Alexandra Barysheva^a, Jevgenij Egle^a, Alexander Markov^a, Sergejs Solovjovs^a

^aEconophysica Ltd., Annecy Court, Ferry Works, Summer Road, Thames Ditton, Surrey KT7 0QJ, United Kingdom 

Abstract

This paper provides an overview of the financial markets (including capital markets) of the so-called Cooperation Council for the Arab States of the Gulf or the Gulf Cooperation Council (GCC), consisting of the following six Arab countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE). Particular attention will get Kuwait financial markets and regulations of the Central Bank of Kuwait (CBK). Financial market development has been a policy priority in the GCC countries over the last two decades, to diversify their economies and reduce their long-standing dependence on hydrocarbon exports.

1. Introduction

Developing financial markets has been a policy priority in many countries of the Gulf region over the past twenty years. Aspirations for financial centres have been high. Visions reached from promoting local financing in support of the development of domestic GCC economies to building true financial hubs for the region on the Arab peninsula, the Middle East and North Africa (MENA) region, or even globally [14, p. 3].

At the beginning of the last century, this strategy looked very promising. In view of depleting oil and gas reserves, economic diversification was an answer to many questions. Finance seemed to solve two problems at once: a thriving financial business would be an attractive high-productivity sector by itself, and would (via easier financing and better asset management) help develop business activity in other sectors. Opening up to the global finances promised greater economic weight in the Arab world and beyond [14, p. 3].

While the rationale of these arguments is as valid as any time before, the global financial crisis (GFC) of 2007 – 2009 has dispelled the magic of the finance business, sent shock waves through private and public sectors on the Arab peninsula and has taken its toll on business sentiment and growth prospects [14, p. 3].

The GCC was set up in 1981 with six member nations: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE. The countries have gained importance w.r.t. global development due to their status as global business hubs backed by 47% of the proven world oil reserves. The GCC produces up to 20% of all world oil, controlling nearly 35% of world oil exports. In these economies, government earning and fiscal planning and expenditures are mostly determined by the oil exports and the international oil prices [18, p. 2].

During the last quarter of a century, the GCC countries focused extensively on their hydrocarbon policies in two aspects. First, the hydrocarbon sector has been the main source of government spending on infrastructure development and heavy transfer payments to citizens, as well as on attracting foreign service industry and workforce with a tax-free environment. Second, large investments have gone into cross-border instruments, mainly in Europe and the United States, in the form of capital market investments [18, p. 2].

The capital market structure of GCC has quite a few limitations as compared to the developed world, e.g., regulatory weaknesses, relatively small number of listed firms with large institutional holdings, and a positive skewness of listed firms to oil-dependent sectors [18, p. 2].

In the last decade, especially post the 2007 oil price shocks and the GFC, much effort has been put by the GCC countries in strengthening the legal, regulatory, and supervisory structures for efficient markets [18, p. 2]. Figures 1, 2 show the GCC comparative overview post the GFC for both the whole region as well as individual member sates (as of year 2010; we also notice that “TUSD” stands for “thousand USD”).

Figure 1: The GCC overview post the GFC (year 2010) [14, p. 3]

Figure 2: The GCC member countries overview post the GFC (year 2010) [14, p. 3]

The GCC member countries represent now very attractive and lucrative emerging economies. The promising potential of the GCC markets has recently become even more prominent with the economies opening up their capital markets. An attractive advantage of the opening of the GCC markets for foreign investors is the benefit of diversification they allow. The markets in the GCC are structurally different from other emerging economies, since they are largely segmented from global equity markets, excessively sensitive to regional political events, and the economies are highly dependent on hydrocarbon exports [18, pp. 2–3].

Figure 3 shows the GCC initial public offerings (IPOs) since 2013 (in both volume and value; also notice that “YTD” stands for “year to date”, and “FY” stands for “fiscal year”), where one can see that Saudi Aramco record breaking IPO on Tadawul (the Saudi stock exchange) during Q4 2019 topped both the GCC and global rankings with the highest proceeds for the year 2019 (generating total proceeds of USD 26.02 billion, which represents 96% of the annual GCC IPO proceeds for 2019 [11, p. 4]). It makes the world highest value listing up to this moment [11, p. 3].

Figure 3: The GCC recent IPO activity [11, p. 7]

Figure 4 shows the GCC equity market performance for the period of 2018 – 2019 (as percentage change since January 1, 2018), where one can see that the cumulative total return remained stable in Q4 2019 for most equity markets except Boursa Kuwait (the national stock market of Kuwait, formerly known as the Kuwait Stock Exchange), which reflected an upward trend [11, p. 8].

Figure 4: GCC equity market performance [11, p. 8]

Motivated by the growing interest in the Arab capital markets, in this paper, we provide an overview of the GCC financial markets (including capital markets), and then dwell on particular case of Kuwait financial markets as well as on the CBK regulations, including those for conventional and Islamic banks.

2.    GCC financial markets

In this section, we provide an overview of the GCC financial markets (including both their history and the current developments). We will mostly follow their convenient investigation of [14].

2.1.     Brief history of GCC

We begin with a brief insight into the history of the GCC. Following [5, p. 20], in the period of 1975 – 1978, four of the current GCC members (namely, Bahrain, Kuwait, Qatar, and the UAE) attempted to reach a monetary coordination, as a step toward issuing a common Gulf currency, i.e., a Gulf dinar. The attempt, however, was unsuccessful and the issuance of the common currency was put off.

In May 1981, these four Gulf countries, along with Saudi Arabia and Oman, signed the Charter of the GCC. The GCC objectives include coordination, integration and inter-connection between member states in all fields, formulation of similar regulations in the fields of economic and financial affairs, commerce, customs and communications. To achieve these objectives the GCC countries created three main entities:

•   Supreme Council

•   Ministerial Council

•   Secretariat General

Each of these organizations may establish sub-agencies as may be necessary (GCC Charter) [5, p. 20].

In accordance with the Charter and to strengthen their economic ties, the GCC members signed the Unified Economic Agreement (UEA) on 25 May 1981 in Abu Dhabi (the capital of the UAE), which laid out the principles of coordination and integration of economic activities. The agreement calls for the following:

1.    Dismantling tariffs on regional products and implementing a common tariff on non-GCC products;

2.    Coordinating member states commercial policies and relations with other states and regional economicblocks with a view to creating balanced trade relations;

3.    Granting all GCC citizens the same treatment with regard to freedom of movement, work and residence,freedom of exercising economic activities and movement of capital;

4.    Coordinating and harmonizing members development plans;

5.    Formulating united oil policies;

6.    Adopting a common legal framework for trade and investment;

7.    Cooperation in the financial and monetary sphere: Article 22 of the agreement reads “member statesshall seek to coordinate their financial, monetary and banking policies and enhance cooperation between monetary agencies and central banks, including the endeavour to establish a joint currency in order to further their desired economic integration” [5, p. 21].

Further milestones of GCC integration include the following [14, p. 37]:

Unified Economic Agreement: The UEA entered into force in 1982 and laid down the principles of a GCC free trade area, the free cross-border movement of citizens and the coordination of banking, financial and monetary policies.

Free Trade Area: Establishment of the Gulf Free Trade Area in 1983 eliminating tariffs between the member states.

Economic Agreement: The Economic Agreement of 2001 formulating more ambitious integration targets, including the creation of a fully integrated common market and the preparation of monetary union.

Currency Peg: Joint adoption of the US dollar as a common anchor currency in 2003.

Customs Union: Completion of the GCC Customs Union in 2003, including common external tariffs and a common customs law.

Common Market Initiative: Launch of a Common Market initiative in 2007 aiming to complete the free movements of goods, services, capital and citizens. Moves towards the Common Market have been incremental, and the project has not yet been concluded.

Common Currency Initiative: Adoption of convergence criteria for the GCC monetary union membership in 2005. Approval of a method for calculating the financial and monetary standards of the convergence criteria in 2007. Conclusion of the GCC Monetary Union Agreement, laying down the legal and institutional framework for a Monetary Council and a GCC Central Bank, to be located in Riyadh (Saudi Arabia) in 2009.

As stated in [5, p. 21], the Gulf countries share several homogeneous aspects. They have same language, culture, and history. The GCC countries face similar set of economic challenges, a fact that necessitates development of stronger economic integration.

Moreover, the GCC countries enjoy relatively cheaper extraction of oil and gas resources, which puts them in an advantageous position relative to other oil and gas producers. The ample wealth generated by the Gulf States from oil and gas exports allows their economies to surpass unprecedented development, with higher standards of living and modern physical infrastructure [5, p. 21].

The total GCC countries GDP has leapt from US dollar 11 billion in 1971 to US dollar 821 billion in 2007. However, the total GCC population has increased from 8.5 million in 1971 to 37 million in 2007 [5, p. 21]. In particular, Figure 5 shows average growth rates of nominal GDP in the GCC region (we notice that “SA” stands for “Saudi Arabia”).

