Kuwait's capital markets regulator works to boost activity on the exchange

Following a slight decline in market capitalisation in 2014, the Kuwait Stock Exchange (KSE) is expected to benefit from a series of reforms that are currently being implemented by the Capital Markets Authority (CMA), the sector regulator. This follows from a comprehensive restructuring of the bourse in the years following the 2007-08 international economic downturn. Since then the market has posted steady growth, which, according to most local players, can be attributed in large part to the government’s efforts at reform. With a handful of significant changes currently under way – including the eventual sale of a sizeable percentage of the KSE in an initial public offering (IPO) and the introduction of several new investment products – many local investors expect to see improvements in the bourse’s market performance in 2015 and 2016.

Obstacles & Opportunities

That said, Kuwait’s investment sector faces a number of challenges. While the KSE is one of the most liquid exchanges in the Gulf region, a substantial percentage of recent market activity can be chalked up to speculative trading among a relatively small cadre of wealthy, local individual investors, who tend to focus their attention primarily on small-cap stocks. Attracting more institutional and foreign investment activity is a key component of the CMA’s ongoing development programme for the market. A handful of regulatory issues – including poor transparency, weak reporting standards at many listed companies and a dearth of new IPOs in recent years – have contributed to declining investor confidence, both in Kuwait and among regional investors and market watchers.

Despite these issues, many local players remain optimistic about the future. “With a market capitalisation-to-GDP ratio of approximately 100%, Kuwait’s stock market is deeper than many of its regional peers,” said Faisal Hasan, a senior vice-president in the investment research department at KIPCO Asset Management Company (KAMCO), a leading local financial services firm. The government’s ongoing efforts to streamline and modernise market activity and corporate governance are widely expected to pay off in the long run. “The introduction of new foreign direct investment (FDI) rules by the Kuwait government and various other similar rules are aimed at making the country a favourable destination to attract investments,” Hasan told OBG. “These regulations should also help in increasing the demand for financial products and raising capital.”

History

Kuwait is home to the oldest stock exchange in the GCC and one of the oldest financial sectors in the Middle East. The country’s first shareholding company, the National Bank of Kuwait (NBK), was formed by a group of local businessmen in 1952, with an initial stock issuance of 13,100 shares. Created nearly a decade before Kuwait gained its independence in 1961, NBK was the first national bank to be established in the Gulf region.

Over the ensuing two decades, informal trading took place at financial institutions around the rapidly developing country. In the 1960s and 1970s the national government introduced a variety of new laws and regulations aimed at ensuring that the country’s burgeoning market met minimum standards, effectively laying the groundwork for a formal market. In the mid- to late 1970s, oil price volatility throughout the region gave rise to a period of intense speculative activity in Kuwait, which resulted in a minor stock market crash in 1977. The government reacted quickly, bailing out investors and rolling out a series of new, strict rules and regulations.

Consequently, beginning in 1978 bullish investors and other market participants began to move money out of the now-tightly controlled formal market and into a new, highly speculative, informal market set up on the outskirts of Kuwait City. The new exchange, which was known locally as the Souk Al Manakh (“camel market”), operated primarily on the basis of post-dated cheques. In August 1982 one such cheque bounced, leading to a chain reaction of defaults, which in turn eventually crashed the Souk Al Manakh and wrought a considerable amount of damage not only in Kuwait but throughout the Gulf region. When the dust cleared, Kuwait’s entire financial system was insolvent, with the exception of NBK. After the crash the government moved quickly to shut down the Souk Al Manakh and, once again, to rebuild the country’s financial industry.

This time round, the state worked with local players to establish a plan and an implementation programme for a well-regulated market. The result was the establishment of the KSE in August 1983. The new market was developed with a dual mandate to simultaneously regulate all investment activity in Kuwait and also serve as the trading platform for that activity. The new market caught on quickly, with growing levels of activity for the next half-decade. However, in 1990-91 Kuwait’s capital markets – not to mention much of the rest of the country – ground to a halt and were subsequently partially destroyed by the Gulf War. After the war, the state bailed out not only the KSE but the entire financial system.

