The Gateway to Algorithmic and Automated Trading

The Middle East: A Region Rich in Opportunity

Published in Automated Trader Magazine Issue 08 Q1 2008

Gary King, Chief Executive Officer, Dubai Mercantile Exchange, explains why trading firms should look beyond Asia for new investment opportunities to a region whose financial markets are primed for an expansion in algorithmic and automated trading.

Much has been written in recent years about the booming economies of India and China. But one other region of the world is undergoing an even more remarkable transformation. According to the International Monetary Fund, the Middle East's gross domestic product is set to outpace global growth rates during 2008 for the eighth successive year, with the regional economy predicted to expand by 6 to 7 per cent.

As the region's financial markets become more liquid and sophisticated, opportunities are emerging for traders throughout the world to engage in its burgeoning economy. And although it is currently not common practice to use algorithmic or automated techniques to execute trades with exchanges that have matching engines located in the region, that is set to change in the near future as both the technological infrastructure and market liquidity continue to develop. Indeed, the Dubai Mercantile Exchange (DME) intends to evaluate the merits of having its own matching engine located in Dubai in the future.

To take advantage of these emerging opportunities, traders will have to leave the comfort of their home environment, if only virtually. The story of the region's progress over the past few years may persuade them to do just that.

Growth and diversification

Private and public sector investment in the Middle East is growing at an unprecedented rate, bolstered by the consistently high price of oil and other commodities. In the Gulf Cooperation Council countries alone - Saudi Arabia, Kuwait, the United Arab Emirates (UAE), Oman, Qatar and Bahrain - at least USD 800 billion is planned to be invested over the next five years. This includes major oil and gas projects by national oil companies, public-private partnership infrastructure schemes and private sector property developments.

The region is now using the wealth generated by its enormous reserves of oil and gas to encourage economic diversification, make substantial overseas investments and attract international investors and expertise. The entrepreneurial spirit is deeply ingrained in the region's culture, combining with sound economic policies and a strategic use of its physical and human resources to drive the Middle East's recent growth and providing further opportunities for trade as the region develops new markets.

Dubai is at the forefront of this transformation. Recognising that its oil reserves are limited and production declining, the emirate decided to diversify its economy and transform into a major global financial hub on a par with London, New York and Hong Kong.

Financial market expansion

The idea of setting up the Middle East's first stock exchange in the United Arab Emirates, either in Dubai or Sharjah, was mooted as long ago as the early 1980s. During the following two decades, a small number of local stocks were traded informally by a limited network of brokers. It was not until 2000, however, that the vision finally became reality with the launch in March that year of the Dubai Financial Market (DFM), followed in November by the opening of the Abu Dhabi Securities Market (ADSM). Both exchanges trade local stocks, although the DFM does list some companies from elsewhere in the region, and both are open outcry.

As the UAE embraced the equity trading culture, the need for an international financial centre soon became apparent. The Dubai International Financial Centre (DIFC) was created in 2004 as a 110-acre free zone designed to become a focus for economic development in the UAE and wider region. The DIFC has attracted leading financial institutions from throughout the world and across the entire Middle East. All institutions and activities within the DIFC are regulated by the Dubai Financial Services Authority (DFSA), created by statute and modelled on best practice from the world's leading financial authorities.

"The DIFC has attracted leading financial institutions from throughout the world and across the entire Middle East."

The launch of three exchanges followed. The Dubai Gold and Commodities Exchange (DGCX) is a fully automated online commodities and currencies exchange located in the Dubai Multi Commodities Centre (DMCC) free zone, while the Dubai International Financial Exchange (DIFX), which lists and trades international equities, and the DME, the leading energy futures and commodities exchange in the Middle East, are both based in the DIFC. A joint venture between the New York Mercantile Exchange (NYMEX), Tatweer, a member of Dubai Holding, and the Oman Development Fund, the DME was established to address an historic anomaly.

Increasing price transparency

The Middle East is the world's largest hydrocarbon-producing province, yet its crude oil was being priced by comparison with entirely different crudes from the United States and Europe, and an over-the-counter instrument based on Dubai Fateh crude oil.

The market had long been calling for a more transparent pricing benchmark. After extensive consultation, the DME and its partners created the Oman crude oil futures contract which began trading on the exchange from its launch and has since become the benchmark for the pricing of Middle East sour crude oil. Both the Government of Dubai and the Sultanate of Oman, two oil-producing nations, now price their crude oil off the daily settlement price of the DME's Oman contract. It can be traded from anywhere in the world on a state-of-the-art electronic exchange that is based in the very heart of the region (the DME Direct trading platform is explained in detail below). Price transparency has since improved significantly and traders are now able to better manage their risk.

Another significant development took place last August with the creation of Borse Dubai, the holding company of the DFM and DIFX. This propelled the UAE into the major league of nations with real critical mass in the financial exchange business. Borse Dubai is poised to purchase a 20 per cent stake in US stock exchange NASDAQ and has already acquired 20 per cent of the London Stock Exchange (LSE). It is also engaged with NASDAQ in the long-running takeover of Nordic stock exchange operator OMX.

