On paper, the Kuwait Stock Exchange (KSE) should be one of the best performing markets in the region. In fiscal and macro-economic terms, the country is uniquely well positioned. Gross domestic product (GDP) growth for 2011 is forecast to reach about 5.7 per cent and the fiscal surplus will be equivalent to 23.6 per cent of GDP – the highest level in the region.

While a degree of oversupply remains in Kuwait’s commercial real-estate sector, the government’s enormous economic development programme combined with under-spending over the past decade means a potential boom in business opportunities lies ahead.

Poor performance of Kuwait bourse

Despite all these advantages, the KSE has been the GCC’s worst performing bourse since the beginning of 2011, falling about 15 per cent. In August, the market’s main index slumped to a seven-year low.

In total, the KSE has lost about $24bn of its market capitalisation since the start of 2011, with daily trading volumes halved to about KD2.5m ($9m). In 2009, the KSE’s daily trading volume was about KD88m. Of the 215 companies listed on the KSE, only a few are highly traded. Since the beginning of the year, 19 firms have ceased trading and many are trading with very low volumes and liquidity.

It would be easy to blame the contagion effects of the Arab Spring and the ripples of the US and EU debt crises, but Kuwait’s stocks have been mostly affected by local factors.

“There are many internal factors affecting the Kuwaiti bourse, particularly tight liquidity, absence of investor’s confidence, significantly low trading activity and the wait-and-see scenario developed by local investors,” says Majdi Gharzeddeene, head of investment research at Kuwait’s Kipco Asset Management Company.

Investor sentiment is at an all-time low, with the lack of confidence stemming from the implementation of the Capital Markets bylaws and regulations. “The market has been filtering itself since the onset of the global financial crisis and investors are distinguishing between good and bad stocks,” says Gharzeddeene.

“There are only around 25 blue-chip stocks and the majority of the listed companies are facing a challenging business environment. There are also a large number of paper companies that are not operational and technically bankrupt.”

The bourse is additionally being dragged down by the real-estate and investment sectors. “They have had big exposure to the local market and exposure to the rest of the GCC and international markets. The majority of the assets were in Kuwait and were hit hard in the financial crisis,” says Gharzeddeene.

For years, investors have claimed that it is too easy for shareholders to manipulate share prices. Stocks are traded mostly on speculation rather than the performance of companies. The lax attitude of the KSE towards documents and accounts over the past few years has kept investors wary, but the lack of transparency and the problems this created for the bourse were too potent to ignore. The exchange has been losing out to the UAE and Egypt due to the regulatory weakness in the capital markets.

The CMA has put strict conditions on investment strategies … keeping institutional investors on the side

Majdi Gharzeddeene, Kipco Asset Management Company

The global financial crisis caused the KSE to lose nearly two thirds of its market capitalisation. Liquidity suffered after traders rushed to sell their stocks and investment portfolios, triggering a $5bn government bailout of financial institutions. This liquidity has still not returned to the market.

The dominance of the finance sector has also held the KSE back. Only two of the top 10 listed firms with the highest market capitalisation are not in the finance sector. With the government keen to reinvigorate the exchange, the new capital markets law was passed with little opposition in parliament, securing strong backing in the first vote on 20 January 2010.

Attracting investors to Kuwait bourse

The Capital Markets Authority (CMA) was set up in March 2010 to act as the industry regulator and implement a regulatory framework to instil confidence in investors again.

The CMA’s bylaws, which are not fully implemented yet, came into effect only in March 2011. Full implementation of the law had been planned for September of this year, but this has now been revised to March 2012.

“The establishment of a regulator is always a good sign,” says Arindam Das, head of UK-based HSBC Securities Services for the Middle East & North Africa. “While there are central banks and other finance regulators, capital markets are quite a niche segment. It is good to have a dedicated regulator for the market.”

