Access to finance and capital markets is essential for growth and economic competitiveness. This chapter investigates MENA capital markets in order to identify common priorities for achieving progress, consistent with the G20/OECD Principles of Corporate Governance. It provides an overview of MENA’s capital markets and goes on to explore factors limiting access to finance, comparing the situation in the region with global trends when possible. The chapter explores how MENA’s companies use public equity financing and corporate bond markets, reviews the structure of its stock exchanges and examines the region’s corporate ownership structure, including concentrated ownership and limits on foreign investors. It concludes with a summary of key challenges to growth in the region, followed by policy options for deepening capital markets and enabling growth companies to obtain finance from them.
Corporate Governance in MENA
Chapter 2. Access to finance and capital markets
Abstract
2.1. Introduction
MENA economies face the challenges of sometimes sluggish economic growth, limited economic diversification and high unemployment, especially among youth and women. A major issue in attempting to address these challenges is limited access to finance. Restricted access to capital markets hampers the development of growth companies, the main drivers of job creation, innovation and productivity.
The region’s share of new entrepreneurs and high-performance enterprises is comparable to that of other emerging economies (OECD/IDRC, 2013). But MENA’s growth companies seem to face higher barriers in their quest for financial resources than larger companies able to offer physical assets as collateral. In an environment constrained by the funding capacity of banks and higher government budget deficits, capital market development and market-based finance can be a viable alternative for growth companies. Better corporate governance is essential in this regard.
This chapter aims to identify the key challenges faced by MENA companies with respect to access to capital markets. Where possible, developments in MENA’s capital markets are compared with global trends. The chapter begins with an overview of financial market developments in the region. It moves on to explore the use of public equity financing and bond markets by MENA companies, initial public offerings (IPOs) by growth companies, and the region’s stock exchanges. It examines the region’s corporate ownership structure, including concentrated ownership and limits on foreign investors. It also touches on banking sector development, which is critical to improving the financial infrastructure of MENA companies. The chapter concludes by offering policy options for improving access to finance.
While the chapter covers all 18 MENA economies under review in this report, insufficient data has led to the assessment of fewer issues in some of them.
2.2. Why capital market development is vital in MENA
Despite considerable diversity in MENA economies, access to finance is restricted in the region. Private credit and stock market capitalisation are low relative to GDP compared with some Southeast Asian countries, for example. Although the MENA financial system is dominated by banks, the high concentration of financial intermediation in the banking sector and high collateral requirements mean that credit is channelled to a small number of large companies. In addition, ongoing economic and political conflicts pose major challenges, including restrictions on access to finance.
2.2.1. Factors affecting access to finance in MENA
There are several ways for companies to access finance in a market economy. Although banks are at the core of financial systems for most countries, in developed and emerging markets supply and demand for finance is not being matched, which has encouraged companies to search for alternative sources. Equity financing has a number of distinct characteristics that give it an advantage over other external sources of capital. Equity finance is permanent and patient, which allows companies to take risks over the medium term. On the other hand, debt financing in the form of bank loans can hold a high cost for some firms. For example, the price of debt financing for smaller firms, who do not always have access to equity financing, can be high due to the default rate of these firms.
While founders, family and friends are generally the leading funding channel at the start-up stage of a company, the funding alternatives should be broadened along the business lifecycle. In particular for growth companies, which are defined as companies with an average turnover or employee growth greater than 20% per annum over a period of three years (Eurostat-OECD, 2007), financing is crucial to transition from a small/medium to a large company. However, entrepreneurs in MENA identify lack of access to sources of capital funding as a major constraint (Figure 2.1).
Figure 2.1. Firms identifying access to finance as a major constraint, 2011-17 (%)
Note: Average percent, 2011-17.
Source: World Bank Enterprise Survey Database (2017).
The region’s financial intermediation is dominated by banks. In 2015, bank deposits accounted for 80% of GDP in the region, compared with a world average of 49% (World Bank GFDD, 2018).1 Banking sector competition in the MENA region is also lower than in most regions of the developing world (Anzoategui et al., 2010), and banking concentration ratios are quite high in MENA economies compared to other selected developing countries (Figure 2.2).
Figure 2.2. Bank concentration ratios, 2015 (%)
Note: Bank concentration ratio measures the assets of the three largest commercial banks as a share of total commercial banking assets.
Source: WB Global Financial Development Database (2017).
Increased competition in the financial sector would help to ensure better access to financing, which can be especially difficult to obtain for SMEs and growth companies. When countries have deep stock markets and other non-bank financial intermediaries, they generally tend to host more competitive banking sectors. A comparison of market capitalisation in MENA economies with that of other countries indicates that there is room for further growth (Figure 2.3).
Figure 2.3. Stock market capitalisation to GDP, 2016 (%)
Source: WB, World Development Indicators Database (2017).
The depth of financial institutions represented by the average ratio of private credit to GDP varies widely across countries in the region. For example, the average private credit to GDP ratio for the 2011-2015 period is 7% in Iraq compared to 88% in Lebanon, a 13-fold difference (World Bank GFDD). Although the region experienced both the negative effects of the 2008 financial crisis and economic and political instability after 2011, credit to GDP ratios have generally rebounded. However, this is not the case in Egypt (43% in 2007, 15% in 2015) or Jordan (85% in 2007, 68% in 2015).
Credit to the private sector has also slowed due to reduced deposit growth as a result of lower oil prices (IMF, 2017a). The decrease in private credit has limited financial alternatives for the private sector, which relies on a bank-dominated financial system. The total credit gap for micro, small and medium-sized enterprises (MSMEs) in MENA is estimated at USD 260-320 billion, which means that a 300% increase in outstanding SME credit is required to close this gap (Stein et al., 2013). In view of the evidence regarding the difficulties faced by companies in securing loans, it can be inferred that the financing gap is also large for growth companies.
Insights into private-sector lending in the region emerge from a MENA enterprise survey conducted in 2013-2014 by the European Bank for Reconstruction and Development, European Investment Bank, and World Bank Group (EBRD et al., 2016). The survey covered more than 6 000 private firms in the manufacturing and services sectors in eight MENA economies: Djibouti, Egypt, Jordan, Lebanon, Morocco, Palestinian Authority, Tunisia and Yemen. It found that credits are concentrated and that most of the companies, especially SMEs, consider themselves as deprived of bank credit.
Another study supports this conclusion (Rocha, Arvai and Farazi, 2011). In the MENA economies that are not in the Gulf Co‑operation Council (GCC), credit concentration ratios – the ratio of the top 20 exposures to total loans – are among the highest in the world. In 2010, the top 20 exposures accounted for more than half of total loans in the economy, implying that credit is channelled to a small number of large companies, leaving the bulk of firms with little or no access to credit.
Furthermore, the requirements set by public banks in many MENA economies favour state enterprises and large industrial firms, meaning that SMEs and growth companies have difficulty accessing capital. A study by Bhattacharya and Wolde (2010) found that MENA jurisdictions were quite successful in mobilising financial resources, but relatively less efficient in allocating them.
There are also high collateral requirements in MENA economies, though not necessarily more so than in other developing countries (Figure 2.4). Those requirements mean that young and small firms may have insufficient assets to qualify for finance.
Figure 2.4. Value of collateral required for a loan (% of loan amount)
Source: World Bank Enterprise Surveys (2017).
These various weaknesses in MENA financial systems – a financial sector dominated by banks, low stock market capitalisation in relation to GDP and the high collateral needed to secure a loan – combine to create restrictions on access to finance in the region.
2.2.2. Equity markets and growth
The role of capital markets in the growth of the economy has been the focus of extensive research. Studies suggest that equity finance can contribute to growth by improving resource allocation. In addition, capital markets make long-term investment possible and improve the efficiency of the whole financial system through the competition among different financial instruments (El-Wassal, 2013).
Characteristics of equity financing
Equity capital has a number of distinct characteristics that give it a unique advantage over other external sources of capital. First, equity finance is permanent. Once equity has been issued, there is no expectation for it to be retired or paid back. This is in contrast to bank loans, which have a finite life span. Second, equity capital is patient and returns are not guaranteed. The shareholder will be paid only after all other stakeholders, such as employees, suppliers, tax authorities and creditors have been paid. Unlike other capital providers, shareholders will be the first to bear the cost of adverse business performance. In contrast, debt lenders have a priority claim on a company’s assets in case of default.
