Kuwait's capital markets reforms have led to global recognition and greater inflows

Kuwait’s equity markets have gone through a remarkable series of reforms in recent years, which have been rewarded with upgrades by international index compilers and ballooning inflows of foreign investment. Enabling infrastructure and a robust legal framework are in place to ensure the markets’ continued development, and demand for assets has been proven. What is critical going forward is a greater supply of high-quality investable securities, from sovereign bonds to small company equity listings by businesses with solid track records.

History

Established in the early 1940s, the first shareholding firm was the Bank of Kuwait and the Middle East. Trading was informally and loosely regulated during the 1960s and 1970s; however, following a particularly detrimental bust cycle in the early 1980s that left most domestic financial institutions insolvent, the Central Bank of Kuwait (CBK) and the Ministry of Finance intervened. They introduced sweeping regulatory reform and officially set up the Kuwait Stock Exchange (KSE), now known as Boursa Kuwait. Kuwait Clearing Company (KCC) was established by the government in 1982 to build trust in the market, and is the region’s oldest established clearing house. It provides clearing, settlement and depository services to Boursa Kuwait, as well as depository services for unlisted securities. It has also played a central role in the recent development of the capital markets. Since the 1990-91 Gulf War, which again damaged Kuwait’s financial infrastructure and necessitated another public intervention, the bourse has expanded rapidly. Today the exchange ranks among the oldest and largest in the region.

Regulation & Oversight

The Capital Markets Authority (CMA) was established in 2010 under Law No. 7 to regulate and supervise all activities related to securities trading in Kuwait. Under its purview, in 2016 the publicly run KSE was replaced by Boursa Kuwait as part of the planned process to privatise the operation of the exchange. Boursa Kuwait is responsible for introducing new trading rules, risk-management practices, price discovery mechanisms and technology to ensure that the market is as robust and secure as possible. Since taking over the stock exchange, Boursa Kuwait has been focused on upgrading the infrastructure and business environment to meet international standards.

Another step towards privatisation of the bourse occurred in February 2019, when an auction was held for a 44% stake in the operator. A consortium of the Athens Stock Exchange and local investors, led by the National Investment Company, won with an offer of KD0.237 ($0.78) per share for a total of KD19.9m ($65.5m). The Public Institution for Social Security owns a 6% stake and there are plans for the remaining 50% to be listed on the exchange via an initial public offering (IPO). “It is great that the private sector is now handling the development of the bourse,” Abdullah Al Bader, senior manager of the alternative investment department at local Dimah Capital, told OBG. “This is a very good step, and we appreciate the government’s efforts on this front. It will have a positive impact and presents an opportunity for greater foreign investment in Kuwait.”

Recent Reforms 

The creation of Boursa Kuwait in 2016 kicked off a round of reforms aimed at the further development of the market. The CMA, Boursa Kuwait and KCC have implemented an expansive series of regular annual reforms that have yielded positive results, including inclusion in a number of global indices: the FTSE Emerging All Cap Index in 2018; the S&P Dow Jones Global Broad Market Index, effective September 2019; and the MSCI Emerging Markets Index, from June 2020 (see analysis).

There have been four phases of market development in quick succession. The first was completed in May 2017, when the exchange enacted a range of updates to its legal and technical infrastructure, bringing Kuwait more in line with international standards. A T+3 settlement cycle was introduced, requiring investors to settle their security transactions within three business days of the trade date; delivery-versus-payment processes were put in place so all securities were delivered on payment for each transaction; foreign account opening processes were simplified and improved; standard tick sizes and up/ down limits were introduced; and changes were made to bourse by-laws. These reforms played a large part in the Kuwaiti market joining the FTSE Emerging All Cap Index in 2018.

The second phase of reform was enacted in April 2018 and focused on trading enhancements. The bourse was reorganised into three new market segments, namely a premier market, a main market and an auction market, with securities assigned to one of the categories based on criteria including capitalisation, years in operation, regulatory compliance and liquidity. Market segmentation is common practice at most major exchanges around the world, including the Nasdaq and the London Stock Exchange, and it provides greater investor protection. Boursa Kuwait added indices for the new segments and different sectors, relaxed its listing rules, delisted companies seen as unsuitable for public investment and introduced circuit breakers to the markets. The reforms also included updated listing requirements and the issuance of a new rulebook for listed firms. These reforms contributed to the upgrade to emerging market status within the S&P Dow Jones Global Broad Market Index, effective September 2019.

