Having two stock exchanges in a market the size of Dubai’s has struck many investors as overkill. So when Dubai Financial Market (DFM), the city-state’s main bourse, announced late last year that it planned to buy NASDAQ Dubai, snapping up Borse Dubai’s 66.7% stake and NASDAQ OMX Group’s 33.3% in a US$121 million deal, it was met with many nods of approval.

Although DFM and NASDAQ Dubai will operate separately under one holding company and report to different regulators, the acquisition is expected to improve liquidity, lower brokers’ fees and attract more listings. This tie-up is also expected to lead to a merger with the Abu Dhabi Securities Exchange.

As NASDAQ Dubai’s securities commenced trading on DFM’s platform in July, Arabic Knowledge at Wharton spoke with Jeff Singer, NASDAQ Dubai’s CEO, about what consolidation means for the development of the Gulf’s nascent financial markets that are "in evolution, not revolution," including its ability to attract more international institutional as well as retail investors.

An edited transcript of the conversation follows:

Arabic Knowledge at Wharton: Why is the consolidation happening now and what are the main benefits?

Jeff Singer: Now is a perfect time as equity volumes are low. If you are going to be making major changes in your markets, the time to do it is when there is the least risk because the volumes are low across the GCC (Gulf Cooperation Council). If you look at strategic reasons in terms of timing, the UAE and Qatar recently were turned down by [stock market index provider] MSCI to be [in its emerging markets index] and if you look at NASDAQ Dubai in the UAE markets, we qualify immediately. So Dubai Financial Market has acquired a full market that is "MSCI emerging market" compliant.

For NASDAQ Dubai, it has been a tremendous benefit because we now have access to DFM’s retail liquidity pool. That was our weakness. We were not attracting enough retail investors and that’s important because institutional investors follow retail investors. If you want a deep liquid market, you have to be able to attract retail first, then institutional.

Arabic Knowledge at Wharton: Why wasn’t NASDAQ Dubai able to attract retail investors?

Singer: We had a model that catered to institutions in the West. While these investors appreciated our model, retail investors here found it different from DFM, which they were used to. It was that difference that created the trading "friction" that stopped them from appreciating the stocks listed on our market. With the consolidation, we have taken every reason off the table for a retail investor to not trade on NASDAQ Dubai.

Arabic Knowledge at Wharton: Why were there no more listings on your exchange?

Singer: DP World listed in November 2007 and Depa in April 2008. Damas listed in July 2008, then Lehman collapsed in September 2008, effectively halting our entire pipeline. We had some companies ready to list in November and December that year, but they postponed their plans. In 2010, we have companies that I was meeting with when I came here two years ago and are now reengaging in conversations about going public again.

Arabic Knowledge at Wharton: Do you expect to attract more listings because of the acquisition and if so, when?

Singer: We are seeing activity now. We hope to see some listings in the fourth quarter of this year and certainly through 2011. We’re looking for companies from all over the Middle East and North Africa, and South Asia. The markets are improving. Capital raising on NASDAQ Dubai enables a company to not only tap international markets — London, the U.S. and Hong Kong — but also get retail investors, who understand and appreciate that company.

Arabic Knowledge at Wharton: Will a merger with the Abu Dhabi Securities Exchange be the next step and is it needed?

Singer: From a business point of view, as I’ve said before, it will be good for the UAE. Any time you consolidate all the issuers, investors and brokers into one pool of liquidity, trading liquidity always increases. When it increases, the companies get a fairer valuation, and that’s what you are seeking. Bringing all the companies from the exchanges together would reduce the costs for brokers and investors, and the regulatory voice from the exchanges could become one voice as opposed to two. Also, the market isn’t big enough for more than one exchange.

Arabic Knowledge at Wharton: How important is the upgrading of Gulf markets to MSCI’s emerging market index?

Singer: It is very important because many institutional investors have mandates to invest in emerging markets. If you are an emerging market fund, you can legitimately overlook the UAE because it’s not an emerging market. As soon as it is reclassified as an emerging market, that fund will put money in and start allocating more and more of its assets to this market. If it does reclassify, money will come to this market, in billions.

Arabic Knowledge at Wharton: MSCI mentioned two issues for not reclassifying the UAE as an emerging market: Foreign ownership restrictions and the need to set up separate trading and custody accounts for institutional investors. Do you think these issues are going to be tackled and are there any other issues?

