Investors and financial analysts in Kuwait are waiting to see who the government chooses to lead the country’s new Capital Market Authority (CMA), now that Kuwait’s parliament, the National Assembly, has passed the framework legislation for this long-awaited new supervisory agency.

Weak regulation is blamed for the price manipulation and lack of transparency that undermines local investors’ confidence and deters foreign institutions from buying stock listed on the Kuwait Stock Exchange (KSE), one of the oldest bourses in the region.

The fragilities of what had seemed a well-resourced national investment sector were brutally exposed by the global crisis. Prices on the KSE suffered more than almost anywhere else in the Middle East, as trust in the core value of local assets slumped. Meanwhile, a number of leading investment houses in the country ran into serious financial problems as the world squeeze on liquidity eroded their access to the short-term funding, which they had relied on to support long-term projects.

Key fact: Some 48 MPs and ministers voted in favour of the new capital market law, with only one opposing the measure

Reform call

These problems were in sharp contrast to the performance of Kuwait’s banking sector which – with the exception of Gulf Bank, hit by specific internal flaws – weathered the global financial crisis with relative ease.

The sector was protected by the prudent lending constraints imposed by the Central Bank of Kuwait.

The painful experiences of the past 18 months gave renewed impetus to the longstanding plans for a new CMA to oversee the KSE and the whole investment sector in the country.

Reform proposals have often run into opposition in the National Assembly. But the election of an enlarged contingent of reformist members of parliament (MPs) in summer last year, and the successful performance of the prime minister, Sheikh Nasser Mohammed al-Ahmed al-Jaber al-Sabah, when summoned for questioning by MPs in December, shifted the parliamentary momentum in the government’s favour. Ministers took advantage of this change in mood to secure the legislature’s approval of both the national development plan and the draft law providing for the establishment of the CMA.

The new capital market law secured strong parliamentary backing in a first vote on 20 January and final endorsement on 2 February. Some 48 MPs and ministers voted in favour, with only one opposing the measure.

In public, at least, the need for a stronger regulatory structure is accepted by almost everyone. Zaid al-Naqeeb, head of asset management at Kipco Asset Management Company (Kamco), points out that Kuwait has a history of investment market problems dating back to the 1970s and 1980s.

A crash in the official stock market in 1977 was followed five years later by the collapse of the Souk al-Manakh informal share market, which bruised thousands of private investors and left many banks technically insolvent.

So there was a feeling of familiarity as Kuwaitis contemplated the latest plunge in asset prices that had got out of touch with their real economic value.

Even before the global crash, many local financiers were pressing for reforms to make regulation less bureaucratic but more rigorous in its focus on fundamental risk issues.

Government was starting, gradually, to respond to these concerns, but it was slow to take concrete action perhaps because Kuwait has such a long history of share-trading and investment activity, and also because its economy and finances are cushioned by oil wealth.

Fresh momentum

However, the sobering experiences of 2008-09 have injected new momentum into the reform drive, particularly as speculation and a lack of transparency had remained serious problems, even after the last market crash.

Investors repeatedly complain that share prices are driven by speculation and manipulation, rather than genuine business performance and prospects, demonstrated through credible company and sector data.

“Lack of transparency is a serious problem and manipulation is real. Timely and factual release of company specific news is a rarity. Most of the time, the market is driven by speculation and not based on real business values,” a source in the investment team at a leading Kuwaiti bank tells MEED.

Sometimes the price of a little-known stock will surge upwards, when no information about the firm concerned is actually available.

Even major stocks can be prone to such volatility. Recent swings in the share price of local telecoms firm Zain were far greater than could reasonably be explained by investor speculation over the possible sale of the company’s African interests or the 46 per cent Al-Khorafi stake in the company, says Al-Naqeed. Volatility, speculation and insider trading have intensified as a result of the economic crisis, particularly as the Kuwaiti government has not introduced a large stimulus package to ensure continued business activity, he says.

It is difficult to forecast how companies and sectors will perform in today’s troubled economic conditions and therefore investment managers cannot develop a long-term strategy, he explains. “There is no stimulus package or transparency. We don’t know which companies are going to be any good,” he says.

As a result, investment managers such as Kamco are turning to short-term trading to sustain revenues. This adds to the uncertainty and volatility in prices.