Figure 5: Average growth rate of nominal GDP in the GCC region [5, p. 22]

A number of factors characterizing the GCC economies or appearing recently led these countries to consider the urgent need for developing their manufacturing sectors. Among such factors are the following:

1.    The fact that oil resources are finite and there is a global tireless search for energy alternatives thatmight soon compete oil;

2.    Awareness of GCC countries that oil will not continue to boost economic growth at the same pace asit did in the 1970s, the first half of the 1980s, and in the period of 2003 – 2008, given the persistent demographic changes in the GCC countries and the increasing oil supply from other world regions.

These factors together with other economic and political challenges, brought by the move to more globalised economy, demand more diversified economies in the Gulf [5, p. 22].

Thus far the industrial development in the Gulf is limited to industries such as basic petrochemicals, fertilisers, and steel as well as aluminium and non-durable consumer goods, most of which are targeting consumers outside the region. Broadly speaking, an individual GCC country cannot carry out its independent industrial development and at the same time enjoy economy of scale, given the relative small size of most GCC economies if considered on their own. Collective integration of industrial development schemes will allow the whole block to gain greater economies of scale and have more diversified economic bases [5, p. 22].

2.1.1.    GCC monetary union

In this section we consider in more detail the above-mentioned (however, yet unsuccessful but still going in the right direction) attempt to create a GCC monetary union.

The member states of the GCC decided in 2000 to explore concrete steps towards a common currency. It was hoped that establishing a single currency area would bring substantial benefits for financial markets and the wider economy. Since then, the GCC has made considerable progress towards this goal, including some remarkable economic convergence as well as first measures to create the required institutional infrastructure and legal prerequisites. At the same time, the project has encountered a number of setbacks, especially the withdrawal of Oman and the UAE. Furthermore, the difficulties in the euro area during the GFC have highlighted the numerous challenges such an undertaking can meet. Nevertheless, monetary union in the GCC is feasible as the economic merits of the project are convincing, and the political determination among the key member states remains strong up to this day [14, p. 37].

The GCC Monetary Union (GMU) would mark the culmination of several decades of economic integration in the Gulf. On this way, the six GCC states have already passed a number of important milestones, including the establishment of a Free Trade Area, the completion of the GCC Customs Union, as well as important measures in the context of the GCC Common Market project, which promises the free movement of goods, services, capital and citizens [14, p. 37].

With the 2009 Monetary Union Agreement (MAU) the GCC has laid the legal and institutional foundations for moving ahead with monetary union, comparable to, but less concrete than, the Economic and Monetary Union (EMU) Protocol of 2002 Maastricht Treaty in Europe. Importantly, the MAU devised the principles which will govern the single currency, and the basic institutional setup of the GMU [14, pp. 37–38]:

Principles: The participants in the project committed themselves to coordinating their economic policies, providing payment and settlement infrastructure, adopting uniform banking legislation and common rules on banking supervision, and finally introducing a single currency.

Monetary Council: To lay the groundwork for the single currency, a newly established Monetary Council was mandated to prepare the necessary infrastructure, especially for establishing a central bank and its analytical and operational capacities. Key tasks include the facilitation of coordination between national central banks and their monetary and exchange-rate policies for national currencies, monitoring the economic convergence of member states and their adherence to the prohibition on central bank lending to public entities, and drawing up the legal and organizational framework for the central bank, including statistical systems, the physical new currency, payment and settlement systems and timelines. In these functions, the Monetary Council can be compared to the European Monetary Institute, which had been mandated with the strategic planning of the EMU between 1994 and 1998.

Central Bank: The MAU stipulates the creation of an independent GMU Central Bank (GCB), the objectives of which would be to secure price stability in the single currency area via optimal utilization of the economic resources that would ensure economic stability. Its tasks would comprise the definition and implementation of monetary and exchange-rate policies, management of foreign-exchange reserves, issuance of the currency, overseeing the financial market infrastructure, and developing general rules for prudential supervision on financial institutions. The GCB would be granted a high degree of independence and would be prohibited from lending directly to public entities. Finally, as the MAU requires member states to adopt economic policies aimed at macroeconomic convergence, the GCB would be mandated to lay out procedures and mechanisms for monitoring and assessing the convergence criteria devised by the Monetary Council.

As preparations for the GMU progressed over time, the project has also experienced setbacks which may significantly impact the future path of action as well as the final shape of the monetary union [14, p. 38]:

Membership: The GMU had been conceived as a project by the GCC and including all GCC members. Oman and the UAE though have withdrawn from the project (reportedly for political reasons). While the remaining GMU participants (Bahrain, Kuwait, Qatar, and Saudi Arabia) are understood to encourage Oman and the UAE to return to the negotiating table, they have declined re-entry so far.

Time schedule: 2010 as the initial entry target for the GMU was abandoned due to delays in preparatory work. The Monetary Council has been asked to work on a new plan for introducing the single currency.

2.2.    GCC financial markets

In this section, we concentrate on the GCC financial markets in both their historic and modern perspective. As stated in [20, p. 4], the financial sector in the GCC, which remains dominated by banks, presents a degree of depth and intermediation capacity in line with the overall level of financial development and structural characteristics of its member countries. Yet it has not produced the expected inclusive growthenhancing benefits, signaling a “quality gap” with respect to the rest of the world. Access to finance for small and medium enterprises is among the lowest in the world and the impact of the financial sector on long-term economic growth is weaker than in other regions.

Financial systems in the GCC have developed significantly over the last couple of decades, but there appears to be further room for progress. The development of bank and equity markets has been supported by a combination of buoyant economic activity, a booming Islamic finance sector, and financial sector reforms. As a result, financial systems have deepened and, overall, the level of financial development compares well with emerging markets. However, it still lags advanced economies and, other than for Saudi Arabia, appears to be lower than would be expected given economic fundamentals, such as income levels [12, p. 3].

Financial development in the GCC has relied to a large extent on banks, while debt markets and nonbank financial institutions are less developed and access to equity markets is narrow. The non-bank financial institutions – pension funds, asset management and finance companies, and insurance – remain small. Domestic debt markets are underdeveloped. While equity markets appear to be well developed by market size, they are dominated by a few large (and often public-sector) companies [12, p. 3]. Figure 6 shows GCC financial market development indicators for the period of 2007 – 2017, where “EM” (resp. “AE”) stands for “emerging markets” (resp. “advanced economies”).

Figure 6: The GCC financial market development indicators [12, p. 13]

2.2.1.    Markets during the GFC

GCC financial markets have experienced two major setbacks during the GFC [14, p. 4]:

•   Markets had reacted sharply to the banking crisis in the US and Europe since the latter half of 2008, as evidenced by the drastic drop in stock markets indices reaching a trough in the first quarter of 2009. At that point, GCC stock market indices had – compared with their levels at the beginning of 2007 – fallen by one-fifth in the case of Oman, around one-third in Bahrain, Kuwait and Abu Dhabi, almost 50% in Saudi Arabia, and as much as two-thirds in Dubai (see Figure 7).

•   Markets responded sensitively to the debt problems of individual state-owned enterprises in Dubai and Saudi Arabia, which culminated in a USD 10 billion bailout of Dubai by neighbouring Abu Dhabi in December 2009. In particular, state-funded investment firms had suffered from the severe decline in real estate and property prices in the region that had ensued in the course of the GFC.

Figure 7: The GCC stock market setbacks during the GFC [14, p. 4]

The turmoil around these two events, together with other factors, has had a profound impact on local financial markets. Not only had factors external to the region left investors in the GCC assets uncertain, but also domestic problems were brought to the surface. Therefore, part of the price collapse of key financial assets has been ascribed to previous exuberance especially in the UAE, as stock market and real estate prices in particular had skyrocketed in preceding years and by 2007 had reached levels widely regarded as out of sync with fundamentals [14, p. 4].

2.2.2.    Banking sector

Large banking sectors are a central commonality among the GCC economies. The industry has grown over several decades, and experienced a boost in credit provision in the heydays of economic dynamism between 2000 and the peak of the financial turmoil. By international standards, banking in the Gulf region has some specific characteristics, which have strongly conditioned its development [14, pp. 11–12]:

High industry concentration: National banking markets are dominated by a small number of banking institutions. High market concentration in the region has been strongly associated with regulatory limitations on market access and favourable funding conditions for publicly sponsored incumbents. As governments have started to liberalise their markets gradually, concentration and the associated risks are likely to ease over time, even though such a process will take time to unfold.

Strong public and domestic ownership: The GCC domestic banking institutions are predominantly controlled by domestic investors, including strong public interests in key financial enterprises. Crossborder restrictions on market access and shareholdings apply to the GCC as well as non-GCC states, so that neither neighbouring GCC investors nor overseas investors hold significant shares in the GCC banks. The situation is accentuated by the special role public investors play in the national markets. Thus, governments, government investment vehicles, and royal families continue to play a significant role as investors and owners of domestic financial firms. Both domestic and public ownership have resulted from restrictive investment policies in the past. Liberalisation policies may bring greater diversification, but such a process has yet to be kicked off.

