The Financial Action Taskforce (FATF) has put the UAE on the gray list, which means there are deficiencies in the country’s corporate governance and regulatory regimes. The placement means that the country gets the opportunity to swiftly resolve gaps in the system to prevent money laundering and terrorist funding, among other things. The decision also entails increased FATF monitoring of UAE.
The FATF action is, however, not expected to have any serious implications for the country’s economy, although it could raise the cost of funding for UAE-based entities. The placement also recognizes the UAE’s political commitment to work with the FATF to strengthen its effectiveness in AML and combating the financing of terrorism.
According to rating agency Standard & Poor’s, while there will be only minimal impact on the economy, the placement on the gray list could increase the cost of foreign funding and potentially make financial transactions more onerous due to additional checks and compliance requirements. It has certain other implications, such as reputational risks for the country, given its role as a regional leader for business innovation and foreign funding.
Over the past few years, the UAE has implemented reforms, particularly to increase supervision of the real estate sector and precious metals dealers. S&P notes that mortgages represented 23 percent of Dubai residential real estate demand in 2021 compared with 19 percent in 2019. Moreover, according to reports, the country confiscated $625 million last year under efforts to prevent money laundering and illegal precious metal transactions.
According to S&P, the gray listing is unlikely to significantly affect the UAE because it is a net exporter of capital to the rest of the world and not dependent on external funding. Inclusion on the FATF gray list would be more serious if the UAE had a weak external position, requiring external funding of current account deficits and support to prop up its foreign currency reserves, but this is not the case.
The agency notes that the UAE economy as a whole is in a very strong net external asset position of over 200% of GDP. The economy also doesn’t depend on foreign direct investment (FDI), another channel that may be affected by inclusion on the gray list, with a small annual net FDI outflow of about 1% of GDP.
That said, the banking and public sectors have relatively high external debt levels, which are more than offset by external assets. Inclusion on the gray list may reduce demand for this debt, with implications for financing costs, but the agency does not expect this to be material.
It is further pointed out that the UAE corporates secure most lending from the domestic banking system, while their debt capital market activities, particularly outside government-related entities, are limited. Any hypothetical increase in cost of funding would mean higher borrowing costs for corporates, but this is not expected to lead to any disruption to trade finance with implications for export/import business in the country.
Likewise, the gray listing is unlikely to significantly disrupt banks’ business or credit profiles. S&P notes that UAE banks have a significant gross external debt position of 23.6% of total assets at Sept. 30, 2021. Banks also held significant external assets at the same date, leading to an overall net external asset position. In addition, they enjoyed strong profitability, with a return on assets ratio of 1.2% at year-end 2021. In fact, according to S&P, the UAE banks stand to benefit from expected higher interest rates with, average profit rising 15% for every 100-basis-point rate increase. Although the gray listing might increase the cost of external debt, UAE banks have ample margins to withstand this.
The same is more or less the case with the insurance sector, which is not expected to be affected much by the gray listing. In October 2020, UAE authorities announced the merger of insurance regulator Emirates Insurance Authority with the Central Bank. This is considered as a positive move as it could strengthen the regulatory oversight and enforcement of applicable laws relating to prudential regulations, AML, and other compliance requirements.
About 80% of total gross written premiums (GWP) in the UAE insurance sector are generated from property/casualty business, which is typically considered low risk for money laundering. Listed insurers mainly have local investors or shareholders and no or very limited debt. While the UAE-based insurers do have exposure to foreign investors and business partners, the gray list placement is not expected to lead to enhanced AML checks or other vetting requirements in the short term as controls already in place are considered adequate.
Also published on Medium.
