The voice of authority: A new law brings market regulation under one roof

The establishment of the Capital Markets Authority (CMA) is the most significant development for Kuwait’s bourse in decades. The new regulatory regime, ushered in by the passing of the Capital Markets Law (CML) in February 2010, replaces an unwieldy system in which a triumvirate of administrative bodies – the Ministry of Commerce and Industry, the Central Bank of Kuwait (CBK) and the Kuwait Stock Exchange (KSE) – oversaw exchange-related activity involving listed companies, brokers, investment firms, banks and individual investors. In forming the CMA, Kuwait did not have to look far for inspiration; the UK’s Financial Services Authority and the US Securities & Exchange Commission have served as useful models for a number of regional exchanges seeking to establish regulatory infrastructure over their own rapidly expanding capital markets. The Dubai Financial Services Authority, Qatar Financial Market Authority and Saudi Arabia’s CMA are all built upon a similar principle of integrated oversight.

ALL TOGETHER NOW: The regulatory gaps and overlaps of the previous system, where multiple bodies addressed various aspects of the capital markets, were therefore becoming anomalies within the wider GCC market at a time when competition for useful capital had never been more intense. The creation of Kuwait’s CMA brings the country in line with a regional movement toward better regulation of financial markets.

“The CML is revolutionary and laudable in its intentions. It had to happen, given that Kuwait’s is one of the largest stock market in the GCC,” Anthony Coleby, a partner at Al Markaz Law Firm, told OBG. Now, with the shift toward a properly regulated market under way, attention has turned to the potential benefits – and possible challenge – that will emerge with the implementation of the transformative legislation.

In addition to the establishment of the new authority the legislation also outlined a plan to privatise the Kuwait Stock Exchange, a move which would make the bourse only the second publicly traded stock market in the Gulf region, after the Dubai Financial Market.

ANTICIPATED EXPANSION: The broad aims of the CML are clear: to effectively regulate all stock market activity (including mergers and acquisitions), improve transparency, and increase investor knowledge regarding the risks, benefits and obligations involved with exposure to the market. The potential advantages of the CMA’s wide-ranging mandate are also readily apparent, having been exhibited elsewhere in the region when similar regulatory transformations have taken place. For example, a study by Markaz Research, which uses the 2003 launch of Saudi Arabia’s CMA (the provisions of which are similar to Kuwait’s) to assess the likely impact of the new regulator on the nation’s bourse, highlights market growth as one of the most likely results of the CML’s implementation.

Saudi Arabia’s Tadawul saw a significant growth in the number of its listed companies, from 73 in 2004 to 136 by the end of 2009 (a rise of nearly 90%), while liquidity (measured by daily value traded) expanded from $160m to $1.3bn over the same period. While the KSE has almost twice as many listed companies as the Tadawul, liquidity on Kuwait’s bourse has always been significantly lower, reaching a high-water mark of $134bn in 2008 and thereafter showing average daily trading values of below $500m in comparison to the $1bn-5bn seen in its neighbour. The potential liquidity boost, therefore, is one of the most important advantages offered by the new regulatory regime.

SOURCES OF GROWTH: The growth anticipated by many market observers may come from numerous sources. A recovery of initial public offering activity on the exchange, which, as elsewhere in the region, has bottomed out in the years since the global economic crisis, may be made easier by pricing mechanisms – a function within the purview of the new CMA.

Improved transparency enforced by an adequately empowered regulator will boost the credibility of the KSE in the eyes of both local and foreign investors, and will primarily be brought about by an improvement in company disclosures that are currently required but not always submitted in a timely manner. According to investment consulting firm MSCI, Kuwait’s existing legislation already grants it the highest foreign inclusion factor (its measure of a market’s openness to foreign investment) in the Gulf region, but this has until recently been only a possibility in the absence of an independent regulatory body with the means to act decisively against market irregularities.

As well as attracting liquidity from both local and foreign sources, such gains in transparency, credibility and investor confidence would bring numerous ancillary benefits to the market– including an increase in equity research coverage from newly interested brokerages and research houses. The Markaz Research study points out, for example, that only three KSE stocks were covered by brokers in 2009, representing just 1% of stocks listed on the exchange.

BENEFITS: Given the new legislation’s potential to spur market growth, it is not surprising to find that Kuwait’s more prominent investment houses, particularly those which have become familiar with the more developed regulatory environments seen elsewhere in the region, have warmly welcomed its arrival.

Gulf Investment Corporation (GIC), headquartered in Kuwait but fully owned by the GCC and created to foster economic growth and diversification across the region, is one of those companies that can both benefit from and bring value to a revivified, well-regulated local exchange. “It’s a very positive move for Kuwait. The new law has put a regulatory framework around the entire arena of investment companies and asset management,” Sebastian Vadakumcherry, head of risk management at GIC, told OBG.

CHALLENGES: While the long-term benefits promised by the new regulatory regime are widely recognised, its implementation is likely to present some challenges in the short term – particularly as investment companies operating in Kuwait have previously experienced relatively light regulation.

Smaller investment firms, already struggling in the wake of the global financial crisis, have been presented with new challenges by the recently passed law. For example, one requirement established by the CMA has already caused investment companies of all sizes to revisit their fund strategies, but may become particularly problematic for smaller firms with a local focus: the imposition of a maximum exposure limit to a single equity of 10% of a fund’s net worth may not seem stringent in comparison to similar barriers in other markets, but on a bourse where the top three equities are so heavily weighted (National Bank of Kuwait has 15% of market share, followed by Kuwait Finance House with 8% and Zain with 13%), the new requirement may not be adequate. The CMA’s firmer approach to financial disclosures is also likely to reveal the weakness of those investment firms worst hit by the global financial crisis, many of which are effectively insolvent.

SHORT-TERM PAIN, LONG-TERM GAIN: Such challenges come with any market’s transformation on the path to better regulation, and some feel that there may be a difficult transition period before the long-term benefits are realised. “The new regulations will probably depress trading in the short term. There is ambiguity about the fate of some investment companies, for example, as well as the nature of some articles, so there will doubtless be teething troubles,” said Vadakumcherry. “It’s a new concept for Kuwait. People have to get used to it, and events are moving very rapidly.”

However, the CMA has the ability to make this transitional phase, and the challenges it brings, as painless as possible for the companies that are most affected by it: the Kuwaiti legislative process is one in which brief, primary legislation is followed by executive enabling regulations which bring the intent of the original statute into effect. Therefore the construction of the KSE’s new regulatory framework is an ongoing process that can be hastened or slowed, tightened or loosened, in response to market reaction. While this process could potentially prolong the implementation period for the CML, it has the advantage of affording the CMA some flexibility when it comes to more contentious issues related to its proposed provisions.

The coming months and years, therefore, are likely to see some alterations and shifts in emphasis to the primary legislation approved in 2010, but the overarching intent will remain the same: to provide Kuwait’s stock market with a best-practice, all-encompassing regulatory framework and, in doing so, to usher in a new era of growth for the exchange and its investors.