All That Glisters...

The Economist writes:

A lot of cities harbour the desire to become a financial centre. Nowhere, however, has been as bold as Dubai

THE sprawling gold souk in the old quarter of Deira is testament to Dubai's history as a staging post along ancient Middle Eastern trade routes. But today the stalls selling glittering bangles attract more tourists than traders. The serious money is pouring into the other, newer Dubai emerging from a forest of construction cranes in the desert a few miles to the south. There, amid some of the world's most luxurious hotels, apartments and shopping malls, the emirate's most audacious gamble is taking shape.

The Dubai International Financial Centre is a small city-within-a-city, clustered around a striking building known as “the Gate”. It is an attempt by the ruling al-Maktoum family and a close-knit web of their business partners to build a global centre for financial services. “Our goal is to put Dubai's clock up on the walls of the world's financial institutions, in a slot between Hong Kong, Singapore and London,” says Nasser Alshaali, a senior official with the centre's new financial exchange.

As capital is becoming more mobile, an unprecedented opportunity exists for cities to join the competition for international financial business. São Paulo, Shanghai, Kuala Lumpur, Johannesburg and Istanbul are all aspiring to become regional financial centres. To succeed, they must meet the needs of international bankers and financiers: transport links, sound regulatory and legal systems, technological sophistication, a good quality of life for expatriate bankers and liquid capital markets (often sustained by an emerging middle class).

Hong Kong and Singapore can already tick all of these boxes. Dubai means to do the same. But the emirate is in a hurry. Instead of building itself up bit by bit and slowly gaining the confidence of financiers—as London and New York did over decades—it is trying to buy its place at the table. Fifteen months after it opened and despite billions of dollars of investments, the results have been mixed and there is scepticism at just how successful it can be. But these are early days.

Dubai starts with considerable advantages. It sits in a region awash with money—thanks largely to surging oil revenues. Financiers reckon that up to $2 trillion in investments come from the Gulf region, the bulk of which is parked abroad, often as American treasury bills and in places like Switzerland and London. But increasingly, money is staying closer to home. According to a report by Capgemini and Merrill Lynch, the number of people in the Middle East with more than $1m in financial assets rose by nearly 10%, to 300,000, last year. The number of very rich is expected to jump to 1.8m by 2010. Governments in the region are also spending billions of dollars on infrastructure, and national investment agencies are on the prowl for things to put their cash into.

No wonder global financial firms are increasing the breadth and depth of their operations in the Middle East. A handful of big banks has been in the region for decades. HSBC, for instance, has operated in Dubai for 60 years. But in the past they were restricted to areas such as commercial banking. As rules have been loosened, more investment banks, insurers, fund managers, private-equity firms and even a few hedge funds have arrived.

Dubai wants them all. It is chasing business not only from the Middle East, but also from countries farther east, such as India. The financial centre is trying to attract corporate and investment banking, private banking, capital markets, asset management, fund administration, reinsurance, Islamic finance and back-office operations. Accordingly, the Dubai financial centre has been granted its own commercial laws, regulators and courts. It is an oasis within the more traditional bureaucratic and legal systems in force elsewhere in Dubai—not to mention the region as a whole.

The rulers' backing
The city is also setting up new markets. Although the Dubai International Financial Exchange is only 15 months old, Dubai will soon open a commodities exchange as well. This will work in partnership with the New York Mercantile Exchange, offering as its main product a new oil-futures contact based on Omani crude, which officials hope will become a new world benchmark. In a sign of Dubai's growing influence, the government of neighbouring Oman recently took a 30% stake in the commodities exchange.

Behind much of this lies a second advantage: the firm hand and deep pockets of Dubai's ruling family. Companies are lured to Dubai by incentives that, so far, are unmatched in the region.

“They have taken some of the best from Bermuda and Switzerland and are combining those concepts,” says Michael Klein, a senior executive with Citigroup. The deals on offer include zero tax on income and profits, 100% foreign ownership, no restrictions on foreign exchange or repatriation of profits, and relatively transparent light-touch regulation (with laws borrowed heavily from Britain and Australia). Even the regulators have been imported.

Thanks to these incentives, coupled with tireless marketing and Dubai's reputation as a relatively comfortable place to live and work, a trickle of interest has turned into a small stampede. The centre aims to become home to 250 international financial firms by 2009; so far, several dozen have set up shop. Two giants, Deutsche Bank and Credit Suisse, arrived early. Since then a gaggle of well-known firms, such as Goldman Sachs and Lehman Brothers, have moved in or plan to do so.

