The Kuwait Stock Exchange (KSE) was one of the biggest casualties of the global financial crisis. The main index on the exchange fell almost 30% in 2008 before small investors won a court order to temporarily shut it down after complaining about the huge losses incurred.
The picture has barely changed in the past three years. The unweighted KSE index and the value-weighted index fell more than 16% year on year in 2011. Market liquidity averaged Kd24.5m ($87.6m), less than half its 2010 average, as the market shed more than Kd7bn of its capitalisation to stand at Kd28.8bn by the end of 2011. Meanwhile, 19 firms ceased trading during the course of the year.
The KSE ranked as the worst-performing bourse in the Gulf Co-operation Council (GCC) in 2011, and in August, the market’s main index slumped to a seven-year low. This disappointing performance has continued into 2012 with the KSE closing the first month of this year almost flat. The price index was up by a negligible 0.9% in January, while the value-weighted index was down 0.4%, reflecting a worse performance by larger caps. Even the country's banks’ broadly positive 2011 results, which were expected to buoy the market, have failed to turn sentiment around.
Indeed, investor appetite for stocks is at an all-time low due to a combination of particularly tight liquidity, low trading activity and the prevailing uncertainty over the bourse’s future.
Inception of the CMA
In February 2010, Kuwait’s parliament, the National Assembly, approved a capital market law that established the Capital Markets Authority (CMA) as an independent regulator for the KSE – more than 30 years after its creation. It grants the CMA the authority to enforce the regulations of the CMA law and to develop the supporting secondary legislation. In this way, it hopes to implement a watertight regulatory framework that will instil confidence in investors once again.
Kuwait is the last GCC country to introduce a market regulator, despite being one of the oldest and the third largest exchange in the Arab world (after Saudi Arabia’s Tadawul and the Qatar Exchange), with a market capitalisation of about $100bn and a total of 215 listed local and foreign companies. Yet the exchange has long been synonymous with rampant market abuses, such as insider and pump-and-dump trading.
“The government realised the importance of having the CMA as an independent institution to oversee the KSE,” says Central Bank of Kuwait (CBK) deputy governor Mohammad Al-Hashel. “Before, there was a stock exchange committee doing that role but it makes sense to introduce a new regulator.”
Indeed, Kuwait’s exchange has noticeably been losing out to its competitors in the Gulf in recent years due to its light-touch regulation. Its lax attitude towards disclosure requirements and corporate governance means the CMA now faces a gargantuan clean-up job. Industry observers are only too aware of this. More than a dozen senior Kuwaitis approached by the government reportedly declined the job of heading up the CMA. In the end, the head of the KSE moved over to take the helm.
Wide remit
The CMA’s regulatory remit covers the entire capital markets system, including clearing and settlement agents, asset managers, investment funds, financial brokers, custodians, investment trustees, financial advisers, issuers of securities and traders.
The authority’s bylaws came into effect in March 2011 with full implementation of the law scheduled for September 2011, although this deadline was subsequently revised to March 2012. However, the new regulator has already set about trying to raise the regulatory bar. No sooner had it started operations than it gave the KSE, brokerage companies and investment firms up to a year to comply with new regulations relating to ownership, capital increases, acquisitions, share offerings, disclosure and compliance.
The CMA also signed a memorandum of understanding (MoU) with the CBK in September 2011 to split the regulation of investment firms, whereby those operating in financing will be regulated by the central bank while those centred on investments and asset management will be supervised by the CMA. Investment firms comprise the bulk of listed companies on the exchange.
“We have signed an MoU with the CMA to draw clear lines between ours and their areas of supervision,” says Mr Al-Hashel. “And wherever there’s any regulatory overlap, we’ve worked out who the responsibility lies with. But we also have a permanent committee from our supervision department sitting at the CMA.”
It is hoped that this demarcation will lead to better regulation of both types of firms by having more specialised staff supervising each and by eliminating any blind spots.
Investment firm concern
The CMA had announced plans to tighten up the operation of investment companies even further through a new piece of regulation due to come into force in March 2012, which states that investment funds cannot hold more than 10% of their capital in a single stock nor can they own more than 10% of the securities of any issuer. However, the plans were met with strong hostility from industry participants who complained that this would force funds to offload good stocks in order to rebalance their portfolios.