Third, since equity only receives residual profits in the form of dividends, equity capital is typically more suited to finance risk than other forms of capital, which yield a strictly defined return regardless of a company’s operating performance.
The permanent, patient, and risk-willing nature of equity capital means that supply and access to equity is not only important for the company. Availability of enough long-term capital is of systemic importance to the very structure and long-term dynamics of an economy’s corporate sector. Importantly, the availability of equity allows for a gradual shift in a country’s industrial structure towards more future oriented, innovative, knowledge-based and human-capital intensive enterprises.
A study examining the effects of financial development in MENA indicates that a reduction of constraints on access to finance – from the MENA average to the world average – could lead to an increase in real per capita GDP growth in the region (Bhattacharya and Wolde, 2010). Evidence that financial stability and efficiency are linked to growth also emerges from a study by Naceur et al. (2017). The authors conclude that the effect of finance depends on a jurisdiction’s income level, policy regime and institutional quality.
Research into how companies that issue in capital markets evolve compared to non-issuers, meanwhile, found that issuers of equity, bonds and syndicated loans in the Arab region were larger and grew faster than non-issuers (Lorente et al., 2017a).
2.2.3. Corporate governance in MENA capital markets
A sound corporate governance framework and sound practices facilitate capital market development over time. Investors need assurance that their rights are protected when they invest in capital markets. Similarly, companies will not be willing to use capital markets without clear responsibilities defined by the rule of law (OECD, 2015a).
Improving the quality of corporate governance frameworks and practices is essential for developing more efficient and deeper capital markets. Corporate governance and capital market development have a symbiotic relationship, each benefitting the other. Progress in corporate governance facilitates capital market development, while requirements (e.g. disclosure) linked to capital markets encourage better corporate governance.
Analysis of data from emerging markets shows that improved corporate governance promotes deeper, more liquid and more efficient capital markets, increasing resilience to global financial shocks (IMF, 2016b). The IMF found that companies in emerging markets with better corporate governance tended to have stronger balance sheets, lower short-term debt ratios, lower default probabilities and the ability to borrow at longer maturities.
The quality of corporate governance affects the cost of capital and company value. Investors who are not confident about a company’s corporate governance structure are less willing to provide financing and more likely to charge higher rates (Claessens and Yurtoglu, 2012). Better corporate governance structure also increases a company’s competitiveness and efficiency through better business decisions.
MENA governments have endeavoured to develop their corporate governance frameworks in recent years (OECD, 2012; Crescent Enterprises, 2016). Reforms undertaken since the 2000s include the establishment of stock exchanges and capital market regulators, review of company laws, adoption of corporate governance codes, imposition of stricter rules, and requirements for greater disclosure and transparency from listed companies.
Today almost all MENA jurisdictions have a corporate governance code, and regulatory initiatives in the corporate governance area continue in the region. Nevertheless, there is room for improvement in several areas, according to a recent S&P Global Ratings report. Weak disclosure and transparency, coupled with a lack of board independence and insufficient oversight, continue to hold back companies from attracting international investors (Gulf Business, 2017).
2.3. Corporate use of public equity markets
Equity is an essential component of corporate finance. Sources of equity finance include retained earnings, private equity, public offerings and, with recent technological advances, alternative platforms such as crowdfunding. A vibrant equity market is crucial to support growth companies and to secure their access to funding through IPOs and secondary public offerings (SPOs).
This section examines how MENA companies use public equity financing. Due to challenges in obtaining data, IPO analysis for the region for the years 2014-2017 is mainly based on the annual reports of stock exchanges and the IPO reports for MENA of Ernst & Young (EY).2
Two global trends on IPO markets affected growth companies after the 2000s. First, there was a shift from advanced economies to emerging markets in terms of the number of IPOs. Second, fewer and larger companies have been going public (OECD, 2018; OECD, 2015a).
Indeed, since the 2000s, there has been marked decline in the IPOs of growth companies, both in terms of their number and average size. This is especially the case in the United States and Europe, and the trend persisted in 2016 in Europe and Japan (OECD, 2017a). Total proceeds of secondary issuances by listed non-financial companies have been higher than proceeds of IPOs since 2005 (OECD, 2015a).
Over the period 2008-2017, a total of 230 MENA companies issued an IPO. The amount of capital raised totalled USD 41 billion (Figure 2.5). Hence, the average value of equity capital raised per company through an IPO over the period was USD 179 million.
As Figure 2.5 indicates, 2014 was a good year for IPOs: MENA companies raised USD 11 billion, a sum comparable to the USD 13 billion raised in 2008, before the global financial crisis (EY, 2015). Overall IPO activity in 2014 saw a 254 % increase in value compared to 2013. In 2014, Saudi Arabia had the largest share (60%) in terms of capital raising from the region, with the proceeds of USD 6.7 billion from its six IPOs. A comparison of average IPO size indicates that larger IPOs took place in 2014 (USD 383 million) than in 2008 (USD 244 million).
Over the 2014-2017 period, the majority of IPOs in MENA took place in Saudi Arabia and Egypt. Together, their IPOs raised USD 10.2 billion in capital. However, Saudi Arabia’s IPOs far exceeded Egypt’s in terms of the value of capital raised (Figures 2.6 and 2.7).
Figure 2.5. Initial public offerings in the MENA region, 2008-17
Source: Adapted from EY MENA IPO reports and the websites of stock exchanges.
Figure 2.6. Number of IPOs per country, 2014-17
Source: Adapted from EY MENA IPO reports and the websites of stock exchanges.
Figure 2.7. Total value of MENA IPOs, 2014-17 (USD billion)
Source: Adapted from EY MENA IPO reports and the websites of stock exchanges.
Figure 2.8 displays the size of IPOs in MENA’s non-financial sector. The IPOs of MENA growth companies rebounded in 2017, possibly due to an increase in small IPOs in the Saudi market. After the launch of the Nomu-Parallel Market on the Saudi Stock Exchange, the capital raised in 2017 totalled 169 USD million, representing 37% of total MENA growth company IPO proceeds.
Figure 2.8. Non-financial IPOs in the MENA region
Source: Adapted from EY MENA IPO reports and the websites of stock exchanges.
It is noteworthy that the share of growth company proceeds in non-financial company IPOs in MENA (35% in 2017, 18.94% in 2014-2017) exceeded global averages (15% in 2008-2016) (OECD, 2017a).
Figure 2.9 displays the sectoral breakdown of MENA initial public offerings of less than USD 100 million over 2014-2017. It shows that total proceeds from growth company IPOs were more or less evenly distributed among different sectors, with the combined consumer goods/services sector (cyclical and non-cyclical) emerging as the main user of equity markets.
Figure 2.9. Sectoral breakdown of small IPOs in MENA, 2014-17
Source: Adapted from EY MENA IPO reports and the websites of stock exchanges. Economic sectors are based on the Thomson Reuters Business Classification.
The situation in MENA differs greatly from advanced economies, where high technology and healthcare accounted for 40% of all equity raised through growth company IPOs from 2000 to 2014. This is in line with research showing that equity markets are especially suitable for growth companies in future-oriented industries with relatively high risk (OECD, 2015a). Conversely, the share of IPOs in technology, telecommunications and healthcare industries is quite low in MENA.
A recent working paper found that secondary equity offerings have grown at a faster rate than IPOs in Arab jurisdictions over the 1991-2014 period (Ismail, Cortina Lorente and Schmukler, 2017a).3 The study was based on a dataset including 138 091 companies and 719 242 security issuances. It showed that the share of IPOs in total equity proceeds decreased from 55% (1991-98) to 26% (2007-14). The jurisdictions with the highest proportions of secondary equity issuances were Kuwait (95%), Egypt (92%) and Qatar (88%). The share of secondary equity offerings was less than 60% in Morocco, Saudi Arabia, Tunisia and UAE.
