LONDON, 17 January 2005 — While the year 2004 has seen the stock markets in the six Gulf Cooperation Council (GCC) states outperform their growth in 2003, on the back of a low interest environment and high liquidity due to the rising oil prices, investors and analysts alike are concerned that local stock exchanges remain loosely regulated and principally underdeveloped.
Saudi Arabia’s Tadawul stock exchange index (TASI) at end November 2004 for instance, had a year-to-date (YTD) gain of 87.71 percent on 2003. The National Bank of Abu Dhabi (NBAD) Index was the next biggest gainer at 61.1 percent. The worst performer was the Kuwait Stock Exchange whose Global General Index posted a mere 12.27 percent gain for the same period.
Buoyant oil prices with its attendant liquidity boom and its resultant multiplier effect on corporate earnings, private investment and consumer spending can be a double edged sword.
There are signs that institutional and private investors are coming home and this investment strategy is dictated by political reasons.
While actual divestment from the US markets has been minimal, new GCC investment into the US has been seriously affected. This has been channeled increasingly to Europe and Asian markets such as Malaysia.
The GCC stock markets also are limited by their size, valuations and the number of primary offerings, with the result that the exchanges are not in a position to absorb the record amount of liquidity flush in the markets. Estimates of the size of idle funds parked in the region vary from between $330 billion to one trillion dollars.
One sector which is gaining over equities as an investment asset class is real estate. The real estate sector has exploded at a frightening pace especially in Saudi Arabia and Dubai. And this is just the tip of the iceberg. The region is also in the midst of a construction boom. Not surprisingly, the performances of property and cement companies’ stocks especially in Saudi Arabia, Qatar and the UAE have boomed in 2004 in terms of sector price to earnings ratios, market capitalization and profitability.
The December 2004 GCC Market Review published recently by Kuwait-based Global Research, the research arm of Global Investment House, stresses that the GCC real estate sector is indeed “slated to see some serious action in the medium-to-long-term. Real estate and cement stocks would most likely be the chief beneficiaries from the buoyant state of the real estate market going forward, as rising real estate prices would support growth in bottom-lines of sector participants.”
Others warn about a long-overdue correction in the GCC real estate market, although this would not be in excess of 20 percent and certainly not in the magnitude of the crisis say in Kuwait in the 1980s. Others further warn of unrealistic valuations and market demographics; and legal issues relating to property ownership and residency for foreigners.
The challenge for GCC stock markets in 2005 and beyond, as such, is to get their act together especially in terms of regulation and disclosure. Global Research identifies rampant insider trading, which is not illegal in the GCC markets, and lack of detailed disclosure especially on mergers and acquisitions, and risk management, as three major debilities.
“Financial intermediaries in the local market,” maintains the Global Research GCC market review, “have been stressing a number of fundamental, yet essential reforms that should be implemented, facilitating a conducive environment for the market to become sound and internationally acclaimed exchanges. Clear cut regulations should be set into place to protect shareholders, investors and corporations alike.”
Analysts agree that there is a great deal of room for improvement especially in a global era of increased compliance and regulation. “This is not to belittle the importance of professional standards but currently, insider trading is not prohibited or penalized, which makes for serious concerns on the part of investors. Detecting and punishing such practices is crucial to maintaining fairness to all investors in the market and protect minority shareholders,” warns the Global Research report, for instance.
The regulation of the primary market in the GCC stock exchanges in particular, stress analysts, needs urgent development. At the moment this primary role of raising capital is nascent and negligible.
Given the political structures of the GCC states, there is an unwitting collusion between governments, lawmakers and regulators on the one hand and institutions, investors, and intermediaries on the other hand.
While this situation may be sustainable during the good times of high oil prices and liquidity, it would only take one or two major financial or corporate collapses or scandals in the GCC to have a knock-on effect on the region as a whole.
The responsibility on those who drive financial market regulatory changes and those who effect such changes is equal. It is high time that the pace of such change in the GCC stock markets is fast-tracked to usher the markets into the era of global best practice in regulation, compliance, transparency, disclosure and risk management.
The GCC countries would be ignoring these warnings at their peril. For, at the onset of the 21st century, it is outrageous that Gulf financial markets should be seen to tolerate insider trading; lack of proper risk management; and poor disclosure.