Weak competition: Concentration and ownership structures weigh heavily on competition, and in the final analysis also on the competitiveness of most national banking sectors in the GCC. Low competition has been reflected in relatively high price levels for financial products, a limited variety of products and services offered by banks, and comparatively low levels of quality in services, e.g., observable in execution times of financial transactions. These effects are mitigated partially where foreign banks have been able to establish operations.

Favourable funding conditions: Widespread public ownership has led to favourable funding conditions for many banks in the region. Government-backed cheap refinancing has been beneficial for the growth of the banking sectors and the extreme expansion of credit in the past decade. At the same time, the competitive implications of this funding advantage for incumbent banks are evident, and implicit subsidisation of domestic banks may result in misallocation of capital in the domestic economy.

Concentration risks in lending: Bank lending accelerated sharply in the first decade of the century, leading, in general, to an elevated level of risk which became visible when growth slowed in the wake of the GFC and credit defaults rose. In particular, the high share of credit handed out to the real estate and construction sectors brought considerable concentration risks to the national banking markets concerned. Lending to households continues to represent a strong share of the credit business. Figure 8 shows the GCC banking system asset and liability structure as of 2017.

Figure 8: The GCC banking system assets and liabilities [12, p. 7]

These characteristics distinguish Gulf financial markets from many emerging and advanced markets in quantitative as well as qualitative terms [14, p. 12]. To conclude, Figure 9 shows the GCC financial institution asset comparison with the same assets of the United States, Japan, and some emerging economies.

Figure 9: The GCC banking system assets and liabilities [12, p. 5]

2.2.3.    Stock markets

The GCC stock markets have gone through a roller coaster ride of development in the last two decades. Young trading venues by international standards, the GCC countries boast equity issuance and trading volumes that started to pick up in the early 2000s, rose dramatically until mid-2008, only to plunge almost as dramatically as a result of the crisis. Markets have stabilised since, even if at significantly lower levels than on the eve of the market turmoil. Attributing these extreme market movements to the dynamism of up-and-coming, non-mature markets and the external impact of global events is an important perspective. But like in the case of Gulf banking, the GCC stock markets have a number of specific characteristics which have influenced their development [14, p. 13]:

Small size, dominated by one market: The GCC stock markets have remained small by international standards. Moreover, a breakdown of the size of the national markets shows that half of the volume is concentrated in the largest market – Saudi Arabia. Kuwait, Qatar, and the UAE are the runner-ups. Stock markets play a major role as financial market segments only in Kuwait and Saudi Arabia.

The lack of size of these markets has very concrete ramifications. First, it clearly limits the choice at the disposal of investors. Second, lack of size goes hand in hand with low liquidity and turnover.

Listings concentrated in a few sectors: Those companies listed on the GCC stock markets tend to be concentrated in a very small number of sectors, especially basic industries and financial services. Strong correlations within and between these sectors, in combination with their limited choice of single stocks, render portfolio diversification within the region for institutional and retail investors difficult. While privatisations and diversification policies have broadened the sectoral composition of the universe of listed companies in recent years, that process will need to continue for a while to bring about a more balanced sectoral structure and a broader range of investment options for investors.

Governments and families in control: Governments, government-owned entities, and families play an extraordinary role as investors in the region. Influential families enter the picture as active investors and important players in the governance of listed enterprises as reflected in their role on supervisory boards. Strong presence and penetration by governments and families may, on the one hand, signal stable share-holdership and a long-term interest in the development of the companies in question. Indeed, most of these institutional shareholdings have a background in full state or family ownership in earlier decades, which got dispersed in recent years through privatisations and IPOs. At the same time, public shareholdings, at least in theory, raise important questions as to the objectives of the official investors and the decisiveness with which financial targets are being pursued by management. In addition, public stakes may stand in the way of more far-reaching private investments and further narrow the scope for trading in already narrow markets.

Limited access for foreign investors: Investment activity by foreign institutional investors in the GCC has remained highly limited. The lack of market breadth, low liquidity, high volatility as well as existing ownership structures and transparency practices but also the lack of hedging instruments have discouraged a more active engagement so far. In addition, foreign investors continue to face restrictions on their activities in individual GCC states. This applies to investors from neighbouring GCC countries which are still subject to investment restrictions, despite the progress made towards a common market in the region, and, it applies, in particular, to investors from outside the GCC. Free zones, such as the Dubai International Financial Centre (DIFC), offer unlimited access to foreign investors and have flourished in past years owing to highly attractive economic, regulatory, and operative framework conditions. Nevertheless, access from the offshore world of DIFC to the onshore world in Dubai is subject to entry conditions as well.

The GCC stock markets have come a long way in terms of development. But the development of stock markets still lags behind in an international comparison. If the GCC continues to pursue an integrated market – which forms part of the single market project adopted by the GCC in 2000 – the face of national stock markets will change considerably, featuring greater openness to the neighbouring GCC and possibly international investors, more harmonised rules and greater competition among a more diverse lot of listed companies [14, p. 15]. To conclude, Figure 10 shows GCC stock market capitalization for the period of 2000 – 2017, where again “EM” (resp. “AE”) stands for “emerging markets” (resp. “advanced economies”).

Figure 10: The GCC stock market capitalization in the period of 2000 – 2017 [12, p. 8]

2.2.4.    Debt markets

Debt securities markets have remained the least developed financial segment in the GCC. Still, the market is on an upward trajectory. In particular, the corporate bond market made some important advances in the GFC environment. Structural features of the market suggest that there is considerable room to grow for bonds in the coming years [14, pp. 15–16]:

Small private corporate segment: The growth of GCC bond markets in recent time has essentially been driven by public authorities even though the share of corporate bonds has edged up over time. On the

one hand, local central banks act as issuers with the aim of regulating domestic liquidity. The so-called Central Bank Local Issuances have been expanded forcefully since the peak of the GFC, featuring an increasing share of sukuk-type instruments.

Government bonds peaked in 2009 when the segment accounted for 53% of all bond issuances. That share has fallen since. In addition, government debt issuance in the GCC is intermittent. Given high and regular government revenues from the hydrocarbon sector, debt financing is used primarily to finance individual projects or dedicated funding purposes which leads to irregular issuance patterns. Issuance calendars have no ongoing or regular scheme and often have gaps of several months when no activity takes place in individual countries.

Reflecting the minor role private enterprises play in most of the GCC economies, the private corporate debt market thus remains a very small segment, and its development potential is closely associated with that of the private sectors in these economies. Issuer demand for debt security finance has remained comparatively low: local credit financing through banks has a strong tradition.

Strong geographic and sectoral concentration: Just like equities, the GCC bond markets exhibit a strong geographic and sectoral focus. In terms of industry background, corporate issuers mainly come from the hydrocarbon sector, financial services, or are directly government-owned enterprises. Other sectors, such as power generation, utilities, transport, and construction play a very limited role.

International access through cross-border issuance: Despite their relatively small size and early stage of development, debt instruments from the GCC have an important role to play from an international perspective in as far as investor access to these instruments is relatively unimpeded. In order to tap a broad base of financiers, a large number of debt instruments of the GCC are co-listed in international markets. In 2011, almost 70% of all issuances were reported to have been co-listed on international exchanges, with Germany, the UK, and Luxembourg as the most important locations for secondary listings. International placements are further facilitated by the wide use of the US dollar and the euro as currencies of denomination for debt securities. As the GCC currencies have been pegged to the US dollar, currency diversification is not a central determinant of investments in the region and the exchange-rate risk exposure for issuers from issuing in US dollar, in particular, is negligible. At the same time, a USD or EUR listing in US and EU jurisdictions contributes to transparency and alleviates the risk management of investors. International investors have an opportunity of diversifying into the region on the basis of international listings and without the obstacles observed in local stock markets.

Figure 11 shows the structure of the GCC debt markets as of year 2017, where again “EM” (resp. “AE”) stands for “emerging markets” (resp. “advanced economies”).

Figure 11: The GCC debt markets as of year 2017 [12, p. 9]

2.2.5.    Derivatives market

Derivatives markets have yet to develop in the GCC. None of the member economies disposes of a comprehensive exchange or Over the Counter (OTC)-based market in derivatives or complex structured financial products captured by statistics. Regulatory limitations on these product categories are a major obstacle to the development of such markets. Most GCC countries have not handed out licenses for the necessary product registration, trading, and clearing infrastructure. In addition, Islamic financial institutions are not in a position to trade in derivative instruments [14, p. 19].