2.4. Stock exchanges in the region
MENA’s stock exchanges date back to the late 19th century, when the Egyptian exchange was established. Since the 1980s, the establishment of stock exchanges has accelerated in the region. However, despite the global process of demutualisation and privatisation in recent decades, most of the region’s exchanges are still state owned or organised as public institutions (Figure 2.10).
Figure 2.10. Ownership structure of MENA stock exchanges
Note: The countries included are Algeria, Bahrain, Egypt EGX, Egypt NILEX, Iraq, Jordan, Kuwait, Lebanon, Morocco, Oman, Palestinian Authority, Qatar, Saudi Arabia, Tunisia, UAE DIFC, UAE Federal.
Source: OECD (2019), OECD Survey of Corporate Governance Frameworks in the Middle East and North Africa 2019, www.oecd.org/corporate/oecd-survey-of-corporate-governance-frameworks-in-mena.htm.
The Palestine Securities Exchange and the Dubai Financial Market are the region’s only stock exchanges with the status of a public listed company, but Kuwait and Saudi Arabia are making structural changes. The Boursa Kuwait, a private entity, was set up in 2014 to develop the Kuwait Stock Exchange, and in October 2016 it was granted an official license to own the exchange. An IPO for Tadawul, the Saudi exchange, originally planned for 2018, is now expected in 2019, according to news reports.
Table 2.1 displays key characteristics of MENA’s stock exchanges in 2017. Total market capitalisation was USD 1.128 billion, or 1.42% of global market capitalisation. Given that MENA’s GDP represents 3% of global GDP, the region’s market size does not reflect its potential.
Table 2.1. Main characteristics of MENA stock exchanges, 2017
Note: Countries marked with an asterisk (*) belong to the Arab Federation of Exchange. Market capitalisation of listed domestic companies (percentage of GDP) has been calculated manually using WB World Development Indicators.
Source: WB World Development Indicators (2018); IMF World Economic Outlook Database (2018).
Market capitalisation varies greatly among MENA exchanges. The Saudi Stock Exchange has the largest market capitalisation, at USD 451 billion, which represents approximately 40% of the total MENA market at the end of 2017. While market capitalisation is also high in other GCC countries, it is very low in several jurisdictions in the region.
The market capitalisation to GDP ratio declined severely in almost all economies after the 2008 financial crisis, but the global average has returned almost to its 2007 level (114% in 2007, 99% in 2016). Recovery has been generally slow in MENA jurisdictions, perhaps due to the region’s exposure to external and internal shocks, especially after 2011. Stock market capitalisation in most jurisdictions declined significantly following the global financial crisis and, apart from the UAE, has not yet caught up with pre-crisis levels. Declines were most severe in non-GCC jurisdictions (Figure 2.11).
The number of companies listed on MENA stock exchanges increased dramatically after 1998, partly as a consequence of privatisation programmes across the region, and the vast majority of these companies were listed in Egypt. The total number of listed companies for the region stood at 1 844 in 2000, of which 1 057 were in Egypt. However, the number of companies on the Egyptian Exchange decreased drastically in 2017, when untraded companies were delisted.
As of 2017, the number of companies listed on MENA stock exchanges totalled 1 350, ranging from five in Algeria to 254 in Egypt (Figure 2.12). Although the Saudi stock exchange is the region’s largest in terms of market capitalisation, more companies are listed in both Egypt (254) and Jordan (194) than in Saudi Arabia (188).
Figure 2.11. Market capitalisation as a percentage of GDP
Source: WB World Development Indicators Database (2017); Rocha, Arvai and Farazi (2011).
Figure 2.12. Number of listed companies on MENA exchanges
Note: The countries included are Bahrain, Egypt, Kuwait, Lebanon, Morocco, Jordan, Oman, Palestinian Authority, Qatar, Saudi Arabia, Tunisia and UAE.
Source: WB Global Financial Development Database (2017), IMF and stock exchange websites.
Regional stock exchanges formerly relied on IPOs of state-owned enterprises as a major source of local and foreign investor interest (OECD, 2012). Privatisation has slowed in recent years. However, several MENA economies have started to reconsider privatisation through IPOs due to the deteriorated fiscal situation of their exchanges. In addition to the efforts of Kuwait and Saudi Arabia, described above, the Egyptian government is launching an IPO programme that will offer shares in dozens of state-owned companies over the next three to five years (Reuters, 2018), and Oman is working on privatisation plans.
New privatisation-related listings could contribute to capital market development by increasing the depth and liquidity of MENA markets. The region’s markets are less liquid than the world average, as indicated by turnover ratios in 2017 (28.5 in MENA, 100.4 globally). But the MENA average masks important differences among jurisdictions. Turnover ratios in Bahrain (2.6) and Morocco (6.3) are far lower than the MENA average, and even the region’s highest turnover ratio, in Saudi Arabia (48), is lower than that of peer countries. These figures indicate that financial market efficiency is insufficient in the region.
Market concentration ratios in terms of market capitalisation and trading volume vary within the region4 (WB GFDD, 2017). High ratios imply that liquidity is limited, with access more difficult for new companies. Market capitalisation in MENA is dominated by financial and infrastructure firms (Table 2.2). The limited sectoral diversification may affect market development and limit investment opportunities.
Table 2.2. Market capitalisation by sector in selected MENA exchanges, 2016 (%)
Source: Annual reports of stock exchanges.
Specialised SME markets or tiers have been introduced in the MENA region. Egypt’s Nilex (2007) was the region’s first dedicated SME market, while the Nomu Parallel Market in Saudi Arabia (2017) is the most recent. Tunisia, Dubai and Qatar also have SME tiers.
Two exchanges in the region have introduced the London Stock Exchange Group’s ELITE business development programme for fast growing companies. The Casablanca Stock Exchange launched the programme in April 2016, and 24 Moroccan companies have enrolled, from sectors including technology, construction and household goods. ELITE has since partnered with the Saudi SME Authority to initiate business support and a capital raising programme.
MENA stock exchanges have also started to invest heavily in financial technology. An example is the Dubai Financial Market’s ambitious Smart Borse initiative, launched in 2014. It includes eIPO, a smart IPO platform that allows investors to participate in IPOs electronically; an iVESTOR card that allows secure payment for transactions; and a smartphone application that lets investors track their stock portfolios. These services had 80 000 users at the end of 2017 (Dubai - MENA Herald, 2017).
Several MENA markets are still classified as “frontier markets” by the MSCI, an index provider widely accepted as a benchmark,5 but the situation is evolving. Compared to developed and emerging markets, frontier markets typically have limitations for foreign investors in their regulatory and operational environments.
As of 2018, the MSCI classified Bahrain, Jordan, Kuwait, Lebanon and Oman as frontier markets; only Egypt, Qatar and UAE were included in the MSCI Emerging Market Index. The Saudi Arabian and Palestinian markets had Standalone Indices, enabling foreign investors to follow them more closely.
However, the MSCI has announced that the MSCI Saudi Arabia Index will be included in the Emerging Markets Index as of June 2019, and that Kuwait will be reviewed in 2019 for possible reclassification as an emerging market. The decision on Saudi Arabia followed reforms by the country in areas including the (T+2) execution rule, short selling and delivery versus payment rules. Inclusion on the MSCI Emerging Markets Index is likely to increase institutional investors’ interest.
Ongoing capital market development in the region requires better corporate governance and more transparency, which are key to attracting listing and liquidity (OECD, 2012). MENA stock exchanges have been supporting good corporate governance by adopting and enforcing higher listing and disclosure standards, providing transparency about listed companies, facilitating the exercise of shareholder rights and conducting public awareness activities about corporate governance. However, there is room for improvement in this area (Chapter 3).
2.5. Corporate use of bond markets
The small size of the MENA corporate bond market suggests that corporate bonds have the potential to become a more prominent alternative source of financing for growth companies. Corporate bond issuance also encourages companies to improve disclosure and transparency, which is in line with good corporate governance. The development of this market can be used as a policy tool to address the financial needs of growth companies, given their importance and the constraints they face in accessing financing. Issuing corporate bonds thus helps growth companies to access public equity markets.