By the mid- to late 1990s, Kuwait’s capital markets were up and running again. As in many other Gulf countries, during this period the KSE experienced rapid growth, both in terms of the total number of market participants and in overall trading activity. Relatively low barriers to entry and easy access to investment capital resulted in a host of new investment companies (ICs) setting up operations in Kuwait. These new players bought into the thriving domestic and regional real estate and equities markets, driving up prices and valuations through the first five years of the 2000s.

The KSE continued to innovate during this period. In 1995 the exchange had rolled out electronic trading – making it the first capital market in the Gulf to do so – and in late 2003 the market launched online trading. “Kuwait has been one of the pioneers in innovation in the capital markets,” Hasan told OBG. “Investors here have the huge experience of asset management and trading in different business cycles, and learning from various boom-bust phases.”

Downturn & Recovery

Unlike many of its neighbours in the region, Kuwait was relatively insulated against the 2007-08 financial downturn. That said, in late 2008 the KSE did drop off significantly, and some ICs – particularly those that had snapped up property and equity investments en masse during the preceding boom – rapidly accrued bad loans and other untenable debt. The government again reacted swiftly, guaranteeing savings at all local banks and, in March 2009, introducing the Financial Stability Law (FSL), an emergency debt-restructuring programme led by the Central Bank of Kuwait (CBK).

Since 2009 a handful of local ICs have taken advantage of the FSL mechanism, whereby the government both assists firms in restructuring their debt and, in certain cases, provides financial relief. Companies that have benefitted from the FSL programme include Aayan Leasing and Investment Company, which entered into an agreement with the CBK to restructure around KD205m ($706.3m) in May 2011; and The Investment Dar, which set out to restructure around KD1bn ($3.4bn) in bad debt, also in 2011. Many other firms have managed to deal with loan book restructuring in the years since the crisis without the assistance of the CBK. Both the Noor Investment Company and Global Investment House, for example, have had success in approaching local lenders directly to negotiate new repayment terms.

Capital Markets Law

In an effort to protect Kuwait’s capital markets against any future downturns, in February 2010 the government introduced the Capital Markets Law (CML), a new, comprehensive regulatory framework aimed at ensuring the long-term stability and growth of the country’s capital markets. Based on similar rulings drawn up and successfully instituted by the US Securities and Exchange Commission and a number of other Gulf nations, the CML’s primary effect was to divide the regulatory and operational arms of the country’s capital markets sector in two. The new market regulator, the CMA, was established with a mandate to improve the industry in line with international standards. Whereas previously the KSE itself and a handful of departments at the Ministry of Commerce and Industry and the CBK had jointly monitored investment activity in Kuwait, under the new system the KSE was made solely responsible for operating and developing the exchange.

Major Developments

The CMA, meanwhile, set out to implement a range of other changes and improvements laid out under the CML. In the years since 2010, the new regulator has enacted a series of new rules aimed at boosting transparency, ensuring that listed firms operate according to international standards, and improving risk management and corporate governance. More recently, the CMA has also moved forward with a plan – introduced in the CML – to privatise and, eventually, to take the KSE public in an IPO. In April 2014 the bourse was converted into a privately managed company, called Bourse Kuwait, under the CMA.

In March 2015, meanwhile, the nation’s parliament passed new legislation under which shares in the exchange are to be floated before the end of the year (see analysis). The CMA will continue to own and operate Bourse Kuwait, albeit on an independent basis, until the firm goes public. By privatising the KSE, the CMA hopes to further improve the bourse’s competitiveness within the region. While share sale details have yet to be formally confirmed, under a draft version of the plan half of the KSE will be sold to citizens, while the rest will be split between various government entities and a private company that has experience in operating stock exchanges.

Technical Upgrades

For its part, the KSE has been working to update its operations for years. Recently the management of the exchange has introduced a handful of major changes. In late 2009, for example, the KSE spent KD18.3m ($63m) on a new trading platform, namely NASDAQ OMX’s X-Stream Trading. As part of the deal, NASDAQ OMX, which is one of the world’s largest exchange operators, provided training for local brokers and other market participants. In addition to running on the KSE, the X-Stream system is currently operational at more than 15 bourses around the world.

