Boosting liquidity and encouraging greater trading volumes are two strategic objectives shared by exchanges in the region, and in pursuing them the GCC’s stock markets face the same central question of how to mitigate the effects of stubbornly low oil prices and the economic uncertainty that results from them. The challenge was thrown into sharp relief in 2015, when it became apparent that the oil price decline would not be reversed in the short term. According to Oman’s Capital Market Authority (CMA), Arab stock exchanges lost $143.6bn in 2015, or 12% of combined market value, due to the oil price drop and muted growth in key emerging economies such as China.
Appealing To Companies
The obvious effect of reduced exchange liquidity is the undermining of investor confidence, which results in lower trading volumes and in some cases an outflow of liquidity from the exchange. This in turn makes the market a less appealing prospect for firms considering it as a potential capital-raising platform. Consequently, 2015 was a poor year for initial public offerings (IPOs) in the GCC, with the region’s aggregate primary market witnessing a 65% year-on-year decline – or just six offerings over the year compared to 17 in 2014.
Oman saw one IPO in 2015, an OR56m ($145.4m) offering by Phoenix Power which, despite being 18 times oversubscribed and therefore well received by the investment community, was a lonely outlier in the primary market compared to the four offerings seen the previous year. Given the central role that primary market issuances play in boosting wider exchange activity and attracting fresh liquidity, a reduced IPO pipeline makes the regulator’s ambition to grow the exchange that much more challenging.
Making The Case
One answer to the problem of subdued exchange activity is to tackle it head on, starting with the primary market. Oman’s CMA has done just this, reporting in 2016 that it is encouraging a number of state-owned enterprises and private institutions to convert to public joint stock companies and float on the Muscat Securities Market (MSM).
The government’s case is a persuasive one: by going public, companies submit themselves to robust legislation and corporate governance standards that inspire confidence in investors, which in turn opens the door to capital inflows and sustainable growth. How quickly this might be brought about, however, is another matter. Private companies, while appreciating the benefits of a flotation, are likely sit out any period of market uncertainty and move to list only when they judge market sentiment to be sufficiently improved.
And while the Omani government has indicated that it may divest itself of all or part of 11 state companies, the experience of other markets in the region suggests that the process of readying government-related entities for an IPO will be a lengthy one.
Marginal Adjustments
Persuading suitable companies to list on the exchange has been an important part of activities for some years, and will continue to be so. Each success brings a valuable liquidity boost, but these victories tend to be widely dispersed and subject to market sentiment. For a more immediate effect on liquidity, a recalibration of exchange regulations is often one of the first courses of action for regulatory bodies, including Oman’s CMA. Its chosen target was the issue of margin trading, by which investors are able to buy shares by borrowing part of the sum needed for the transaction from the broker – generally using securities in the investor’s account as collateral.
The CMA moved in May 2016, announcing a series of amendments to existing margin trading, or secured financing as it is called in the region, which significantly liberalised the framework in a bid to boost liquidity in the market. One of the most fundamental of these innovations is the opening up of margin trading to a much larger segment of the companies listed on the exchange. According to the sultanate’s first margin trading provisions, which were introduced more than five years ago, only stocks listed on the MSM30 index were eligible targets for the practice.
As of 2016, however, the larger number of listings on the parallel market – the section of the secondary market where shares are subject to simplified listing requirements prior to their listing in the regular market – have also been opened up to the margin trading framework. In a single reform, therefore, the CMA has more than doubled the number of stocks which investors can take a margin trading approach too, adding 58 listings to the range of possibilities.
According to the amended rules, brokers are also able to extend more capital to investors looking to purchase stocks on margin: the revised framework has increased the amount a company can grant in secured financing from OR250,000 ($649,000) to OR500,000 ($1.3m). The prudential limits governing the activities of brokers have also been revised, with the CMA granting brokers authority to provide margin finance up to 10% of their total assets, while the amount that they can direct to a single client has been raised to 15% of the funds set aside for secured financing.
Greater Liberalisation
Yet more market liberalisation comes in the form of a newly relaxed approach to the maintenance margin ratio, or the minimum amount of equity that must be maintained in a margin account. This ratio stays active throughout the life of the trade, and under the CMA’s old system if the price of a stock fell to such an extent that the margin ratio limit was broken, the client and broker had three working days to resolve the situation. This sets in train the margin call process, by which the broker calls on the client to deposit sufficient cash to return his account to a position above the maintenance margin limit or allow the broker to liquidate sufficient securities in order to achieve the same result. Under the new rules, instead of three days to return accounts to compliance with the maintenance margin ratio, brokers and their clients have five days to rectify the situation, which increases the possibility of market movement rendering a cash deposit or liquidation of shares unnecessary.
Implications
Oman is not alone in looking to margin trading as a means to boost liquidity on its exchange. Markets around the GCC have revisited their existing regulations or created new ones to allow for the practice, although the increased risk associated with leveraged stock purchases has meant that the roll out of new frameworks has been incremental. Qatar, for example, first introduced margin-trading rules in 2014, but did not fully implement them until December 2015. In Oman’s case, the risk that retail investors will build up significant positions using borrowed capital and then struggle to cover them should the market turn negative means that the prudential safeguards set in place by the CMA are likely to be closely supervised by the regulator over the coming year.
Determining the scale of the anticipated reward, in terms of liquidity, is difficult. The efficacy of manipulating margin trading regulations to boost liquidity on an exchange is a question that has occupied economists for years. Few doubt, however, that the practice has a broadly positive effect on liquidity. A recent joint study by the Stockholm School of Economics and Yale School of Management used the Indian stock exchange, where the list of stocks eligible for margin trading is revised every month, to demonstrate a causal relationship between traders’ leverage constraints and a stock market’s liquidity. The most fundamental finding of the 2014 report was that liquidity is higher when stocks become eligible for margin trading, which suggests that the CMA’s decision to allow brokers to advance margins on stocks on the MSM’s parallel market, as well as the MSM30 index, will result in a similar uptick in liquidity.
The gains over the upcoming year, however, are expected to be limited by the relatively small number of retail investors who are sufficiently market savvy to engage in margin trading – a situation that the brokerage segment will doubtless be doing its best to rectify.
