The introduction of derivatives is set to transform the market

The Kuwait Stock Exchange (KSE) was operating purely as an equities exchange at the end of 2013. The lack of product diversification was seen as a key weakness by both the exchange’s management and the Capital Markets Authority (CMA). The introduction of derivatives to the KSE, expected to take place before the end of 2014, could transform the market. “We plan to introduce a number of international-style derivatives and other products to the exchange, including options, futures, exchange-traded funds (ETFs), bonds and sukuks (sharia-compliant bonds),” said Issam Alusaimi, a technology and development advisor at the KSE. “We have a hunch that derivatives could eventually be very popular here, though it will likely take investors some time to learn how to use them properly.”

A Solid Foundation

The KSE has been laying the groundwork for the introduction of new trading products for the past four years. Under the Capital Markets Law (CML), which was introduced in February 2010, the state sought to bring the exchange in line with international best practice in all areas. Under the new law regulatory oversight of the exchange was transferred to the newly formed CMA, which set out to update the market’s framework. Along with the regulator, the management of the KSE aimed to completely overhaul the exchange itself. Under a KD18.3m ($64.34m) agreement with NASDAQ OMX, the world’s largest bourse operator, in May 2012 the KSE launched a new electronic trading system. NASDAQ X-Stream Trading, which has been set up in more than 15 other markets around the world, is widely considered to be a major improvement on the KSE’s previous electronic trading system, both in terms of efficiency and, importantly, security.

Among X-Stream’s major strengths is that it can be calibrated to handle a wide variety of financial instruments, including bonds and other fixed-income products. According to the KSE the only obstacle to launching derivatives for public trading on the exchange as of early 2014 was final regulatory approval. “Our derivatives platform has been ready to go since December 2013,” Alusaimi told OBG. “Just as for ETFs, we do not need to make any functional changes to our systems to trade these products; however, our brokerage and post-trade community will have to.”

Product Diversification

Since October 1998 the exchange has been able to handle forwards, and futures were introduced in August 2003, just a few months before online trading began in November of that year. However, these developments did not result in the creation of any fundamentally new products. According to Alusaimi, once the CMA approves the new derivatives platform, the KSE plans to roll out various products over a six- to 12-month period, likely beginning with more straightforward products like exchange-traded funds (ETFs) or fixed-income instruments. The first products are expected by the end of 2014, though while most players agree that there is currently considerable investor demand for such products, supply is another issue. “We can enable ETF trading on the new trading platform without any functional changes, and, as soon as the CMA authorises one of these funds, we will be delighted to facilitate trading,” said Alusaimi.

Kuwait’s financial services sector is expected to be a major source of new products. “There are basically limited investment opportunities in the fixed-income market in Kuwait right now,” said Ziad Shehab, a vice president of alternative investments at Kuwait Projects Company’s (KIPCO) Asset Management Company ( KAMCO), a local financial services firm. “However, there is great potential for sukuk (Islamic bonds) and conventional bonds, as Kuwait is home to many companies that are theoretically well-positioned to issue debt.”

That Kuwait is already home to some of the largest corporates in the region, including the National Bank of Kuwait, KIPCO and Global Investment House, bodes well for the derivatives market. “As one of the oldest financial sectors in the Gulf, Kuwait is home to many well-established investment companies,” said Alusaimi. “I expect that many of these are already in the process of preparing derivatives listings of various sorts.”