The third phase of improvements came in April 2019, with the specific objective of attaining an upgrade from index provider MSCI. Foreign accounts can now be opened within 72 hours, the 49% limit on foreign ownership of bank equity has been lifted and off-exchange trades have been introduced, as well as short selling and stock lending and borrowing. Following these reforms, in June 2019 the MSCI announced that Kuwait will be included in its Emerging Markets Index beginning in June 2020.

Reforms

The reforms achieved by the CMA, Boursa Kuwait and KCC are held in high regard by many market participants, as the legal, physical and digital infrastructure that underpins Kuwait’s capital markets have been upgraded substantially, and regulations have been clarified. Indeed, the reforms and enhancements have had a positive impact on the market. The upgrades by international index compilers have led to sizeable inflows of foreign investment, driving market performance and improving liquidity. Additional inflows are expected in 2019 and 2020 in the run-up to the MSCI upgrade becoming effective in mid-2020. Areas with room for improvement, however, include accelerating certain approval processes and increasing firms’ corporate transparency.

Structure

Boursa Kuwait had a total market capitalisation of KD32.3bn ($106.4bn) at the end of September 2019, with 175 listed companies. Banks are among the largest listed entities, followed by other financial services firms, industrials, telecoms providers and real estate companies. Since April 2018 the market has been divided into three segments depending on the size and information available on the security. To qualify for listing in the premier market, a firm must be valued at more than KD144m ($474.3m), with average daily trading of at least KD90,000 ($296,000). The premier market had 19 firms and a market capitalisation of KD23.7bn ($78.1bn) at the end of September 2019. Banks account for four of the five largest firms by capitalisation on the premier market, led by Kuwait Finance House and National Bank of Kuwait, with Mobile Telecommunications being the only non-banking entity.

The main market, meanwhile, requires average daily trading values of between KD22,500 ($74,100) and KD90,000 ($296,000). The main market had 144 listed securities with a market capitalisation of KD8.6bn ($28.3bn) at the end of September 2019. At the same time, the auction market had 12 listings with a market capitalisation of KD82.1m ($270.4m).

Performance 

The bourse has performed well in recent years, particularly the premier market, which is the destination for the bulk of foreign investment. Looking at total returns of the premier index, including dividends, the market was up 11% in 2017, 12% in 2018 and a sizeable 26% in the first six months of 2019. This made Boursa Kuwait the top-performing market in the GCC in the first half of the year, with Saudi Arabia’s Tadawul in second.

In terms of trading activity, the value of traded shares rose f rom KD2.9bn ($9.6bn) in 2016 to KD4.1bn ($13.5bn) in 2018. Again, improved performance was particularly stark in the first half of 2019, with traded value reaching KD3.8bn ($12.5bn) in six months, up 164% on the same period of 2018.

The upgrades to emerging market status and the resulting inflows of foreign investment are the primary driver of improved performance. The bourse has seen approximately $2bn in foreign inflows as a result of the index providers’ announcements, with more to come. Beyond the upgrades, a significant improvement in the bottom line of banks has contributed to higher metrics (see Banking chapter), along with steady economic growth in Kuwait that contrasts with slowdowns in other GCC countries.

IPO

As recent reforms have increased demand for assets, Kuwait now needs to deepen the pool of available quality assets to further grow the market. Boursa Kuwait has been proactive in trying to attract new companies, visiting family offices and educating them on the benefits of a public listing. For many of these firms, opening their accounts to the public is not appealing, especially at the lower valuations seen in the past. However, with the recent market upgrades, strong foreign demand and ever-rising valuations, the mindset of many family holding companies could begin to change. Passing on generational wealth within large families may also necessitate a public listing in order to realise the equity value in some of these companies. “Kuwait was a challenging market in the past, and private companies decided not to go public at low valuations,” Wajih Al Boustany, a portfolio manager at local financial services firm NBK Capital, told OBG. “However, the current market conditions are getting more interesting with better valuations. There is more money chasing Kuwaiti assets, and this could generate a drive for the listing of large family businesses.” An increase in listings is also needed to provide more opportunities to investors, according to Al Boustany. “More participation would take the market to the next level, but they need to be quality companies with a proper operational track record,” he said. According to Manaf Abdulaziz Alhajeri, CEO of Kuwait Financial Centre, strengthening the market will first require growing the domestic base. “To achieve sustainable growth, we need to be able to invest internally,” Alhajeri told OBG. “This would only materialise by improving the ease of doing business in the country, fully activating the private sector and nurturing a domestic institutional investor base. By institutionalising the stock market, it also becomes less volatile and more attractive for international investors.”

