This article is part of an Executive special report on wealth management and private banking. Read more stories as they’re published here, or pick up September’s issue at newsstands in Lebanon.
With the lack of active capital markets, banks have as of yet provided the largest source of outside financing to private companies, resulting largely in a lending monoculture. Yet, their conservative lending policies dictate a disproportionate amount of collateral on loans, leaving much of the market financially underserved. In most economies, capital market and traditional banking activities complement each other when financing companies. There is little doubt that the proper and rigorous development of capital markets would equally benefit the Lebanese economy.
Historically weak capital markets
Despite the fact that Lebanese companies across all sectors are highly underfinanced, the development of Lebanese capital markets throughout the years has not been treated with the utmost priority. With various draft laws surfacing to regulate the capital markets as early as the 1990s, it was not until 2011 that the Capital Markets Law was passed (along with the Insider Trading Law on the same date), in a move that would create the framework to establish proper regulations.
Before the passage of this law, capital markets were regulated as a peripheral activity from a department within Banque du Liban (BDL), which would approve new financial instruments before they were released, and supervised by the Banking Control Commission (BCC). The most recent World Bank report on Lebanon’s financial sector, published in 2013, noted in its assessment of Lebanon’s capital markets that this supervision focused on prudential issues — consistency with standards within the various organizations — largely overlooking market conduct.
This under-regulation compounded the inactivity of Lebanese capital markets, already shaken by a civil war, ongoing political and security instability, skeptical investors, as well as reluctant owners of family businesses who were not entirely sold on the idea of opening their companies to outsider ownership and scrutiny.
The most striking example of market inactivity is today’s Beirut Stock Exchange (BSE), the country’s sole securities market. With a mere 11 companies listed — most of which are financial institutions — it had an average daily traded volume of 230,000 shares over the past three months (May–July 2014). Although set up in 1920 as the region’s second stock exchange after Egypt, BSE activity pales in comparison to a genuinely active stock exchange such as the Dubai Financial Market which saw a 50-day average volume of 619 million shares as of mid-August. Until the 2011 Capital Markets Law placed it under the mandate of the Capital Markets Authority (CMA), the BSE was self-regulated under the supervision of the Ministry of Finance.
The CMA: A credible regulator?
The Capital Markets Law of 2011 called for a handing over of all regulatory duties to and for the establishment of the CMA. Within the CMA, the law called for a board, secretariat, capital markets control unit and sanctions committee. The mandate of the CMA includes “organizing and developing capital markets in Lebanon and promoting their use by investors and issuers alike,” “protecting investors from illegal, irregular or unfair practices, including the prohibition of direct or indirect insider trading,” and “sanctioning administrative violations of this law.” This law was the most inclusive and detailed document on capital markets thus far, and according to Chadia El Meouchi, managing partner at Badri and Salim El Meouchi law firm, it is of “high standards.”
Once the CMA’s board of directors was selected a year after the law was passed in July 2012, it took them another nine months to completely take over activities from the BDL as capital markets regulator. “You can’t just get into the market, suddenly create a new authority and start spreading new rules and laws and regulations in the market,” says Firas Safieddine, vice chair on the board of the CMA, speaking of the delay.
While the capital markets control unit has been set up to supervise the market, neither the sanctions committee that the law calls for nor a separate capital markets tribunal have been set up because “they require ministers’ nomination followed by cabinet approval,” according to Safieddine. This creates something of a split situation whereby the CMA has some real and some not fully realized powers. The agency has teams working on licensing of financial products and on supervising both the business and market conduct of various institutions, but the functions of sanctioning and filing charges over violations have not yet been fully established. Until the sanctions committee is staffed, the CMA relies on other bodies to assist in legally executing these oversight functions. “We can revoke a license, we can send letters of warnings … [but] we currently fall short of having proper sanctioning,” says Safieddine.
A long-term failure to implement the sanctions committee could make the CMA border on irrelevancy, but this is a remote danger and the committee’s absence, according to El Meouchi, so far does not cripple the regulatory efforts. “It definitely hinders [the operation] from a legal perspective because you don’t have the body in place to enforce the regulations,” she says, but adds that in most countries “there is a transition period for companies to get used to [new regulations], and people will usually not get sanctioned during a transitional period, because they will give time and adaptation for the market to get used to it … And then by that time hopefully the committee will be in place.” She adds that for any new law there needs to be a learning curve, where the authority gives warnings rather than sanctions directly, and that Lebanon was only at the beginning of the learning curve.
The CMA is in the process of updating and releasing new regulations. They released 16 regulations so far which govern financial markets including disclosure policy, crowdfunding, insider trading, derivatives, securitization and collective investment schemes, as well as regulations concerning financial institutions and the suitability of people selling financial products. On this end, “we don’t have to go back to parliament and sit 10 years before a new regulation comes out. We are free to create our own regulations when it comes to capital markets,” says Safieddine. “We came in, we rewrote all the regulations that existed. Today we are drafting new, proper regulations, in collaboration with the World Bank. We’re writing regulations with the market, these regulations are best business practices.” Currently, every new fund or financial instrument has to get their approval before it can be released on the market.
The CMA is operating on a one-time contribution from the state budget of LBP 15 billion ($10 million), but are supposed to sustain themselves in the future with contributions imposed on listed companies, charges and fees for licenses, requests and submission, as well as profits from the stock exchange and, of course, aid and donations. So far they have spent about $3 million according to their annual report, which also estimates that they will be down by a total of about $6 million by the end of 2014. The remaining $4 million “will keep us going for another year or two,” according to Safieddine, though it is debatable whether this will be enough time to build up a capital market strong enough to sustain their activities.
Next tangible steps
The regulations are a first step to developing capital markets, but following suit is the question of supply and demand. For the development of active capital markets, the next steps include getting more companies to list and attracting the attention of more investors. While the World Bank’s most recent survey of Lebanon’s capital markets proposes a plethora of sweeping recommendations such as creating more appetite for institutional investment through insurance companies or by creating a national social security fund, stakeholders have proposed a few modest and tangible steps that could be taken at this time. The Capital Markets law calls for the BSE to be turned into a joint-stock company. This would provide incentive for the shareholders to increase activity because it would be run as a for-profit business. “Once you have a joint-stock company, you would have a board of directors and a CEO that would run it properly,” says Safieddine. “We [currently] have a stock exchange that is a government institution, that has a board without a CEO… So the demand for participation or investing in the stock exchange was by default, by the nature of the setup,” he adds.
Ghaleb Mahmassani, the president of the BSE, is equally eager to see the stock market turn into a joint-stock company. He tells Executive that the BSE has prepared a roadmap for this change but it is awaiting a decision from the council of ministers. “We hope that once fully privatized, the trust of operators and investors will increase and will help and boost other companies to register,” he says.
Other options to increase supply on the stock exchange include listing government-owned companies, as well as creating incentives for family-owned companies to list. El Meouchi proposes this be done through tax incentives, such as providing a tax waiver that would make it more attractive for companies to list.
While the supply and demand issue is sometimes regarded as secondary after the regulations, it will be of more and more relevance over time. And while Lebanese capital markets still have a long way to go before the regulation mechanisms are in full force, these beginnings are certainly a step in the right direction.