Beyond regulatory issues, there are, however, important economic reasons for this gap in the financial landscape. Conditions in the underlying markets have not been conducive to the development of complex financial instruments. National equity and debt markets are not sufficiently deep for the evolution of derivatives, and they often lack the breadth to justify the development of meaningful index or synthetic exchange-traded products. Limited market liquidity also discourages the application of trading strategies such as short selling. The absence of derivatives markets, in turn, withholds important liquidity impulses from underlying markets. In the wake of the GFC, complex financial instruments are viewed with greater caution by policymakers, regulators, and even market participants. However, a prudent development of derivatives instruments in GCC markets may bring benefits in terms of greater liquidity and underlying markets, better risk management for investors, and wider scope for diversification [14, p. 19].

Governments and markets have addressed these issues in past years with limited outcomes. In Kuwait a market segment for options and futures on equities has been established, providing derivative contracts on a number of individual stocks. In the UAE, the Dubai Multi Commodities Centre offers commodity derivatives, while in Abu Dhabi a range of Exchange Traded Funds has been listed. For the future, there is an initiative to license a broad range of derivatives and structured products on the Bahrain Financial Exchange, which, in cooperation with the International Swaps and Derivatives Association, has developed global standards for Islamic derivatives in 2010. A Hedging Master Agreement is intended to provide a structure under which institutions can trade derivatives such as profit-rate and currency swaps. Qatar’s plans for introducing a market for energy derivatives, in contrast, have been shelved [14, p. 19].

Progress on the derivatives front therefore remains isolated, and the development of broad and liquid markets will certainly take a number of years. The late starting point for these market segments, however, gives local regulators the chance to establish a modern market environment in line with the current reforms of OTC and exchange-traded derivatives markets and infrastructure as coordinated by the Financial Services Board. There is, thus, a unique opportunity to start cutting-edge structures from scratch [14, p. 19].

2.2.6.    Shari’ah-compliant financing

In addition to conventional equity, bond, and bank assets, Shari’ah-compliant finance offers a wide range of financial products and services in the Gulf region. Islamic finance is more developed in this region than in other parts of the world and has grown to be the basis of a large share of financial activity in the GCC. Whether Islamic finance forms a financial system sui generis has been debated. In this paper, Shari’ah finance represents an important complement to conventional financial products and services, adding to the options for financial diversification, and it provides access to clients who in the absence of this market would (for religious beliefs) have had very limited access (if any at all) to financial services. Islamic financial practices in the GCC has a number of characteristics which can be summarised as follows [14, pp. 16–17]:

Dual system: Finance in the GCC can be regarded as a dual financial system distinguishing between conventional and Islamic finance, and in which market participants compete freely. Officially, financing must be provided on the basis of conventional pricing and terms, even though governments in the GCC have introduced dedicated legislation to provide suitable legal frameworks for Islamic finance.

Customer freedom: Islamic finance is regarded as a matter of customer choice.

Practice: A large part of the population is understood to have a preference for Shari’ah-compliant products and services, but take recourse to conventional banks in particular for overdraft facilities, which Islamic institutions cannot offer in that form. Typically, Islamic bank clients would also maintain an account with a conventional bank to secure access to services only they can provide.

Islamic finance represents a comparatively novel development of the past sixty years, with Bahrain as one of the pioneering countries promoting the establishment of Islamic financial institutions and laying the foundations for this market segment by establishing the necessary legal framework as early as the 1970s. Only in the last two decades, however, has the market expanded rapidly in the GCC region. In addition, Islamic finance has spread from the GCC, and from Malaysia as the second pioneering economy besides Bahrain, to international financial centres in Asia, Europe, and Africa. Globally, this expansion has made Islamic finance a large business segment, dominated by Islamic commercial banks, but also with sizeable shares of investment bank assets, sukuk issues, and Islamic investment funds. This market, however, is still small relative to conventional finance [14, p. 17].

Despite spectacular growth elsewhere, the GCC remains the hub of the global Shari’ah finance market, with many financial institutions active in this market and a significant share of total Islamic assets worldwide. Compared with conventional finance in the GCC, Islamic finance constitutes an important part of the financial market in the region [14, p. 17].

Islamic bank assets form the basis of a large network of dedicated banking institutions in the GCC members with a wide range of retail and commercial operations. They do so either in the form of standalone Islamic institutions, solely dedicated to offering Shari’ah-compliant services, or as so-called window banks, i.e., conventional institutions with separate operations in the Shari’ah market. The sukuk market plays an important part, being the most important traded assets class among Islamic instruments [14, p. 17].

As dynamic as the market has been in recent years, it is widely believed to have remained below its potential. While economic growth in the region has been benign, and demographics are favourable, with a growing and young population of increasingly wealthy Muslims many market participants have yet to be convinced that Islamic banking as currently practiced provides suitable solutions. Market uncertainties, especially from the perspective of international investors, primarily emanate from three sources [14, p. 18]:

Shari’ah compliance: Whether products comply with the standards of the Shari’ah requires verification on an individual basis. However, there is no uniform interpretation of the Shari’ah, and criteria for verification differ across the globe, within the GCC, and even within individual jurisdictions. Shari’ah advisors or consultative boards have been established in supervisory authorities and in Islamic financial institutions. But licensing remains heterogeneous, and legal uncertainty over the compliance of a product may persist even after the approval of such bodies given competing interpretations and the absence of final instances of judgement.

Regulation and supervision: Islamic financial laws and practices differ across countries. Some countries have introduced separate legal frameworks for Islamic finance, others do not provide formal regulation or oversight. The Islamic Financial Standards Board (IFSB) and the Islamic Development Bank (IDB) are working on establishing common standards for national regulation and supervision. In the same vein, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) establishes accounting, auditing, governance, ethics and Shari’ah standards for Islamic financial institutions and industry. The progress on convergence, however, has been limited.

Prudential issues: Islamic finance does not correspond to prudential standards across of whole range of regulation criteria. There is no cross-border market infrastructure, and instruments for managing bank liquidity risks are limited. Similarly, international authorities have expressed concern over the absence of bank rescue and resolution regimes in the Gulf region and beyond. Key issues and recommendations have been identified in this regard, most importantly by the IFSB and the IDB, but in this area decisive steps still need to be taken.

The identified problems are very fundamental and represent a serious shortcoming that clearly stands in the way of the attractiveness of Islamic finance as a complementary segment to conventional financial markets. Even though Islamic financial institutions have avoided important risks in the past due to the restrictions they face on getting involved in structured finance, derivatives instruments, and complex trading practices, there is a strong rationale for the GCC countries (and other economies with large Islamic markets) to improve investor confidence and protection and work on improved regulatory and supervisory standards to safeguard the stability of the sector. Success in this area is expected to greatly influence the future of Islamic finance. In terms of market growth, the prospects for Islamic finance are promising as baseline growth is expected to outperform global financial markets [14, p. 18]. Figure 12 shows evolution of Islamic banking in the GCC in the period of 2006 – 2017.

Figure 12: Evolution of Islamic banking in the GCC [12, p. 7]

The basics of Shari’ah-compliant finance: Islamic banking refers to financial activities consistent with the body of Islamic law – the Shari’ah. The Shari’ah prohibits certain market activities customary to conventional financial markets, e.g., the following are Shari’ah compliance Qur’an-based rules [14, p. 16]: • the prohibition of fixed or floating payment or acceptance of specific interest or fees for loans of money (riba);

•   the prohibition of contractual uncertainty and gambling (gharar and maysir);

•   the prohibition of certain industries such as those related to pork products, pornography, or alcoholic beverages (haram);

•   the obligation to pay part of the profits incurred to benefit society (zakat); in addition, practitioners and supervisors must observe principles to comply with Islamic jurisprudence, including compliance with the wider body of Islamic law, segregation of Islamic and conventional funds, Shari’ah-compliant accounting standards, and awareness campaigns.

To comply with these principles, market participants can take recourse to a wide range of Shari’ahcompliant financial products and services, including [14, p. 16]:

Sukuk: Financial certificate, Islamic equivalent of a bond.

Takaful: Islamic insurance structured as a charitable collective pool of funds based on the idea of mutual assistance.

Ijarah: Islamic lease agreement.

Mudarabah: Investment partnership for financing business activities.

Murabahah: Purchase and resale agreement, instead of lending money.

Musharakah: Profit- and loss-sharing partnership.

The Shari’ah-based financial system is overseen by an increasingly sophisticated system of regulatory and supervisory bodies [14, p. 16]:

•   Islamic Financial Services Board, based in Kuala Lumpur, Malaysia;

•   Accounting and Auditing Organization for Islamic Financial Institutions, based in Manama, Bahrain;

•   Islamic Development Bank, based in Jeddah, Saudi Arabia.

2.2.7.    Recent GCC capital market developments

As has been mentioned in the introductory section, Saudi Aramco record breaking IPO on Tadawul (the Saudi stock exchange) during Q4 2019 topped the GCC and global rankings with the highest proceeds for the year 2019 [11, p. 4]. Figure 13 shows GCC IPO trends during the period of 2013 – 2020.