2.5.1. Overview of MENA corporate bond markets
Global bond issuances have increased significantly since the 2008 financial crisis in both developed and emerging economies. This is the case in MENA region, where companies have increasingly used domestic bond markets as a source of finance, to the sum of almost USD 66 billion as of 2014 (Table 2.3).
Nevertheless, the region’s corporate bond market remains small. Factors affecting its development include oil prices, the dominance of banks, cultural and religious preferences, and a small investor base. Another possible factor is weak creditors’ rights (Garcia-Kilroy and Silva, 2011).
Conditions have been changing in the region since 2014, mainly due to lower oil prices. In the GCC countries, fiscal deficits have increased and economic conditions have deteriorated, while factors in the non-GCC countries include lower remittances and tourism revenues, and security concerns. Against this backdrop, MENA governments have started to use the bond markets more often, especially international bond markets, which offer better conditions.
Table 2.3 presents the size, growth rate and depth of domestic and international corporate bond markets in the MENA region.
Table 2.3. MENA corporate bond markets, 2014
Note: Size shows total amount outstanding in USD billion and is based on the definition of the BIS, domestic versus international outstanding. A dash (-) indicates that data for the variable is not reported by IOSCO.
Source: Tendulkar (2015), Corporate Bond Markets: An Emerging Markets Perspective.
Corporate bond issuance as a percentage of GDP has generally been increasing in the region since the onset of the financial crisis (Figure 2.13). The exceptions are Saudi Arabia, Kuwait and Lebanon. Although Saudi Arabia has been one of the fastest growing domestic corporate bond markets (60% globally for the 2005-14 period), its corporate bond issuance as a percentage of GDP decreased over 2007-14 compared to 2000-06.
Figure 2.13. Corporate bond issuances as a percentage of GDP (average)
Note: 0 values are displayed for Morocco and Tunisia (2000-06) and Jordan and Tunisia (2007-14).
Source: Adapted from Tendulkar (2015), Corporate Bond Markets: An Emerging Markets Perspective.
The total size of corporate bond markets as a percentage of GDP remains small, however, relative to the size of the MENA economies. Under a classification system for domestic corporate bond markets presented in a recent working report (Tendulkar, 2015), United Arab Emirates was categorised in 2014 as a medium-sized market (USD 30-100 billion), Saudi Arabia as a developing market (USD 10‑30 billion) and Morocco and Tunisia as micro markets (less than USD 1 billion). The region had no established market (greater than USD 100 billion), and Bahrain, Kuwait and Qatar were classified as absent markets. Table 2.4 presents further information from the working report.
Table 2.4. Corporate bond market development in MENA
Note: Growth is delineated as follows, based on the compounded annual growth rate: Equal or greater than 20% (fast), 10-19% (medium), 1-9% (slow), less than 1% stalled/negative). Depth is classified as a percentage of GDP as follows: equal to or greater than 100% (very deep), 50-99% (deep), 20-49% (moderate), 5-19% (shallow), less than 5% (very shallow). The percentage of domestic corporate bond market size versus international corporate bond size is based on the 2014 amount outstanding.
Source: Tendulkar (2015), Corporate Bond Markets: An Emerging Markets Perspective.
The recent study of Arab companies cited above found that bond activity remains low in Arab jurisdictions compared to international levels, even though bond issuances have increased (Ismail, Cortina Lorente and Schmukler, 2017a). It also suggests that Arab non-financial companies6 issued the world’s longest-term corporate bonds (11.5 years) during the period. This may be due to the large share of corporate bond issuances for infrastructure financing by large Arab companies operating in the transportation, electricity and gas sectors.
Perhaps because of the large share of infrastructure bonds, the median issue size in Arab countries (USD 200 million) is much higher than in other regions (USD 44 million in Asia, USD 97 million in G7). This indicates that corporate bonds in the region are being issued by large firms. A separate study confirms this, finding that corporate bond issuers in the region tend to be vastly larger than equity issuers (Cortina Lorente, Ismail and Schmukler, 2017b). Over 2003-11, the median equity issuer had assets of around USD 240 million, while the median bond issuer’s assets were USD 10.4 billion.
Other characteristics of MENA corporate bond markets include the following:
MENA companies generally use international markets rather than domestic markets. Saudi Arabia and Egypt are the region’s only countries with large domestic corporate bond markets comparable to international markets.
Issuer concentration is high, which can make it difficult for growth companies to access the corporate bond market. When the issuances of the top 10 issuers in each market are measured against total issuance in that market, concentration is 100% in Bahrain, Egypt, Kuwait, Lebanon, Morocco and Oman for the 2010-14 period (Tendulkar, 2015). UAE stands out as the region’s only market with a relatively low issuer concentration (59%).
In addition to conventional bonds, MENA companies issue sukuk (Islamic bonds). In 2017, the sukuk issuances of GCC countries raised a total of USD 4.61 billion, representing around 29% of global corporate sukuk volume (IFSB, 2018).
Several MENA jurisdictions are acting to accelerate procedures and reduce the cost of issuing bonds. Saudi Arabia has adopted new corporate bond regulations to shorten procedures; Kuwait, Oman and UAE have updated their sukuk regulations (Zawya, 2016); and Egypt has introduced new regulations under which credit rating is not required in the case of private placements (Gramon, 2016). Some MENA jurisdictions are also moving to modernise bankruptcy regimes (Reuters, 2017).
2.5.2. Growth companies and the corporate bond market
A growth company might choose corporate bonds as a source of finance since their issue does not affect its ownership and control structure. Bonds might also be suitable for some companies due to their fixed term, determined in accordance with expected cash flows by the issuer. Moreover, issuance procedures are generally simpler for corporate bonds than for equity.
Nevertheless, bond issuances by growth companies remain limited in both advanced and emerging markets. Corporate bond markets are more suitable to larger companies due to factors including the fee structures of service providers, such as rating agencies and underwriters; the investment strategies of institutional investors; and the incentives of market makers (OECD, 2015a).
In addition to the small size of the MENA corporate bond market, growth companies face disadvantages such as a limited track record, lower visibility and higher information asymmetries affecting their access to market.
An OECD study based on data from more than 150 000 individual transactions between 1995 and 2014 indicates that nearly 50% of all listed companies that issue corporate bonds for the first time during the period five years prior and after their IPO date do so within three years following their entry in the market (OECD, 2015a). This result shows that joining the stock market, which requires a formal corporate governance structure, may increase opportunities to tap into the corporate bond market. The reverse may also be valid when there is a well-functioning corporate bond market that requires disclosure and transparency.
2.6. Corporate ownership structure
Ownership structure directly affects corporate governance. Concentrated ownership, which is prevalent in the MENA region, raises corporate governance issues including disclosure and transparency, related party transactions and minority shareholder rights.
Ownership categories affect monitoring and shareholder engagement in the corporate decision-making process. Companies with concentrated ownership in the form of sovereign investors or families can face conflicts between the controlling shareholders and minority shareholders.
The region’s relatively small base of institutional investors, the dominance of retail investors on its stock exchanges and restrictions that limit foreign investor interest also present challenges. This section presents an overview of MENA’s corporate ownership structures and owner categories.
2.6.1. Concentrated ownership
The majority of listed MENA companies have concentrated shareholders in the form of sovereign investors or families (OECD, 2017b). State ownership is high in listed companies because of previous privatisations and active investment by sovereign investors.
An analysis of the 600 largest firms listed on the region’s exchanges, which account for 97% of total market capitalisation (GOVERN, 2016), demonstrates that sovereign investors are the largest investor category in all MENA markets except Lebanon and Tunisia. It shows that:
30% of the region’s largest listed companies have a government shareholder
MENA listed companies that have government stakes account for 65% of market capitalisation.
These figures are even higher in large companies and in the GCC markets.
With the exception of the oil business, 80% of MENA companies are family-owned businesses (IFC, 2016). Family companies in MENA are generally reluctant to list their shares on MENA exchanges, SMEs may be the exception. For example, in Saudi Arabia, only 19% of the companies listed on the main market are family-owned companies, compared to more than 90% for those listed on the country’s SME market (WFE, 2018).
