Oman's alternative investment instruments gain momentum in the markets

Muted investor sentiment since 2016 has resulted in a slowdown of activity on Oman’s stock market. Sovereign downgrades by all three major ratings agencies and constricted government spending in the wake of a rapid oil price decline have taken their toll on trading volumes, nudging the exchange’s index into a negative trend over 2018. However, some parts of the market are benefitting from the altered economic scenario. Bonds and sukuk (Islamic bonds) have become a more inviting prospect for investors seeking a reliable return, and the two financial instruments have seen a rapid increase in turnover during 2018. The development of regulations concerning real estate could also boost the popularity of a new financial instrument, the uptake of which has thus far been sluggish. Rising oil prices in late 2018 may prompt a return of more traditional market drivers, greatly increasing the possibility of a reinvigorated capital market over the coming year.

History

The development of Muscat’s capital markets began with the economic renaissance ushered in by Sultan Qaboos bin Said al Said upon his ascension to the throne in 1970. In the following year, Oman Hotels became the first joint-stock company to offer shares to the public, marking the beginning of two decades of capital markets expansion, during which emerged more than 70 joint-stock companies and around 17,000 shareholders. In response to the increasing size and complexity of the market, in 1989 the government established the Muscat Securities Market (MSM) to act as a formal trading platform. The new exchange was given a broad range of responsibilities, which included the provision of a suitable arena for equities trading, the regulation of market activities, ensuring investor protection and establishing the new market as a tool for the development of the national economy.

The new regulatory framework allowed for another phase of capital market growth, which was further accelerated in 1997, when the MSM switched from manual to electronic trading – a change which simultaneously enhanced trading volume and reduced risk. This technological advance established Oman at the forefront of regional exchange development, but a market crash the following year highlighted a number of regulatory shortcomings. The most troubling of these was the MSM’s responsibility for all of the central functions of the market, including regulation, trading, and the associated settlement and clearing activity of the buying and selling processes.

Reorganisation

In answering this structural challenge, the government introduced a radical reorganisation of the exchange in 1998, which laid the foundations for the modern market. Two royal decrees redefined market operations and divided them between three separate entities: the MSM was established as a government entity with financial and administrative independence, and given the primary responsibility of listing and trading securities; the Capital Market Authority (CMA) was newly founded and tasked with regulating the capital market and insurance sector; and the Muscat Clearing and Depository (MCD) Company was formed as a closed joint-stock company owned by the MSM, banks and market participants, and given a mandate to oversee important procedural functions, such as processing buy and sell contracts and maintaining shareholders registers.

More recently, the exchange has embarked on a new phase of development. In October 2017 the MSM received permission from the regulator to establish itself as a wholly owned subsidiary of the State General Reserve Fund, in preparation for its public offering. Under the previous framework, the MSM was both under the authority and supervision of the regulator. The new framework reduces the regulator’s role to one of oversight alone, which is in line with how most regional and global regulators operate.

Modern Market

Today, the exchange is a multi-asset platform with a focus on equities, the wide range of which is a reflection of the sultanate’s increasingly diverse economy. Stocks are organised into three main sectors – financial, services and industrial – and further divided into a larger set of 23 subsectors, including banking, insurance, cement, chemicals, telecoms and real estate. A notable characteristic of the MSM is the large amount of market value accounted for by closely held corporations, where equity is limited to a small number of shareholders, a phenomenon that has a limiting effect on exchange liquidity. In 2017 closely held corporations accounted for around OR7.1bn ($18.4bn), or 39.8% of total market capitalisation, making it the single-biggest block on the exchange. In terms of trading activity by sector, financial services came first with market capitalisation of OR3.9bn ($10.1bn), followed by the services sector with OR3.1bn ($8.1bn) and the industry sector with OR1.2bn ($3.1bn).

As of late October 2018 a total of 117 companies were listed on the MSM, five more than at the end of 2017. Companies have the option to list on the regular market, which is the principal board of the exchange, or on the parallel market, which is governed by less demanding listing requirements and acts as a feeder platform for the regular market. The primary tracking tool of the exchange is the MSM30 Index, which monitors the 30 most capitalised, liquid and profitable firms in the market. These stocks, the price movements of which are the focus of most investors, include blue chip companies such as Bank Muscat and Oman Telecommunications. The MSM also includes a third market for off-floor share dealing with or without a broker, and a rights issue market, which is the primary market where shares are issued to the public for the first time. Of all the exchange’s platforms, the regular market is by far the most active. In 2017 around 0R653.3m ($1.7bn) worth of securities were traded on the regular market, compared to OR261.1m ($678.1m) on the parallel market and OR2.1m ($5.5m) on the third market.