Figure 13: GCC IPO activity in the period of 2013 – 2019 [11, p. 7]

The energy industry led the equity market in Q4 2019 with the USD 25.6 billion listing of Saudi Aramco on Tadawul and USD 23 million listing of Musandam Power Company SAOG (Oman) on Muscat Securities Market (the only stock exchange in Oman). A year after the last IPO on Qatar Stock Exchange, Baladna (Qatar leading and largest dairy producer) was listed on it in Q4 2019, raising USD 395.51 million. Altogether, Tadawul continued to be the front runner amongst the GCC stock markets in 2019 in terms of both number of listings and proceeds raised [11, p. 4].

Whilst 2019 experienced record breaking IPO proceeds, the number of listings significantly reduced to 8 IPOs, compared to 17 in 2018. In 2019, a number of steps were taken in Saudi Arabia which could help in maintaining Tadawul as the preferred listing location in the region, including [11, p. 4]:

•   Tadawul’s inclusion in the FTSE Russell Emerging Markets Index and MSCI Emerging Market index;

•   Issuance of regulations by Saudi Arabia’s Capital Market Authority for cross listing, allowing companies from other Gulf countries to list on Tadawul.

Figure 14: Top IPOs comparison [11, p. 2]

For the sake of comparison, Figure 14 shows top 3 IPOs in 2019 by proceeds in both the GCC and the world. As can be seen from the figure, apart from Saudi Aramco, the GCC IPOs lie below the world ones.

Figure 15 shows share price performance of 2018 and 2019 GCC IPOs by sector, relative to the respective all share index, from the IPO date to 31 December 2019. As can be seen from the figure, logistic (resp. industrial) sector is the main gainer (resp. looser) on the share market.

Figure 15: The GCC share price performance [11, p. 8]

Q4 2019 also experienced multiple high value transactions with sovereign and corporate sukuks dominating the market. IDB, through IDB Trust Services Limited, issued its first green sukuk (Shari’ah compliant investments in renewable energy and other environmental assets) worth EUR 1 billion on Nasdaq Dubai in Q4. Including the green sukuk and two issues of USD 1.5 billion each in 2019 (April and October), IDB Trust Service Limited has 11 sukuks with a total value of USD 13.65 billion listed on Nasdaq Dubai. Emirate of Sharjah (the UAE) also issued a USD 750 million sukuk during Q4 on Nasdaq Dubai following a USD 1 billion issuance in April. Industrial and Commercial Bank of China Limited, Dubai (DIFC) Branch issued two bonds of USD 500 million each in October 2019 on Nasdaq Dubai. This move helped the bank in securing the position of the largest overseas bond issuer listed on the exchange by value with total listed bonds value of USD 4.56 billion [11, p. 10].

The high value sukuks issued on Nasdaq Dubai in 2019 have strengthened Dubai’s role as one of the largest global centres in the world for sukuk listings by value. Saudi Arabia offered a total of USD 3.67 billion worth of sukuks during Q4 2019 on Tadawul of which USD 1.18 billion were issued in Q4 and USD 2.49 billion were issued in the previous quarters as a part of the unlimited sukuk program established by the Ministry of Finance in July 2017. Oman issued a USD 520 million and USD 260 million sukuk with a coupon rate of 5.5% and 5% and maturity of 7 and 5 years respectively. It also issued a sovereign bond worth USD 520 million with a coupon rate of 5.75 years and a maturity of 10 years [11, p. 10].

2.3.    GCC capital markets in unprecedented times

At the moment, markets are facing an unprecedented crisis as the global economy is disrupted by the coronavirus pandemic. The Middle East, however, is dealing with a double shock – the impact of COVID-19 and the oil price plunge. The pandemic is causing significant economic turmoil in terms of a decline in demand, a negative impact on trade, reduced consumer confidence, and tighter financial conditions in the region. The GCC governments have responded with fiscal and monetary stimulus packages, but volatility in their respective markets will likely continue until the effects of COVID-19 subside. Equity markets are down across the region and sovereign spreads have widened. Such tightening in financial conditions could make raising capital a challenge [2]. The following are the main points of impact of the current crisis.

Oil prices have a ripple effect on the GCC economies: Oil price recently declined as low as USD 22.7 per barrel, and a near-term recovery seems unlikely amid declining demand and abundant supply heavily impacting the GCC exports. Oil price stability is the most important factor in forecasts of the GCC project spending, driven by government spending and bank credit. The GCC oil exporters are impacted by lower exports, which are pressuring government budgets, with ripple effects on the rest of the economy. Situation worsens as top oil firms declare force majeure on oil imports from major supplier countries such as Saudi Arabia, the UAE, and Kuwait on reduced demand due to travel restrictions and global lockdowns [2].

Capital markets are exposed to global uncertainty. Debt markets expected to surge: Portfolio inflows declined by almost USD 2 billion since mid-February to 23 March 2020 as global investors parked funds in safer havens. Financial conditions tighten as equity prices fall and bond spreads widen. Nearly USD 35 billion worth of sovereign debt is estimated to mature in 2020. The respective sovereigns could find it difficult to refinance this debt, e.g., Oman and Bahrain whose CDS spreads have widened significantly [2].

Sectors such as tourism, hospitality, and real estate are deeply hit. The real estate sector is likely to see a significant impact with a drop in international buyers and weaker market sentiment. Developers are struggling with debt repayments that have been restructured a number of time, while property linked earnings have gone down significantly [2].

Fiscal deficits will widen with the fall in oil prices, accelerating drawdowns from wealth funds and debt issuances. Moody’s expected the Islamic finance markets to keep expanding and global sukuk issuances to remain stable at USD 180 billion in 2020 (vs. 36% year-over-year growth to USD 179 billion in 2019) after expanding for four consecutive years. As per S&P, the volume of sukuks issued in the six GCC countries increased to USD 8.6 billion in the first two months of 2020 (from USD 5.8 billion in the same period of 2019). The volume of bond issuances in the region was stable at USD 18 billion in the first two months of 2020 (vs. USD 17.9 billion in the first two months of 2019). Fitch expects the GCC funding mix to shift to drawdowns from fiscal reserves in 2020. With around USD 110 billion in drawdowns from fiscal reserves and wealth funds (vs. only USD 15 billion last year), the region is also expected to issue around USD 42 billion in foreign debt in 2020 (vs. USD 48 billion last year) [2].

Equity issuances have been affected. At the start of 2020, as many as 16 IPOs were expected in the GCC region, but they seem to be delayed now as the coronavirus outbreak hurts investor appetite. IPO of Aman REIF (Oman), launched in January 2020 and priced in March 2020, did not see significant subscription. Saudi exchange Tadawul, the flag-bearer of the GCC capital markets, recorded a price-to-earning ratio of

16.34 as of 31 March 2020 (vs. 19.51 as of 31 December 2019) [2].

Weakening banking sector and declining growth: Banking sector is heavily impacted, and there are risks of further rating downgrades. The slowdown is likely to weigh heavily on the banking sector. The lowering of interest rates by the US Federal Reserve, followed by most of the GCC central banks, could directly impact the banking sector net interest income, lowering net interest margins. The GCC bank concentration of government deposits is high, and thus a prolonged period of lower oil prices would lead to reduced deposit inflows from government and government-related entities. Cost of risk is also expected to increase, lowering bank profitability in the next 12 – 24 months. Mergers and acquisitions among Islamic and conventional banks in the GCC region are likely to continue [2].

Moreover, Moody’s changed its outlook on the banking systems of five GCC countries (Saudi Arabia, Qatar, the UAE, Bahrain, and Kuwait) to negative from stable on 2 April 2020, while maintaining a negative outlook on Oman banking system, due to the oil price collapse and coronavirus outbreak. S&P recently revised its outlook on a few UAE banks to negative. Fitch, however, believes the Kuwaiti banks are better placed than most of their GCC peers. Downward pressure on profitability and loan quality due to deteriorating operating conditions is likely to result in more credit rating downgrades of banks in the region, according to the rating agencies [2].

Lastly, GDP growth in GCC is declining, but better positioned than in the rest of the MENA region. Growing pandemic fears are likely to wipe out global growth, with growth rates already revised down a few times in recent weeks. The region’s GDP growth is expected to decline to 0.6% in 2020 (vs. previous estimate of 2.2%), although better than the wider MENA region’s (−0.3% in 2020) [2].

3.    Kuwait financial markets

As an example of what a GGC member state looks like on its own, in this section we pay attention to the state of Kuwait financial markets (including capital markets).

According to [13, p. 7], Kuwait is an oil-dominated economy that has proved resilient to shocks. Prudent fiscal management allowed the country to record high fiscal and external surpluses and build strong financial buffers during periods of high oil prices. The resulting fiscal space allowed the authorities to smooth the impact of low oil prices after 2014 and to support growth through sizeable investment spending. Banks remained liquid throughout the period of low oil prices. Equity prices, after declining in 2014 – 2016, have been recovering somewhat in 2017 – 2018. Figure 16 shows dependence on oil in Kuwait and the GCC (notice that “SWF” stands for “Sovereign Wealth Fund”, and “KIA” stands for “Kuwait Investment Authority”).