“There were crucial concerns about the new investment limits that investment funds should implement,” says Majdi Gharzeddeene, head of investment research at Kuwait’s Kipco Asset Management Company. “Investors were under pressure and believed that the CMA regulations will force them to dump blue-chip stocks that would result in more market losses and reduced liquidity.”
Institutions have shown a propensity to invest in only a handful of the KSE's 215 listed companies, with many funds holding up to about 30% of their assets in a single stock, such as the country’s largest lender National Bank of Kuwait or telecom operator Zain. Indeed, there are only about 25 blue-chip stocks trading on the KSE, while there are also a large number of paper companies that are not operational and could be technically classified as bankrupt.
An outcry from investors initially led the deadline for compliance to be extended by six months to March 2012 but before this deadline could be met, the CMA amended the regulations in February 2012. The new rules state that a fund can invest more than 10% of its net asset value in any single security but may not exceed the corresponding security’s weight relative to the KSE’s total market cap. Meanwhile, funds specialising in a specific sector can invest more than 10% of its net asset value in any single security in the corresponding sector, but cannot exceed the percentage weight of the security relative to the sector market capitalisation.
“The new rules are more flexible and I do believe that institutional investors are regaining confidence in the market,” says Mr Gharzeddeene. “However, this will take some time since the KSE is still in a transitional phase.”
Privatisation plans
The CMA law also calls for the privatisation of the exchange. Fifty per cent of the bourse will be floated in an initial public offering for Kuwaiti citizens, with the remaining 50% sold to listed companies, each of which will only be allowed to buy a 5% stake in the market. This move will make it the second publicly traded bourse in the region, after the Dubai Financial Market. In January 2012, the CMA hired HSBC to act as an adviser for a period of six months under which the bank will begin the privatisation process.
“I think the privatisation of the KSE is a positive step,” says Mr Al-Hashel. “Let the people take ownership of the stock exchange – I want to see the private sector play a bigger role in the economy.”
It is hoped that the discipline of going through a listing process will help the KSE better understand the needs of companies on the bourse. It is also expected that it will help it transition to a more commercial organisation, as once privatised it will open the market for competition and there will be an onus on it to make money for a wide array of stakeholders and not just the government.
“Privatising the KSE and listing its shares on the bourse following its restructuring will result in more efficiency and independence in its operations,” says Mr Gharzeddeene.
The KSE is also in the process of upgrading to the Nasdaq OMX system after signing a Kd18.3m contract with Nasdaq, the second largest operator of US stock exchanges, in October 2009. This will link the exchange with clearing companies and brokers in order to provide a holistically transparent system that can help mitigate stock manipulations.
“The new trading system will be launched on May 13 this year, along with the new flagship index 'Kuwait 15' and the new sectors classification,” says Sara Abdel Samad, a consultant for the technical bureau department at the KSE.
Crucial cog
The KSE may only comprise one cog in the government’s privatisation agenda, but it is a crucial one. The delayed implementation of the country’s five-year economic development plan spanning from 2010 to 2014 and aimed at growing the role of the private sector means companies have few local investment opportunities.
Kuwait's adverse macro-economic operating environment is reflected in the fact that the best-performing sector in January was that of non-Kuwaiti companies, up a respective 9.6% and 6.9% on a price and value-weighted index.
However, the country’s ambitious privatisation plans could include up to 32 different projects, raising a total of about $28bn. There are six initial public offerings (IPOs) alone planned on the back of the $7bn metro project. However, for a wave of new IPOs to be particularly successful, the CMA will have to show that it is committed to cleaning up the exchange, which will then help attract a wider variety of investors to generate the liquidity all these flotations need.
No official clampdown on market abuses has taken place yet, though it is still early days. But if the CMA is serious about turning the KSE around then it needs to show it has the teeth of a true market watchdog. If implemented coherently, then the CMA’s new regulatory framework and the upgrade to the Nasdaq trading system could herald a new era for the KSE.