The government is supporting this effort because it is aligned with the aim of growing the private sector, including through the privatisation of public companies. In June 2019 Mohamed Al Osaimi, acting CEO of Boursa Kuwait, told local media that the remaining 50% share of the exchange would be listed by the beginning of 2020, and that he expected another two or three IPOs in the coming 12 months.

The Al Zour North Independent Water and Power Project is another major public asset scheduled for a future IPO, a process that began with consultations in the second half of 2017. “All the reforms that have been implemented and the subsequent upgrade and inclusion into major global indices, and then a couple of IPOs after a silent period will be good for the market, increasing citizen trust and confidence that has been dented by the global financial crisis,” Khaldoun Al Tabtabaie, CEO of KCC, told OBG.

Debt Market

Activity in Kuwait’s debt markets has been limited recently, especially with regards to sovereign issuances, although some banks have come to market for capital-raising and some senior debt issuance. The only sovereign bond was issued in 2017, and liquidity on the secondary market is low. Further issuance is being blocked by parliamentary delays in passing a new debt law in mid-2019 after the previous law expired in October 2017.

The hold-up is not a question of demand, as there is clearly appetite for Kuwaiti debt. Past issuances have been heavily oversubscribed, such as a $300m sukuk (Islamic bond) issuance by Kuwait Investment Bank in May 2019 that was approximately 15 times oversubscribed. The lack of issuance in the market encourages long-term investors to buy and hold, thus discouraging secondary trading and weakening the price-discovery function of Kuwait’s debt markets.

Sovereign Support

More sovereign debt activity would support issuance by other government-related entities (GREs), as well as by corporates. It is difficult and expensive for corporates to issue debt when there is no sovereign debt in the market to provide a benchmark and guideline for pricing. Parliament passing a new law to allow the sovereign to issue debt would lead to greater corporate issuance, thus increasing the pool of investable assets in Kuwait, and supporting the development of the country’s capital markets and financial services more widely.

With excess liquidity in the banking system, banks and insurance firms are also in need of quality assets to invest in. Banks have been pushed into low-yielding assets from the central bank, and insurers are overexposed to domestic equity markets partly because they have few alternative investment options.

“The debt law is in its final stages; it is agreed and just needs to be passed by Parliament. Some covenants have been added – such as tying the debt ceiling to GDP, which make sense – and they are unlikely to impact the volume of issuance,” Waleed Al Awadhi, executive director of supervision at the CBK, told OBG in June 2019.

Once the law is passed, there is potential for the government and some large GREs to issue debt within the next 12 months. In early 2019 Kuwait Petroleum Company (KPC) formulated a long-term financing plan for the organisation with the help of a specialised adviser, and the Cabinet approved its borrowing plan in April 2019.

“A committee exists between the government, the CBK and the Kuwait Investment Authority to manage public debt issuance, such as when issuance takes place and who carries it out,” Al Awadhi told OBG. “We have also set up a new committee that includes KPC to align debt issuance plans with the oil sector, as this will help answer questions about when the oil sector should tap international and local markets.”

Outlook

A recent series of reforms has lead to the continued positive performance of the Kuwaiti stock exchange, as has the sound structure of the financial services sector in the country overall. “Returns are very low risk in Kuwait. State banks and the currency are backed by the central bank, and markets are liquid and of good value,” Al Bader of Dimah Capital, told OBG. “We expect the market to expand by 15-20% in 2019, mainly as a result of upgrades. The upside will primarily be seen among the blue-chip companies that are to become part of the MSCI Emerging Markets Index.”

Further improvements to the market are expected over the medium term. By 2020 compulsory investor relations for companies trading in the premier market is expected to be introduced. By the end of 2020 enhancements will include the introduction of central counterparty clearing, clearing member structures and a reformed risk waterfall for defaults. In early 2021 Boursa Kuwait is set to become the first exchange in the GCC region to offer derivative products, and there are plans to introduce a trading platform for debt securities.

The drive to develop Kuwait’s capital markets is far from over, and participants in the domestic market appear upbeat. “The outlook for the market is positive, as the MSCI upgrade is still to come and will be implemented in 2020. Although on-budget government spending has slowed, it should pick up with the upcoming infrastructure project pipeline, and off-budget spending in the oil and gas sector will stay strong with future plans. This will continue to drive bank profits and support the market,” Al Boustany told OBG. Positive market sentiment from abroad was reflected in a June 2019 poll by Reuters. Of the 11 Middle East funds surveyed, six said they planned to increase their investments in Kuwait in the coming months, while keeping their exposure to countries in the rest of the region largely constant.