New developments helping expand Bahrain's capital markets

Like other bourses in the region, the Bahrain exchange faced strong economic headwinds in 2015 as a result of falling oil prices and the unrest in the wider Middle East. Nevertheless, a process of market development continues in the form of technical upgrades, legislative improvements and a steady stream of new investment instruments. As regional competition for liquidity intensifies, the exchange authorities are banking on these important enhancements to attract retail and institutional investors to the nation’s well-respected market.

Rapid Development

Capital markets activity in Bahrain might be said to have begun with the establishment of the first Bahraini public shareholding company in 1957, which predated the existence of an official exchange in the kingdom. The oil-driven economic boom that the Middle East experienced over the following two decades saw the emergence of similarly formulated institutions, as increasingly wealthy local investors indulged in a newly acquired taste for Gulf companies. Trading in these companies took place on an unofficial exchange known as the Al Jowhara Market, which by the late 1970s was the scene of increasingly heated trading activity as higher oil prices generated unprecedented wealth and a growing demand for investment opportunities.

The rapid rise in stock prices proved ultimately unsustainable. The bursting in 1982 of an equities bubble in Kuwait’s informal stock market, the Souk Al Manakh, triggered a similar collapse of Bahrain’s unregulated market and ultimately led to its demise. The end of Al Jowhara, however, only marked a new beginning. Dismayed by the instability the market’s failure had caused, the Bahraini government joined forces with the International Finance Corporation to prepare a feasibility study for an official exchange in the country. The result was the establishment in 1987 of the Bahrain Stock Exchange. The new market began operations two years later with 29 listed companies, trading only in common shares over a manual system; this gave way in 1999 to a significantly more efficient automated trading system.

Technical developments were mirrored by regulatory advancement: in 2002 the Ministry of Commerce relinquished its responsibility for the exchange to the Central Bank of Bahrain (CBB), which regulates its activities to this day. The CBB has overseen a widening of the exchange’s activities from its beginnings as a single-product market to one that now includes financial instruments such as preferred shares, bonds, sukuk (Islamic bonds) and mutual funds – some of which were pioneered in the region by Bahrain. In 2010, the exchange passed through another key evolution, moving to new premises in the Bahrain Financial Harbour and rebranding itself from the Bahrain Stock Exchange to the Bahrain Bourse (BHB).

Listings

As of December 2015, the BHB is home to 46 listed companies (four of which were suspended) distributed across a number of categories including: commercial banks, investment, services, insurance, industrial, hotels and tourism, closed companies and non-Bahraini companies. Bahrain’s status as a regional financial centre is evident in the composition of its bourse, on which banks, investment firms and insurance companies are heavily weighted. Seven commercial banks, including the National Bank of Bahrain and Bahrain Islamic Bank, make up the single largest sector on the exchange, accounting for 45.5% of total market capitalisation at the close of the second quarter of 2015, according to BHB data.

Twelve investment companies form the second largest group, with 26.3% of market capitalisation. These include domestic conventional and sharia-compliant firms, such as Al Baraka Banking Group and Gulf Finance House, that have historically played a central role in the economic development of the region. The five listings in the insurance category, meanwhile, contain some of the key local players, such as Al Ahlia and the Arab Insurance Group, which have contributed to Bahrain’s reputation as the Gulf’s insurance centre. Of the non-financial sectors, the largest is the services category, which as of the second quarter of 2015 had 10 listings and 14.3% of market capitalisation and includes such giants as Bahrain Telecommunications Company (Batelco). This was followed by the industrial sector, which accounts for 12.9% of market capitalisation despite holding just three listings, thanks largely to the presence of Aluminium Bahrain (Alba), one of the largest aluminium smelters in the world and a significant contributor to the national economy. Five leisure companies make up the BHB’s hotels and tourism sector, accounting for 2.77% of market capitalisation, while there are two foreign firms listed on the exchange: Bank Muscat and Global Investment House (currently suspended).