Morgan Stanley, which opened an office last spring, is the sort of firm that local officials love.

“Dubai has done it right,” says George Makhoul, a Lebanese-born manager who runs the investment bank's operations in the Middle East and North Africa. “They built it and then said come get it.” The firm more than doubled its regional revenues in its first six months, he says. Although its usual practice is to enter a new market one step at a time, starting with investment banking, Morgan Stanley offered its full array of wholesale financial services in Dubai from the outset. “You can't get in just by getting your toes wet,” adds Mr Makhoul. Given the demand, “our strategy was probably justified in the first week.”

Dubai's third advantage is a history of pulling off grand schemes. Blessed with fewer oil or gas deposits than its neighbours, the emirate has long sought other ways to make a living and has thrived as a trading entrepot living off its wits. “When I look at Dubai, I think of Amsterdam in the 16th century,” says Saskia Sassen, a sociologist at the University of Chicago, who studies global cities. “Dubai is not a six-month miracle.”

Dubai's big successes include the Jebel Ali container port; a world-class airport; a leading airline in Emirates; duty-free stores that would exhaust the most indefatigable shopper; the world's first seven-star hotel; luxury beach resorts; regional centres for media and health care; as well as more unusual projects, including man-made islands in fantastic shapes. The world's tallest building, the Burj Dubai, is also under construction. All this helps to attract celebrities, from Saudi princes to Russian plutocrats and professional footballers, who often buy homes. Although some find it all a bit tacky, Dubai has shown imagination, a knack for getting things done, and an ability to harness capital and use top international talent.

Not everyone is convinced that Dubai's financial designs will be so profitable.

“People are committing too many resources to the region,” says a private-equity manager associated with one of the Gulf's big investment firms. “If the whole world is coming to Dubai to do business, they're going to be disappointed,” adds a banker who sits on the financial exchange's board. “There's not enough business for 30 global financial institutions.”

Even Morgan Stanley's Mr Makhoul admits that, given the wide variety of firms the centre is courting, the time is approaching for Dubai to produce more results. “It seems there's an abundance of initiatives,” he says. “We'd like to see some of these things come to fruition.”

Below expectations
Whereas international banks report an increase in their institutional securities business (mergers and acquisitions, for instance), the volume of trading on the Dubai International Financial Exchange has been disappointing. Until the market becomes bigger and more liquid, successful public offerings will be hard to attract. And financiers complain that Dubai's rulers, despite many hopes, have not yet floated some of its successful state-owned ventures on the exchange. “If the exchange is so great, why is the Dubai government not using it?” asks a former regulator.

An international banker on the exchange's board agrees that the shortage of initial offerings is a problem. He suggests that the big banks will give the market another six to 12 months to get products trading with good liquidity before they reconsider their involvement. “The basic question people are asking is, ‘is this a place to raise money or not, a place to access capital in the region?'” he says. “People need to clearly think this is going in the right direction.”

Predictably, Mr Alshaali, the local official, defends the government. “We don't expect to force a listing of one of its assets,” he says. But he acknowledges that volatile conditions in the region's stockmarkets this year—some indices have plunged by as much as 60%—have made the timing of public listings awkward.

Mr Alshaali points out that both issuers and investors are more careful nowadays. The cautious mood extends throughout the region, where even taxi drivers poured their cash into fledgling stockmarkets only to see their money evaporate. It came as a shock to first-time investors, says Nasser Saidi, a Lebanese-born economist working at the Dubai financial centre: “Everyone thought the only way was up.” Niall Booker, head of HSBC's banking operations in the Middle East, notes that boom-and-bust cycles are typical of emerging markets. Now, he says, valuations have become more realistic.

The test of Dubai's financial sticking power will be its ability to bring together those who offer capital and those who need it. There are growing indications that Middle Eastern companies want to tap public markets to expand abroad, for instance, and Dubai's successful offering of the world's biggest sukuk—in effect, an Islamic bond—earlier this year raised hopes.

Much rests on the independence and legitimacy of Dubai's regulators. An early problem was the resignation of some well-known expatriates brought in to oversee the centre and its exchange. They claimed that local officials were improperly meddling, although the locals insist it was all a “cultural misunderstanding”. Indeed, there has been something of a revolving door for foreign executives. The latest arrival is a former head of OMX, the operator of a successful Scandinavian financial exchange, who took over running the financial exchange earlier this year.