The installation of the new platform was widely taken as a sign of the KSE’s intentions to eventually introduce new financial instruments to the market. At the time of writing, however, this had yet to occur. Currently the bourse only handles a small number of basic products, including equities, mutual funds and call options, despite the CMA announcing in late 2013 that it planned to allow derivatives trading before the end of 2014. The delay in rolling out new products is generally attributed to bureaucratic issues at the federal level and at the CMA.

Regardless of this, in addition to derivatives, eventually the KSE plans to introduce a range of other new products as well, including futures, commodities trading, short selling, automated margin lending, exchange-traded funds and both conventional and Islamic fixed-income securities, the latter of which are known as sukuk. “The legislation to organise and regulate the fixed-income instruments and sukuks are in the pipeline already,” said Hasan. “The bond market is currently issuer-driven, so there is tremendous potential to grow once the regulations are in place to facilitate easy listing and trading of fixed-income products.”

Classification

Also in 2009, the KSE introduced a new market classification system and a new flagship market index, the Kuwait 15 Index (K15). Under the new classification, the companies listed on the KSE are organised into 15 sectors as mandated by the International Industry Classification Benchmark System, instead of into just eight sectors as under the previous, provisional system. The new index, for its part, is made up of the top 15 companies on the bourse by market capitalisation and liquidity, and is revised semi-annually. It is only the first of a raft of new indices planned by the KSE. At the end of 2014, the 15 firms on the K15 index made up 42% of the KSE’s market capitalisation, according to KAMCO.

By the Numbers

At the end of 2014 the market capitalisation of the KSE as a whole was at KD29.71bn ($102.4bn), down 4.5% from KD31.1bn ($107.1bn) at the end of the previous year, according to data provided by KAMCO. Average daily trading volume dropped off considerably in 2014, falling to 4908 trades per day from nearly 9000 the previous year.

That said, it is important to note that in 2012 the bourse saw around 4800 daily trades on average. This suggests not so much a decline in 2014 as a volatile period of growth in market activity in 2013. According to KAMCO, the KSE price index fell 13.4% in 2014, and the value-weighted index dropped 3.1%. Again, however, the end-2014 price index figure of 6535.7 is perhaps more usefully understood not only as a decline on 2013, when the index ended the year at 7549.5, but as a solid improvement on end-2012, when it was at 5934.3. The K15 index, meanwhile, ended the year down 0.8%.

KSE market valuation is heavily concentrated at the top of the exchange. The top 10 largest firms listed on the bourse accounted for more than 57% of total market capitalisation at the end of 2014, for example, while the top five accounted for 41.5%, the top three for 32.9% and the market leader in terms of capitalisation – namely NBK – for 14.7%.

Similarly, six of the 10 largest KSE-listed companies are financial institutions. Indeed, the banking sector accounts for 49% of the total KSE value by market capitalisation. The second-largest sector is telecoms, with 11%, followed by financial services with 10%, industrials with 9%, real estate with 8%, and consumer goods with 4%.

Major Companies

NBK, which is both Kuwait’s largest bank and one of the oldest shareholder corporations in the Gulf region, was also the largest listed firm on the KSE at the end of 2014, a position it has held for much of the bourse’s existence. As of early May 2015, the most recent period for which data was available at the time of writing, the institution boasted a total market capitalisation of KD4.23bn ($14.6bn), down slightly from KD4.37bn ($15.1bn) at the end of 2014. NBK’s price-to-earnings ratio dropped slightly over the same period, from 17.2 at the end of 2014 to 16.2 as of early May 2015. In addition to its dominant position on Kuwait’s capital market, NBK also leads the banking sector in terms of total assets, deposits and lending. In 2014 the institution brought in KD261.8m ($902m) in profits, up from KD238.1m ($820.3m) in 2013, a jump that contributed to the bank’s total asset base rising 17% over the same period. According to data from the CBK, at the end of 2014 NBK also held almost 35% of the overall banking sector loan portfolio and 30% of total banking sector deposits.

