An issue of trust

Youthful Arab bourses struggle to restore their prestige after the global crash

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The Arab World’s 16 active stock markets’ combined market capitalization in the fourth quarter of 2010 amounted to substantially more than $900 billion, confirming that Middle East and North African (MENA) equity markets are an increasingly important force in regional economic development.

The performance was not all sunny, however. Market indices for member institutions of the Union of Arab Stock Exchanges (UASE) at the end of 2010 were visibly below their more optimistic days almost three years ago. Eagerness for listing companies has also dropped. New initial public offerings and trading debuts have been rare.

Although, or perhaps because, performance of Arab equities has been marred by the global financial crisis of 2008, the macroeconomic relevance of financial markets has become a topic demanding increasing attention.

Arab stock exchange operators have been feeling the need to do more than their bread-and-butter business of running trading rooms and electronic platforms and assuring smooth operations that comply with national regulations in each market.

Markets are to enter a “new era of collaboration and cooperation,” the chairman of the UASE, Suliman Alshahomy, said in October 2010 at the opening of the second UASE Annual Conference in Beirut.

The tenor of Arab stock market operators is a combination of needed improvements and regaining investor trust.

“Implementing principles of transparency of Arab markets is our main goal. We want to provide Arab investors with linking of all financial markets,” said Alshahomy.

The exchanges face a major challenge in restoring trust. According to UASE Secretary General Fadi Khalaf, “greed led us to a place where confidence in the market weakened.” Confidence may have been built over years, only to be lost in days, he added in a keynote speech to stock market operators and financial experts.

Still young at heart

The Arab stock exchanges are a young industry by the standards of the region’s financial sector, and even more so when compared with the 400-or-so-year history attributed to the business model of trading centers dedicated to the buying and selling of shares in something that is not physically present at the exchange.

Union of Arab Stock Exchanges member exchanges by year of establishment

Nominally, three Arab stock exchanges — in Egypt, Morocco and Lebanon — trace their incorporation back to the first half of the last century, with late 19th century commodities trading in Alexandria at the root of the region’s first bourse. The Kuwaiti and Tunisian exchanges date from the 1960s. The 11 others were decreed and went into operations between 1984 and 2009.

In the late 19th century, large-scale trading of Egyptian cotton export exploded, making for a furious start of bourse operations in the Middle East. The exchanges in Cairo and Alexandria boomed so much that the region’s first stock market crash in 1907 even played a role — by way of depleting British hard currency resources — in a financial confidence crisis in distant New York: the famous Knickerbocker Trust panic which ultimately led to the establishment of the Fed. 

However, the growth of Middle Eastern securities trading was stymied in the conflicts over the global political and social order that hit Arab economies in the 1950s. Until deep into the 1990s, the region’s bourses were impaired by inexperience, oil money that came too easy, ideological follies, anti-economical politics, wars and all the other Middle Eastern challenges of the 20th century.

Recent rough ride

Therefore, for all intents and purposes, it is fair to say that the industry of Arab bourse operators was only really formed in the last 20 years. It may be a surprise then that this young-but-important segment of financial market already needs a facelift. 

The need for instilling new confidence in the regional investor community is, naturally, related to the local impact of the 2008 crisis in global financial markets. Between summer 2008 and spring 2009, Arab investors saw the market value of their shares plummet at rates of more than 90 percent for some stocks and benchmark market indices in the region commonly lost 60 to 70 percent during the crisis. Of course, so did pretty much every investor community in most global markets.

With very few exceptions — one of them ironically an Arab bourse, the Tunis Stock Exchange — securities markets the world over dropped precipitously in the peak crisis period between September 2008 and March 2009, as institutional and individual investors alike were caught in the recession like the proverbial deer in the headlights.

But that was the past. By the third and fourth quarters in 2010, recovery ruled in virtually all stock markets. Herein lies the problem that has been confronting Arab bourse operators in 2010: the rate of recovery of the Arab markets’ averages was much slower than in peer emerging markets.

UASE Secretary General Fadi Khalaf, and UASE Chairman Suliman Alshahomy,  at the UASE Annual Conference in Beirut

When compared with some developed and emerging markets in November 2010 —  26 months after the Lehman Brothers collapse heralded the financial crisis in world markets — a few numbers illustrate Arab investors’ lingering loss of confidence in their markets.

The Dow Jones Industrial Index, which crashed from nearly 12,000 points in mid-2008 to decade-lows in the 6,400 range by March 2009, had regained all ground by the fourth quarter of 2010, closing at mere 2 percent downward variation on November 15, 2010 when compared with July 1, 2008.

The United Kingdom’s FTSE 100 and Germany’s DAX, which each had dipped below 4,000 points in spring 2009, both quoted higher in mid-November 2010 than their respective levels in the summer of 2008. In Asia, where the Nikkei 225 was a laggard at about 25 percent down in the same comparison, the Hang Sang showed full recovery from 2008/2009 index losses in the third quarter of 2010.

In emerging markets, Standard & Poor’s BRIC 40 and Morgan Stanley’s MSCI Emerging Markets Index ascended in October 2010 for the first time above their values last recorded in July 2008. Looking at 2010’s top growth markets in stocks, the best gainers were all in emerging quarters. Exchanges in Indonesia, Chile, Argentina and Turkey not only added more than 40 percent to their indices in the 12 months ending October 2010, they each also scaled a new historic record in November 2010.

Of the four leading Arab exchanges by market capitalization, which accounted for approximately 70 percent of total market cap in MENA in autumn 2010, three benchmark indices — Saudi Arabia, Egypt and Qatar — were lower by 31 to 32 percent in November 2010 versus July 2008. The Kuwaiti bourse was even further behind, down 55 percent in its index over the same timeline.

