Pablo Conde talks to banks about the prospects for growth in the structured products markets of the Middle East. Additional reporting by Kim Hunter.

Most global investment banks' structured products chiefs list the Middle East market as one on which they are pinning their hopes for expansion. The region has, notwithstanding the faltering price of crude this month, what it would seem to take to achieve takeoff for self-sustained growth in the structured products industry - a deep well of savings and rapidly developing markets.

It is still in early days in most countries, though players are heartened by the development of the capital markets, in which the 'sukuk' bond market is growing rapidly alongside increasingly liquid equities. As Merrill Lynch's head of equity derivatives sales to the Middle East and North Africa, Karim Mathlouthi, explains, increasing liquidity on GCC stocks means the bank can extend the payoffs it offers; the bank is also now able to recycle volatility with clients such as hedge funds and prop desks. "We have today a virtuous circle of risk recycling: this helps develop the growth of the regional structured products market," he says.

Merrill says it was the first bank to offer structured products linked to GCC Equities, initially Asian call-based growth products, and income products based on annual individually capped calls. "We focused on themes which were appealing to clients and marketed successfully a three-year capital-protected EMTN offering an exposure to real estate stocks of the Middle East, for example," he says.

There are actually two Middle East structured products markets - the Swiss 'suitcase banking' market, where money from ultra high net worth and Royal Family clients is deposited in Swiss banks such UBS, Credit Suisse, Pictet, and the local market, also driven by the asset managers of private banks and also largely targeting the ultra high net worth. This division makes it extremely difficult to calculate the size of the market with any accuracy and estimates do vary considerably. While one observer said his gut feel is around $6bn per year regionally, DB's regional head of ME structuring Geert Bossuyt estimates between $2bn and $3bn. Growth is around 15% per annum, according to some estimates.

The private banking:retail ratio is considered to be 80:20. "In regards to the retail market, we are seeing more and more activity in term of structured funds and other structured products, but it is still relatively small if we compare it with the success of markets such as Germany, Hong Kong, Switzerland, or France," says Bossuyt. The region's well-paid expatriates are also driving the retail structured market.

Although hedged by international derivatives players, local distribution of structured products remains in the hands of local banks, the most active of which are National Commercial bank in Bahrain, Arab United Bank, National Bank of Dubai and UAE bank. The banks have a monopoly, and a sales force not yet dedicated to particular product sets. "It is very difficult to convince them that the structured products are interesting products for the commercial network, though they will still do structured products for ultra high network individuals," says Bossuyt. It is a difficult mindset to change.

International players have the capability, but nowhere to showcase their products, he says. "You can only get National Bank approval to make a public offering in the UAE, for example, if you have a banking licence to distribute financial products. Most of the international players have a licence in the DIFX, not in the UAE, so theoretically they cannot distribute products in that country...
but they do it using local banks."

Generally speaking, the regulatory framework has not yet accommodated structured products and according to some international bankers the DIFX is not doing enough to implement a derivatives exchange. Neither is there a connection between the DIFX and the retail customer. Nonetheless, the regulatory scene ought to have received a fillip from the establishment last year of the Arab Union for Securities Commissions.

Islamic products punch above their weight in terms of press: they account for only around 10% of products, but well over half the column inches dedicated to the region's structured products. Perhaps this is because Islamic financing is gaining momentum. Ultimately that will probably result in the financing industry becoming mainly Islamic," says Bossuyt.

In Saudi Arabia, where most of the market is Islamic, National Commercial Bank is an example of one that used to be a conventional player but today is a fully Islamic bank.

Players point out that there are some difficulties inherent in the Islamic structuring process. For example funds are 100% Shariah compliant, but structured notes are not, because the issuance mechanism itself is black-boxed and this reduces transparency.

A structured note is guaranteed by a third party but if this third party is not independent of the issuer (which happens often), the note does not comply with Shariah law. Some banks wrap notes in funds but you cannot put Murabahad (the equivalent of a zero coupon) in a fund. So there is no such thing as a Shariah-compliant structured fund.

As far as payoffs are concerned, the Middle East market is one of simple products where range and accrual structures are usually as complex as it gets.

Israel, which of all the countries in the region most resembles a European retail market, the United Arab Emirates and Bahrain account for most of the business.

Bahrain
Bahrain is said to represent around 15% of monthly issuance, a lot of its business also being done with investors in Saudi Arabia and Kuwait.

The Central Bank of Bahrain (CBB) gives approval on a product-by-product basis, and views structured products as suitable only for clients with an investable net worth of over $1m. The slow turnaround time of this approach does not facilitate nimble issuance with tight deadlines.

Nonetheless, issuance is estimated at $50m per month by more than one market participant, largely from foreign investment banks, with distribution primarily among corporate and higher net worth private investors.

Our research suggests Capivest, National Bank of Bahrain, CIMB Islamic Bank of Bahrain & Kuwait, Shamil Bank of Bahrain, Bahraini Saudi Bank, Arab Bank Bahrain, HSBC Bahrain (personal banking), BNP Paribas Bahrain, Al Salam Bank's treasury unit, Mashreqbank Bahrain, Ahli United Bank, Citibank Bahrain, as well as UBS AG Bahrain, to be among the main issuers.

