To leap or To Lag - Choices before GCC regulators


Kuwait Financial Center (Markaz), in its recently published report has provided a roadmap to the Capital market regulators in the GCC region. The report ranks eleven capital markets in the GCC, MENA and BRIC region across eight parameters. As per the study, India and Egypt lead while Bahrain and Qatar lag. The ranks are provided using a combination of qualitative and quantitative parameters that serve as a gap analysis among the practices followed in the capital markets located in GCC, MENA and the BRIC region. According to M.R. Raghu & M. Amrith, authors of the report, GCC capital market structures and the regulatory environment need to bridge many gaps to realize the aspiration towards developing into full fledged financial centers. The report has been divided into issues of paramount importance for a healthy capital market including the Capital market authority, Capital market law, structure of stock exchanges, foreign investment, and institutional participation among others. All the eleven markets taken into analysis have been compared on a scale of 0- 10, where by 0 implies poor and 10 implies the best. The eight parameters which are discussed in the report are: Capital Market Authority (CMA) The author’s argue that the Capital Markets need to be regulated by an independent regulatory authority as is the case with developed capital markets. The relevance of this issue in the GCC context is more profound as the report points to some GCC markets operating without a CMA or markets regulated by governmental bodies. The report provides a list of structures that is followed by the eleven markets. In the ranking for CMA, Brazil tops the list followed by Egypt and China. In GCC Saudi Arabia, UAE and Oman have formal CMA’s. The Bahrain stock market is overseen by the Central Bank of Bahrain and Qatar has an internal market regulating committee within the Doha securities market. Kuwait has various governmental institutions overseeing the functions of the capital market. Capital Market Law (CML) The report brings out the fine line dividing operational documents to a well documented CML. A CML is a tool which provides authority and responsibility to a group of people and states clearly how it will regulate the securities industry and also take care of the interests of investors at large. The report examines two factors: availability and duration of existence of CML. In the context of GCC markets, it has been noted that some of the markets are currently operating without a well framed Capital market law. Stock exchange Some of the stock exchanges enjoy over a century of existence! (Brazil, India and Egypt) while others like Qatar and Russia have been in existence only for a few years now. Among GCC, Kuwait had a head start having established its stock exchange in the year 1983 followed by Saudi Arabia and UAE in 1984. The stock exchanges in the GCC region are also predominantly owned by governmental bodies whereas they are free standing corporate entities in the BRIC region. BRIC markets offer a wide range of products including cash and derivative products. Egypt and GCC countries lag behind significantly on this. Only Kuwait provides limited derivative products (call options and futures), while debt market products are virtually absent. However, GCC markets showcase strong systems and have lower settlement cycles. When benchmarked with BRIC’s, GCC region has higher costs of brokerage and commissions. Information disclosure The stock exchange is the most favored and first point of contact for investors on information concerning companies listed on its exchange. The report provides a ranking on the level of information disclosure by various stock exchanges in the eleven markets. The report portrays the wide variations between the regional stock exchanges on the information disclosure front and compares it to BRIC exchanges too. Primary market The report throws light on the various pricing mechanisms available for an Initial Public Offering (IPO) in eleven markets. The report notes that GCC markets lag behind the BRIC markets in terms of sophisticated pricing mechanisms for pricing IPO’s. The report argues that the practice of fixed price mechanism has started showing its negative impact in the GCC markets. The under pricing and the high appreciation rates in IPO’s have created an expectation among investors that all IPO’s will lead to super normal profits. Foreign Investments In the GCC context, the subject of Foreign investor participation has always been a sticky issue. However, it has been proved by studies that on a longer term basis, opening up of the market to foreign institutional investors enhances the profile of market and also brings in new capital into the economy. The report provides a comparative study of the various rules and limits followed in the various capital markets. GCC stock markets prohibit foreign investment in varying measures. While some stocks are off-limits even to GCC citizens, others are off-limits to foreign investors. It can be seen that Saudi Arabia is the most closed market while Bahrain is the most open stock market to foreign investors. Most of the BRIC economies have liberalized their economies in the last five to seven years and have welcomed foreign investor participation. This had led to a steady growth in the capital markets during the same time frame. Egypt has the most liberalized norms for foreign investment, followed by China and India. Institutional Investments The Author’s argue that higher the institutional investments in a capital market, the higher will be the stability of the markets over long periods of time. The report showcases the level of institutional participation in each of the market and also provides a ranking on the same. In the GCC context, calculating the extent of institutional participation is rendered difficult due to lack of organized data. It is estimated that Saudi Arabian institutional investors constitute about 10% of the investor base. GCC markets continue to witness lower institutional participation. This phenomenon can again be tied back to various other parameters such as access to the markets and also the availability of breadth for financial institutions to operate. Among the BRIC’s, Brazil and China lead the pack. Market breadth & depth Thanks to the booming GCC economy, there have been a sizeable number of additions in the number of companies over the last 3 – 4 years. This is in comparison with a net decline in the number of companies available for investors in the BRIC region. However, still the BRIC markets continue to offer higher absolute breadth in comparison to the GCC markets. Road Map The author’s believe that even though, the GCC Capital markets have taken small steps to specifically address issues of market volatility, there are larger and more structural issues which need a great deal of attention from the regulators. Some of the GCC markets in the recent past have allowed foreign residents to trade directly in the exchange and have also unveiled tougher provisions against insider trading. Coupled with this there has been a heightened monitoring over Banks exposure to the stock market through consumer loans. However, the report believes that there are more vital issues which are calling for attention. Issues such as formation of regulators, ensuring that there is no conflict of interest between the stock exchange and the regulator, drafting law’s to protect investor interests, increasing the number of products in the stock exchanges, reducing transaction costs, providing various means of IPO pricing and enhancing information disclosure by stock exchanges are believed to be of outmost importance. The execution of these factors will facilitate an increase in participation of institutional and foreign investors, which will in turn lead to longer term sustainability and growth of the GCC markets. About Markaz Kuwait Financial Centre 'Markaz', with total assets under management of over KD1.20 billion as of December 31, 2006, was established in 1974 has become one of the leading asset management and investment banking institutions in the Arabian Gulf Region. Markaz was listed on the Kuwait Stock Exchange (KSE) in 1997; and was recently awarded a BBB+ corporate rating by Capital Intelligence Ltd.