Concrete steps

Al-Naqeeb believes that even after the crisis, Kuwait may struggle to gain the confidence of international investors unless it strengthens the supervision and governance of capital markets. International financial institutions repeatedly cite regulatory weakness as the reason why they steer clear of the country, opting instead for the likes of Egypt or the UAE, he says.

Parliament’s approval of the capital market law has generally been welcomed. But market observers are waiting to see what it will amount to in practice.

Although the law has 164 articles spelling out the prerogatives of the CMA, many issues that will be key to the authority’s effectiveness – such as the membership of its five-person governing board – have yet to be clarified. The fact the final version of the reform has been shaped by at least five different alternative proposals has only added to uncertainty over how it will function in practice.

The final version appears to be mainly the product of internal commerce ministry thinking and of the work of Amani Buresli, professor of finance at Kuwait University, who in 2006 was commissioned by the government to produce a draft proposal of the CMA legislation.

Many financiers remain to be convinced the new entity will have the power and independence to meet Kuwait’s regulatory shortcomings. “I think it is not a bad move, but I don’t think it’s a drastic move that could produce drastic results,” says Adnan al-Bahar, chairman and managing director of The International Investor (TII), one of Kuwait’s leading specialist investment banks.

In Al-Bahar’s view, it is vital the new authority enjoys clear independence both from the stock exchange – the main capital market to be regulated – and from government political control. In formal legal terms, the CMA is being established by the state, with the board members appointed in the name of the Emir. So much will hang on the choice of individuals to take up these key posts. They will have the task of demonstrating that the new authority is effective, credible and genuinely independent.

Saudi Arabia’s own CMA is sometimes cited as a model for the new Kuwaiti regulator, although the context is different.

While the KSE was established back in 1962, the Saudi stock exchange, the Tadawul, was not set up until 1994, and the development of local bourse investment culture has been a more recent phenomenon. But Al-Naqeeb points out the KSE has failed to crack down on what are essentially ‘paper’ companies with little real value. He believes Kuwait can learn useful lessons from the Saudi experience – although the Tadawul sees heavy trading just like the KSE – the CMA in Riyadh keeps matters in hand through firm discipline. “The Saudi market is highly tradable, but there is some trust in the market regulator; people have been sentenced to jail for abuses,” he says.

The way stocks are assessed and valued depends not only on regulation but also on attitudes among investors. Al-Naqeeb is not convinced that in Kuwait there will be a universal welcome for a strong new regulator.

“There is a big investment community who say they want the authority, but many people do not really want it,” he says. “When some of the investment companies made high risk investments, people did not ask hard questions. Investors liked the high dividends.”

But there are some investment houses that have faced up to the need for change including Kamco. “We really learned the lesson very hard. In my department [asset management] we are changing everything, concentrating on risk management, hiring new people,” says Al-Naqeeb.

Al-Bahar suggests that introducing competition could raise standards. He believes the new CMA should be separate from the KSE altogether, with a brief to oversee all capital markets – including, for example, local bond trading, which used to be more active 20 years ago but has faded in recent years.

He also thinks the market should be liberalised to permit the establishment of new bourses, to compete against the existing market. “If there is enough business to have one stock exchange in Bahrain, there is enough business to have three stock exchanges in Kuwait. The way to get things moving is to have more markets,” he says.

Competition would drive up standards of operation and transparency, as the markets would have to compete to attract listings of tradable assets – debt and derivatives as well as equities – and to draw the interest of portfolio investors from Kuwait, the Gulf region and the wider international community.

Al-Bahar says the KSE should be privatised and the new markets should be set up by private sector interests. Al-Naqeeb also endorses the case for liberalisation.

For the source in the bank investment team, the key driver for change is not so much the potential for foreign investor interest as a firm  regulatory hand to promote transparency.

“We don’t believe the market will achieve more stability if it becomes more international,” the source says. “What will make it more stable is transparency, accountability, strict enforcement of rules and regulations and severe punishment – monetary as well as criminal – for any type of manipulation.

“We also need stricter and more demanding listing norms. Delisting altogether or moving to a separate exchange at least half of the currently listed companies – highly illiquid small caps with very limited trading volumes, mostly from the investment and real estate sectors, that do not justify continued listing on the exchange – would stabilise the market. Limits on the daily up and down movement of a stock price is another aspect that needs a fresh look.”