Debt Market

The MSM also manages a debt market, which has historically been underutilised, as is the case with most exchanges in the region. As of late October 2018 there were 33 bonds and sukuk listed on the MSM, 18 of which were government issuances. The smaller number of corporate issuances are largely derived from the financial services sector, a common trend of nascent debt markets. However, despite the slow development of Oman’s debt market, since 2017 the bond and sukuk market has emerged as one of the more interesting areas of the economy. This is due in large part to the government’s need to secure alternative sources of funding to replace diminishing hydrocarbons revenues. The bond market was mostly responsible for the exchange’s overall 3.5% increase in turnover in 2017. While the total value of trading in the equity market declined by 3% that year, the bond and sukuk market expanded by nearly 470% from OR13.4m ($34.8m) to OR76.1m ($197.6m). Increased activity in the debt market continued into 2018, when Oman issued a $6.5bn sovereign bond – its largest ever – in January. As the country’s roster of public debt grows, the sovereign issuance is forming a useful yield curve for the pricing of corporate offerings (see analysis).

The private sector has also made a notable issuance. In April 2018 Omantel, the country’s first telecoms company and primary provider of internet services, issued bonds worth $1.5bn in a two-tranche sale, with the first tranche ($600m) to mature in 2023 and the second ($900m) in 2028. The deal was the largest corporate issuance in Omani history, and the proceeds of it were expected to be used to repay a loan facility Omantel had secured to fund its investment in Kuwaiti telecoms firm Zain in November 2017. For the 5.5-year tranche, around 40% of investors were from the US, the UK and Europe, while 47% of investors attracted by the 10-year bond were foreign. At one stage of the transaction, the order book reached $8bn, representing an oversubscription of 5.3 times, before settling at $6.9bn.

Performance

In 2017 Omani stocks were negatively affected by the impact of low oil prices on Gulf economies, subdued profits of corporates and weak investor confidence. According to the MSM’s 2017 annual report, the MSM30 closed the year at 5099 points, a decline of around 12% on the previous year. Meanwhile, the sharia-compliant index dropped by nearly 18%, to close at 714 points. The prices of 66 listed securities out of 103 declined in 2017, while 18 remained stable and just 19 posted gains. In the MSM30 Index, Oman Fisheries recorded the strongest performance with a 138% gain, followed by Al Madina Takaful (31%) and Oman United Insurance (18%). The companies showing the biggest declines in values over the period were Raysut Cement (-47%), Oman and Emirates Investment Holding (-40% ) and Gulf Investment Services (-35%).

Muted investor sentiment continued into 2018, with the MSM30 following a broadly downward trend over the year. Starting at a little over 5000 points in January, the index declined to reach a support level of 4320 in July, and thereafter tracked a broadly horizontal channel. The turnover of shares during the first nine months of 2018 was 7.5% lower year-on-year, according to the MSM. Increasing trading volume on the MSM and attracting new liquidity are therefore key challenges for the regulator over the short to medium term.

Regulation

The CMA is regarded as one of the most prudent regulators in the region and was an early mover in the harmonisation of standards with global best practice. The MSM was the first exchange in the GCC to introduce obligatory financial reporting on a quarterly basis, suspending the trading of equities of companies which fail to meet reporting deadlines. The regulator’s prudential oversight also extends to global service providers, which interact with domestic entities. For example, in 2017 the CMA issued a regulatory warning to consulting firm PwC for deficiencies in its audit of a listed company. The sector is governed according to the Capital Market Law of 1998 and its subsequent implementing regulations. While the introduction of this framework resulted in an era of stability and growth in Oman’s capital markets, many stakeholders – including the regulator – believe that future growth of the sector would be best secured under a new legislative model.

The CMA first met stakeholders to discuss a revised law in January 2017, having published the draft legislation on its website the previous month. In formulating the new framework, the CMA aims to secure the “dynamic and innovative growth of the industry”, according to a model which is in line with international best practice. Key themes of the new law include consumer protection and a clearer delineation of the roles and responsibilities of the major market institutions. Additionally, the proposed legislation, yet to be enacted as of late October 2018, would invest the regulator with greater powers of enforcement than is currently the case, a provision which would enable it to step up its campaign for market accountability and transparency.

