Electronification rising amid turbulence: Taking a closer look at the MENA FX picture

By Vivek Shankar

November 2023 in Regional Perspectives

The MENA region has never grabbed FX headlines quite as violently as it did this past month. News of the Israel-Hamas conflict increased volatility in the stock and commodity markets, with the side effects impacting FX flows.

However, the current crisis has not changed the prevailing e-FX story in MENA. The electronification of FX, fintech sophistication, and the Gulf region’s decoupling from oil wealth are all steadily rising. Add to this the resilience of Israel’s nascent fintech sector and growing diversity in financial products on offer and the MENA’s overall economic and technology outlook seems well placed despite current events.

Hussain Almohri, Head of Trading, MENAT, at HSBC, points to strong GDP growth as a factor for increasing FX demand. “During the past couple of years, what with strong GDP growth in the region,” he says, “there has been a material shift in FX requirements, particularly after the pandemic.”

“Saudi Arabia alone is projected to see its GDP reach US$1.7tn by 2030. It stood at over US$1trn for 2022, up from US$868bn the year before. In addition, many asset managers and hedge funds have moved their physical locations to MENA, to capitalise on the economic growth of the region, the region’s vision to invest in its infrastructure, as well as its ambitious growth plans.”

Delivering transparency

Recent local economic reports show that cross-border FX needs have remained high, given the number of expat workers in the region’s biggest markets. While recent drives to hire citizens in Gulf countries have slowed FX volumes a bit, the region continues to account for a significant amount of outflows.

For instance, the Gulf region accounts for the highest amount of FX outflows to South Asian countries despite slowing economic growth (The Gulf region grew by 7.4% in 2022, a number expected to drop to 2.5% per the World Bank.)

“We have seen SAR, AED, and KWD as the currencies most in demand,” Almohri says, “with AED having the most notable growth in terms of volumes over the past 18 months.” 

“During the past couple of years, what with strong GDP growth in the region, there has been a material shift in FX requirements, particularly after the pandemic.”

Hussain Almohri

News is not as positive with the Israeli Shekel, which has lost strength due to internal government crises in that country and the recent war.

Despite Israel’s central bank pouring $30 billion into supporting its currency, the Shekel shed 3% in its biggest fall since February 2023, when the judicial crisis was at its peak. Observers can divide the MENA picture between the GCC and the rest, with the rest experiencing considerable strain.

Lebanon continues to reel under the weight of consecutive economic crises, and Egypt’s dependence on external tourism for hard currency receipts has not reduced. Given its proximity to the Gaza war zone and recent errant excursions by Israel’s military, Egypt faces significant challenges in managing its currency exchange rate.

On the positive side, Chinese investments in the region have increased, creating more diverse sources of FX flows, and pushing traders to call for more transparency and efficient risk management. Small vanilla FX flows are largely automated, with more market participants demanding TCA as standard. 

Albert Blackburn, EMEA EM Business Development Manager, FX, at LSEG, explains, “The buy side is eager to understand trade costs and what their impact is on the market and how their liquidity will be used. Pre-trade and post-trade analytics continue to see an increase in their usage and offer better transparency to the market.” 

And what about STP and TMS demands?

“STP and Treasury Management Systems continue to be rolled out at pace across the regions as firms seek to maximise their positions,” he says. This rise in electronification has shrunk spreads, with more banks offering greater context behind their pricing, like market news and historical trends.

Regulation and continued government investment in infrastructure are slowly turning the GCC into a hub for sophisticated investors

Other transparency-enhancing efforts include IM communication channels and data-backed insights into RFQ workflows. Blackburn lists a few ways in which LSEG is meeting these demands. “LSEG FX has a history of delivering market infrastructure and workflow tools into frontier and emerging markets,” he says. 

“Matching and FXall offer robust best-in-class solutions that can be leveraged by regional banks and clients with little friction. Our white-label workflow products provide turn-key solutions that reduce time-to-market for smaller banks looking to quickly expand their digital footprint.”

Blackburn notes that local banks have released new features to their platform in response to corporate demand. And what are some of these? “Competitive quotes are always key, and the ability to trade at the best price is key,” he says. “However resting orders, options, and fixing orders are also in demand. Some of the banks have started to use algo for trading and this continues to be a new growth area for the banks that serve the region.”

HSBC’s Almohri agrees. “Local banks are adapting to electronification at pace,” he says. “It’s a strong trend that we do not see slowing down anytime soon. This has involved material changes in workflow, processes, and technological buildout, which, as one might expect, can carry operational risks in their execution and, therefore, might require adjustment in planning timelines.”   