These are still very early days in the establishment of sophisticated financial markets in the Middle East. Dubai is by many experts' reckoning three to five years ahead of its nearest rivals. But competition is growing. Qatar is competing fiercely as a rival financial centre, eager to develop its own domestic financial services industry. The Qatar Investment Authority has been making substantial long-term investments, including a number of complex share deals involving OMX, and a 15 per cent stake in the LSE. Bahrain, the region's former financial hub, is seeking to regain its prior status with the establishment of a new financial centre. Rumours abound of similar moves by other regional players.

"Participation in financial markets by local entities is also growing as the level of knowledge and expertise in the region continues to develop."

International and local participation

Participation in financial markets by local entities is also growing as the level of knowledge and expertise in the region continues to develop. Local financial institutions such as Mashreq Bank, a 100 per cent UAE-based operation and DME member, have their own trading desk operations, trading mostly local stocks on the Dubai International Financial Exchange and the Dubai Financial Market. Mashreq Bank has also taken a seat on the DME's trading floor. Initiatives such as the DME-AUD Academy (a joint venture between the DME and the American University of Dubai) and the DIFX Academy aim to accelerate local participation by providing training courses for a wide range of local market participants.

The idea of professional trading groups (PTGs) or trading arcades has also been introduced to Dubai recently. A joint venture between experienced market professionals based in Dubai and the Dubai Multi Commodities Centre, the Dubai PTG provides the first trading hub in the Middle East for both professional and new traders looking to establish a base in the region, with access to more than 47 markets around the globe. Located in a zero-tax environment guaranteed for 50 years, the Dubai PTG is fully electronic. Its open-plan trading room has 36 trading stations with high-end technical equipment, market information and risk management systems, plus front- and back-office administrative support. The group plans to introduce a second trading room later this year with 100 additional trading stations.

International trading companies are also finding local partners with whom they can do business. For example, Vitol, a UK-based energy trading group, and the Oman Oil Company recently created a joint venture oil trading firm, Oman Trading International. Within the DIFC, international entities do not need a local partner to set up operations and major institutions such as Standard Chartered, Lehman Bros and Merrill Lynch have taken up floor membership of the DME. Indian traders are extremely active on the Dubai Gold and Commodities Exchange (DGCX), buying and selling gold bullion. Major international banks with representative offices in the DIFC are also trading on the DIFX.

A technology-driven market

As crude oil is a truly global product, with more than two thirds of Asian crude oil imports sourced from the Middle East, the DME is arguably the most international of the region's exchanges with participation from a wide variety of clients based in more than 100 countries across the globe. It has also secured regulatory approvals from many overseas jurisdictions, including the world's largest trading communities.

"… there has been active trading of the DME's Oman contract as far out as March 2010."

The DME's Oman crude oil futures contract is physically delivered using the Mina al Fahal crude oil storage and loading facilities in Oman. The contract size is 1,000 barrels and it is settled daily at the close of the Singapore trading day. The minimum position size to take physical delivery is 200,000 barrels. All contracts are cleared at the NYMEX Clearinghouse. Since its launch, the DME has seen solid, consistent growth in trading volumes. Nearly 250,000 Oman crude oil futures contracts have been traded on the exchange to date and there has been active trading of its Oman contract as far out as March 2010. January 2008 saw a record total of 42,903 contracts traded, surpassing the previous monthly volume high of 42,568 set during November 2007. And in another new record, open interest on the DME at the close of January trading stood at 13,773 contracts, surpassing the previous monthly high of 11,060, also recorded last November. The exchange is developing additional products that it expects to list in future.

The DME is fully electronic. Using NYMEX's trading technology enables the exchange to operate as a stand-alone entity and provide customers with maximum access. The technology has a proven track record as a highly reliable trading system and brings a number of benefits, including a seamless interface to NYMEX's post-trade processes and a scalable architecture, giving the DME the capacity to increase product offerings in the future. The platform, DME Direct, was developed by NYMEX to enable market participants to execute trades with ease and flexibility. DME Direct is supported and hosted in New York and provides real-time reporting of DME quotes and trades to market data vendors through NYMEX's Price Reporting System (PRS). The interface to DME Direct is via the industry standard FIX protocol, FIX 4.2, which enables customers to connect via either in-house proprietary trading solutions or a third-party ISV trading system. Order types include: limits; stop limits; good till cancelled; good till day; and trading at settlement. All trades executed on the DME Direct are cleared at NYMEX's AA+-rated clearinghouse.

Automated trading on the horizon

DME Direct will ultimately migrate to Dubai and a decision regarding this will be announced at the appropriate time. Dubai's communications infrastructure was significantly enhanced recently by the completion of a major investment by BT Radianz that took the speed, bandwidth, redundancy and reliability of the emirate's communications infrastructure to the level where algorithmic and automated trading would be possible on a platform located within the region. This has been likened to putting a new entry/exit ramp in Dubai on the world's communications superhighway and has enabled new initiatives to be launched that support the growth of trading within Dubai and the wider region.

While much of the Middle East's wealth is still generated by oil and gas, and will be for the foreseeable future, the region's economies are swiftly becoming more diverse and complex. The region may not be immune from the vicissitudes of the global economy, but the Middle East can look to the future with confidence as it continues to attract a growing number of investors and partners from across the world. The international trading community is already playing a significant role in this remarkable transformation. The opportunities are emerging. Now is the time to engage.