Singer: The dual account structure requires an international investor to transfer assets from a custody account to its trading account before the trading occurs, which is an extra step. This operational difference is discomforting to many international investors and it is linked to a larger issue. In the GCC markets, before the trade occurs, the shares need to be in the account and money needs to be with the broker. MSCI was giving an indirect message that the T+2 settlement cycle in the GCC is not in harmony with the T+3 cycle that the West is used to. It’s an operational issue that has ramifications for technology and broker policies and some regulations have to be looked at. It is a philosophical difference. With Sharia law, you can’t sell something you don’t own and you can’t buy something you haven’t paid for. It might be difficult for a Sharia scholar to be comfortable with a T+3 settlement cycle [in which investors must complete their transactions in three business days].

Foreign ownership can be an issue. It is a philosophical difference. It might be easier to change the rule for certain industries one at a time. There are certain national assets that countries might want to preserve, such as telecoms and airlines. You can preserve your national assets and offer more flexibility for other assets. Even in developed markets, publicly held companies that are national assets have foreign ownership limits.

Arabic Knowledge at Wharton: Does the Gulf region need foreign investors?

Singer: The answer is an emphatic yes…. International investors are not looking to own majority shares of companies here. They are looking for alpha higher in emerging markets than the benchmark indices of the West. This market is very interesting for them from a returns perspective. Institutional investors come with a lot of liquidity and shares. Together, they balance the market. If it’s all retail, the price is volatile. If it’s all institutional, prices don’t move.

We need short selling because if institutional investors realize there is something wrong in the world, instead of pulling their money out, you want them to change their strategy. You want them to hedge their positions and go short the market, but stay in because as soon as you go short, someone will have to go long.

If you are going to have a bear market, you want to have a healthy bear market. A healthy bear market is a market that is going down but has strong volumes, and that means investors are staying in the market.

Arabic Knowledge at Wharton: How important is short selling for this market?

Singer: It is very important. One of the main weaknesses of the GCC is that you can only make money when there is a bull market. As soon as market sentiment shifts and the markets start to decline in a bear market, you have to pull out if you can’t make money. We witnessed that in 2008 when problems started to occur and Lehman went bankrupt. International and local investors had to pull out. The worst thing that can happen to a market is a full-scale liquidity drain. If the market is going down, you want short sellers there making money, because the market will find its valuation faster than if you let it go down over an extended period of time in an uneven manner. Short sellers enable the market to find its parity and find its natural position faster.

NASDAQ Dubai allows short selling. The rest of the GCC is looking into it to try to understand how to incorporate Sharia law so that exchanges can satisfy those requirements.

Arabic Knowledge at Wharton: What are the plans for second-tier listings?

Singer: If you look at the demographics of the Gulf, the preponderance of companies are small to mid-sized enterprises [SMEs]. So there needs to be some sort of facility that enables those companies to access capital markets. They raise a lot less capital, might access the market more frequently and certainly find a different investment pool than the larger companies, but these companies are known and need to access to capital.

We want to put out some new listing frameworks. Once it comes back from consultation, NASDAQ Dubai will have a full framework to list these SMEs. We expect that to happen this year. SMEs might raise [anywhere between] US$30 million and US$100 million.

Arabic Knowledge at Wharton: How has transparency improved in the Gulf?

Singer: It is getting better. The UAE is a market in evolution, not revolution. These things take time…. In time, they will see that investors putting money in the market are on the same side [as them].

Arabic Knowledge at Wharton: Is there competition between the Gulf’s exchanges, such as Qatar’s tie-up with NYSE Euronext and Dubai with Nasdaq?

Singer: The competition is very healthy. You want people to be innovative. You want the financial centers and exchanges to be customer-focused and driven by the market. The issues of scale and cost provide opportunities for collaboration, but you have to have competition in the beginning.

Arabic Knowledge at Wharton: Do you foresee a consolidation of the GCC’s stock markets?

Singer: Sweden, Norway, Denmark and Iceland operate off of one trading book. All liquidity is consolidated into one order book, but some functions are kept separate. That enables a country to keep its exchange’s identity and preserve its capital markets. It is very easy to see how the Abu Dhabi Securities Exchange could join DFM and NASDAQ Dubai, but keep its identity alive. For example, Bahrain and Oman could join us, but keep clearing and settling separate. Everybody benefits if there’s a bigger liquidity pool and it will benefit everyone exactly the way it has for the Nordics. In my view, it is something that should happen eventually and it is not a question of if, but when.