The Middle East’s only exchange with a long track record that bucked the downtrend was the Tunis Stock Exchange; its Tunindex climbed 75 percent from July 1 2008 through November 15 2010.

Concentrated and diverse?

Besides the rebuilding of investor trust, the Arab exchanges face another challenge in taking their collaboration to the new levels envisioned by UASE for the coming decade. Experts and operators recognize that there are no strong merger prospects in the short term — save the possible exception of the two United Arab Emirates exchanges in Abu Dhabi and Dubai — and also know that regional securities markets will not be easy to align, given disparities between trading systems and regulatory standards.

According to a UASE survey of 14 member bourses, the sector has both a large diversity and a lot of concentration. The contradiction arises from the fact that market concentration is massive in terms of capitalization and even more so in terms of trade activity.

Tadawul, as the Saudi Stock Exchange (SSE) is best known, is the engine of all Arab shares trading. With 143 listed companies, the SSE hosts about 11 percent of the publicly traded firms in MENA — but these are larger companies and the market is more liquid than average in the region, accounting for up to 40 percent of market cap and even higher proportions of daily share movements by volume and value.

 Traders crowd the floor at the Kuwait Stock Exchange

Responses by Arab market operators to the UASE survey put the total number of investors in Arab stock markets at more than nine million, with the totals ranging from nearly 3.6 million in Saudi Arabia to 5,500 on the young Damascene bourse.

According to the UASE survey, Tadawul in mid 2010 accounted for 40.5 percent of market capitalization and captured more than 60 percent of trading activity, a statistic which, due to a technical issue precluding the Kuwait Stock Exchange’s timely response to the survey, did not include data for the Kuwait bourse. By contrast, five of the small exchanges represented only 1.5 percent of the region’s market cap combined.

A different set of disparities exists in the operational realities of Arab bourses. The UASE study found that half of the exchanges enjoy independence in regard to market trading, clearing and regulatory processes.

However, while 38 percent of the bourses today are nominally operating as private sector entities — mostly joint stock companies along with two listed companies — government control is still the daily reality for at least 80 percent of Arab bourses.

The resultant picture is one where Arab exchanges are fragmented in operational and structural terms, with a variety of international partnerships, technological platforms and methodologies in place. Regulatory frameworks are most advanced in the Gulf Cooperation Council but operators there are last in terms of independence. The state-centric organization of exchanges limits the options for development. “If we want to be a hub, we should start by being a listed company on the exchange. If the exchange is a private sector company, it becomes an option to merge or create a new entity. It is not possible today to dream of merging,” UASE’s chairman, Alshahomy, told Executive.

The upside is that Arab stock exchanges are maturing in the challenges they face and have become increasingly aware of their role in nurturing and diversifying economic development. Tadawul Chairman Abdullah Alsuweilmy told the recent UASE Annual Conference: “We are entrusted with enhancing the economies we belong to. That is very important.”

Proposals and objectives of UASE

Transparency is the word of the year for Arab stock market executives. When asked by Executive what defines a healthy stock exchange, four out of five exchange chairmen included “transparency” in their answer. Likewise, transparency, together with good regulation, has ranked in 2010 in the top tier of desirable qualities in discussions of the World Federation of Exchanges, the global alliance of bourse operators.

Market executives from around the MENA region shared a wide range of proposals at the 2010 Annual UASE Conference, as did the team from the Libyan Stock Market, which carried out the UASE member survey and evaluation as part of the country’s one-year term in chairing the federation in 2010. (The Union’s chairmanship is due to rotate to Qatar in 2011).

UASE has two immediate projects on its agenda before embarking on further development initiatives, said Secretary General Khalaf: to commence publication of reports on the Arab markets and to work on a benchmark index for the region. Further steps could include the creation of exchange-traded funds (ETF) that track the new regional index. An Arab index could generally be expected to enhance professional investor attention to the region’s stocks. But index creation is more than an exercise in calculation skills. 

Exchange inventory

“We have to start somewhere, which is the benchmark index. There are thousands of indices but the indices that survive are those done with international institutions,” Khalaf said, giving clear indication that the UASE doesn’t want to go it alone in deploying a regional index but rather has engaged in discussions to implement a partnership with one of the big global names in index formulation.  While a home-brewed index could be launched fairly quickly, working with a major partner could drag out the launch time for up to two years, though Khalaf admitted “I hope it will be faster.” 

The UASE upgraded its stature in 2009 with the establishment of a full-time elected secretary general and the positioning of annual conferences as high-caliber events to offer a forum for contributions to and from all members. For organizational development, UASE targets some expansion of the primary membership base, from 16 full members in 2009 to 23 at end of 2010, comprising 16 exchanges and seven clearinghouses.  New members expected to join shortly include Sudan’s Khartoum Stock Exchange and the Algerian exchange, hitherto a stock market in name only as it seemed to be one of the world’s least active trading places in the past decade. Membership on an associate level includes 23 brokerages.

But with the regional count of active brokerages standing at 650 firms, according to the UASE survey, and the brokerage sectors from a dozen countries severely underrepresented or not represented at all in the UASE membership, the organization appears to have a large opportunity to expand its ranks among market intermediaries.     

Khalaf emphasized that the federation will not change the fundamentals of how its members operate. “We play the same role that all stock exchanges play in their economies. We are a federation that groups all those exchanges and will not create something that the local exchanges didn’t create already,” he said.





Thomas Schellen

Thomas Schellen is Executive's editor-at-large. He has been reporting on Middle Eastern business and economy for over 20 years. Send mail