shareholders and all market participants.
"Accordingly, merger is able to improve performance, and help UAE to get a significant rank among the stock markets regionally as well as internationally."
Proposed merger
The study highlighted benefits of the proposed merger as consolidating operations of the ADX and DFM will be an opportunity to create one strong and functioning stock market that could promote long-run economic growth for UAE more than two separate small exchanges can do.
"Competition among exchanges is heating up on a global scale, as its scope has broadened from the domestic to the international level. This growing competition has led to the wave of consolidation through mergers and alliances.
"The competition is considering as an incentive to reform. In our case, DFM and ADX instead of compete with each others, they better go for merge and consolidation.
"Become partners instead of competitors, will consequently, gain increasing in trading value and of course cut the way of destabilising and fragmenting effect of the recent competition," it said. It added that small exchanges do not attract portfolio investors' attention so consolidating DFM and ADX in one strong and big exchange will expect to create set of diversified benefits for investors, which include a decline in trading cost, narrow spread of stock prices as a result of increasing in liquidity, and a wider choice of products.
That will result in growing in domestic investors as well as attracting more potential investors, especially foreign investors and international portfolios.
Another benefit of the proposed merger will be increasing the number of listed securities. Issuers are likely to consider the listing requirements and reputation of the stock market before chose it for listing, as well as the sophistication of investors who trade on these exchange.
A merger between two exchanges is likely to result in a higher listing standard for the combined exchange than for the pre-merger.
Shareholders of DFM and ADX will get benefits from the proposed merger. These benefits include participation in a larger entity, financially and operationally, invest in a bigger entity and access to synergies and strong premium to share price performance and increased dividend payout ratio.
Benefits for market participants from the proposed merger are expected to include one front-line market supervisor, an improved environment for trading, one trading system, and one clearing and settlement system. Integration will improve the standards and services provided for brokerage firms.
Risk factors
However, the study does not offer a rosy outlook of the merger as it highlighted several risks that may arise in the merger.
"As many of the world's stock exchanges are frantically engaging in mergers and alliances in an attempt to gain competitive advantage, also the risk issues behind the merger should be considered in the first place.
"The proposed merger involve a number of risks and uncertainties, that factors need to be resolved, before this merger become a realistic and viable option, to reduce the risk of failure of the merger," Wafa said.
The main risk is creating combined strategies and objectives of both the DFM and ADX before the merger to guarantee that the merger provides mutual benefits to both of them.
Also, differences in market internal regulations and rules may take long time of discussions on how to unify them or which one to be chose. The possibility of not realising the expected efficiencies from the proposed merger in the short term.
The risk that the integration of DFM and ADX may be more challenging than expected. And therefore the synergies expected from the merger cannot be realised in full or within the timeframe.
This shows that there are differences in many terms between DFM and ADX which need to be addressed to have successful integration. But comparing with the common terms, is not a big deal and can be easily managed, which make such merge a great strategic fit.
Stating such an ambitious goal is farfetched if it does not get the government support, but with this support it would be much feasible and viable to have in place.