Blackburn notes that LSEG doesn’t view the region as an emerging market, as is the prevalent global view. Several GCC countries only recently moved from the MSCI Frontier Markets index to the Emerging Markets one. While this move has accelerated FDI inflows, volumes remain small compared to global benchmarks.

“Like elsewhere, the buyside across the MENA region is eager to understand trade costs and what their impact is on the market and how their liquidity will be used.”

Albert Blackburn

He explains further. “Many of the regional firms have been engaged in electronic trading in the global FX market for many years,” he says. “Whilst there are opportunities to support governments and central banks evolve market structure as countries look to reform access to their domestic currencies, we see no difference in the levels of client sophistication in this region to any other.”

Demand from sophisticated investors

Regulation and continued government investment in infrastructure are slowly turning the GCC into a hub for sophisticated investors. Almohri lists a few reasons for several hedge funds and asset managers setting up shop here.

“Exponential growth in the region’s debt capital markets, following the oil price drops between 2014 to 2016, together with the transformation and economic diversification plans in MENA, has attracted a large number of hedge funds and asset managers into the region,” he says. “With that, we have observed a higher interest in methods of execution and data analytics, which are tailored for a more sophisticated segment of the market.”

Many asset managers and hedge funds have moved their physical locations to MENA, to capitalise on the economic growth of the region

“We have observed more demand and FX flow driven by foreign investors,” he continues. “This has been in response to policy changes leading to a relaxation of restrictions on foreign ownership of assets and allowing more access to the market.”

As electronification steadily rises, algo adoption is also increasing. “FX algo execution is still at an early stage of adoption in MENA,” cautions Almohri, “although it is becoming a growing topic of discussion with clients as an additional tool at their disposal, particularly among institutions that trade equities. Algorithmic stock executions are more mature and already embedded in their typical workflow.”

And what does the electronic versus voice trading picture look like? Some MENA currencies are famously illiquid. Has electronification changed that picture? Blackburn and Almohri reckon it hasn’t. “Electronic markets are now the norm in more established and larger Middle East economies,” Blackburn says, “however in smaller markets, central banks are seeking to work with their local counterparties to facilitate orderly markets. In some regions e-trading is still relatively new, continued pressures on credit and banks are facilitating this approach.”

“Voice trading is still the preferred channel for large transactions,” Almohri says, “where electronic liquidity doesn’t exist or is particularly thin. One significant factor for further increasing electronic liquidity distribution would be an electronic interbank market in the region, which would act as a precursor to a fully-fledged electronic offering.”

However, Almohri notes that the share of electronic trading is increasing, a trend he expects to accelerate. Blackburn echoes this view and highlights a few changes that have supported this trend. “Regional banks across the region have developed their single dealer offerings to allow customers to reach their branches, customers, and the wider community of multi-dealer platform users,” he says. 

“There has been a general consensus from MENA countries to change their methods of trading, and central banks have been key to ensuring that markets operate with a degree of transparency around them.”

Islamic finance – Vanilla but in high demand

Increasing sophistication amongst MENA investors has affected another unique aspect of the region’s markets: Islamic finance. Demand for Shari’a-compliant products has steadily increased, with service providers offering both innovative and questionable products.

Retail FX is an example of the latter. Shari’a law prohibits interest and gambling, both of which are present in copious amounts in the retail FX market. While brokers cannot control a client’s gambling instinct, they have full control over interest charges, and this leads to interesting compromises.

Swaps, for instance, are central to the FX market’s functions, but several brokers in the region advertise swap-free accounts. These brokers reframe the swap as a client fee and execute the swap on the back end. Is such a product truly Islamic?

Other examples such as the approval for futures products reflect an attitude of balancing customer demand with Shari’a needs. So far, MENA governments haven’t commented on such tactics. On the institutional side, greater financial engineering leeway has resulted in the creation of Shari’a-compliant hedges, swaps, and options.

However, these products remain relatively vanilla. Bloomberg’s FXGO platform currently offers the trading of Islamic deposits and forwards (Wa’ad)

Qatar ramps up Fintech Strategy 2030

Qatar is a relatively silent presence in the Gulf region compared to the behemoth that is KSA and the flashy UAE, led by the Emirate of Dubai. However, the Government of Qatar has made regulatory moves that reflect the Kingdom’s ambition to be counted amongst its neighbours.