Real Estate

One of the most significant regulatory developments over the past years was the issuance of the Real Estate Investment Trust (REIT) regulations in March 2018. REITs are popular investment instruments on global exchanges, but a relatively new phenomenon in GCC markets. In 2014 Nasdaq Dubai became the first exchange in the region to list a REIT, and since then Saudi Arabia, Bahrain and Qatar have rolled out similar regulatory frameworks. The topic of REITs has been on the agenda in Oman for some years, and in the long term they are expected to be popular instruments for both property developers and investors: their principal appeal being that they trade on the exchange like ordinary stock and provide investors with access to ownership in large real estate projects at low ticket sizes.

REIT structures are regulated by the CMA under a governing framework similar to those found elsewhere in the region. Accordingly, the dividend payout ratio of a REIT must be at least 90% of its net realised income, which is also the requirement imposed on REITs in the UK. A REIT established in Oman must have a paid-up capital of no less than OR10m ($26m) and offer at least 40% of its equity for public subscription. At least 50% of the total value of a REIT’s assets should at all times be invested in income-generating real-estate properties, and investment in undeveloped land is not permitted – although investment in real estate under construction remains an option for REIT managers. Despite these and other restrictions, the new regulations are notable for their flexibility. The regulator has the power to exceed the limits established by the REIT regulations in cases where a particular investment is judged to be to the overall advantage of the unit holders.

The introduction of REITs in Oman forms part of the government’s attempts to broaden the country’s economic base and attract more foreign investment under Tanfeedh, the National Programme for Enhancing Economic Diversification. The new instrument allows foreign nationals to invest in the real estate market and foreign-born residents to place their money in Omani property rather than send their money abroad. Uptake of the new instrument, however, has been slow, and as of October 2018, no REITs were listed on the MSM. Talking to local press in June 2018, Mohamed Said Al Abri, vice-president of the capital markets sector at the CMA, attributed the delay to the complexity of introducing the new instrument to a market unaccustomed to REITs and maintained that a number of exploratory applications had been received by the regulator. However, some market participants have pointed to the 15% capital gains tax on assets transferred to a REIT and a 5% levy on transferring title deeds as more fundamental blocks to the uptake of the instrument in Oman.

IPO Pipeline

While the promise of REITs has yet to be realised, many market observers hope that stabilising oil prices will result in a return of more traditional, voluntary flotations. According to Salem Al Noaimi, CEO and managing director of Waha Capital, an Abu Dhabi-based investment firm, market volatility and lower oil prices have made industry players more cautious. “The overarching theme for us is to avoid focusing on short-term gains and take on a longer-term approach,” he told OBG. Challenging market conditions in the wake of the oil price decline, which started in mid-2014, has also meant that the compulsory flotations of insurers have formed the bulk of the initial public offering (IPO) pipeline: between the third quarter of 2017 and the second quarter of 2018 five of the six offerings on the exchange were staged by domestic insurers meeting the legislative requirement to list, according to global professional services firm EY. The largest of them was the flotation of the National Life and General Insurance Company in December 2017, which raised $55.1m. However, while larger, well-capitalised insurers have provided a number of investment opportunities, many of the mandatory insurance IPOs have not been well received by investors. The prospect of improving market conditions and a phase of voluntary flotations is therefore a welcome one. In the meantime, more compulsory flotations are expected to maintain a steady flow of IPOs on the MSM over the medium term. Six power generation and water desalination firms are due to list before 2021, according to local media in January 2018. Independent power and water projects are required by their foundation agreements to offer at least 35% of their share capital to the public within four years of their incorporation, and previous offerings from the sector have proved popular with investors. The IPO of the Muscat City Desalination Company in December 2017 was oversubscribed 19 times, and shares in the firm increased more than 35% in value upon their listing.

Outlook

The performance of the stock market is largely connected to oil prices and the expansion of the real economy, and on both counts the outlook for 2019 is a broadly positive one. In July 2018 JP Morgan forecast that the price of Brent crude would average $70 per barrel in both 2018 and 2019, up from a previous forecast of $65 and $60 per barrel, respectively. In October 2018 the IMF predicted that Oman would have the highest GDP growth rate in the GCC in 2019, at an estimated 5%. These trends are likely to exert a positive effect on Omani equity valuations. The prospects for continued expansion of debt market activity are also favourable, given the need of the banking sector to raise Tier-1 capital to meet regulatory requirements.