United Arab Emirates
Merrill's Mathlouthi confirms Dubai, and the UAE in general, not only as one of the region's main markets, but probably 'the most important in terms of volume and activity'.

It is an important market in terms of retail products and has some Islamic products at the retail level, though the bigger proportion of business is conventional structured products. The majority of business done in the UAE is suitcase banking, with wealthy local clients serviced in Geneva.

Local banks have been relatively slow to issue structured products, though several launch structured deposits into a select market.

Merrill Lynch has two main channels of distribution in the UAE, which it says have the legal framework of offshore markets: it acts as third party to such issuers as Abu Dhabi Commercial Bank, and teams up with local entities to sell EMTNs for distribution among their clients.

Mathlouthi says investors, in common with other jurisdictions, are focused on capital protection, and want income with a semi-annual or annual coupon linked to equities, rather than growth products. As bond markets are not as developed as equity markets in the Gulf, there is investor demand for structured products with an income feature.

The structured notes arena, in which international names such as HSBC, Standard Chartered and Citi are all present, is more 'interesting' than structured deposits.

The only regulatory requirement is that the prospectus for a mass market offering must be lodged with the regulator. The product itself, however, does not need regulatory permission. Structured deposits have also to be lodged, but not approved, by the regulator.

North Africa
The most developed country in North Africa and the most mature market in terms of retail distribution is Morocco. Banks such as Merrill Lynch have traded products there. However, the problem in most North African markets is that you cannot directly exchange the local currency.

Algeria and Libya
The Algerian equity market has only three (partially) listed public companies. Algeria and Libya have, however, ambitious development plans which in Algeria are worth $80bn over five years, or nearly 100% of GDP. The banking sector will look to the developing capital markets for financing.

Israel
Structured products have been listed on the Tel Aviv Stock Exchange (TASE) since 2004, including reverse certificates on equity indices and notes linked to the HFRX Global Hedge Fund Index and commodities indices. CDOs, equity index-linked and credit-linked notes have all been successfully marketed.

A number of Israeli banks now offer their customers various structured deposits, two notable retail players being Bank Leumi and Bank Hapoalim. The Israel Securities Authority (ISA) is concerned, however, that the marketing of the products as deposits could give customers the wrong impression about the risks involved. Accordingly, the regulator has taken the position that structured deposits constitute financial assets for purposes of the Investment Counselling & Portfolio Management Law 1995. This law applies licensing requirements and fiduciary and other obligations on 'investment counselling' providers.

Egypt
There is little public information about structured products. The National Bank of Egypt lists some certificates; HSBC Bank Egypt and EFG Hermes issued the HSBC Bank Egypt 2nd Fund in May this year. Other banks with some capability include Arab Banking Corporation, Cairo Amman, Commercial International Bank, HSBC Egypt, Credit Agricolé Egypt and Barclays Egypt.

Jordan/Lebanon
Up to a dozen banks mention structured products on their web site, though many of them have issued single products, or on one case, one product per year for the last five years.

Turkey
Structured products began to be launched around December last year, mainly capital-protected structures linked to the local stock market, but most of the capital-protected structures launched since then have performed badly, due to local market conditions and comparison with high interest rates in a high inflation environment.

Orhan Ozalp, from DB Global Markets in Istanbul, says banks have thus been forced to suspend or delay product launches, and are now working on products that include some fixed coupons. There has been no live pricing of existing products for around two months. There are half a dozen banks offering third party prices.

Oman
Retail structured products have still to develop in the Sultanate of Oman. However, Bank Muscat, which apparently structured a retail product there over a decade ago, is building a business among high-net-worth and institutional clients.

Qatar
Qatar is similar to Dubai and Bahrain. Banks here will often have a separate unit to sell structured notes to high net worth individuals. Qatar Financial Markets Authority was established in 2007, with the mission of implementing a 'modern and robust' securities markets regulatory framework.

Kuwait
Kuwait has more Islamic products than any other country in the Middle East, other than Saudi Arabia. The majority of business is offshore, though with the difference that structured products must be both lodged with and approved by the regulator.

The process can be laborious for foreign entities, since documentation has to be submitted in both Arabic and in English. Comments are sent back in Arabic, which has to be translated into English and reincorporated into the Arabic version. Seven local banks say they offer structured products on their web sites.

Saudi Arabia
The Saudi Arabian market is the preserve of a select few banks, mainly selling Islamic structured products. The majority of business done here is private placements to customers of Swiss, British and US private banks.

Perhaps because of this private placement emphasis, the regulation of structured products has not been clarified. Several banks, however, sell structured notes through their own distribution channels - ABM, National Commercial Bank, and SAMBA, which used to be part-owned by Citibank.

National Commercial Bank and SAMBA also sell local currency-denominated capital-protected deposits linked to overseas equity indices such as the S&P500.