Kuwait Financial Centre S.A.K “Markaz” recently released an update to its April 2010 report on the Kuwait Capital Market Law in which it benchmarked against Saudi experience with the same in terms of market expectations. A year later, Kuwait found itself in the midst of implementing the Capital Market Authority (CMA) Law and its Regulations, with all related stakeholders still trying to gain a grip on the issue and its various implications.
CMA provisions affect different players via different modes. Major impact of CMA provisions are observed for the fund industry with implications for other players such as investment bankers, listed companies and service providers. The gamut of impact range from operational to procedural and in some cases tend to impact the business model itself.
The authors have identified 21 issues regarding the various regulations and laws issued by the body. The majority of these relate to Fund activities, with an even split between Business model, Operational and Procedural issues.
The authors make a few broad contextual remarks before delving into the findings of the report. The Capital Market in Kuwait, and to a great extent in the region, has always been one- dimensional (equity focused). The organic growth of the market (measured in terms of number of companies listed and growth of liquidity) has always been weak and hence stock market (an important constituent of capital market architecture) remained a place to do some speculation and little capital raising (measured in terms of rights issue). The broad stock index composition never mirrored that of the broad economy. Banks were the main financial intermediary and were well represented in stock markets as well. However, with the financial crisis more than 4 years behind us, banks have developed caution (read: risk aversion). This will mean that financial intermediation will now shift in a serious way directly to capital markets with companies using it as a venue to raise alternative capital. Also, companies would require debt as much as equity and this means the role of capital markets will become multi-dimensional; all of which adds up to tough responsibilities for a new regulator.
The launching of a CMA is more of a flow than a stock. It gains momentum over time and gradually gains pace. A strong and rigorous coordination among various stakeholders will make sure that this is not a false start.
Following an in-depth analysis and study of the CMA Regulations and their impact on various areas of the financial sector, the authors have provided suggested action steps for the CMA to follow in order to ensure a smooth transition to full compliance. These suggestions are both macro and specific in nature:
The CMA should
- The CMA should require full disclosure of board member involvement in other firms, in addition to monitoring those individuals or groups which have a wider degree of influence on the market. This would be more effective than instituting a ban on cross membership.
- The CMA has highlighted the equity conflicts of interests. They also need to enhance clarity on debt conflicts of interest and the regulatory stance to mitigate them.
- All funds (foreign or domestic) need to be routed through CMA. Establishment of a fast track clearance for a fund vetted by a foreign regulator would be useful
- Promotion and selling expenses of the fund are to be borne by the Fund Manager. Realistically, the fund would pay this directly or indirectly, it is essential to prevent mis-selling and regulate the items of expenditure rather than who bears it or the amount.
- Needs to elaborate on the role of cash as part of the Fund’s objective. Holding cash is a function of the market condition and the fund’s strategy. For e.g. an opportunistic fund may hold cash for a significant time waiting for the right opportunity
- During extreme market conditions, the fund manager may have to take decision in minutes. Role clarity is needed on the ability of the Fund Manager to make unilateral decisions without waiting for the Board to convene and decide
- Issue explanatory circulars to fully flesh out the restrictions placed on Board members in terms of participation in Funds and entities
- Clarify the duties expected of Board members, qualifications and any limits placed on the same in terms of membership on other Fund boards which may produce conflicts of interest.
- Application guidelines are needed to enable the fund manager to do adequate reporting rather than over or under reporting.
- Concerning appointment of auditors; Kuwait may not have enough qualified external auditors to handle all the funds. This coupled with frequent changes, once in 3 years, may dilute the rigor of audit
- If a licensed person manages more than one mutual fund, they must separate the management and the operations of each fund. Segregation of the back office is a must but the CMA also needs to encourage segregation of portfolio management from trading activities.
- Provide clarity on the process by which Fund Managers are chosen (by the CMA) in the event that unitholders have voted to oust the current manager
- Provide clarity on margin lending regulations and whether they contradict the CBK circular requesting firms to disengage from lending activities
- Issue an explanatory note on Article (147) in regards to fee sharing and discounts and whether they are permissible or constitute an incentive
- CMA needs to issue selection criteria for the critical positions. Employee holding more than one registered function should be a stop gap arrangement rather than a norm.