Figure 16: The GCC and Kuwait dependence on oil [13, p. 8]

Kuwaiti financial system is bank-centric, with Islamic finance playing a significant role. Financial system assets stood at 232.7 percent of GDP at end-2017 (see Figure 17, where “KD” stands for “Kuwaiti dinar”, the currency of Kuwait, denoted “KWD”) and are mostly held by the banking sector, which is itself dominated by two major banks (see Figure 18). Foreign banks operate through branches, and account for less than four percent of consolidated banking assets. The non-bank financial sector, which is dominated by investment companies (ICs), has been declining in importance since the GFC. The insurance sector is under-developed: its assets account for less than one percent of GDP. While conventional finance dominates, the Islamic banking sector is one of the largest in the world in terms of its share in consolidated banking assets (40%), and 55% of assets held by ICs are managed according to Islamic finance principles [13, p. 7].

Figure 17: Kuwait financial sector structure [13, p. 9]

Figure 18: Market share of local banks in Kuwait in 2018 [9, p. 21]

Banks operate relatively simple business models and continued to see their activity grow despite the fall in oil prices. Assets are dominated by claims on the domestic private sector and by net foreign assets (see Figure 19). Domestic credit is concentrated on the household sector (43%), where installment loans for home purchase and repair dominate, and on the real estate and construction sectors (28%) (see Figure 20). Funding is mostly originated through deposits (two-third of total). At the system level, the capital adequacy ratio remained consistently well above the minimum requirement of 13%, hovering between 17.5% and almost 19% between 2011 and 2017. The liquidity ratio (supported by the large oil-financed government spending) remained comfortably above the 18% regulatory requirement, reaching 27.8% in June 2017 and further improving through September 2018. Asset quality improved steadily despite the slowdown in growth, with non-performing loans hitting a low of 1.9% at the end of 2017, with a provisioning coverage ratio of 230%. Despite conservative provisioning requirements, profits have been stable. In addition to prudent regulation and supervision, the banking sector benefited from general government support to the economy: an increase in public sector deposits partly offset a slowdown in private sector deposit growth, and countercyclical public spending supported credit growth, credit quality, and financial stability. Banks also proactively maintained the quality of their balance sheets by actively writing off non-performing assets against provisions [13, p. 9].

Figure 19: Kuwait banking sector: liabilities and assets [13, p. 10]

Figure 20: Kuwait loans by sector [13, p. 13]

The IC segment has shrunk significantly since the GFC, under challenging market conditions and tightened regulation. The business models of ICs vary widely. Since 2008, they have been shifting away from proprietary investment towards asset management and financial services. With the establishment of the Capital Markets Authority (CMA) in 2011, ICs have also been subject to enhanced regulation and supervision. They have reduced their leverage, relying increasingly on own funds (48% of total funding in February 2018), while local bank financing declined from 40% to 23% of total funding between 2016 and 2018. The interconnectedness between ICs and banks (an important source of systemic risk) has declined substantially, as the exposure of banks to ICs fell from 12% of total banking assets during the GFC to 2.4% in 2017. On balance sheet, ICs are mainly exposed to foreign assets (about one third of total assets) and domestic financial investments (23%) [13, p. 10]. Figure 21 shows the structure of Kuwait IC assets and liabilities.

Figure 21: Kuwait ICs: liabilities and assets [13, p. 11]

Kuwait capital markets development is limited. The bond market is nascent. Between 2015 and 2017, the government increased issuances of 2- to 10-year maturity bonds to cover its funding needs and extend the risk-free yield curve. The CBK issues 3- and 6-month bonds and tawarruq for liquidity management purposes (tawarruq in Islamic finance is a financial instrument where a buyer purchases a commodity from a seller on a deferred payment basis, and the buyer sells the same commodity to a third party on a spot payment basis (i.e., payment is made on the spot); the buyer basically borrows the cash needed to make the initial purchase; a convenient description of tawarruq is provided in [7]). Risk-free securities (around 20% of GDP in total) are almost entirely held by banks to maturity. Thus, there is no secondary market or market yield curve [13, p. 11]. Figure 22 shows outstanding Kuwait government bonds and tawarruq.

Figure 22: Kuwait government bonds and tawarruq outstanding [13, p. 11]

By capitalization, the stock market of Kuwait is the second largest in the GCC in percent of GDP, but its liquidity is limited. At the end of 2017, 177 companies were listed, with banks, followed by other financial services, industry, telecom, and real estate, making up most of the listings. However, turnover was limited, representing 20% of a market capitalization equivalent to 80% of GDP [13, p. 11]. Figure 23 shows Kuwait stock market capitalization and stock trading volume by sector.

Figure 23: Kuwait stock markets [13, p. 12]

3.1.    Boursa Kuwait

In this section, we will provide an outlook at the Kuwait Stock Exchange (KSE) known as Boursa Kuwait since 2016. According to [10, p. 14], securities activities have started in Kuwait in the beginning of the second half of the 20th century. Therefore, the 1960s and 1970s have witnessed a remarkable increase in the establishment of shareholding companies, whose shares formed the starting point of Kuwait’s stock exchange and securities activities. In the beginning of the 1980s, Souk Al-Manakh stock market crash highly affected the local economy and demanded the interference of the Kuwaiti legislator to issue a number of bylaws and decrees in order to regulate the stock market (as noted in [3, p. 8], the Souk Al-Manakh crisis was caused by inadequate government regulation, insufficient financial disclosure, frivolous speculation, the use of post-dated cheques, and lack of government control over Gulf shareholding companies; CBK converted the banks’ minor bad debts into cash and major debts into government bonds after the sharp correction of the unofficial stock market, and the Kuwait Investment Authority (the investment arm of the government) purchased the stocks of large number of companies to prevent the stock prices from falling [19, p. 9]). Then an Amiri decree was issued on August 14, 1983 to regulate the stock market, and was amended later in 2005. It was a crucial point, marking the commencement of a regulated and comprehensive trading of securities.

The stock market, whose building was opened in September 19, 1984, started its activity on September 29, 1984. It was the start of new consecutive developing procedures that placed it in a well-earned pioneering position regionally and in the Arab world. Nevertheless, such procedures did not prevent the market from facing several crises due to various reasons. Most important of which was the diversity of the supervisory and regulatory entities of securities activities, and it became evident that a unified legislative and regulatory body must be established. Consequently, the CMA was established pursuant to Law No. 7 of 2010 (the law was gazetted on March 13, 2011 [3, p. 9]) on the Establishment of the Capital Markets Authority and Regulating Securities Activities and its amendments to carry out the role of complete market oversight with respect to legislation, regulation and supervision within a transitional phase that started with the establishment of the CMA and lasted until April 25, 2016, namely, the date of inaugurating Boursa Kuwait as the stock exchange’s operator [10, p. 14].

In general, securities trading in Kuwait can be summed up in four major phases. The first one lasted between the mid of the 20th century until the beginning of the 1980s, in particular at the time of Souk AlManakh stock market crash in 1982. The second phase started when the markets regulation was reorganized in 1983 and ended with the issuance of CMA’s Law No. 7 in 2010. The third phase lasted from that date until the time of market privatization. That marked the start of the last phase in 2016. This phase went through many challenges that required taking several actions [10, pp. 14–15]. In the following, we list the main challenges of Boursa Kuwait according to [10, pp. 15–17]:

•   Decline in liquidity: The relapse in the stock market’s trading in quantity and value, and the reduction in its market value has been the most dominant feature of its activity since the GFC. The stock exchange’s indices show that it did not recover from such crisis (see, e.g., Figure 24).

Figure 24: Kuwait stock market index and turnover [16, p. 9]

•   Difficulties of big block trades: Major owners and traders in the exchange are facing difficulties in executing big block trades, which require very long periods of time to complete.

•   Absence of an attractive issuers base in the exchange: Nearly 8% of companies listed in the exchange may be classified as large-sized companies with regard to its market value according to the World Economic Forum classification of stock exchanges in 2016 (16 companies out of 197), 19% of which medium-sized (38 companies) 26% small ones (52 companies), and 46% micro (91 companies). The classification, which is based on the average daily trading volume, shows that 33% of listed companies are of transactions over KWD 100,000, while the average of the daily transactions of 44% of them amounts to less than KWD 25,000.

•   Deficiency in listing rules: A number of the listing requirements lacks the sufficient justifications. They also face many obstacles which affect the listing process in general.

•   Low degree of economic information efficiency: The reality of local securities activities lacks financial studies, especially those relevant to listed companies, which affects negatively the sought transparency and results in lower factors necessary for making the right investment decision. Absence of economic information and low degree of its efficiency, accuracy, and timing has its impact on the transparency levels, and market and trading culture which eventually leads to an unattractive issuers’ base. Additionally, companies would not be keen to disclose, and investors would not ask for extra information. This would result in lack of confidence in such companies and they may be repeatedly suspended from trading.