One of the biggest difficulties in the Gulf is its notoriously opaque business culture. “We don't want to do business in hotel lobbies,” says Morgan Stanley's Mr Makhoul. “We're trying to bring a global standard to the market, not just do deals.” Yet a recent report from Hawkamah, a corporate-governance institute headed by Mr Saidi, concluded that regional business practices fall well behind Western standards of transparency and accounting. This may not be so surprising considering that about 85% of firms in the region are family-owned.

Putting down cash
If Dubai is to succeed in its ambition, other practices must also change. The emirate has a long-standing reputation for smuggling and money-laundering—the terrorists who struck on September 11th 2001 transferred some of their funds through Dubai. The financial centre has worked hard to show Western governments that it has cracked down, but elsewhere in Dubai it is not uncommon to hear stories about pricey luxury apartments paid for in cash by rich Russians who rarely visit.

Because the financial centre was created from scratch with a commitment to transparency and international standards, its officials say such worries are unfounded. Yet, in private, Western financial executives operating in Dubai remain on guard about accepting potentially dirty funds. “There is money here from questionable sources, which is very tempting,” says one executive whose firm recently opened in the centre. “We haven't turned down money yet, but I expect it will happen. We have to know our investors.”

The questions of image and security go wider. Expatriate circles gossip about how the ruling family tries to protect the emirate from threats like that of al-Qaeda. One line of defence is an elaborate intelligence network. Another is strict immigration controls. Migrant labour is a sensitive issue. “The entire economy is run on the backs of migrant workers,” claims Hadi Ghaemi of Human Rights Watch. More than 80% of workers in the United Arab Emirates' private sector are migrants. Despite a series of protests against low pay and poor working conditions, the government has taken little action. Trade unions and strikes are banned. Human Rights Watch found that 34 site-related deaths of construction workers were reported to the Dubai government in 2004, but Mr Ghaemi says it counted 880 dead bodies sent home by foreign embassies the same year. “They can't explain the deaths,” he adds.

As in other city states with firm controls, Dubai also keeps a grip on the media. Journalists exercise self-censorship, steering clear of stories critical of the ruling family or anything that might damage the economy. Even Skype, the free internet-phone service, is banned in order to protect the local telecoms provider. It remains to be seen whether such restrictions will continue as the UAE inches toward democracy—it will hold limited elections for the legislature in the coming week.

So far, the flush of new wealth and relatively good quality of life have trumped such issues in the minds of foreign investors. Expatriates worry aloud more about spiralling inflation and grinding traffic jams. If inflation continues unabated, the UAE “faces the danger of pricing itself out of the low end of the processing market in banking and insurance,” says Mr Booker.

There is a recognition that if tiny Dubai can succeed as a money giant, it will be tied closely to its role as a gateway to the Gulf, much as Hong Kong is a gateway to China. Yet it is not the first place to dream of becoming a Middle Eastern financial hub. Beirut filled that role until war wrecked its economy in the 1980s and investors shifted toward the Gulf. Bahrain, Qatar and Kuwait have all since found their niches. Abu Dhabi, a rival next door with its own financial ambitions is now trying to become a place for the arts. It has signed a deal to build the world's biggest Guggenheim museum and is in talks to build an offshoot of the Louvre as well.
One obstacle for other countries in the region is the life they offer foreigners. Many are seen as relatively strict and dull places to live. But Dubai is not. “We're living in an Islamic ocean and we're a tiny common-law island,” says Sandy Shipton, an expatriate executive at the Dubai financial centre.

One country with a particular bearing in Dubai is Saudi Arabia. So far, its conservative culture and restrictive religious practices have led many international firms to try to serve the country from regional offices in Dubai; other executives who work there park their families in Dubai and fly back at weekends. But the Saudis are becoming more demanding: they now require a business licence and a Saudi office for foreign firms doing business in their country. Work has also started on a new commercial hub called King Abdullah City, near Jeddah, that will target global firms.
Despite all the jockeying for the attention of international financiers, some see the emergence of several financial hubs in the Middle East as a healthy sign. Indeed, one possibility is the growth of various centres of excellence. “The new reality is you can have a very capable network,” says Ms Sassen. “It's not simply a winner-take-all situation.” She cites Singapore's ties with the Chinese city of Shenzhen as an example of regional collaboration.

Executives at the Dubai financial centre see the parallels with Asia and increasingly promote it as a complement to places like Singapore, rather than a competitor for them. The Omani oil-futures contract, for instance, was chosen as a benchmark for the new Dubai commodities exchange in part because the contract is used by oil traders in Singapore.

Dubai has spent a fortune and done virtually everything within its power to establish an attractive market. In the end, though, successful financial centres cannot be created by government fiat. Success now depends on forces that are largely beyond its control.

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