The BHB incorporates a debt market that contains nine listed bonds or sukuk. The government plays a leading role in debt issuance, with regular sales of short- and medium-term Treasury bills. Increasing government issuances and creating a framework that encourages corporate listings has been a key focus of activity for the BHB authorities over the past year.

As of September 2015 the market was served by 12 brokers, the largest of which, Securities and Investment Company (SICO), is one of eight that operate on investment bank licences. In most cases these firms with investment bank licences hold an advantage over the remaining “List A” and “List B” firms, operating on individual broker licences, in that they have access to the clients of their bank’s retail division.

Fund Management

Besides the bourse’s core activity of equity and bond listings, one of the most active areas of the market is mutual funds. These have grown rapidly in popularity since formal regulations concerning them were introduced in 1992, and as of September 2015 there were 21 listed on the BHB, all of which were open-ended. The largest player in this segment is the Bahrain-based SICO, with eight funds traded on the market, followed by Global Investment House, with five. Other key fund issuers that have listed their products on the BHB include the National Bank of Kuwait and the Makaseb Fund Company. In terms of fund types, recent years have seen increased diversity: in 2015 the traditional equity instruments remain popular, but have given some ground to more specialised funds such as large-cap, money market, distressed, real estate and Islamic funds.

Bahrain is a well-established centre of fund activity, with the bulk of it taking place over the counter. Indeed, the Ministry of Finance and Economic Development Board have collaborated to make Bahrain a more attractive host for asset managers, envisioning Bahrain as a bridge between traditional financial markets and developing markets such as those in Africa and Asia, as well as those in the GCC.

As of August 2015 the total number of funds authorised by the CBB was 2879, of which 82 funds were domiciled in Bahrain and 95 were Islamic funds. The combined net asset value of those funds totalled $7.2bn at the end of June 2015. “The CBB provides a strong, well-maintained regulatory framework that serves as a good entryway to the GCC, just as Hong Kong provides a platform for investing in China,” Stephen Vineburg, CEO of ASMA Capital Partners, told OBG. Vineburg, a former partner at CVC Capital Partners in London, was brought to ASMA Capital to launch a second infrastructure fund for the Saudi-based Islamic Development Bank. “The next step will be to promote the Bahrain workforce and increase air and other transportation links,” he added.

Regulation

Overseeing the increasingly complex market is the CBB, which implements one of the most widely respected regulatory regimes in the region. Since it assumed regulatory responsibility for the exchange in 2006, it has worked with the BHB authorities to ensure that the framework within which the nation’s capital markets operate remains in line with international best practice. Its oversight of the wider financial sector means that it is able to monitor all market participants, including conventional and Islamic banks, insurance companies, investment firms and brokers, and it regulates the interactions of these bodies through the CBB Rulebook.

The activities of Bahrain’s capital markets are addressed in Volume 6 of the rulebook, the development of which began in 2008 and continues under the aegis of the CBB’s Capital Markets Supervision Directorate (CMSD). Recent years have seen the CMSD release the nation’s first codified module for mergers and acquisitions, incorporate robust corporate governance guidelines into the rulebook, and update its securities regulations, which had previously been dispersed over a number of documents and circulars. Combined, these initiatives have significantly enhanced the relationship between the bourse and its listed, or potentially listed, companies.

Tracking & Indices

Though the variety of instruments on the exchange is increasing, the BHB remains predominantly an equities market. The principal benchmark by which it is tracked by brokers, investors and other market participants is the Bahrain All Share Index, which includes all actively traded companies. First formulated in 2004, it has since been joined by two other main indices, which provide an overview of total market direction. The first of them, the Esterad Index, was established in 2005 and was the first privately administered tracker on the bourse. Owned by a local investment firm that is itself a listed company, the index tracks the price movements of 25 BHB-listed companies, selected using a methodology that takes into account a number of criteria, such as balance of sector representation, market capitalisation and liquidity. The Dow Jones Bahrain Index, also launched in 2005, was created in partnership with the BHB to provide a tracking instrument to represent all companies domiciled and headquartered in Bahrain whose stocks trade on the bourse. This variable-component-number, full-market-capitalisation index is reviewed quarterly and uses the proprietary Dow Jones sector classification system. This differs significantly from the BHB’s sector structure, allowing participants to view the bourse in an alternative fashion.