- CMA may require passing a qualifying test to fill the registered functions. The qualifying criteria needs to weigh in experience and have a provision for upgrade exams/portability of international certifications
- Consider lowering regulatory costs related to listing, licensing, M&A etc, in order to improve compliance among firms and not discourage activity
- Clarify the 30% “takeover trigger” as it could be the result of a passive action for e.g. rights issue, increased treasury shares etc
- Issue regulations concerning minority squeeze-outs and drag-along rights, particularly as they relate to the “30% takeover trigger”
- Share holders having portfolio accounts across firms may need to aggregate their holdings and disclose it to the regulator or Investors need to have unique investment numbers/identifiers identifying them as the beneficial owner.
- CMA should clarify Broker business practices, Brokers should be adequately monitored with the CMA spelling out fines and penalties for unethical behavior
The creation of the CMA has impacted four distinct stakeholders; namely, Funds, Investment Companies, Corporates, and Service Providers.
The CMA regulates fund activities and their operations in terms of models, governance, capital raising etc through various executive regulations. There have already been a great deal of issues and questions from fund managers and investment professionals concerning a few of the articles contained within the law which either require clarification or are contentious and seen as prohibitively restrictive. Consequently, the CMA has already begun issuing explanatory papers to clarify some of these issues before the respective deadlines.
Moreover, many aspects of the Private Equity (PE) model are coming under question here as the CMA Fund regulations are almost entirely opposite to the “normal” functioning of a Private Equity Fund. These aspects include Capital Raising (whereby Drawdowns are prohibited) in addition to structure issues (such a Board membership and control).
Various other elements of Fund Management are affected by the regulations including governance, capital raising, unit-holder activism etc.
2. Investment Companies
The CMA regulations provide many guidelines and stipulations which will affect the portfolio/wealth management and Investment Banking industry in the country. Disclosure and increased client information are high on the regulations list of stipulations. Additionally, restrictions are placed on margin lending. By regulating margin deals, the CMA is sending a clear message that all activities related to the securities industry are under its purview. The margin lending segment needs to factor in that the Central Bank has sent a circular to investment firms requesting them to segregate the investment management aspect from the lending aspect. It is unclear if margin lending would also be construed as lending.
Additionally, from the investment firm’s end, the CMA regulations are unclear as to whether fee sharing or the discounting of fees is permissible or whether the same is to be considered an incentive. Most financial institutions also have employee incentive schemes linked to sales. Furthermore, it is common industry practice to have selling agents and institution level sharing of referral fees.
Prior to CMA, Mergers and Acquisitions were not regulated efficiently meaning that small investors did not always have all the information to act on offers. The current regulation has protective clauses to safeguard the interests of small investors. Acquisition of a significant stake in a listed company tends to bring change in management and hence warrants regulation and fair play. During such acquisitions, it is important to protect the interests of minority shareholders by treating them in an equitable manner while at the same time avoiding the tyranny of a small malevolent minority.
The provisions of acquisition will involve both listed companies and unlisted companies. It is quite possible that a listed company takes over an unlisted company and vice-versa. The CMA regulations will come into play in all such circumstances except where an unlisted company takes over another unlisted company.
4. Service Providers
Currently, we have 14 registered brokers in Kuwait and the new CMA law is entitled to offer licenses to any person who fits the rules and regulation. To become authorized, a Broker would have to pay a license fee and an annual service fee. It is premature to argue that the new provisions will induce a proliferation of brokers as happened in Saudi Arabia. Pursuant to the launch of Saudi CMA, the number of authorized brokers swelled from a modest 8 in 2005 to more than 100 by 2010. At the same time, value traded (which actually provides business to brokers) slumped from USD 1.1 trillion to USD 338 billion leading to diffusion of business activity.
By reducing red tapes around setting up a brokerage firm the CMA would benefit from Licensing fee and annual service fees payable to it. It is expected that the number of brokerage firms will see an increase while commission fees are capped. However, brokerage firms may resort to churning and other unethical activities to boost the bottom line. From a customer perspective competition is healthy and so we may see a differentiation in services provided whereby brokerage firms could offer training, company research and investment strategies to clients based on risk tolerance thereby increasing the sophistication of the investor base.
All in all being liberal in handing out licenses should go hand in hand with being liberal in revoking licenses when brokerage firms stray.
For more details on the report, visit www.markaz.com/research
About Kuwait Financial Centre “Markaz”
Kuwait Financial Centre S.A.K. 'Markaz', established in 1974 with total assets under management of over KD 865 million as of December 31st, 2011, is the leading and award winning asset management and investment banking institution in the Arabian Gulf Region. Markaz is listed on the Kuwait Stock Exchange (KSE) since 1997 under ticker Markaz.