Does the Gulf’s trillion-dollar growth story have a hedging problem?

A treasurer in Europe can usually hedge long-term debt exposure quickly. In contrast, those in Dubai or Riyadh often face more difficulties, especially with large or multi-year hedges. Even though the global derivatives market is worth hundreds of trillions of dollars, companies in the Gulf have far fewer options to manage these risks. As more regional companies expand abroad and take on currency, interest rate, and commodity risks, this gap is becoming more important.

THE MISSING LAYER OF LIQUIDITY

The gap between what Gulf corporates can do and what their Western counterparts take for granted is, depending on who you ask, either a structural problem or a cultural one. David Jenkins, Market Development Manager for Commodities at Tradition, directly challenges the premise. “There are an increasing number of hedge funds and trading houses based in the UAE in particular, so there is a large trading fraternity now active, and there isn’t really what you would call a hedging or liquidity gap,” he says.

The locally owned, predominantly state-owned GCC companies tend to be conservative by nature, and some suspicion of derivatives persists. However, Jenkins notes that this has been changing in recent years, as state-owned companies and financial institutions have increasingly set up trading divisions to optimize and capitalize on their trade flows. “I would call it more of a cultural gap than a hedging gap,” he says.

Rohit Gehani, Structured Products Advisor based in the UAE, sees the structural constraints in more specific terms. A European corporate with long-dated debt exposure, he says, “could use various hedging strategies at their disposal at razor-thin bid-ask spreads with minimal collateral strain due to standardized ISDA/CSA clearing frameworks.” For Gulf corporates, “the picture is vastly different.” Executing long-dated hedges of seven to fifteen years in local currencies such as the Saudi riyal and UAE dirham, or secondary MENA currencies like the Egyptian pound, “is fraught with illiquidity,” with bid-ask spreads widening dramatically beyond a three-to-five-year tenor.

On options, because the UAE and Saudi stock exchanges “lack active, liquid options markets, corporate equity desks, and treasury units cannot buy tailored option protection,” including caps, collars, and swaptions, leaving non-linear risks difficult to hedge. On capital, while Western peers “use central clearing and two-way margin (ISDA SIMM) to optimize capital usage,” Gulf corporates “often face heavy credit-line consumption or steep initial margin demands from single-bank OTC desks because deep interbank market-making does not exist locally.”

THE REAL CONSTRAINT

On whether Islamic finance or market structure is the primary constraint, the consensus leans clearly in one direction. Hasan Haider, Founder and Managing Partner at Plus VC, says, “The majority of the gap likely exists due to the unavailability of products and participants in the area, not anything to do with Islamic finance,” adding that “there are structures that could be applied using Shariah principles if there was the right demand and supply.”

According to Jenkins, the issue is “more of a mentality issue which comes from a naturally conservative nature,” and the fact that until recent years the range of financial instruments available in the GCC was limited. He notes that there are now “liquid local Bonds, Capital, Equity and FX markets in most of the local Middle East countries.”

Gehani provides a detailed breakdown, stating that the underdevelopment is “heavily leaned towards market depth and participants rather than Islamic Finance constraints.” The buy-side in the GCC is dominated by sovereign wealth funds, long-only regional institutions, and high-net-worth individuals, “few of whom actively trade derivatives or act as two-way market makers,” with liquidity concentrated in MSCI EM and MSCI MENA index constituents and “virtually no secondary market liquidity” outside those names.

The Islamic finance framework, meanwhile, “is no longer a fundamental blocker,” with standardized structures such as Wa’ad and Islamic Profit Rate Swaps, documented under ISDA and IIFM, having “successfully replicated conventional swaps and caps.” What Islamic structures do add, however, is “operational friction and cost”: a multi-stage Murabaha or Wa’ad trade requires underlying asset transfers across commodities, real estate, or local shares, “creating execution lag, transaction fees, and administrative overhead that conventional OTC trades avoid.”

THE DERIVATIVES PUSH

Jenkins says progress is already being made to build markets and instruments tailored to the Gulf. “The CME launched a joint venture with the government of Dubai, the Dubai Mercantile Exchange, several years ago to try and attract new financial instruments based on local GCC markets,” he says. More recently, “the Saudi government has joined this venture, which is now called the Gulf Mercantile Exchange.”

He believes the broader development of the region’s capital markets is also helping address some of these gaps. “The Dubai Financial Market (DFM) is now capitalized at over AED 1 trillion and the Abu Dhabi Securities Exchange (ADX) is now capitalized at over AED 2.8 trillion,” Jenkins says. With a steady flow of state-owned companies being partially privatized, he says, “it has created an exponential growth of the local capital markets.”