2.6.2. Small institutional investor base
Publicly available data is limited on the size of institutional investors in MENA markets, but several international organisations report that the institutional investor base (pension funds, insurance companies and investment funds) is rather small in the region.
Across the GCC countries, which have the MENA’s largest capital markets, the assets of mutual funds amounted to USD 25 billion and public pension funds to USD 411 billion in 2016 (Ernst & Young, 2018a). The total assets of GCC sovereign wealth funds were dramatically greater, at USD 2.9 trillion.
Indeed, of the world’s 15 largest sovereign wealth funds, seven are from the MENA region (SWFI, 2018). The total wealth of high-net-worth individuals in the Middle East stands at USD 2.42 trillion (World Wealth Report, 2017).
These figures contrast with global trends. In the OECD member states, institutional investors are the dominant type of investor, and the assets of institutional investors are increasing rapidly. In 2016, for instance, the assets of pension funds grew faster than GDP in 25 of the 35 OECD countries.
2.6.3. Dominance of retail investors
MENA stock exchanges are dominated by retail investors, with an estimated 39% of shares belonging to retail investors across the region, and retail dominance in trading is even higher (GOVERN, 2016). This is confirmed by a recent analysis by the World Federation of Exchanges on the impact of retail participation on equity markets (WFE, 2017a).
For the four MENA exchanges included in the WFE study, the average value of retail trades in 2016 amounted to 64% of the value of total trades on the Egyptian Exchange, 71% on the Dubai Financial Markets, 83% on the Amman Stock Exchange and 92% on the Muscat Securities Market.
Retail investors contribute a reasonable proportion of total trades in other MENA markets. The exception is the Casablanca Stock Exchange, which has a developed institutional investor base and where the average value of retail trades in 2016 was just 10% of the value of total trades. The figure for 2016 was 30% on the Bahrain Stock Exchange, 40% on the Kuwait Stock Exchange, 51% on the Qatar Stock Exchange and 83% on Saudi Arabia’s Tadawul. As for the Moroccan financial centre, institutional investors accounted for 90% of the total value traded in 2016.
2.6.4. Limited foreign investor interest
Foreign investor interest has remained relatively limited in MENA economies because of restrictions on foreign ownership and other regional factors such as the relatively small size of markets, low liquidity and existing ownership structures. A report prepared under the MENA-OECD Investment Programme (2011) identified foreign ownership limitations as one of the main obstacles to foreign investment in the GCC.
Limits on foreign investment may be motivated by reasons such as the protection of national interests or strategic sectors. In order to attract foreign interest, some MENA jurisdictions have recently started to revise those constraints in line with national diversification and economic liberalisation policies.
Regulatory amendments were adopted in Bahrain in 2016 and in UAE in 2018 to allow for 100% foreign ownership in companies. Qatar raised foreign ownership limits from 25% to 49% in 2014, and Saudi Arabia has adopted new rules to open up direct access to its capital market to foreign investors.
2.7. The way forward
2.7.1. Key findings
The findings of this chapter indicate that MENA economies could benefit from deepening their capital markets. Capital market development would increase opportunities for growth companies to access finance and contribute to the region’s overall economic development. Better corporate governance is crucial in this regard.
Despite differences among MENA jurisdictions, there are common challenges across the region. Key findings include the following:
Stock market size measured by market capitalisation relative to GDP is relatively low in MENA compared to peer countries. Equity markets have the potential to offer more capital for the real sector in the region.
The total value of growth company IPOs and the low sectoral diversification in equity markets suggest that a limited number of companies have access to capital markets.
Large companies have increasingly used domestic bond markets as a source of finance in MENA. Nevertheless, the region’s corporate bond market remains small. Bond issuances by growth companies remain limited in both advanced and emerging markets.
Bank lending in the region is channelled to large companies, particularly state-owned enterprises and large industrial firms, leaving SMEs and growth companies deprived of bank credit.
Concentrated ownership in the form of sovereign shareholders or families is common. The reluctance of family-owned companies to disclose information or dilute their stakes by going public affects capital market development in the region.
A large and diversified investor base is crucial for capital market development since it ensures liquidity and stable demand. Institutional investors can have a positive impact on corporate governance by monitoring company practices and engaging with company management. Yet the region’s institutional investor base is small and its markets are dominated by retail investors, which may not be conducive to the long-term growth of companies.
Restrictions on foreign ownership are a key obstacle to greater foreign interest in investing in the region. Other obstacles include MENA’s small market size and ownership structures.
Efforts by policy makers to address these challenges would need to address three main target areas in which there are indications of market imperfections, or where MENA capital markets may be underperforming their potential.
First, distortions in the allocation of bank credits must be avoided. This relates particularly to an apparent preference given to SOE borrowers as well as certain large well-connected incumbent companies.
Second, family owned companies and other SMEs should be better incentivised to raise equity finance. This includes taking measures to establish or improve the attractiveness of SME equity market segments. Some countries may also want to review elements of their national legislation, including concerning the tax treatment of debt and equity. The apparent reluctance of family firms to disclose information could be addressed both via less onerous reporting requirements on small listed companies, and by requiring larger unlisted family companies to raise their disclosure requirements.
Third, an overriding priority is measures to increase the overall attractiveness of being listed in equity markets in the MENA region. Some options for further action to raise market liquidity, transparency, investor protection and market infrastructure are reviewed in the following section.
2.7.2. Policy options
A group of interrelated policy options is proposed to address the challenges facing MENA economies in terms of capital market development and access to finance (Figure 2.14).
Figure 2.14. Main policy areas for better access to capital markets
These key policy options are summarised in Table 2.5 and developed below. Not all recommendations apply to every country; the policy options must be tailored to each MENA economy’s specific circumstances and needs.
However, the recommendations as a whole are intended to ensure the deepening of capital markets and to enable growth companies to obtain finance from them. If possible, therefore, they should be implemented in a holistic manner under a comprehensive reform programme suited to each economy’s needs.
Table 2.5. Policy options for improving access to capital markets
2.7.3. Developing strategies for capital market growth
Stable macro-economic conditions, strong institutional settings and legal structure, and a well-functioning financial infrastructure are preconditions for local capital market development. Similarly, sound corporate governance and the availability of long-term savings are crucial for active market-based finance. Bond market development is more challenging than equity market development since the necessary infrastructure is more complex and extends to areas such as creditor rights and insolvency regimes.7 The government should have a strong role in tackling these challenges.
MENA governments are aware of these challenges and have implemented reform programmes to deepen their capital markets. However, even after determining the measures needed to deepen the markets, putting them practice can prove difficult.
Because the policy options are generally interrelated, co‑operation is needed among several institutions: regulatory and supervisory authorities of financial sectors; stock exchanges; tax authorities; and other government institutions supporting entrepreneurship. A coherent national action plan should be prepared through consultation with all related parties.
Policy makers should consult targeted market participants at an early stage while programmes are being designed. Public awareness programmes could then be organised to reach a larger target audience. Regular monitoring and review could result in a best-practice model that would benefit the entire MENA region.
Box 2.1. Saudi Arabia’s Financial Sector Development Programme
Saudi Arabia has recently accelerated efforts to facilitate investment and strengthen the role of capital markets as a funding channel. In April 2017, the country’s Council of Economic and Development Affairs (CEDA) launched a Financial Sector Development Programme in line with Saudi Vision 2030, a comprehensive plan to diversify the economy.
The programme seeks to create a thriving financial sector in order to support economic development by stimulating savings, finance and investment. It is underpinned by three main pillars:
enabling financial institutions to support private sector growth
developing an advanced capital market
promoting and enabling financial planning.
The programme, which was designed to comply with international standards of financial stability, aims to increase the country’s financial assets to GDP ratio, the share of capital market assets and the share of SME financing at banks. It also envisions a digital transformation as the country moves towards a cashless society.
The programme defines the responsibilities of all related institutions, including the Capital Markets Authority; the Ministry of Finance, Ministry of Commerce and Investment, and Ministry of Economy and Planning; the Public Investment Fund; and the Monetary Agency. Efforts are co-ordinated among relevant stakeholders and progress is monitored.
