Modernising GCC Capital Markets: 5 Important Steps

May 3, 2015

 

 

While GCC enjoys high standard of living and richness, it is still behind the curve when it comes to its capital markets. The definition of capital markets predominantly means equity markets primarily due to the lesser role played by the debt market. Notwithstanding, there is an immediate need to modernize the GCC capital markets in a way that it can deliver its true function i.e., efficient capital allocation.

While there are myriad factors that can contribute to this modernization efforts, here are the five most important things:

  1. Integrate the Markets: GCC stock markets, like GCC states, are not a homogenous group. With Saudi Arabia’s market cap pegged at over $570 billion and that of Oman pegged at $17 billion (as on Apr 29th, 2015), the comparison is never apple to apple. Several efforts to unify GCC on many fronts including customs, currency, etc. achieved partial success if not total failure primarily due to political differences. In spite of this, unifying the capital markets and creating one stock exchange representing all GCC markets that trades both equities and debt can be a great step towards modernizing. This will obviate the need to reinvent many things including state-of-art technology needed for a modernized stock market. Privatizing such an exchange (demutualization) in itself can be an interesting sub-development within this concept. However, attempt to create a Gulf Central Bank got stymied for lack of consensus on issues like where it should be headquartered. Leaders should move beyond in order not to miss the trees for the woods. A unified GCC stock market can be worth more than $ 1trillion in market cap and can list nearly 700 stocks, making foreign investors take a serious note of this region.

  2. Institutionalize the markets: The major worry about GCC stock markets is the lack of institutional investors and therefore predominant presence of retail investors. The domination of retail investors is not bad per se, but the absence of credible long-term institutional investors is a serious worry. Institutional investors provide the much needed stability and liquidity to the markets and can significantly deepen the market. Such institutional investors can range sovereign wealth funds, mutual funds, pension funds, hedge funds, foreign institutional investors, insurance firms etc. Presently, only mutual funds are seen to the exclusive absence of other categories. Even mutual fund penetration is quite low ranging from 2% to 5%. Attracting institutions to the market cannot happen through a decree. However, regulators and policy planners can take proactive steps in strengthening market microstructure in a way it can start appealing to institutional investors. Restrictions like foreign investment can be a big negative towards this process. Requiring market participants to adopt sound corporate governance  codes can be a big positive.

  3. Strengthen Information Base: GCC stock markets are relatively new compared to many other markets in the world. While Kuwait and Saudi Arabia can boost of some good history, other markets are of recent phenomena. A critical missing link here is the ability to obtain stock market related information from websites. A curious investor should sift through several pages (in English and Arabic) in order to even assemble some meaningful basic information about listed companies and markets. While several data providers like Thomson Reuters, Bloomberg, provide information, the paid nature of such services precludes many other aspirants seeking information. Technology can assist in this effort to seamlessly provide information across companies, sectors, family groups, etc. thereby improving transparency and openness and this initiative can be taken by the respective stock exchanges. It is heartening to note the increase in research coverage of GCC stocks by local and foreign investment banks.

  4. Improve Liquidity: The main casualty of the Global Financial crisis has been the stock market liquidity for GCC markets. After hitting a peak of $ 1.6 trillion in 2006 (implying a turnover velocity of 233% measured as value traded/market cap), value traded for GCC stock markets hit a low of $296 billion in 2010 (implying a turnover velocity of 40%). At the end of 2014, total value traded was placed at $772 billion with a turnover velocity of 73%. It may be a long time before GCC stock markets can return to witness the hey days of 2006 in terms of turnover volume and value. Even extrapolating IMF forecast for GDP and its linkage to market cap, the turnover value is expected to touch $963 billion by 2020 implying a turnover velocity of 74% purely on a back of envelop calculation basis, still a far cry from the super year peak of 2006. The liquidity is a key dimension for the survival and growth of the brokerage industry and can be a key input for foreign investment. It is also an important factor for including GCC markets in global indices like the MSCI Emerging market index. Presently UAE and Qatar have managed to enter this prestigious club but notable absentees still include Saudi Arabia and Kuwait. Low levels of liquidity increases the cost of transactions (through higher bid/ask spreads) and dissuades credible long-term investors from taking positions. In an earlier article published by the same author on the subject of GCC stock market liquidity, it was opined that the relative halting of lending across the region has played a large part in the declining liquidity on the exchanges.

  5. Provide more tools for Risk Management: GCC stock markets are inherently more volatile than their emerging market peers primarily due to its nascent stage of development. Hence, managing this risk or volatility is a key underpinning for institutional investor entry. A buy and hold environment may not enable this. Availability of broader tools like derivatives (options and futures) can provide the needed tools for managing this volatility. Derivatives is more viewed with trepidation here in the region primarily because of its debilitating effect in the Global Financial Crisis. However, a good tool in the hands of a bad person does not make the tool bad. Proper checks and balances can make this serve the original purpose for which it is invented i.e, to hedge risk and protect downside. Availability of derivatives can also improve liquidity and therefore lead to better market efficiency.

Modernizing GCC capital markets can lead to several improvements that can be tangibly measured:

  1. It can increase the role of capital market in the overall economy as measured by the market capitalization to GDP ratio. Currently it stands at 64% (end 2014) while many countries in the world enjoy a ratio of over 100%.

  2. It can increase the liquidity of the market as measured by the turnover velocity (value traded/market cap). Currently it stands at 73% (end 2014) while a ratio of 100 or 200% is not uncommon.

  3. It can enable GCC markets to find a place in the MSCI Emerging Market index. Presently only UAE and Qatar have this coveted status.

  4. It can increase the foreign institutional investment especially long-term investors like pension funds and endowments.

  5. It can result in improving the new listings which is at the core of market development. New listings enable to increase market depth.

The beauty of these results are they are all measurable. Can we then think of making these as the Key Performance Indicators (KPI’s) for our regulators and policy planners?

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