According to data from the Dow Jones Bahrain Index, as of end-September 2015, the financial sector accounted for 74.4% of the BHB’s value, followed by basic materials (10.1%), telecommunications (9.3%), consumer services (5.4%), industrials (0.5%) and consumer goods (0.3%). Finally, aside from the three main indices, the BHB provides a series of six minor indices made up of the components of each market sector.

Performance

Bahrain’s open economy and status as a regional financial centre mean that it is not immune to external events, and the performance of the market in recent years reflects this reality: an uninterrupted rise in market capitalisation from 2002 peaked in 2007 at $10.19bn before falling off to $6.1bn in 2009. A modest rally in 2010 saw market cap increase to $7.57bn, but domestic and regional unrest in 2011 resulted in a decrease in value to $6.25bn by the end of the year, with the Bahrain All Share Index falling by 20.15%, according to figures from the BHB and Global Investment House. While declines were recorded across the bourse, the investment index posted the largest decrease, at 28.8%, followed by the industrial index at 26.7%. A strong recovery began in early 2014, with the Bahrain All Share Index rising from 1247.98 on January 2 to close the year at 1426.57, an increase of 14.2%. Encouragingly, the year also saw an increase in both traded value (up 19.2% year-on-year) and number of transactions (up 14.2%). Over the course of 2014 the share prices of 24 companies made gains, while nine remained unchanged and 14 companies showed price decreases.

The aggregate result of this movement was an increase in market capitalisation that demonstrated the exchange’s potential as a fundraising platform. Total market capitalisation for Bahraini public shareholding companies rose from BD6.96bn ($18.3bn) at the beginning of the year to reach BD8.33bn ($21.9bn) by December 31, 2014, up 19.59%.

The largest gains were made in the investment sector, which grew by 35.8% over the year, followed by services (up 22.9%) and commercial banks (up 16.3%). Only the industrial and insurance sectors saw declines, a modest 1.4% and 1.7%, respectively.

In 2015 the BHB underwent a period of retrenchment, a trend also seen in other exchanges around the Gulf, as markets reacted to a precipitous falls in oil prices. By September 1, 2015 the All Share Index had dropped to 1299.01 which, though higher than its level at the close of 2013, represents a loss of more than half the gains made in 2014.

Technical Upgrades

Short-term index movements, however, are not the primary concern of the BHB authorities. The long-term future of the nation’s exchange as an agent of economic development in Bahrain depends upon its ability to attract liquidity – a task made all the more challenging by the emergence of other stock markets in the region and fierce competition for the attention of domestic, regional and international investors. To this end the BHB has been assiduously developing its technical capacity, regulatory framework and product offerings in a bid to deepen the market and cement its position at the centre of the nation’s economic life. On the technical side, in 2014 the BHB completed its transition from its old Horizon trading platform to the new X-Stream system from Nasdaq OMX. This technology has been widely adopted in the region, and its implementation has opened the door to a raft of new services and instruments on the exchange.

Legal Changes

The legislative framework for these innovations came in September 2014, when the BHB introduced its new “Market Rules” – a bundle of legislation that places the exchange at the forefront of regional markets in a number of areas. One important innovation of the new regime is the introduction of margin trading, which gives investors the ability to purchase stock by borrowing funds from their brokers – a practice which, when implemented with robust safeguards, is widely considered key to boosting liquidity. Another potential liquidity-boosting development is the opening up of the market to non-Bahraini brokers, who are licensed by the capital markets authority of their respective countries on the condition that they appoint an authorised clearing member to settle their transactions on the BHB. Foreign brokers are therefore no longer required to establish representative offices in the country, thereby significantly reducing the costs associated with serving the market.

