Formally established in 1983, the Kuwait Stock Exchange (KSE) is the oldest capital market in the Gulf, and the third-oldest in the Middle East after Beirut and Tehran. In the UAE, the Dubai Financial Market and the Abu Dhabi Securities Exchange were created in 2000, while Saudi Arabia had to wait until 2007 for the formal incorporation of the Saudi Stock Exchange (Tadawul).

The KSE is also one of the largest and, in theory at least, most open exchanges in the Gulf. More than 200 companies are listed on the market across a spectrum of sectors including banking, insurance, real estate, investment, industry, food, telecoms and hydrocarbons. It has the second-largest capitalisation after the Tadawul, with a market value of more than $100bn.

Market frontrunner

In the months to come, the KSE could benefit from a regrading of stock markets in Qatar and the UAE, both of which were upgraded in June by Morgan Stanley Capital International (MSCI) from frontier market to emerging market. “There is a gap in investments in frontier economies that has to be made up,” says Fouad Fahmi, head of brokerage at Gulf Investment House in Kuwait. “Kuwait is at the forefront of that market.”

Unlike other exchanges in the GCC, the KSE is more open to overseas investment. “There’s no barrier to foreign investment in the KSE,” says Abdul Aziz al-Yaqout, partner at US law firm DLA Piper. “In general, Kuwaiti companies can only be 49 per cent owned by foreigners, but listed companies are an exception. Since 2001, foreign companies can technically own 100 per cent of a Kuwaiti listed company. This isn’t the case anywhere else in the Gulf, apart from offshore.”

When the corporate governance measures are implemented, we will see an upturn in trading

Abdul Aziz al-Yaqout, DLA Piper

But there are limitations to the openness of the KSE. It remains dominated by local firms, and many of these are run by wealthy individuals who at best have not yet developed a culture of transparency, and at worst are heavily resistant to it. Foreign investors account for barely 10 per cent of total investment.

“There are quite a lot of stocks, but the number of them that it is realistic for a foreign investor to invest in is probably a couple of dozen at most,” says Simon Kitchen, director of Cairo-based investment bank EFG-Hermes. According to a 2013 study, almost half of trading value was concentrated in 21 stocks that represented just 3 per cent of the market.

The KSE is widely criticised for poor disclosure and trading practices. “There are problems with corporate governance and insider trading,” says Kitchen. “It’s very difficult for the regulator [the Capital Markets Authority (CMA)] to really crack down on the market. Legislation on insider trading has led to a fall in trading volumes, but it is very difficult to enforce. It is under review at the moment, and we might see more realistic legislation as a result.”

Behind the reticence of Kuwaiti companies to reform their business practices is a political system in which, compared with the closed regimes of the rest of the Gulf, they have a considerable say. “There is a long-standing tension between merchant families and the government in Kuwait,” says Kitchen. “It is difficult to see the regulator being really effective until some of the bigger political issues are dealt with, and that doesn’t seem very likely. At the end of the day, they are family businesses and they are reluctant to allow outsiders to play a role.”

Chief replaced

In August, Saleh al-Falah’s tenure as head of the CMA came to a premature end, following the reduction of his term in office from five years to four years. The reasons for the change have not been officially stated, although Kuwait’s local media reported growing resentment in the market of Al-Falah’s attempts to crack down on speculation.

Al-Falah has been replaced by Nayef al-Hajraf, who was formerly minister of employment and, briefly, minister of finance. Whatever the motives behind the end of
Al-Falah’s term, there has been a positive response to the appointment of Al-Hajraf. “I think he’ll make a positive impact in creating a more transparent and efficient regulator,” says Al-Yaqout.

The creation of the CMA in 2010 was a major milestone in the KSE’s development. It took over responsibility for organising and regulating trading activity, meaning that for the first time the regulation of the exchange was independent from the stock market itself. “In the eyes of a potential investor, the creation of a regulator is the cornerstone of a market, especially if it’s in a frontier domain,” says Fahmi.