The CMA will also regulate the entire capital markets system, including clearing and settlement agents, asset managers, investment funds, financial brokers, custodians, investment trustees, financial advisors, issuers of securities and traders. The CMA is expected to discourage manipulation by capping limits on ownership of stocks. It also intends to protect minority shareholder rights when large stakes in a company are acquired.

While the CMA is generally seen as a positive step, it has faced problems. Three of the five commissioners appointed were accused of holding positions that violated CMA regulations, leaving three posts still open. The commissioners need to be selected by the Commerce Ministry and the choices must then be approved by the Cabinet and finally Kuwait’s Emir, Sheikh Sabah al-Ahmad al-Sabah.

“We should not be overly concerned by this,” says Das. “In due course they will find successors. If it takes months, then there will be a lack of progress, but in the larger scheme of things, it is not such a big issue.”

Market reaction

It is still unclear whether the CMA’s bylaws and regulators will create an improved or more complex market. How the rest of the market participants will adjust also remains to be seen.

Earlier this year, the CMA and the country’s central bank agreed to split regulation of investment firms, depending on their investment and financing activities. Investment companies are still wary of issues that may arise from the transfer of regulations.

The limitation on the amount of investment may also trouble investors. Under the new rules, investment funds cannot invest more than 10 per cent of their fund assets in a single stock. They cannot own more than 10 per cent of the securities of any issuer, which analysts believe will have an adverse impact as some of these funds may be forced to off-load good stocks to comply with the new rules and regulations that will be implemented in March 2012. This will further impact the lack of liquidity of the bourse.

“The CMA has put strict conditions on investment strategies and these regulations are keeping institutional investors on the side. They are thinking about how to adjust their positions,” says Gharzeddeene. 

Moreover, the new law has not been readily welcomed by everyone. Brokerage firms have also been banned from employing part-time traders and so many are likely to lose their jobs.

KSE employees, whose contracts have now been transferred to the CMA, went on strike earlier in September over legal issues and payments with their new contracts. They had given the authorities three weeks to meet their demands ahead of a strike planned for 19 October, which threatened to grind the KSE to a halt. The strike was called off after the government settled their salary payments from the date of employment to March 2010, when their contracts were transferred over to the CMA.

“These are all affecting confidence in the market and institutional investors,” says Gharzeddeene. 

But others are slightly more optimistic. “Whenever a new organisation is set up, there are problems,” says Das. “We should not judge the future impact by the settling-down period.”

The full impact of the CMA Law remains unclear. It includes the privatisation of the bourse, of which 50 per cent will be offered to citizens with the rest planned to be distributed in 5 per cent stakes to 10 of the listed companies. There are concerns that floating the KSE will undermine its independence however.

“Restructuring of the KSE will happen. It will be privatised. It has not been implemented yet because of the ongoing dispute between the CMA and KSE,” says Gharzeddeene.

These problems centre around this transitional phase as each party adjusts to the new rules and laws. The main challenges that stand in the way of the KSE’s bounce back to good performance is the implementation and enforcement of the laws and regulations and applying a new trading system.

Boosting trade

The KSE is upgrading to Nasdaq OMX, an advanced system that links the stock market with clearing companies and brokers. This is intended to prevent manipulations of stocks and provide an accurate system. Nasdaq OMX Group Inc, the second-biggest operator of US stock exchanges, signed a KD18.3m ($66.4m) contract with KSE in October 2009 to supply it with a trading system and advisory services. It is currently in the testing phase, but should be implemented soon and is likely to enhance trading activity.

“The regulator is receptive and responsive and if they are willing to listen to market participants and respond to them then that’s a good situation,” says Das. “After talks with the CMA, early indications suggest they are willing to engage with the market.”

“We are optimistic about 2012,” concludes Gharzeddeene. “This year was a tough year for investors. Hopefully the market will recover next year following the full implementation of the CMA bylaws and regulations, which will restore confidence to the market, protect investors interest and segregate the good stocks from the ‘not so good’ stocks.”