For Jenkins, this reflects “an increasing awareness by regional governments to grow markets specific to the Gulf.” He believes the next stage of that development will come from the private sector, with “locally owned private companies” beginning to float on regional exchanges “in a meaningful number.”

Haider says the response to these gaps is increasingly coming from both fintech startups and established financial institutions. “There are many fintech startups that started in various areas to serve corporate clients that have seen this area as a place to expand into,” he says, while financial institutions are also looking to deepen their relationships with existing corporate clients by exploring the space.

He also believes the market is still in an early experimentation phase, with different players testing where the biggest opportunities lie. “It’s likely any dominant player will emerge from early experimentation in the space,” he says, suggesting that the platforms and business models that ultimately address the region’s gaps may be shaped by this initial wave of competition and experimentation.

Gehani says exchanges and regulators are “laying the pipeline,” although institutional adoption is still lagging. He points to growing activity across the region, with Boursa Kuwait, Saudi Exchange (Tadawul), Dubai Financial Market (DFM), and Abu Dhabi Securities Exchange (ADX) introducing exchange-traded derivatives, including “single-stock futures (SSFs) and index futures” such as FADX 15 and MT30.

He also highlights changes to market access as an important development. With Saudi Arabia’s Capital Market Authority removing the Qualified Foreign Investor (QFI) regime and phasing out mandatory P-Note structures, “foreign capital can access the market directly,” Gehani says.

However, he believes the infrastructure is still ahead of actual institutional usage. “Exchange-traded single-stock futures remain thinly traded compared to cash markets,” he says, with institutional players yet to use them at scale because “position limits are restrictive.” In contrast, liquidity remains concentrated in a handful of market leaders rather than spreading across the wider exchange.

RATES, COMMODITIES AND RISK

Gehani believes that interest rate swaps and similar products are what businesses in the region need most right now. He highlights the fast growth in real estate, logistics, energy, and Vision 2030 mega-projects, much of which is financed by group bank loans and loans with variable interest rates. “Rates higher than usual have made switching to long-term fixed rates a practical must,” he says.

He thinks that without solid rate-hedging options, companies are at risk from changes in the global yield curve. “Without deep rate-hedging pools, corporate balance sheets remain exposed to global yield curve shifts,” Gehani says.

Foreign exchange derivatives are less urgent in the GCC, as the region’s dollar pegs help shield against currency swings. However, he says these tools become more important when GCC companies trade with Europe, Asia, or other growing markets in the MENA region. “The gap becomes critical when GCC corporates trade with Europe, Asia, or broader MENA growth markets,” he says. He also points out that “long-dated cross-currency swaps beyond 12–24 months are expensive and illiquid.”

Haider says that currency forwards are already common among larger regional companies, especially since the GCC is “heavily an importer of finished goods.” He thinks most of this need is already covered by existing banking relationships, so the more urgent gaps are now in other areas.

Haider is noticing increased demand for both commodity derivatives and interest-rate hedging tools in today’s market. “We’re seeing the emergence of the need for commodity derivatives and interest hedging tools in the current volatile environment we find ourselves in,” he says. He thinks these tools could become even more important as regional businesses face greater market volatility.

Jenkins says the main challenge in the region is not a lack of liquidity, but a lack of awareness about how businesses can use these instruments. “I don’t think there is really a gap in terms of trading liquidity but more a gap in understanding the opportunities available by using those instruments,” he says.

He believes this knowledge gap is closing quickly, especially as the UAE brings in more global financial institutions. “This knowledge gap is closing fast as the UAE, in particular, attracts financial institutions,” Jenkins says. The growth of the Dubai International Financial Center (DIFC) supports this. “The DIFC is at around 97% capacity right now and is urgently building new offices to house expected new entrants to the region,” he says. This shows the financial ecosystem is growing and more expertise is entering the market.

THE PRICE OF IMPERFECT PROTECTION

Jenkins points out that many local companies still depend on long-standing relationships with banks for hedging solutions. He explains that while this is common, it can limit their ability to get the best deals. “It often doesn’t give them access to the best prices and liquidity.”

He thinks companies need to change how they think about market access and become more comfortable using exchanges and brokers directly. “There needs to be a change in mindset to change this and an embracing of access directly to the market either via exchanges or brokers,” he says. However, he notes that local business culture can be a barrier, since paying commissions is sometimes seen differently. “The payment of commission is a local custom that hinders this to an extent,” he adds.

Haider explains that bigger companies can usually rely on their banks for hedging products. “Most companies of a certain scale are likely to have products offered to them by their existing banking relationships,” he says. He sees the main gap in the middle of the market, where it is not always profitable for banks to offer these products. “The gap exists in the middle of the market, mostly where these products aren’t profitable to offer by the existing financial system.”

