The Emirates Securities and Commodities Authority (Esca) has warned UAE companies not to present unfair valuation of their shares, or else they will face legal action.
Esca CEO Abdullah Al Turaifi told Emirates Business that the authority is drawing up standard regulations controlling the valuation of shares and companies in co-operation with experts.
Al Turaifi said the regulations will be issued during this year. He said large discrepancies and conflicting figures in share price valuations by international and local establishments are a source of concern and discontent for investors and brokers.
“Once Esca proves a link between a company’s share valuation and its own special interests, we will take legal measures against violators,” warned Al Turaifi.
He said the authority will check the valuations and if any of them affected the movement of shares and harmed investors in the stockmarket Esca will take necessary measures.
Fair valuation is important for the formation of a stocks portfolio by investors in their selection of prominent or low-priced shares.
Over the past six months, the UAE and some other Gulf markets have seen a wave of valuations made by international, Arab and local investment banks and companies.
However, price levels of one establishment and another were sometimes highly conflicting and neither would disclose the scientific and practical basis adopted in the pricing confusing investors.
Some brokers have called for a halt to all valuation processes pending the issue of regulations by Esca. They have also demanded active intervention by Esca to stop the publishing of any report without its prior approval.
Q&A: An expert’s view
The head of research at an investment bank, who wished to remain anonymous, said the separation between buy-side and sell-side analysis has always been a strictly adhered practice, and explained how the lack of a ‘Chinese wall’ can lead to conflict.
What is the objective of a Chinese wall?
First of all, the sell-side don’t know what the buy-side’s positions are or what their forthcoming trades are. We don’t know what they are about to buy. Secondly, buy-side research doesn’t know what we are about to publish. There is a clear separation there, and we treat the buy-side team as a client. If we provide them with a service, we expect to be remunerated.
How do you ensure that the wall is not penetrated?
As sell-side research analysts, we sit in separate, distinct spaces that are not adjoining. There is access control, and we don’t have the freedom of movement for us to go to them or for them to come to us.
How can conflict arise?
If a firm is small, it becomes difficult to separate buy-side research and sell-side research. Many firms in the region, in my experience, double up the two.
The same people who write the research and advise the brokerage clients are the ones who basically decide what goes into the fund. You don’t want your sell-side analysts to write research, or who are about to write research, to then direct their fund to invest before the research comes out. Obviously, if you are a company that runs a fund and also has a brokerage, and doesn’t have the resources to run two separate research units, then there will be the temptation to make them one and the same as it costs money to run research departments. But the relationship between brokerage and buy-side has to be very strict.
Why do we need separation?
You need to have a separation between buy-side and sell-side research because they have two different masters. The master of sell-side is the client, the retail investor, the institutional investor and the brokerage arm of the company.
The master of the buy-side analyst is the fund manager who serves investors that want to achieve the best performance. Because they serve two different masters, they have to be separate.
So without separation, is conflict inevitable?
If you have the same team doing the buy and sell side the analyst has to have a Chinese wall down his head. If he believes something is a buy, he has a choice. He can issue a note and the brokerage clients get a fair deal.
By doing this, he ends up providing a brokerage service to the fund manager. The second choice is that he tells his fund manager to buy a certain stock and the fund manager buys it, and then the analyst writes a note, which front-runs the brokerage client.It is a very difficult thing to split the same team, so the research analysts have to be very distinct and separate. (Mohammed Aly Sergie)
Wadah Al Taha
Head of Research Emaar Financial Services
The brokerage licence in the UAE is very limited. Normally the motivation behind establishing a research department is to provide satisfactory information without reaching a recommendation.
The purpose of research is to give investors some guidance rather than to tell them to buy or sell and we do not issue reports offering fair values for stocks.
The licences issued by the Securities and Commodities Authority (SCA) only allows brokerages to buy and sell local shares. From a purely legal point of view the licence does not permit the setting up of research departments. The activities of research departments are not easily identified. Each brokerage has its own definition for the mandate of its research team.
Providing information on the fair market value of stocks is, in my opinion, most confusing. Many brokerage firms are flooding the market with data, while the duration between these reports is becoming shorter and shorter. Recently, one broker issued two different valuations for the same stock in a matter of days, which only leads to more confusion.
What would help to solve this problem would be proper definitions and a detailed manual, like what has been introduced in Saudi Arabia. The kingdom has five different activities that brokerages can apply for a licence to perform – trading, consultancy, research, management and mediation. The Securities and Commodities Authority has formulated draft regulations that are largely the same as the Saudi ones, but there are currently many grey areas.
For example, there are four different methods of calculating a stock’s fair value and so by changing the method you are changing the end result – the assumptions in each model are different. These range from the way to calculate cash flow to variations in interest rate risk, so these questions must be answered to form a clear set of guidelines for brokerages to follow and therefore avoid misinterpretation.
Some research firms are switching from one method to another when evaluating a stock, which only adds to the confusion. They compile a 30-page research report on a particular company, but the only part an investor reads is the line stating its fair value. A research department should work independently. This is especially important at brokers that also run funds, because there is a clear conflict of interest if it issues recommendations on stocks that could be in its portfolio.
It is unethical and even illegal for brokers to attract investors in a subjective manner by selecting certain methods to analyse a company. Research reports can impact the market, especially those issued by the big foreign institutions. Brokerages must specify the assumptions and models used in their forecasts – the credibility of the institution depends on it. (Matt Smith)
Mohammed Ali Yasin
Managing Director Emirates Securities
There is a problem in the timing of the announcement of share prices. And undoubtedly the timing needs some organisation and checking.
I ask the Securities and Commodities Authority to organise the timing of the announcement of or issue of the fair price of the share.
It can be for instance one week or 15 days after the announcement of company profits.
The authority should have a control role and should have financial analysts to review the detailed reports on which the evaluation is based so that there would be no violations. Also it has to see to it that all reports are published.
There are reports issued by financial services or other companies, and they all do not agree to one price for the share.
Share prices are controlled by supply and demand, and the most important thing is the authority should maintain behind the scenes control in companies to ensure that reports issued by research sections do not benefit other sections of the company in the first place.
I stress the importance of analyses issued by financial service companies or investment bank companies. Such analyses indicate the development of financial markets in the country since they give the investor the option to choose according to a scientific analysis rather than a blind selection.
Also it is these analyses that make the companies different from brokerage ones, and those who do the analyses are analysts with scientific qualification and big experiences.
The problems lies not in the financial analysis process but with the investor, who is too slack to read all analyses and who does not look at the other details that set the fair prices of shares and their timings and whether the analyses were built on a scientific basis or not, and how to compare this company with that company, or whether there are investors who rely in their decisions on the media which highlights certain figures.
Most small investors, especially the smart speculators, try to exploit any new figures and data to score quick profits, and this is a big problem.
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