By Mohammed Aly Sergie
The Dubai International Financial Centre has benefited from an influx of international investment banks and budding start-ups. Riad Meliti, Arqaam Capital's CEO, tells Mohammed Aly Sergie how his company will revolutionise the region's capital markets.
It is difficult to look at any of the new financial services companies in the region without a degree of scepticism. With the incredible liquidity in the region, buoyant real estate sector, and a flurry of international mergers and acquisitions, there's no doubt that bankers are raking their fees in hand over fist.
The scene is so ripe with conventional opportunities that few firms are even trying to be innovative, focusing instead on riding the wave. This has led to a somewhat complacent environment, and one that Arqaam Capital's CEO, Riad Meliti hopes to transform for the benefit of his company, and the market.
Do I want to be the classic investment banker and have 2.2 cars, 3.2 kids, and be a statistic and have a good life, or do I make a play?
Youthful and energetic, Meliti does not exude the reserve common among chief executives, or indeed corporate bankers with 13 years of experience. Indeed, he speaks candidly about the reason why he left the blue-chip banks to set up his own company. "I became frustrated with the inability of the large firms to cater to this opportunity in the Middle East marketplace. I started asking questions like why are they incapable, what are the barriers of entry, and what are the opportunities in the region that should be capitalised upon? There was a lot of talk about the opportunity, but very few people had the granularity of information to actually execute a strategy."
Meliti says that he "was always attracted by the glamour and excitement of capital markets", so upon graduation from University College London, he went to work for Credit Suisse First Boston (CSFB). There he was responsible for designing and building macroeconomic models for a propriety hedge fund at CSFB. In 1994, hedge funds were certainly not new in the world of finance, but they were relatively unknown outside a cadre of elite investors. The CSFB hedge fund did not have to use any of its client's money, and was mainly a "macro hedge fund trading anomalies in swap curves".
He doesn't say how much of CSFB's capital was deployed in the fund, but claims that was sizable and comparable to those at Goldman Sachs and other major players. Here Meliti shifts from talking about the intricacies of exotic trades, and displays a trait that is unusual among executives in the C-suite: he actually praises his mentors, mentions their names, and gives them credit for imparting their knowledge to him. He says that his number one goal throughout his career was "knowledge accumulation" and that he was on the constant lookout for opportunities to hone his craft. After a few years at CSFB, Meliti grew "tired of looking at a computer screen all day" and felt that he had reached his apex - he "became a spreadsheet and number crunching expert". So his next move in knowledge accumulation was to UBS Warburg. Some years earlier, the Swiss bank acquired O'Connor, a Chicago-based firm that specialised in derivatives. Through the O'Connor-trained managers, Meliti learned the ins and outs of derivatives, and he holds these mentors in the highest esteem.
By 1999, Meliti says that he built a significant business for the firm in the Middle East in fixed income and derivatives and executed a number of transactions, both public and private. "We executed the Euro currency bond issue for Bahrain-based private equity firm Investcorp, which was the first Euro currency issuance in the region", boasts Meliti. That year, Barclays Capital poached the rising star in order to build its Middle East capital market business. "I arrived at Barclays Capital full of energy and excitement, and later on I realised that it was a virtual start-up in terms of operations," Meliti says. "My title was head of asset distribution into the Middle East, but I arrived and found out that I was reporting to myself." He was also put in charge of central banking activities. Meliti knew that his career was going well, but felt that he was "deviating away from" his core passion in capital markets.
This was the point when Meliti had reached the proverbial crossroads. "I had to make a decision", he explains. "Do I want to be the classic investment banker and have 2.2 cars, 3.2 kids, and be a statistic and have a good life, or do I make a play?" It was not an easy decision. He says that his experience and capabilities place him among an elite group of individuals who are very well-compensated. So he had to reach a conclusion that a move to the region was not based on a "monetary motive in and of itself" but his "motive is to create, to fix something that isn't working efficiently, and to build a legacy".
In order to identify the opportunity (and explain it), Meliti seriously studied the market as any quantitative analyst would. To illustrate the rationale for launching a new financial services firm in a well-saturated market, Meliti dons a professor's hat and maps the strategy on a whiteboard - he remains lively, speaking at a rapid-fire pace.
According to Meliti's analysis, the financial sector in the region has gone through three phases. The first began with the 1970s rise in oil prices which saw the birth of Middle Eastern funds that sought opportunities abroad. This is the era when players such as Investcorp and Arcapita began operations. While there were some developments and mega-projects in the region, most were serviced by the ‘suitcase' bankers from global institutions.
