Developing a niche: A new bourse has the potential to boost liquidity

For most of the world’s large securities markets, increasing trading volume and value – liquidity – is a priority. In Bahrain, where more activity in securities trading could be a valued complement to the capital markets services and capacities already in place, officials are in the midst of a multi-pronged strategy to make it happen. This includes the introduction of a second bourse to complement the government-owned one, changes to trading rules, improved regulations and market rules, and the potential opening up of membership in the exchange. For the future, ideas include a specialised offering to entire small and medium-sized enterprises (SMEs), and a new ownership structure for the Bahrain Bourse (BHB). It may also include the privatisation of key government holdings via the market – the most direct and immediate way to boost trading.

REFORM: While some reforms can be a slow and methodical process, the bidding system for the BHB has been changed so that bids and offers must be in larger increments. As opposed to dollars or euros, which are divided into cents, the Bahraini dinar is divided into 1000 fils. Small bids can therefore move stock prices up and down in increments, potentially 10-times smaller, and that lowers price volatility. In a bid to balance out volatility and stability, bourse officials have changed the rules so that a bid must be at least two fils higher instead of one, and that should make price swings larger and subsequently encourage more trading.

The bourse is also updating its rulebook, including listing rules and disclosure requirements. The aim is to facilitate participation by eliminating or relaxing rules that are too onerous, but not to the extent that market integrity is compromised, BHB officials told OBG.

One example in the field of listing requirements is the rule that only companies with a track record of two years of profitability are eligible. In the current economic climate, with the global economy still recovering from the 2007-08 financial crisis and uncertainty about European sovereign debt and social unrest in the wider Middle East and North Africa region, two years of profits suddenly looks like a more onerous requirement for an initial public offering (IPO) than it once was.

CONVERGENCE: The bourse’s listing rules are being updated simultaneously with those of the Central Bank of Bahrain (CBB), which is reviewing its conditions with the same factors in mind. Eventually, however, listing rules for BHB or for the Bahrain Financial Exchange, the kingdom’s other trading platform, may be harmonised with the rest of the region. The GCC has been developing listing rules of its own, and is looking for further opportunities for convergence in practices. Securities regulators from member countries met in Riyadh in November 2012 to review progress.

In the long term, the BHB’s evolving corporate structure will play a meaningful role, as well as attracting liquidity. Until 2011 it was a quasi-government agency, but was at that point corporatised and placed under the Ministry of Finance. Migration from one structure to the other is a process still under way, but was done in hopes of freeing the exchange to innovate and evolve. That fits a global trend in which exchanges are shifting away from mutual models or government structures in favour of becoming corporations, and sometimes publicly-traded ones. As this has happened exchanges worldwide have teamed up, forming alliances they believe are the appropriate response to the globalisation trend and the ease of moving money across borders. Leaders in this effort include the New York Stock Exchange and the US’s second major equities market, Nasdaq. In Europe, the London Stock Exchange (LSE) and Scandinavia’s Aktiebolaget Optionsmä klarna/Helsinki Stock Exchange are examples. Partnerships between groups such as these and developing country exchanges are increasingly common and one could help Bahrain as well. Bourse officials anticipate this will make it easier and improve the process of introducing new instruments – derivatives and other advanced securities are on the table for 2014 or 2015.

Another step toward acknowledging the increasingly borderless world of capital markets could be the Another step toward acknowledging the increasingly borderless world of capital markets could be the elimination of a rule that BHB members must be domiciled in Bahrain. That would give direct access to the bourse, and therefore cheaper fees, to anyone willing to apply for a CBB licence. CBB regulations as they stand allow for this in certain cases, although as of March 2013 there were no examples of current licensed members from other countries. Bahrain does nonetheless offer some very stable equities options leveraging the regional economy, such as the large banks listed or Aluminium Bahrain, and these could ultimately be attractive to GCC-oriented equities funds. Investors from Saudi Arabia, Dubai and Singapore in particular have expressed interest, according to the CBB.

NEW IDEAS: Another possibility is a new class of equities listings for SMEs. What is under consideration is not a separate trading platform as a market for junior stocks, but simply a set of less demanding listing procedures and rules paired with outside advisory help for SMEs to encourage them to list, and also for investors to feel safe with the listing. The concept could borrow from the nominated advisor (NOMAD) system in place at the LSE’s AIM market. NOMADs in this system are companies that guide the listing firm via a process that includes developing a prospectus, holding an annual general meeting, preparing quarterly earnings reports, and making annual reports and material disclosures.

The NOMAD role is filled by an investment bank that is licensed by the LSE and relied upon to essentially take on the regulatory burden for that particular company. Typically, the idea of a junior exchange or board within an overall market is to provide a place for companies to grow with a view to them eventually joining the main market, but in the case of AIM the lower cost of compliance and fewer regulations mean that it is increasingly a more popular option than the LSE itself.

In Bahrain, a NOMAD-type system would provide a potential new income stream for some investment banks. It would also pose a question for the CBB, which has developed a reputation as a regulator able to balance prudence with facilitation, of how precisely to do that in this type of system. Moves to increase trading of what already exists would help, but what some investors say would make the most significant impact are moves to increase the offerings through IPOs. That means potential IPOs of government-owned entities. This has happened in the past, such as the sales of shares in Aluminium Bahrain and Bahrain Telecommunications (Batelco), the mobile-network operator.

Additional listings could potentially come from the portfolio of Mumtalakat, the kingdom’s investment arm for non-oil and -gas holdings. Mumtalakat at present holds stakes in more than 35 commercial enterprises, representing a portfolio value of approximately BD2.7bn ($7.1bn) as of June 30, 2012, and spanning a variety of companies and sectors, including Aluminium Bahrain and Batelco, as well as financial services, real estate, tourism, transportation, and food.

MARKETMAKERS: ings on the BHB would ultimately be to encourage the major institutional shareholders, such as Mumtalakat and several pension funds, to be more active partici- pants. These groups are large shareholders in almost every large listing, and tend not to trade in and out of these positions. They are long-term investors, and although that is what listed companies like to see, as it reduces the pressure for short-term profits and allows for sustainable growth, a balance between stability and volatility would mean these companies agreeing to set aside at least some of their portfolios for turnover.

Moving in and out would mean acting as a market-maker – facilitating trades when there is a bid but no offer on the board, or vice versa. This is an idea that has been tried successfully elsewhere in the region, such as Oman, said Jithesh Gopi, head of research for Securities & Investment Company, a securities-focused investment bank. “Mumtalakat and various others are holding significant amounts of securities. A portfolio for trading would create some flow in the market and encourage others to trade,” he told OBG.

It would be important to ensure that IPOs are handled smoothly, however. Aluminium Bahrain’s IPO came in November 2010, and the shares did not enjoy a rally from the start, as many investors in IPOs expect. Typically, shares just off an IPO are expected to climb, as they are priced accordingly, and because most IPOs are timed when market conditions are favourable for a rally. Aluminium Bahrain’s stock lost value, however, and more than two years later it is trading at less than half the value at the time of the IPO. Yet, this is not a commentary on the market conditions or a miss-step on the part of those managing the IPO.

Instead, a decision by the government in 2012 to raise the price of natural gas sold to Aluminium Bahrain caused the company to regroup. Natural gas is an important feedstock for the smelter and a key component of its production costs. As a result, while the firm’s IPO has faced challenges, it is notable that these hurdles are not endemic to the current market culture, and with long-term stability and profit the primary

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