Source: www.vision2030.gov.sa/en/FSDP
Saudi Arabia, Jordan and Qatar have already introduced national programmes aimed at developing capital markets. Saudi Arabia’s Financial Sector Development Programme offers a good-practice example that may be of interest to other jurisdictions in the region (Box 2.1).
Initiatives taken by countries outside the region could also prove interesting to MENA policy makers as they seek to deepen capital markets. For example, the European Union’s capital market union aims to increase the access of smaller growth companies to capital markets. Measures range from introducing simpler disclosure rules for small companies to creating pan-European institutional investors specialising in long-term investment, particularly in SMEs.
The EU has also introduced corporate governance initiatives that aim to strengthening shareholders’ rights and that encourage long-term shareholder engagement in listed companies. The EU Shareholder Rights Directive was amended in 2017 for this purpose.
Monitoring these developments and understanding alternative policy options can help MENA policy makers to build their own models. Existing international organisations, such as the Union of Arab Securities Authorities (UASA) and Union of Arab Stock Exchanges, can play an active role in information and experience sharing.
However, MENA policy makers also need to consider their domestic and regional circumstances in order to develop suitable policy options. For example, state-owned stock exchanges in MENA jurisdictions generally face different challenges than demutualised stock exchanges in setting standards; monitoring; and enforcing listing and corporate governance rules. Assigning such stock exchanges central roles for the regulation and monitoring of members could support overall market development efforts and ease the burden on securities regulators.
Similarly, sovereign investors, as the biggest investor category in the MENA region, could assume a strong role in supporting capital market investment in growth companies or influencing a company’s corporate governance practices. Finally, Islamic capital markets can play a vital role in growth company financing. The importance of Islamic finance has been recognised by MENA authorities, and several countries have accelerated their efforts to develop this market. For example, United Arab Emirates has taken initiatives aimed at promoting Dubai as the capital of the global Islamic economy.
Policy makers must also lay the groundwork for an effective corporate governance framework. This framework determines which corporations are allowed to access public markets and the terms upon which savers are able to invest in a corporation (Çelik and Isaksson, 2017).
Investors need assurance that their rights are protected when they convert their savings into investments. Capital market investors also need detailed, up-to-date information in order to evaluate investment opportunities in the market and to monitor the use of their investments. Companies may also be unwilling to use capital markets without clear responsibilities defined by the rule of law (OECD, 2015a).
Policy makers must be committed to establishing a regulatory environment that is flexible and attractive enough to enable any company, including growth companies, to tap into capital markets, while at the same time enhancing investor confidence.
Their programmes should also address identified weaknesses in corporate governance practices and regulation in MENA jurisdictions. These weaknesses, which are discussed in detail in Chapter 3, involve disclosure and transparency, board independence and oversight.
2.7.4. Enhancing the capacity of key institutions
Securities regulation is relatively recent in the region, but regulators have been able to achieve considerable improvements in a short period (Amico, 2014). Recent amendments to capital market legislation and corporate governance rules indicate that regulation and practice are being reformed to meet changing needs. However, the monitoring and enforcement capacity of securities regulators will need to be strengthened as capital markets expand. Markets are becoming more complex due to technological and market innovations as well as increasing cross-border trade, and detecting possible market misconduct is becoming more challenging for every supervisory authority in the world.
MENA regulators have intensified efforts to strengthen supervision, investor protection and effective enforcement. In complex cases, including insider trading, supervisory authorities have published their regulatory enforcement actions (UAE, Saudi Arabia, Oman, Iraq).
In 2016, the United Arab Emirates established a new regulator, the Dubai Centre for Economic Security, to combat financial crimes such as market abuse. The centre has wide powers to supervise, investigate, take precautionary measures and exchange information. The UAE also enacted protection for whistle blowers in 2016. These developments can serve as a model for other markets in the region.
Capacity building programmes are also being conducted in the region for the staff of regulatory authorities. One such programme was launched by the UASA in the second half of 2017.
In order to increase investor confidence, the competent authorities must have adequate powers, resources and institutional capacity to supervise the market and enforce capital market rules effectively. It is essential that the authorities be operationally and financially independent, and also accountable.
International co‑operation can help strengthen the institutional capacity of securities regulators. Twelve MENA jurisdictions (Algeria, Bahrain, Egypt, Jordan, Kuwait, Morocco, Oman, Palestine, Qatar, Saudi Arabia, Tunisia and UAE) are currently members of the International Organisation of Securities Commissions (IOSCO), while only two (Egypt and UAE) are members of the International Forum of International Audit Regulators (IFIAR). Active involvement and participation in these organisations, which work on setting standards in capital markets, would improve regulation quality and facilitate experience sharing and co‑operation among countries.
2.7.5. Improving capital market financing alternatives
Meeting the funding needs of issuers is fundamental for efficient capital market development in the MENA region. Equity financing is particularly suitable for growth companies. Alternative investment products and methods, such as securitisation, cover bonds, sukuk and fund collection via private placement and crowd funding, are also being used for financing younger growth companies in most markets.
Policy makers could promote market-based finance by acknowledging the value of these alternatives. Regulation and clear schemes for implementation must first be in place, and programmes, rules and regulations should be in line with the realities of the business landscape and be understood by target companies.
MENA companies may prefer to issue Islamic capital market instruments rather than conventional instruments in order to attract a wider investor base. To realise the full potential of Islamic capital markets, however, several challenges must be addressed. These include the complexity of Islamic instruments, the high cost of Islamic contracts, lack of standardisation, lack of diversification, low liquidity and low availability of qualified human resources (Mohieldin, 2012). Issuing sukuk, for instance, is reported to be more complex and costly than issuing conventional bonds (IFSB, 2018).
A limited time frame for the approval process would make issuance procedures more transparent. The use of this good practice has begun in the region. For example, Egypt’s financial regulatory authority adopted a regulation in 2017 introducing a 15-day time frame for the review of an IPO application.
MENA authorities could also consider evaluating the efficiency of their public offering regime for facilitating companies’ access to capital markets. In particular, the efficiency of prospectus rules should be reviewed, since time-consuming and costly procedures can influence potential issuers. Prospectuses should provide adequate disclosure about the issuer and the offer to allow an informed investment decision. Good practices adopted at the international level, such as the IOSCO disclosure standards for cross-border offers or the EU Prospectus Directive, can serve as a guide.
Common methods for lowering costs and administrative burdens in public offerings include: prospectus exemptions based on offer size or targeted investors (such as qualified investors); a proportionate disclosure regime for companies with reduced market capitalisation; use of incorporation by reference; shelf registration systems; and simplified rules for secondary issuance regimes or frequent issuers. MENA policy makers who have not yet implemented such measures should seek to strike the right balance between investor protection and alleviating administrative burdens on issuers and offers.
A hybrid issuance procedure and private placement regime for equities and bonds is another option for easing access to capital markets for smaller growth companies. In a hybrid offer regime, some issuance and disclosure requirements are reduced for private placements to institutional investors. This regime is widely used globally, especially in corporate bond markets.
A recent report noted that procedures for public offers and public placement of corporate bonds are similar in Egypt, Jordan, Morocco and Tunisia, where the evaluation of a bond issuance application takes three to four months (EBRD and AMF, 2015). Under changing market conditions, long evaluation periods and complex issuance procedures could discourage potential issuers.
A private placement regime is especially important for growth companies. Private placement helps unlisted growth companies to tap into capital markets for the first time. It generates a closer relationship between security holders and the company, and this relationship creates opportunities for growth companies to reach capital market investors (OECD, 2015a).
In other words, a privately placed issue can enable an unlisted company to gain experience in capital markets while operating with lighter regulatory requirements. The company can in turn assess its options for attaining further funding from the capital markets, and complete any capacity improvements needed for that purpose.
Access to any form of capital market finance requires reliable, consistent and timely disclosure of company information, as well as formalisation of rights and obligations with respect to how a company is managed. In this sense, an offer through private placement also encourages companies to adopt a better corporate governance structure.