The new rules also allow for the trading of new investment instruments, such as options, exchange-traded funds (ETFs) and real estate investment trusts (REITs). The introduction of ETFs will provide investors with a useful alternative to mutual funds, offering exposure to a group of equities, market segments or “styles” of stock such as green energy or sharia-compliant companies. Moreover, since these are passively managed instruments, such diversity comes at a much lower price, with expense ratios far more favourable than those demanded by managed funds. The first ETF to be listed on the bourse, officials at the BHB told OBG, will likely be from a provider that can also offer options on the instrument, with both innovations launched simultaneously. In July 2015, Eskan Bank announced that it had appointed SICO as lead arranger for the first REIT to be listed on the bourse, which will also be only the second sharia-compliant REIT in the Gulf region. As a result, retail and institutional investors will have access to a well-regulated investment instrument tied directly to the bank’s real estate portfolio, which will provide them with potential yield and a further diversification of options.

Debt Market

The development of Bahrain’s debt market has been another key focus of the BHB over the past year. Debt issuance in Bahrain has historically been of little interest to non-institutional investors, with government debt secured by local banks almost on an allocation basis and held to term, with no secondary market activity at all. A decree by the CBB that 20% of government debt bought by banks should be made available to retail investors did not significantly change market dynamics, as retail clients were not offered beneficial ownership of any purchased debt. The BHB has traditionally left the operation of the primary market to the banks and the CBB; but lately, having recognised its importance to investors and fund managers, it has worked with the CBB to establish a system by which they can gain direct, beneficial access to primary government debt issuances.

Announced in January 2015, the mechanism is the first of its kind in the Middle East, and allows both individuals and institutions, Bahraini and non-Bahraini, to subscribe directly to government issuances through registered brokers, and thereafter trade the bonds on the secondary market at the BHB. In order to encourage retail investors, the BHB specified a low minimum subscription rate of BD500 ($1317) – or 500 sukuk issued at a par value of BD1 ($2.63) each. “We chose the BD500 ($1317) subscription level because the minimum deposit for high-interest savings accounts is usually BD1000 ($2634), so we wanted to catch the lower end of the market,” Abdulla Jaffar Abdin, director of the Central Securities Depository at the BHB, told OBG.

By July 2015, the BHB had already seen two successful government issues of sukuk using an ijara (Islamic lease) structure under the new mechanism, as well as the successful offering of a BD150m ($395m) conventional government development bond. The implementation of the system represents a significant broadening of exchange activity, and provides a useful route to yields for the investment community. “The response so far has been encouraging. All classes of broker have become involved, as well as the big institutions with savings schemes,” said Abdin.

Outlook

The exchange continues to broaden the range of investment instruments it hosts. Initiatives in the pipeline include the introduction of its first ETF and the implementation of a short-selling regime. Infrastructural developments are also in the works: the Central Securities Depository is finalising plans to establish itself as an independent clearing house, provisionally called Bahrain Clear, which will leverage Bahrain’s reputation as a well-regulated financial centre to market itself as a clearing facility for the region. The nation’s smaller businesses, meanwhile, will be given the opportunity to use the exchange as a funding platform if plans to establish a new Bahrain Investment Market come to fruition. The BHB has been cooperating with local institutions, such as the Bahrain Development Bank and Tamkeen, to establish the new market within the exchange, the listing rules for which will be more amenable to smaller firms while robust enough (based on international financial reporting standards) to match the risk requirements of investors. While index movements will remain subject to external factors such as regional unrest and oil prices, developments such as these promise to transform the workings of the exchange, further embedding it within the nation’s economic ecosystem.