The second phase began with the rise of oil prices six years ago, the dotcom bust, and the attacks of September 11, 2001. This period was marked by the rise of funds in the Middle East that deployed their capital in the region. Companies such as EFG-Hermes, Shuaa, Abraaj, and Global Investment House emerged as the new players catering to investor demands. These institutions are performing very well today, but Meliti doesn't think that the phenomenon is sustainable. "If you look at the products available in the marketplace, there are still a lot of products that haven't been created that need to be created," he says. This is a valid observation. Very few exotic products have been introduced to capital markets over the years, and the market seems to be filled with very basic equity and debt offerings.
But the landscape is slowly changing. The third phase that Meliti outlines is more recent. We are now seeing funds and institutional investors from abroad investing in opportunities in Middle Eastern capital markets, and here is where Arqaam is looking to make its mark. Meliti says that his "hypothesis is not that Middle Eastern investors don't want to invest in the Middle East, but that there is no capital intermediary that offers products to attract the capital back".
The lack of sophistication in the local financial products is the crux of what Meliti sees as his opportunity. Arqaam Capital was established in 2004 in the UK and received it licence to operate in the DIFC earlier this year. There are four main areas where Meliti sees opportunities, and he has been actively exploiting them. The first stems from the dearth in high calibre professionals and quant specialists, a situation that can be overcome by, what he calls, "human capital arbitrage".
Meliti's main tactic to accomplish this, and win the ferocious poaching war in the region's finance sector, is to come up with the best compensation structure (which is developed with Ernst & Young and is "proprietary"). As Meliti puts it: "It is effectively an opportunity that exists in the marketplace due to a lack of human capital, so we arbitrate that by creating the platform to attract the talent."
We didn’t want to be too closely aligned with any institution, or corporation or family.
The second inefficiency that Arqaam is looking at is the fact that regulations have not been established throughout the region in terms of capital markets, and there are simply too many regulators to keep track of. This "regulatory arbitrage" is exploited by using human talent to map the regulations and develop products in collaboration with authorities so the laws are adjusted and developed as the market develops.
Meliti also sees opportunities in the regional credit markets, but admits that companies have been receiving higher credit ratings so the prospects have diminished. But he says that "mortgages in particular, are being issued at very high levels in comparison to international standards, which presents a credit arbitrage opportunity". The final point that Meliti identifies is the myriad of jurisdictions and the lack of standardised legal contracts in the region that must be understood in order to complete any financial transactions - or "legal arbitrage". Meliti explains that this severely hampers any player's ability to introduce new products to the region's capital markets. He says that the inability to obtain a "clean legal opinion on the enforceability of certain financial contracts in the Middle East is a huge barrier to executing transactions". Arqaam is hoping to overcome this hurdle and use it to its advantage by acquiring knowledge. Meliti says that his company has "just completed a massive legal exercise in terms of mapping out a legal structure of the Middle East marketplace".
With all the planning and strategising out of the way, Meliti is ready to launch some products, but he is not ready to disclose that information yet. The firm is capitalised at US$140m, and according to Meliti, the private placement was oversubscribed. "We had to diplomatically decline a number of institutions because we wanted to create a platform based out of Dubai that would operate in the entire Middle East. We didn't want to be too closely aligned with any institution, or corporation or family", Meliti explains.
Meliti will raise another US$60m in a private placement after Ramadan, with a portion "going to existing shareholder - to make them happy - and a portion going to new shareholders, because I want to increase the shareholder base and increase the platform".
The main activity Arqaam Capital will enter in the near future is OTC (over-the-counter) equity derivatives. (Derivatives are financial instruments whose value depends on the value of a commodity, stock, bond, or currency). Meliti notes that in developed markets "equity derivatives as a volume is a multiple of the value of the underlying cash stock market", and when China introduced derivatives to its market in 2005, by 2006 they constituted more than 25% of the market volume.
When applied to the Middle East, the potential market in these financial products could reach more than US$250bn within three years. Meliti is very optimistic about this prospect. "I have more appetite right now than I can handle. There are people out there who know what these are, trade them on international markets, and they want the product."
If investors share his enthusiasm and buy into his narrative, there is no doubt that the future of Middle Eastern capital markets are in for a revolution.