The Qatar Central Bank’s Fintech Strategy 2030 details an ambitious plan to electronify the Kingdom’s financial infrastructure

The Qatar Central Bank’s Fintech Strategy 2030 details an ambitious plan to electronify the Kingdom’s financial infrastructure. While the central bank’s regulations surrounding loan-based crowdfunding grabbed headlines, the body outlined a roadmap to define regulations for wealth tech, eKYC, DLT initiatives, open banking, and digital banking, amongst others.

This initiative comes in conjunction with greater foreign investment interest in the Kingdom driving the need for a sophisticated support system. The plan seeks to triple the number of registered fintechs in the country by 2027 and promote greater financial inclusion.

The move also comes after Fitch Ratings analysts pointed out the lack of regulation holding back Qatar’s fintech sector. As FDI inflows increase in the region, Qatar is positioning itself as a viable alternative to Dubai and Riyadh.

What’s in store for the MENA?

Despite the region experiencing instability and illiquidity in some pockets, industry analysts view the MENA’s prospects favourably. The Gulf economies’ growth is undoubtedly positive and is expected to turn that region into a financial hub.

Dubai is well-positioned as a financial centre already, and with KSA opening its economy, analysts expect more firms to consider Riyadh as a potential hub. While localisation efforts will reduce expat FX outflows from the region, investor sophistication will increase. As a result, electronic FX workflows and automation will likely experience steady adoption.

In short, the MENA continues to move forward, despite current turbulence.

The state of retail FX in MENA

Low volatility, the crypto winter, and high interest rate macro environments: Retail brokers have had plenty to contend with over the past year. When we last checked in with Mohammad Isbeer, Global Head of Brokerage Sales at Equiti Group, he noted observing high retail trading flows, particularly in the crypto and DeFi space. Is this still the case? “I’d say overall flows haven’t dropped off, but they certainly have switched from speculative assets like crypto to safe-haven ones like gold. Low volatility across all asset classes and macro uncertainty have pushed flows that way,” he states.

Isbeer notes that gold has accounted for over half of all retail trading flows over the past three to four quarters. As retail interest in FX and CFD trading remains high, the MENA region has witnessed more retail brokers emerging, leading to a highly competitive sector.

Mohammad Isbeer

“A lot of this rise is driven by regulations opening up, like the SCA licence in the UAE and Jordan modifying regulations a couple of years ago,” Isbeer says. “Add to this existing centres like Bahrain, and you have fertile ground for retail presence.”

He’s quick to point out that while regulations are weeding out undesirable brokers, even fully licensed ones face challenges when getting business up and running. For one, their choice of LP is crucial. “The market has seen some offers too good to be true, and unfortunately, some brokers have fallen victim to them.”

“Checking whether an LP can offer you Tier 1 access to prices is the most critical thing,” Isbeer continues. “If your LP can’t give you that access, then what’s the point of the relationship? Regulation is important too. Every credible LP is regulated in a Tier 1 jurisdiction.”

Isbeer also recommends brokers check their LP’s balance sheet strength and risk management. “It boils down to security,” he says. “What are their risk limits, and how do they monitor them? Any risk lapses on the LP’s end will reflect poorly on the retail broker too, costing them their reputation.”

A loss of reputation in a crowded market might spell the end of a broker’s business. Add to this mix increasing sophistication amongst investors, and risk management becomes paramount. Brokers seem to be taking this into account.

“Many brokers are working towards reducing risk limits, incorporating tools like smart hedging to reduce their exposure.” Isbeer also explains that technology is playing a role in trading strategies. 

“EA activity continues to increase, along with other auto trading models,” he says. “Right now, I’d say the direction is towards AI and ML tool development, something that is impacting how brokers assess risk too.”

Interestingly, Isbeer explains that low volatility has given simple strategies the space to become profitable once again. He cites the Martingale strategy as an example of realising significant profit over the past year. While simplicity is playing well in FX, reduced volatility has reduced crypto demand in MENA. “Institutional demand for crypto is always present to a certain extent because retail brokers want them. We’re meeting that demand, but overall volumes have been sluggish,” Isbeer says.

Brokers are riding out the winter, he explains, focusing on offering those products via CFDs to their clients, and managing their risk appropriately. Isbeer is bullish about the growth of retail eFX in MENA.

“Regulation is only opening up further, and we’re seeing several EU and American institutions set up base in Dubai due to this,” he says. “Demand is increasing, both on the retail side and the institutional end. For now, MENA continues to show great potential, and I expect it to only grow from here.”