2.7.6. Establishing specialised markets for growth companies
Public equity and bond markets designed in accordance with the needs of growth companies should be developed in the MENA region. Special equity markets for young and growing companies have been established in many of the world’s economies, yet only three such dedicated parallel markets currently exist in MENA, in Egypt, Morocco and Saudi Arabia (Box 2.2).
Dedicated alternative markets provide access to capital markets for smaller growth companies with lighter regulatory requirements. After the establishment of the Nomu-Parallel Market in Saudi Arabia, which was promoted by Tadawul as a market open to companies of all sizes, the total amount of capital raised in the market was 169 USD million, representing 37% of total MENA growth company IPO proceeds in 2017.
Box 2.2. SME markets around the world
Many of the world’s stock exchanges have established SME markets to encourage smaller companies to access capital markets. As of the end of 2017, 33 stock exchanges had dedicated SME markets. The number of listed companies on those markets has expanded from fewer than 5 000 in 2002 to 6 807 at the end of 2017, with the size of the SME markets varying from two to nearly 2 000 listed companies.
Three MENA stock exchanges have established SME markets. As of the end of 2017, listed SMEs numbered 32 in Egypt and 27 in Morocco. Saudi Arabia established its Nomu-Parallel Market in February 2017, and by April 2018 counted 9 listed companies.
Research by the World Federation of Exchanges on SME exchanges (WFE, 2017b) delivered the following findings:
While obtaining access to finance is important element in listing decisions, other factors, such as positioning the firm for growth and diversifying the investor base, also play a role.
Companies perceive the process of initial and ongoing listing requirements to be burdensome, costly and time consuming.
SMEs may not have adequate information on various aspects of listing, such as initial and ongoing listing requirements, ongoing listing costs and the benefits of listing.
Investors would value the opportunity to have access to more information on SMEs.
All surveyed parties attach importance to the market liquidity of company shares.
These results indicate factors that need to be addressed for the development of a successful SME market.
Source: WFE (2018b), SME Markets: Key data points; WFE (2017b), SME Financing and Equity Markets.
In addition to equity markets, special bond markets for unlisted SMEs can be designed. Different markets across Europe target corporate bonds issued by smaller companies (mini bonds). They include the London Stock Exchange's Order Book for Retail Bonds, the Stuttgart Bond Market, B and C segments at Euronext, Alternext in France, Mercato Alternativo de Rent Fija in Spain and ExtraMOT PRO in Italy.
These examples can provide useful insights for MENA policy makers. It should be noted, however, that developing a parallel market is complex and that not all special markets are successful. Information asymmetry, high listing and maintenance costs, compliance costs, lack of awareness, low levels of liquidity and high monitoring costs are commonly mentioned as brakes on the success of these markets.
Focusing on growth companies could be useful in establishing a specialised market. Several studies note that public equity financing is appropriate for high growth, innovative companies (OECD, 2015b; Harwood and Konidaris, 2015).
Methods used by policy makers around the world to address these challenges include: applying more flexible listing conditions, relaxing disclosure requirements, lowering admission costs and requiring a key adviser and/or liquidity provider. However, there are no magic bullets for ensuring a positive outcome. Each jurisdiction should consider how to design measures guaranteeing investor protection without creating barriers restraining market conditions.
Certain methods, even if not in widespread global use, could correspond to the market characteristics of a particular economy. For example, instead of implementing lower disclosure standards for younger growth companies, policy makers could consider creating a special segment in stock exchanges for companies that implement higher corporate governance standards.
Several stock exchanges, such as the London Premium Market or Brazil’s Nova Mercado, have taken this approach. Adopting higher corporate governance standards may strengthen investor demand for growth company shares, which are normally perceived as high risk. It may also encourage other companies to improve their corporate governance practices.
2.7.7. Addressing issuer side factors
Understanding the factors that can influence potential issuers is crucial for addressing the reluctance of MENA companies to access public capital markets, and the consequent small size of these markets in the region.
For this purpose, rules and regulations that may constrain companies’ issuance and listing decisions should be analysed in detail. Such studies, especially in relation to the family-owned company structure that is common in MENA, would provide considerable input.
MENA policy makers can already benefit from studies conducted by other regulators or international organisations. For example, WFE research that included family-owned companies from two economies in the region found that the main reason family companies are not being listed is concern about loss of control. It would probably be safe to assume that this concern is valid for the entire region.
The one-share-one-vote system adopted in a number of MENA economies may also exacerbate company concerns about loss of control. It is argued that investors may accept alternatives to the one-share-one-vote option if the investment is deemed otherwise attractive.
Where appropriate, MENA economies that apply the one-share-one-vote principle might want to assess the pros and cons of introducing dual share mechanisms, in which one class of shares is offered to the general public and another to company founders, executives and family. In this case, the protection of minority shareholders requires adequate safeguards such as disclosure, board member loyalty to the company and shareholders, and qualified majorities for certain shareholder decisions.
This approach is reflected in the G20/OECD Principles of Corporate Governance, which recommend flexibility and proportionality to make the framework flexible enough to meet the needs of companies operating in different circumstances. Factors that may call for flexibility include the size of listed companies as well as their ownership and control structure, geographical presence, sectors of activity and stage of development.
Lack of awareness among companies and investors about the role and potential benefits of capital market finance may also be a factor in the small size of MENA’s capital markets. Greater involvement in relevant studies by non-governmental organisations, such as professional unions, associations and universities, could be beneficial.
However, awareness-raising programmes do not suffice to address issuers’ concerns. Companies also need to be prepared for the longer-term commitments arising from capital market financing, and notably the reporting obligations. Consulting services to support the cultural and organisational development of all related institutions could help increase growth companies’ access to capital markets. The ELITE business development programme in Morocco and Saudi Arabia, mentioned above, is a good example.
Another example is the Irish Stock Exchange’s IPO-ready programme, which was launched in 2014 to provide high-growth IPO candidate companies with extensive support. It prepares them to raise strategic finance, become listed on the stock exchange and attract investment from domestic and international shareholders. The programme, supported by Enterprise Ireland and the Ireland Sovereign Development Fund, could be of interest in a region with the largest sovereign funds in the world.
The high advisory and legal costs associated with accessing capital markets may also discourage listings by growth companies. Although there is no comprehensive study to identify the cost structure of IPOs in the region, the overall IPO cost as a percentage of the offered amount is estimated at 5-10% in Dubai and 10% in Morocco (IOSCO, 2015).
Given those relatively high expenses, MENA policy makers could consider measures that have been taken elsewhere, such as lower listing fees, subsidies to help cover the cost of IPOs, government credits and tax breaks. Reinforcing competitive conditions in the IPO services markets could also lead to better outcomes.
2.7.8. Developing the investor base
The development of a robust investor base is essential in the region. To spur investor interest, policy makers should aim to promote a capital market culture. This requires raising overall financial literacy, building trust by ensuring strong minority rights and good corporate governance practices, and requiring more transparency and disclosure. Efficient insolvency regimes and effective enforcement of creditor rights are important for investor interest in corporate bonds.
A vibrant secondary market also makes equity investment more attractive. However, the limited number of listed companies and low liquidity in MENA may discourage investor participation.
Around the world, it is common to require a minimum free float of 25% to support liquidity in equity markets. The main MENA markets have different free float requirements: 30% in Saudi Arabia, 25-30% in UAE, 10% in Bahrain, 5% in Egypt. In order to address liquidity problems, MENA policy makers should evaluate the efficiency of free float requirements in their market. Depending on the results, they could consider increasing free float requirements. Other widely used measures, such as establishing a market maker system or a call market, could be considered to address liquidity concerns. Issuances in sufficient size and frequency are essential for secondary bond market liquidity.
Planned privatisations around the region could also provide liquidity and improve market attractiveness. However, policy makers need to clarify prior to privatisation the main goals that are to be achieved in financial and non-financial terms. Of key importance is whether an IPO should target a small class of professional investors or the general public. The World Bank has argued that deep discount distributions in the past have resulted in massive oversubscriptions, retarding the development of the markets’ price discovery function (Rocha, Arvai and Farazi, 2011). Conversely, some European countries have successfully developed domestic "mass shareholder cultures” by offering SOE shares to the public at somewhat discounted prices. In any case, in order to attract investors, state-owned enterprises need to adopt an adequate corporate governance structure prior to privatisation.