While a considerable percentage of NBK’s revenues come from business carried out in Kuwait, the institution is also active in more than 15 countries around the world, including Saudi Arabia, the UAE, Bahrain, Turkey, Jordan, Egypt, the UK, the US, Switzerland, France and China. In 2012 NBK acquired a 58.4% stake in the local sharia-compliant lender Boubyan Bank. Additionally, in 2014 NBK sold its 30% stake in the International Bank of Qatar, indicating that it would rather seek opportunities where it can hold a controlling interest. The Kuwait institution is reportedly exploring other options in Qatar and throughout the GCC (see Banking chapter).

Kuwait Finance House (KFH) was the second-largest listed company on the KSE at the end of 2014, with a market capitalisation of KD3.12bn ($10.7bn) and a price-to-earnings ratio of 25.9, according to KAMCO data. With total assets of KD17.2bn ($59.3bn) at the end of 2014, KFH is the second-largest sharia-compliant financial institution in the world. In 2013 the institution completed a major restructuring programme, which involved consolidating its business into three distinct vehicles, namely KFH Investment, KFH Capital and KFH Real Estate, in addition to improving corporate governance and risk management practices. Like NBK, KFH is active in a variety of regional and global markets, including the UAE, Saudi Arabia, Malaysia and Turkey.

Rounding out the KSE’s top-five largest listed firms at the end of 2014 were Zain, a leading telecommunications operator, which is active not only throughout the Middle East but further afield as well; Ahli United Bank; and the Kuwait Food Company, which, operating as the Americana Group, manages a number of casual dining and fast food restaurants.

New Listings

The KSE has not hosted an IPO since 2011, when the Al Imtiaz Investment Group floated a number of shares. The slowdown in new listings can be attributed in large part to a decline in confidence among investors in the wake of the 2007-08 downturn. While a variety of firms had plans in place to sell new shares when the crisis hit, most of these were subsequently cancelled or put on hold indefinitely. In recent years, however, the IPO market has started to turn around. In 2013 and 2014, in particular, a handful of Kuwaiti firms have announced plans to launch new listings in the near future.

Companies with plans to list on the KSE include the Kuwait Investment Company and the Kuwaiti branch of Dow Chemical. Food producer and distributor Mezzan Holding listed in June 2015. Additionally – and perhaps more important for the long-term health of the market – the government is widely expected to eventually sell shares in a variety of state-owned entities, including the national airline, Kuwait Airways. While plans for these listings have yet to be formalised, under the state’s long-term Kuwait Development Plan, which was launched in February 2015, the government is looking to raise a substantial amount of capital with an eye towards investing in new transport and industrial infrastructure (see Economy chapter). Floating shares of state-owned companies on the KSE is an obvious and relatively straightforward way to do this, whilst also ensuring that Kuwait’s citizens are able to participate in the future expansion of the economy.

Outlook

Kuwaiti investors and other market participants currently face a number of challenging issues. The continued dominance of retail investors, the majority of whom operate with a relatively short investment horizon, has had an adverse effect on the market, contributing to speculative trading and, consequently, market volatility. Furthermore, according to KAMCO’s Hasan, the relatively small number of investment products available in the country continues to hamper market growth. “The KSE lacks depth in terms of investible products,” he told OBG. “The fixed-income market – both Islamic and conventional – has yet to take off in Kuwait, which is a major issue for firms looking to raise capital by issuing bonds of any kind.” Underpinning these issues is the kingdom’s long-running challenge of attracting more FDI, an increase in which would likely boost demand for local financial products.

The CMA is working to address these issues. “Regulation is the key to developing the capital market in Kuwait,” said Hasan. “The regulator is working hard on this front, introducing rules from time to time concerning important aspects of the market.” Given the KSE’s lengthy history and the numerous changes recently put in place – including the new X-Stream trading platform and market classification system in 2009 and the CML in 2010 – many local players expect to see market expansion in the future.

Provided the CMA’s plans come to fruition, upcoming market growth will be driven by large institutional investments. One key motivating factor in 2014 was the upgrade of two other capital markets in the region – in Qatar and the UAE – to emerging market status by Morgan Stanley Capital International (MCSI). “As a result of the upgrade, the weight of Kuwait in the MCSI Frontier Market Index increased significantly,” said Hasan. “Moreover, the upgrade also provides an implied motivation to other markets, including Saudi Arabia and Kuwait, to upgrade their respective market rules and regulations in order to open up to a greater degree of foreign capital.”