Generating liquidity growth is a concern for the management and regulators of exchanges across the region. As markets from Kuwait to Muscat battle for investment flows, the long-term future of the Bahrain Bourse (BHB) depends upon its ability to attract fresh capital to its increasing array of investment instruments. Most of its major innovations in terms of products and services over recent years have been carried out with the question of liquidity in mind, including the transition to the Nasdaq OMX platform in 2014, the introduction of secondary market debt trading and the more recent implementation of the first Islamic index in the GCC. Three developments in particular, however, have caught the attention of market observers for their potential to boost liquidity on the kingdom’s bourse.
FREE FLOAT: One of the challenging characteristics of Bahrain’s equity market is a low free float and the consequent thin trading on the exchange. In 2016, nine of the top stocks on the exchange had a free float of lower than 25%, and outside of the blue chips the proportion of companies’ shares publicly traded on the market is considerably smaller. This phenomenon is common in emerging markets, where family-owned businesses prefer to maintain a higher level of ownership, or where governments seek to maintain control of some of the nation’s prized corporate assets. For some investors, companies with low free floats are a tempting prospect. The relatively small amount of a company’s shares made available to investors often results in exaggerated movements in the stock price, as a scenario of demand-supply mismatch is quickly reached. Short-term traders seeking opportunities in volatility find stocks with low free floats match their strategies well, and are particularly pleased to find them in markets where volatility is otherwise low.
However, volatility works both ways and is associated with higher trading risk, and for that reason, most investors only assign a small percentage of their portfolio to equities with a low free float. These stocks are not, therefore, seen as solid investment instruments, and an exchange that is home to a high percentage of them is likely to face challenges in attracting liquidity.
In 2014 the CBB decided it was time to tackle the free float question through an amendment to its offering of securities module, proposing a minimum free float of 20% of total issued shares. The response of market participants was generally favourable; two main suggestions were that the CBB retain the right to lower this limit where such a decision would serve the interests of the market, such as the flotation of Alba in 2010, in which 10% of shares was offered; and that the new minimum float requirement be reduced to 10% to be more consistent with the BHB listing rules and to provide more encouragement for listing.
The latter point is an interesting one. While increasing the minimum float is a means of making listed stocks more attractive as investment vehicles, it can also make the task of encouraging companies – particularly family-owned businesses – to list on the exchange more challenging, a development which would also restrict liquidity. In tackling the liquidity problem through alterations to the free float requirement, the CBB and BHB had a fine line to tread, and ultimately sided with market consensus Resolution No. 5 of 2015, which obligates all listed companies to have a minimum free float of 10% of the issued and fully paid shares.
MAKING THE MARKET: The new free float requirement has made feasible the introduction of an important new exchange function in the form of market making. Market makers are useful liquidity boosters in exchanges around the world, but are relatively few in number in the GCC. Their role is to assume the risk of holding a certain number of shares in a particular stock and set both the bid and ask prices on their publicly available quote screen. They then stand prepared to make transactions with their customers at these rates, taking the opposite side of the trade. Most market makers are big institutions capable of carrying large volumes of a security and fulfilling large numbers of orders. For example, many of the 21 market makers providing continuous pricing on the London Stock Exchange order book are household names, such as BNP Paribas, UBS and Citibank. The profits market makers derive from these transactions stem from the spread charged on each security they recover, which are relatively small in size but high in volume.
The BHB issued a consultation paper on market making in April 2016, seeking to sound out the views of exchange participants prior to the implementation of the market making rules and guidelines. Explaining the rationale for the introduction of market making to the exchange, Sheikh Khalifa bin Ebrahim Al Khalifa, CEO of BHB, said in a statement to the press, “Having qualified market makers will create a continuous balance between supply and demand and will bridge the gap between the buy and sell prices. Market makers will also make bids and offers for shares available, along with the volumes required for buy and sell and will find the balance price for the security by entering the bids and offers of securities.” News regarding Bahrain’s first market maker followed quickly. In May 2016 Manama-based Securities & Investment Company (SICO) signed an agreement with the BHB which granted it approval to act as the first market maker at the bourse.
LIQUIDITY FUND: With the market making regulatory infrastructure in place, Bahrain was ready in 2016 to reveal its latest liquidity-boosting measure, the Bahrain Liquidity Fund. Details regarding the new facility were announced in June of that year, including that the fund will be managed by SICO, and that it will act as a market maker, providing two-way quotes on most of the BHB’s listed stocks – with a reasonable spread so as to encourage higher trading volumes.
The fund’s seed investors are prominent Bahrain-based institutions, giving the fund the flavour of a national endeavour. Osool Asset Management is an investment arm of the Social Insurance Organisation and Military Pension Fund. Since its establishment in 2011, it has invested in private equity opportunities, one of the most prominent of which is Bahrain Pharma.
BBK, formerly known as the Bank of Bahrain and Kuwait, has operated in Bahrain for more than 45 years, and is one of three commercial banks which dominate the domestic retail market, where it has pioneered the so-called financial mall concept in Manama. Established in 2006, Mumtalakat is the independent holding company for Bahrain’s strategic non-oil and gas related assets, and as such is the chief investment division of the government. In a region renowned for its sovereign wealth funds (SWFs), Mumtalakat is a moderately-sized player, ranked by the SWF Institute as 40th largest in the world. In 2016 it held stakes in more than 40 commercial enterprises, in sectors ranging from education to industrial manufacturing.
Lastly, the National Bank of Bahrain was the kingdom’s first locally owned bank, and remains the leading provider of retail and commercial banking services. Its ownership structure has been key to its ability to attract business and play a central role in the development of the nation. Mumtalakat retains a 51% stake in the company, while government interest is further represented by the Pension Fund Commission, which owns 6.24%.
These institutions have provided $100m in assets to the Bahrain Liquidity Fund, either in cash or in shares in kind. SICO will oversee the management of the fund, while a supervisory board representing the seed investors will monitor its performance and activities.
EVOLUTION: The efforts of the BHB and CBB to attract liquidity will not end with the fund’s implementation. The continued evolution of the listing rules and the introduction of a new market for small and mid-cap companies are just two initiatives, which are being undertaken with an eye to attracting more investment inflows. The ongoing development of exchanges across the region will further ensure that Manama’s efforts to attract liquidity will remain a perennial priority.