•   Low level of foreign investments: Lacking elements of attracting foreign investments in the local market create challenges relevant to overcoming its several obstacles such as the prolonged procedures of opening trading accounts for such investor, and the large quantity of documents required for such a procedure, which are sometimes repeated.

•   Challenges relevant to elevating the market’s classification to an emerging market: In its pursuit to become an emerging market, Boursa Kuwait faces a number of challenges, some of which are not within its control such as the economic growth, while others are within its competence.Although some of the required classification’s criteria are met, others require extra efforts to achieve, in particular the ones relevant to foreign investments, the competency of the operational framework, and the settlement and clearing cycle.

To conclude, we notice that Boursa Kuwait launched OTC market on November 18, 2018 [15]. This type of market is not subject to the rules of listing, trading or mandatory governance. Such rules are voluntary as adopted in global markets. This market serves companies deleted and withdrawn from the regular market, in addition to the shareholding companies that are listed in the pre-IPO period to support the listing process and the closed shareholding companies. Boursa Kuwait created a trading platform for financial and investment securities (non-listed shares, bonds and sukuk, private equity). This system provides transparency in price discovery. It also contributes to providing liquidity, enables special trades, and improves settlement and clearing mechanism [10, pp. 17–18].

4.    CBK and its regulations

Taking on the previous section, where we considered a particular member of the GCC on its own, in this section, we will concentrate on the Central Bank of Kuwait (CBK) and some of its regulations. According to [19, p. 4], CBK was established by virtue of the Law No. 32 of 1968 concerning Currency, the Central Bank of Kuwait and the Organization of Banking Business. It replaced the Kuwaiti Currency Board, which had been established by virtue of the Amiri Decree No. 41 of 1960. The establishment of CBK was to administer the role of the monetary and financial policy in the pursuit of social and economic development in the country. CBK started operating on the 1st of April 1969 as specified in Article 15 of Law No. 32 of 1968, with the following objectives:

•   to issue currency on behalf of the State;

•   to secure the stability of the Kuwaiti currency and its free convertibility into foreign currencies;

•   to direct the credit policy to assist social and economic progress and increase national income;

•   to supervise the banking system in the State of Kuwait;

•   to serve as banker to the Government;

•   to provide financial advice to the Government.

Figure 25 provides Kuwaiti banking system as of 2009 (we notice that not all banks are listed). To get a feeling of the banking sector to control, Figure 26 shows some numbers from this sector as of year 2018 (where “PPP” stands for “public-private partnership”).

The CBK is managed by a Board of Directors encompassing the Governor of CBK – chairman, the Deputy Governor of CBK, a representative of the Ministry of Finance and a representative of the Ministry of Commerce and Industry. The Board also comprises of four other members with proven experience in the economic, financial and banking affairs, appointed by an Amiri Decree for a renewable three-year term [8].

The CBK supervises listed banks, investment companies, and exchange houses (Law No. 32, 1968). Mutual funds, however, have been supervised by the KSE Market Committee since July 2005 (Amiri Decree No. 158, 2005). The CBK has the power to inspect institutions under its supervision at any time for compliance with its provisions, laws, resolutions, and regulations. It plays a substantial role in the supervision of KSE listed companies, since many of these are banks or investment companies [3, p. 10].

The capital market in Kuwait is regulated and supervised by three enforcement bodies: the Ministry of Commerce and Industry (MoCI), the KSE Market Committee and the CBK [3, p. 10]. The primary market for equities is supervised by the MoCI, while the secondary market is supervised by the Market Committee, and the CBK supervises financial institutions [3, p. 11].

The CBK has been the supervisory body for Islamic finance since 1990. The growing number of Islamic financial institutions is expected to increase competition and the CBK believes that currently the market for Islamic financing is concentrated. Creativity and innovation has helped in the growth of Islamic finance industry in Kuwait, bringing out competitive products appealing to the Muslim population [19, p. 5].

The CBK recently embarked on a strategy to promote innovation and transform the operational efficiency of both the CBK and the country’s financial institutions. This strategy focuses on using digital technologies to automate and re-engineer CBK supervisory processes, making them more agile and adaptive, and laying the basis for the future implementation of artificial intelligence and supervisory technology [9, p. 32].

To conclude, Figure 27 shows the CBK balance sheet from the annual report for the year 2018/2019.

Figure 25: Kuwait banking structure [19, p. 4]

4.1.    CBK regulations

The CBK issues laws and regulations focused on strengthening the Kuwait banks and keeping with international standards. The examples include raising the Capital Adequacy Ratio from 10% to 12% and announcing the government’s full support to local banks by providing a 100% guarantee on all customer deposits after the GFC hit the GCC countries. A supportive regulatory environment is provided by the CBK willingness and ability to support the local banks. Licensing process adopted for banks in Kuwait is very stiff, and it could be challenging to get a license for a new bank. The regulations on the international banks are quite strict. Above all the CBK conducts routine checks on liquidity, internal control, and risk management to ensure the health of the Kuwaiti banking system. The above factors indicate that Kuwait has a protective regulatory environment [19, p. 10].

The supervisory function of the CBK has developed and improved with the advice sought from the international financial institutions and outside consultants. The CBK has appointed a number of on-site inspectors and off-site supervisors and financial analysts to overview the activities of all the banks and investment companies operating in Kuwait. The CBK also invests in training for the constant improvement of its human capital. It is dedicated to inspect each institution; the CBK aims for an average cycle of 2.5 years for each institution depending on its size and range of activities. A credit bureau was set up in April 2003, which collates all relevant pieces of information on consumer loans granted by Kuwaiti banks, investment companies, and other companies that sell goods on a monthly installment basis. It is a platform aimed at sharing of information for collective management of risks pertaining to retail lending (including residential real estate financing), which helps banks to fully comply with the CBK regulations [19, p. 10].

Figure 26: Kuwait banking sector [9, p. 7]

Figure 27: The CBK balance sheet [8, p. 50]

The CBK follows a well organized method of off-site supervision where banks are required to submit a multitude of standardized returns periodically. Reporting requirements are comprehensive including returns indicating compliance with the CBK administrative measures. The CBK requires that the finances of every bank be audited and approved by two separate auditors. Even though this provides comfort as to the quality and accuracy of the bank finances, it adds to the already significant regulatory cost in the system [19, p. 10].

Kuwaiti banks follow International Financial Reporting Standards (IFRS) except for International Accounting Standards (IAS) 39. The CBK has replaced this specific requirement for collective provisioning for a minimum general provision. IFRS 7 and the amendments to IAS 1 were adopted by the banks in 2007, which has improved the level of quality of disclosures. The decision of CBK to adopt Basel II in 2005 has enhanced the level of reporting. The public disclosure of these banks have elevated above regional standards. The unaudited quarterly financial statements published by Kuwaiti banks show a fair degree of detail when compared to regional peers [19, p. 10]. Following is a list of CBK regulations issued in the last two decades.

Provisioning: In March 2007, the CBK issued a circular amending the basis of making minimum general provisions on facilities (in lieu of IAS39 requirements for collective impairment provisions), changing the mandatory rate to 1% from 2% for funded facilities and 0.5% for non-funded facilities. These new rates have been applied from January 1, 2007, on the net increase in facilities. The general provision as of this date, in excess of the 1% for funded facilities and 0.5% for non-funded facilities, has been retained as general provision until further directive from the CBK. This move by the CBK triggered a system-wide decrease in new loan-loss provision generation in 2007. Banks must post provisions of 20%, 50%, and 100% for the portions of their loan portfolios that are 90 days, 180 days, and 360 days, respectively, past due (after deducting collateral value) [19, p. 12].

Capital adequacy: The CBK endorsed the application (of the standardized approach) of the Basel II capital adequacy requirements to conventional domestic banks as of December 31, 2005, thereby making Kuwait the first country to apply these standards. The minimum capital adequacy ratio was set to 12%. Banks have also started disclosing Pillar III in their annual reports since 2007. The CBK has prepared instructions to Islamic banks for the application of the revised Basel II standards. The CBK raised in May 2008 the risk-weighting on consumer and housing loans from 75% to 100%, while assigning a 150% risk-weight to real estate loans and facilities to finance share purchases (with exceptions) [19, p. 12].

Large exposures: Exposure to a single group is subject to a legal lending limit of 15% of equity. The exposure includes all types of securities, but is net of collateral in the form of cash or government securities. Exposure to a single bank is limited to 10% of equity. Lending to related parties is discouraged, and monitored tightly by the Central Bank. Lending to board directors has to be approved by three-quarters of the board of directors and must be collateralized [19, p. 12].