As liquidity largely depends on the existence of a robust investor base with different investment preferences, the development of institutional investors should be an essential part of MENA policies for capital market development. Governments should take action to create a regulatory environment conducive to the growth of private pension funds, insurance companies and investment funds, which can provide long-term finance.
The presence of institutional investors as a strong shareholder group could also promote better corporate governance practices (OECD, 2017b). In the presence of a strong shareholder group, institutional investors would have the capacity to represent shareholder interests and influence corporate management, either directly or through monitoring and possible exit.
MENA markets have great potential for further development of institutional investors. The Islamic funds industry in particular deserves more attention in the region. Although Saudi Arabia accounts for 38% of total assets under management in the global Islamic funds industry, the Islamic funds market is relatively small in other MENA economies (IFSB, 2018). As prospects for the global Islamic funds industry are positive, with global Islamic funds under management expected to reach USD 77 billion by 2019 (Thomson Reuters, 2015), MENA economies must try to develop their Islamic fund markets. Because global Islamic funds invest largely in equity – 42% in 2017 (IFSB, 2018) – development of this market may also create a stable investor base for growth companies.
Longstanding regional conflicts and economic slowdown have limited the development of institutional investors in the MENA region. Economies also face challenges in demanding good corporate governance practices due to the region’s small market size and concentrated ownership structure. The presence of a dominant shareholder weakens the capacity of institutional investors to influence corporate governance. In some cases, institutional investors do not have proportional voting rights and as a result may not vote at shareholder meetings and will not disclose their voting policies (GOVERN, 2016).
MENA economies could follow the example of other countries with a prevalence of controlling shareholder structures, such as Chile and Indonesia, to encourage institutional investors to take a more active role in corporate governance. This may include requirements on the disclosure of voting rights and management of conflicts of interest. The G20/OECD Principles of Corporate Governance note that requirements to engage, for example through voting, may be ineffective and lead to a box-ticking approach when shareholder engagement is not part of the institutional investor’s business model. Therefore, a first step could be to encourage institutional investors to establish and disclose their voting policy.
Different models are required or recommended for the exercise of voting rights by institutional investors. This is especially the case when an institutional investor holds more than a specified share of a company’s equity or for voting on certain important issues, such as the election of board members and the compensation committee, and compensation for the board of directors and executive management (OECD, 2017b). It may be worth exploring the benefits of voluntary stewardship codes that institutional investors can follow, especially where they are dominant investors in the equity market, as in Morocco.
MENA policy makers could also consider reviewing portfolio limitations of institutional investors to assess whether relaxing limits on capital market investments could encourage more active institutional investor representation in corporate management. New regulations could possibly be adopted to allow institutional investors to invest in certain types of companies, such as younger high-growth companies.
Finally, sovereign wealth funds, the largest institutional investor category in the MENA region, have the potential to contribute to the improvement of capital markets and corporate governance practices. Capital market investments by sovereign wealth funds could therefore be encouraged. Investments by sovereign wealth funds in growth companies could be increased through programmes that are devised with the stock exchange and other relevant authorities, such as Ireland’s IPO-ready.
Sovereign wealth funds around the world use different methods to influence the corporate governance practices of investee companies. Norges Bank Investment Management, for example, formulates expectations in terms of good governance and board accountability, and publishes guidelines on voting policy. Companies are monitored, and those found to be unfit – on issues including environmental damage, sustainability and violations of human rights – are excluded from its investment portfolio. MENA sovereign wealth funds that adopt such methods could favour the development of good governance.
Sovereign investors could also make a significant contribution on their own initiative by implementing good governance practices. They have the potential to reduce possible political pressure and improve accountability by increasing board effectiveness, publishing governance and voting policies, monitoring investee companies and adopting strong internal control and risk management processes. This is important for sustainable value creation and sound capital market development.
While local institutional investors are evolving in the region, foreign investors could contribute to competition, shareholder engagement and the transfer of know-how as well as liquidity and price discovery in the market. As noted above, several MENA economies have already started to relax foreign ownership limits, and with greater liberalisation the level of foreign investors will probably increase. Efforts to liberalise foreign investment in capital markets should be continued.
2.7.9. Enhancing a sound financial ecosystem
A sound financial ecosystem is vital for the functioning and deepening of capital markets. A strong ecosystem includes independent professionals such as analysts, brokers, rating agencies and market makers that support companies during and after a public offer.
A weak ecosystem may impede market development, reduce the willingness of companies to tap into the market and deter investors from investing. It is therefore important for policy makers to establish the right regulatory infrastructure, including incentives and requirements, to enable all service providers to work effectively. Requiring or encouraging the disclosure of potential conflicts of interest faced by service providers falls within the framework of sound corporate governance practices and underpins capital market integrity. Disclosure of how conflicts of interests are managed is also beneficial.
Nonetheless, the capital market ecosystem is under pressure in many countries around the world, with particularly onerous effects for smaller growth companies. For example, there are less “support services”, such as analyst coverage and proxy advice, for smaller companies. As a result capital markets are used mostly by large companies.
This seems to be relevant for MENA markets. According to a study conducted in 2015 for the largest GCC markets (Kuwait, Qatar, Saudi Arabia, UAE), analyst coverage as a percentage of all stocks traded in securities exchanges ranges from 8.1% in Kuwait to 49.7% in Saudi Arabia (Marmore, 2015). This suggests low levels within the region. A closer look reveals that analyst coverage for large-cap companies is considerably higher, ranging from 64% to 100%, and that the ratio drops significantly for small-cap companies, ranging from 3% to 28%. Furthermore, in Egypt, 73% of all listed companies have no analyst coverage and only 20 companies are followed by five or more analysts (GOVERN, 2016). The greater availability of research and public information for large-cap companies may play into differences in analyst coverage.
Initiatives taken by other countries to increase analyst coverage could be instructive for MENA. For example, Euronext has adopted a fee scheme that introduces lower trading costs for brokers who meet certain criteria with respect to trading volumes and equity research coverage. EnterNext, a Euronext subsidiary that supports SMEs, set up a partnership with the Morningstar investment research company to provide analysis on the 330 small and midcap tech companies listed on Euronext markets.
In further examples, an independent research company produces one or two reports per year for companies listed on the SME platform of India’s BSE market, with the cost of the research covered by the country’s Investor Protection Fund. And an initiative by Spain’s Alternative Stock Market and the Spanish Institute of Financial Analysts aims to increase the market visibility of listed companies (Arce, López and Sanjuán, 2011).
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Notes
← 1. The bank deposits to GDP ratio is especially high in Lebanon (247%). Excluding Lebanon, the ratio is 66.41 %.
← 2. General IPO activity in MENA is provided for the 2008-17 period. Detailed IPO analysis for the region covering the years 2014-2017 is based on the annual reports of stock exchanges and Ernst & Young’s MENA IPO reports. IPO data excludes real estate investment trusts, investment funds and unit/trust offerings.
← 3. The paper focuses on 12 Arab countries, namely Algeria, Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Oman, Qatar, Saudi Arabia, Tunisia and UAE.
← 4. Value traded excluding top 10 traded companies to total value traded is between 25-59 %, market capitalisation excluding top 10 companies to total market capitalisation is between 21-71%.
← 5. Rating agencies and index providers classifying markets include MSCI, S&P, Dow Jones, FTSE and Russell. Rating agencies and index providers classify markets as developed, emerging and frontier markets based on different parameters (such as size, liquidity, market accessibility). Less advanced capital markets from emerging markets are classified as frontier markets.
← 6. The study includes dataset of companies from Algeria, Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Oman, Qatar, Saudi Arabia, Tunisia, and the United Arab Emirates.
← 7. This difference may be in part due to the importance placed on infrastructure and the institutional and legal structure in bond market development owing to the limited return on bonds compared to equity, which presents the possibility of unlimited return (Laeven, 2014).