Gulf stock markets in search of a role

01 November 2010

The year to come should be good for investors in GCC securities. But the markets of the region continue to disappoint

The combined value of shares listed on GCC stock exchanges is larger by a wide margin than their equivalents in the rest of the Middle East region in aggregate. Turnover in Saudi shares in a single week is often larger than it is for an entire year in markets outside the Gulf.

GCC capital markets are failing to fulfill the hopes vested in them

And yet, GCC capital markets are failing to fulfill the hopes vested in them. Turnover is low and shares of most quoted companies are infrequently traded. In the first half of 2010, there were fewer than 10 initial public offerings (IPOs). GCC stock markets have in price terms been among the worst-performing in the world in the past five years.

MEED’s Capital Markets 2010 conference in Abu Dhabi heard that the failings of GCC stock exchanges were due to a several factors. The first was the casino-style speculation by retail investors before the region’s markets crashed in February 2006. After a brief recovery, GCC markets slumped again as a result of the 2008 financial crisis.

Foreign capital invested exited the GCC in 2009 as investors concluded that there was not going to be a revaluation of Gulf currencies against the dollar. Banks, the largest single component of GCC stock markets, were hit by non-performing loans (NPLs), the financial difficulties of Saudi Arabia’s Saad al-Gosaibi and, finally, by the Dubai debt moratorium announced a year ago this month.

All this is well known. The conference therefore focused on what could be done to reverse the trend. The top priority is to attract large, institutional investors. In advanced economies, institutional investors are dominant. In the GCC, retail investors often rule.

The lack of long-term investors reduces demand for equity research. Without that, the pressure on GCC companies to increase transparency falls.

Head of Middle East equity research at JP Morgan Christian Kern said institutional investment should rise in 2010. There are about 50 Middle East North Africa funds obliged to invest in the region’s markets. International emerging market funds are showing fresh interest and hedge funds are checking Gulf equities.

But markets will have to help themselves. The biggest defect is that it is effectively impossible to hedge against market volatility. This does not matter when markets rise. You buy, hold and harvest profits when the time was right. But when prices fall, investors are completely exposed. This is stimulating calls for the introduction of equity derivatives to help investors protect themselves against downside risks.

A plan to introduce derivatives has been submitted for approval to the Capital Market Authority (CMA), which regulates the Saudi Arabian stock market (Tadawul). There are other suggestions. Nasdaq Dubai chief executive Jeff Singer called for short-selling to be allowed. This is a controversial proposal. Short-selling was blamed for the 2008 equity crash, particularly in the US where it was temporarily banned. Singer argued this was because it was impossible to track short-selling in the US. Gulf markets allow deals to be monitored. Short-selling in these conditions would provide protection against downside share movements.

Singer’s three other proposals are less contentious. Merging GCC liquidity pools, rather than merging exchanges, will allow existing markets to draw on each other’s investable resources. This is what Nasdaq Dubai has done in an agreement reached with the Dubai Financial Market (DFM) in July. Singer’s suggests similar agreements should be reached among other GCC markets.

The limited turnover in most GCC shares is a further problem. Big institutions do not want equities that cannot be quickly sold, but Singer believes this issue will become less pressing over time. The fourth proposal is for the MSCI to include GCC equities more extensively in its indexes, the conventional performance benchmarks for large-scale emerging market investors.

Big institutions do not want equities that cannot be quickly sold

All this may well happen, but when? The conservativeness of GCC capital market regulators has been validated by the events of 2008. Resisting the inflow of speculative funds meant the GCC market crash was less severe than it might have been. Limiting the range of capital market products also prevented GCC banks from being even more exposed than they were to downside volatility. No one is expecting GCC regulators quickly to stop being cautious.

There is more excitement about prospects for GCC bond markets. The region has tended to rely on bank credit for long-term finance. But this is being restricted by the response of the banking industry to the shocks of 2008 and in anticipation of the Basel III capital adequacy rules which will reduce the attractiveness of term lending. Bonds, which banks can sell or hold, are less risky than loans. For borrowers, the cost of servicing bonds comprises interest and discounts. This too is an automatic risk mechanism, which is becoming more attractive at a time of financial uncertainty.

According to head of HSBC’s global financing in the Middle East Andrew Dell, the value of new bonds issued in the region will rise to $30bn in 2010 and should grow by 20 per cent and more in 2011.

The mood in the GCC capital market is as a consequence more positive than it has been for half a decade. The challenge for champions of Gulf stock exchanges to win over investors and corporations with initiatives that will make what has been built so far work better.

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