Personal lending: Regulatory efforts and refinements have been made to complement the 80:20 customer loans to customer deposits ratio. Under this regulation, a bank’s customer loan portfolio may not exceed 80% of its customer deposits. Further refining of previous circulars for banks and investment companies, which were introducing amendments to the rules and regulations on the granting of consumer and other installment loans, have also been made in March 2008 [19, p. 12].

Related-party lending: The significant presence of family ownership in Kuwait banks poses the potential risk that credit and personnel decisions are not based on merit, resulting in name lending. Related-party lending at Kuwait banks, however, is limited and tightly controlled by the CBK [19, p. 13].

Liquidity: A bank must invest at least 20% of its domestic customer deposits in T-bills and bonds, or any other instruments issued by the CBK, in addition to their balances within the CBK. Such liquidity requirements are in place to curb credit growth and limit banks’ loan leverage [19, p. 13].

Ownership: It is prohibited for non-Kuwaiti investors (GCC and foreign) to exceed the ownership of 49% in the capital of any individual bank, except after attaining a preceding approval from the Council of Ministers, and after consulting the CBK. In April 2004, the CBK endorsed the application of executive procedures that put limits on the ownership structure of Kuwaiti banks by setting the maximum limit for any shareholder at 5% of a bank’s capital, unless prior consent is obtained from the CBK and excluding government entities and positions existing prior to this law. The Banking Law was amended in January 2004 to allow foreign banks to operate in Kuwait. An amendment to the Banking Law passed by parliament in January 2004 also enabled foreign banks to establish local branches [19, p. 13].

Basel III: Banks in Kuwait have long maintained robust capital adequacy, which has been supported by the CBK emphasis on financial stability. Kuwaiti banks have been required to comply with Basel III capital adequacy requirements since 2014. The consolidated Capital Adequacy Ratio (CAR) – total capital to risk-weighted assets – reported that year had declined to 16.9% from 18.9% in 2013. However, this had been due to the implementation of Basel III and the recalculation of CAR under the new rules. Nonetheless, CAR has picked up since then to reach 18.3% in 2018, exceeding CBK requirement of 13% in line with Basel III standards. The financial strength of Kuwaiti banks is mainly driven by Tier 1 capital, which accounted for 90% of total capital, and 16.4% of risk-weighted assets in 2018. The CBK requires banks to maintain Tier 1 capital at a minimum of 11% of risk-weighted assets [9, p. 25].

Moreover, once the full implementation of Basel III is complete, Kuwaiti banks will have to comply with five different sets of liquidity regulations: the regulatory liquidity ratio, the maturity ladder approach, the loan-to-available sources of funds ratio, the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR). The introduction of the Basel III rules (the LCR and NSFR) provide a perfect opportunity for the CBK to consider whether other regulations can be adjusted or removed [17, p. 3].

A particular and important role plays regulation of Islamic banks. As of 2015, there were five banks in Kuwait operating in accordance with the provisions of Islamic Shari’ah (Kuwait Finance House, Boubyan Bank, Kuwait International Bank, Al-Ahli United Bank, Warba Bank, and Al Rajhi Bank which is a branch of a foreign Islamic bank). The Islamic banking industry has become increasingly important in the local market following the amendments made on May 25, 2003 to the legislative and regulatory framework of the banking and financial system. Those amendments were made to regulate the activities of Islamic banks in Kuwait and to organize the CBK supervision and oversight of these institutions. Significantly, Law No. 30 of 2003 included the addition of a special section on Islamic banks to Chapter 3 of the CBK Law. In this context, an operating Islamic bank (Kuwait Finance House established in 1977) was registered during 2004, and a new Islamic bank (Boubyan Bank) was established and commenced operations by the end of 2004. Also, a specialized local bank (Kuwait Real Estate Bank) was converted, in 2007, into an Islamic bank named Kuwait International Bank. In March 2010 a commercial bank (Bank of Kuwait and the MiddleEast) converted into an Islamic bank, named Al-Ahli United Bank, and on April 27, 2010 Warba Bank was listed with the CBK as an Islamic bank [4, p. 42].

The supervision of Islamic banks has unique characteristics such as self-censorship, internal supervision, and external supervision. Self-censorship means that all employees in the banks must follow Shari’ah Law. The internal supervision occurs through the bank’s Shari’ah Supervisory Board and accounting review. The external supervision occurs through the supervisory authority such as the CBK and external auditing firm as well as the external Shari’ah supervision. It is worth mentioning that the Kuwaiti banks do not have an external auditing firm to review their transactions, unlike the Islamic Non-Bank Financial Institutions which, according to the Executive bylaw of the Capital Market Law, must appoint an external auditing firm to review the institutions transactions [4, pp. 42 –43].

In accordance with Article 97 of the CBK Law, the Board of Directors of the CBK sets the rules and regulations for the supervision of Islamic banks with respect to liquidity, solvency, and business organization, including in particular [4, p. 47]:

•   a system for liquidity and elements thereof;

•   capital adequacy standards through specifying the ratio of capital to asset elements;

•   the rules for calculation of the required provisions for asset risks.

A convenient insight into the CBK regulations for Islamic banks is provided in [4, p. 47].

According to [1, p. 30], in 2016, the CBK issued instructions on “Shari’ah Supervisory Governance for Kuwaiti Islamic Banks”. The aforesaid instructions replace the CBK instructions regarding “Rules and Conditions for the appointment and Responsibilities of the Shari’ah Supervisory Board in Islamic Board in Islamic Banks” issued on June 15 and June 19, 2003 and complement the instructions related to “Rules & Standards of Corporate Governance in Kuwaiti Banks” issued in 2012.

The new instructions are organized and divided into the following sections on Shari’ah supervision governance: definitions, general requirements of the framework, principles of Shari’ah supervision governance including oversight, accountability and responsibility, roles of the board of directors, executive management and Shari’ah supervisory board, independence requirements, “Fit and Proper” requirements for the board members, confidentiality of information, and requirements for consistency among board members in their decision-making and in providing advice to the bank [1, p. 31].

These instructions incorporate both internal and external Shari’ah auditing, including the scope and objectives of the audit, and the qualifications required of Shari’ah auditors, since one of the major challenges facing the development of Islamic banking is the necessity to ensure that Shari’ah principles are complied with, otherwise known as “Shari’ah auditing” [1, pp. 31–32].

5.    CBK regulations

In this paper, we provided an overview of the GCC financial markets, and also considered a particular member of GCC on its own, namely, Kuwait. While facing the same problems as, e.g., Western financial markets, GCC region has an additional point of attention – Islamic finance. In particular, one of the major challenges facing the development of Islamic banking is the necessity of verification that Shari’ah principles are complied with, which could often be a difficult task, since there is no uniform interpretation of the Shari’ah, and criteria for verification differ even within individual jurisdictions.

In conclusion, we note that as per [6, p. 60], in 2020, a cross-border payment system GCC-RTGS (realtime gross settlement system) is expected to go live, settling payments in the currencies of the GCC countries (see Figure 28). The central banks will convert the currencies based on foreign exchange (FX) rates set at the start of the business day. The fact that the GCC countries peg their currency to the US dollar (Kuwait is an exception, pegging its currency to a basket of currencies, of which the US dollar is the most dominant) alleviates FX risk. Based in Saudi Arabia, the Gulf Payments Company will operate the system.

Figure 28: Payment flow in the GCC real-time gross settlement system [6, p. 59]

Cross-border payments are generally slower, more expensive and more opaque than domestic ones. They tend to flow through the so-called correspondent banking network, where chains of banks work to get funds from the payer to the payee. There are several ways to potentially improve cross-border payments. One is to streamline processing along the chains of correspondent banks. Another is to replace the payment chains (or parts thereof) with dedicated cross-border and/or multi-currency (CBMC) payment systems [6, p. 53].

CBMC arrangements are not new, but relatively rare. One reason is the difficulties in setting them up. On top of operational challenges, some complexities of domestic systems are amplified in a cross-border context. These include cross-border governance, conflict of laws issues, and adherence to multiple antimoney laundering and combating the financing of terrorism regimes. Some issues are unique to cross-border or cross-currency systems such as FX conversion and liquidity management in foreign currencies [6, p. 53].

There are about half a dozen multi-currency cross-border systems in operation. They fall into three groups, based on the services offered: cross-currency, choice of currency, and payment versus payment (PvP) arrangements (the cross-border element relates to the fact that even if parties within a jurisdiction agree to pay each other in, say, USD, there is still need for a settlement agent with access to the US payment system to square net positions at some point [6, p. 54]). Cross-currency service allows the payer to be debited in one currency and the payee to be credited in another (e.g., GCC-RTGS). In contrast, choice of currency service allows users to select the currency of a payment from among those the system settles in (e.g., the Regional Payment and Settlement System of the Common Market for Eastern and Southern Africa). PvP allows conditional processing of payments, a prime example being CLS (i.e., Continuous Linked Settlement – a US-based financial institution that provides settlement services to its members in FX market) [6, p. 59].

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