Because of this, smaller businesses often have to use less formal or more costly options. Haider says, “The alternatives present are informal or quite expensive,” and for many small companies, the cost of proper hedging tools is hard to justify compared to the risks they face.

Gehani adds that companies still use a mix of options when exchange-traded options with deep OTC markets are unavailable. One solution is to use custom bank structures, like “Delta-1 or Delta-2 structures,” including total return swaps. But he notes these can get very expensive once balance-sheet costs are included, especially for non-index names.

He also mentions Participatory Notes (P-Notes), which foreign investors once used to access Saudi equities. Now that direct foreign investment is more common, there is less need for P-Notes. “P-Note programs became operationally cumbersome,” he says, with high maintenance fees and extra administrative work.

Another option is proxy hedging, where traders use widely traded international instruments to hedge local risks. However, he warns this brings significant “basis risk,” since the proxy can move very differently from the local stock or project during market stress, leaving companies exposed when they need protection most.

For some companies, the easiest choice is not to hedge at all. “Many regional corporates simply choose not to hedge non-linear or long-dated risks, keeping higher cash buffers on hand,” he says. While this offers some protection, Gehani points out that it can lead to “capital inefficiency” and lower Return on Equity (ROE).

A MARKET IN THE MAKING

Jenkins says the region’s derivatives market is starting to develop, helped by available capital, supportive regulations, and a business-friendly environment. “I think it is already starting to happen,” he says. “There is a lot of money tied up in sovereign funds in the area, and this is attracting banks, trading houses and brokers.” He adds that government support, low taxes, and fewer regulations than in the West make the region appealing to financial firms. “Along with the sovereign funds, the area is becoming very attractive to start trading operations in,” Jenkins says.

He thinks it is hard to compare this region to other emerging markets, especially because of religious rules about financial products. “I am not sure what you mean by constraints, as generally the area is very welcoming to business,” he says. Jenkins explains that the region is finding ways to address these issues. “There are an increasing number of financial instruments that get around these constraints,” he says. “There aren’t really any similar regions where there have been religious constraints such as these to use as examples or templates.”

He says the main priority is building local central counterparty clearinghouse (CCP) infrastructure at a large enough scale to support OTC clearing. “CCPs eliminate bilateral credit limits between local banks and lower collateral requirements,” he says. This makes them an important foundation for deeper liquidity.

Gehani believes regulators should give better incentives to market makers. “Regulators must mandate or incentivize local and international primary dealers to quote continuous two-way prices with tight spreads,” he says, adding that this should be supported by stock-lending and borrowing frameworks. He also thinks institutional investors need to be more involved. Regional sovereign wealth funds, pension funds, and insurers should shift from passive investing to more active risk management and strategies such as writing options, covered calls, and providing liquidity.

THE GROWTH CASE FOR HEDGING

Gehani explains that closing the region’s hedging gap would do more than just cut transaction costs. “The shift extends beyond cost savings,” he says, noting it could also lower the cost of capital. Better risk-transfer tools might reduce the risk premium that international lenders require, thereby “directly reducing corporate borrowing costs.”

He also thinks that stronger hedging markets could help infrastructure and energy developers feel more confident about making long-term investments. With “longer project tenors,” developers could plan for 15- to 20-year spending cycles without facing unpredictable interest-rate or FX risks.

A stronger derivatives market could also make Gulf markets more appealing to global investors. Gehani points out that “global institutional investors, such as pensions and macro hedge funds, avoid markets where they cannot dynamically hedge downside risk.” So, deeper derivatives markets could help turn short-term foreign investments into “long-term strategic allocations.”

He adds that companies themselves would benefit from how they use their capital. Instead of keeping large cash reserves to guard against market swings, they could put that money into “M&A, R&D, and expansion across the broader MENA region.”

Haider says that closing the hedging gap would mainly improve risk management throughout the economy. He believes it would “result in a reduction in risk in areas which haven’t been hedged historically,” helping businesses manage exposures that were previously unprotected. For Haider, the impact goes beyond cost savings, as better access to hedging tools could reduce risks that companies have not managed before.

Jenkins believes the main benefit of closing the hedging gap is that it would help Gulf companies improve their business operations management. He says, “The main savings from the increasing embrace of derivatives would be the optimizing of business flows to reduce risk and maximize margins.”

For Jenkins, the impact is more than just a reduction in hedging costs. Using more derivatives could help companies manage risk more effectively, protect and even improve their margins, and make risk management a bigger part of their overall business strategy.