Inevitably, the CMA has had difficulties exerting control over a market that had already been operating for 27 years when the regulator was created. “They didn’t get off to a good start,” says Al-Yaqout. “The executive regulations were flawed, not clear. There was a lot of copy-paste [from other capital market regulations] and a lot of people didn’t understand the concepts properly.”

The CMA has a long way to go to effectively impose the standards of governance and disclosure that are mandated by existing regulations. “Compliance and governance are still a problem,” says Al-Yaqout. “Last year the CMA issued far-reaching corporate governance rules. Maybe they went too far, but it’s hard to say – they only came into effect in June 2013.”

Transparency issues

A reticence among listed companies to fully disclose their financials remains an issue. Since its creation, the CMA has de-listed several firms for failing to disclose historical financial data. “There’s still a lack of transparency,” says Al-Yaqout. “But with the new regulations and reporting requirements this will improve, and over time there will be more confidence in the market.”

Teething problems are no great surprise. With a swathe of new regulations introduced in a short space of time, both the CMA and KSE-listed firms are on a steep learning curve. “The CMA has only been there a couple of years,” says Fahmi. “It takes time, but we believe that the flow of foreign investment will increase.”

Al-Yaqout agrees: “People will have to learn to use the regulations to regulate. But when we get to that point and are able to use them effectively, we’ll be in a better place.”

The KSE has pledged its commitment to achieving a “fair, transparent, orderly and efficient marketplace,” and there is optimism that it is on the right track. “They are working hard to fix [the problems],” says Al-Yaqout. “They’re revamping the executive regulations and improving the clearing situation. They’re trying to get their act together. We will have to wait and see how it pans out, but there will be a marked difference in the next three to four years; I’m quite confident of that.”

Among the key changes under way are the introduction of a corporate governance code and the privatisation of the KSE itself. The enormity of carrying out these tasks in tandem, though, is creating problems, and delays have become frequent as the market adapts to what is realistic. In April, the CMA pushed back the deadline for the implementation of corporate governance reforms from the end of 2014 to June 2016 to give companies more time to prepare.

Plans to privatise the KSE were outlined in the February 2010 capital markets law. The plan involves the sale of 50 per cent of the KSE to listed companies, with a 5 per cent ownership limit for each firm. The remaining 50 per cent will be made available to Kuwaiti nationals through an initial public offering (IPO). In early 2012, the UK’s HSBC was appointed adviser on the process, and DLA Piper legal adviser. In April 2014, the CMA took another step towards the privatisation of the KSE, announcing that it had established the Kuwait Bourse Company with capital of KD60m ($213m).

In its move towards privatisation, Kuwait is ahead of its regional peers, all of which have publicly owned exchanges. But the implementation schedule has already been repeatedly put back. The government was initially aiming to complete the privatisation in the first quarter of 2012. When the plans met with opposition from employees of the exchange, the target was postponed to the end of 2013.

That target was missed too, partly due to the CMA’s announcement in 2012 that regulations in the capital markets law preventing the regulator from participating in commercial activity might impede it from overseeing the KSE listing. The regulations had to be changed, and the privatisation schedule postponed once more.

There are also concerns that a lack of market activity might compromise the listing plans. Trading volume on the KSE has fallen in recent years. For example, in 2010 it was $100bn lower than in 2007-08. Other indicators, though, are more positive. Market liquidity is significantly up in recent years and was second only to Saudi Arabia in 2013, and the overall market index is one of the best-
performing in the GCC.

Unusual move

Selling off the exchange to companies that are listed on it is an unusual move, and its consequences are difficult to predict. “It’s an ongoing dilemma in Kuwait how the privatisation of the exchange will impact the market,” says Alissa Amico, project manager for corporate governance at the Organisation for Economic Co-operation and Development in Paris. “The introduction of the CMA has complicated things in the sense that the privatisation of the market and the creation of the CMA are happening concurrently.”

But the potential upsides to the reform of the KSE are great. “When the corporate governance measures are implemented, we will see an upturn in trading like Saudi Arabia experienced four or five years ago,” says Al-Yaqout. “Improvements in reporting rules and listing requirements spurred trading activity and led to a weeding out of small caps. It will happen in Kuwait, there is no question in my mind.”