When the ripple effects of the global financial crisis caused Kuwait’s stock market to implode in 2008, frustrated local investors didn’t wait for the government to intervene. They got a court order in November that year to temporarily close the bourse, which had lost more than 40% over a hair-raising six months since troubles began in early summer.

Kuwait has come a long way since the unprecedented court order. But 2008’s global financial-markets haemorrhage has prompted the country and its neighbors — Saudi Arabia, Qatar, Oman, Bahrain and the United Arab Emirates — to take steps to regain investor confidence. But there is still a lot of work to do, which was made clear in June, when MSCI, the stock market-index compiler, said it would not elevate the status of Qatar and the UAE so they can join its emerging markets index, a step that is vital for attracting large, foreign institutional investors.

"Unfortunately, due to the global crisis, regulators and decision makers [in the Gulf] have been busy with many other problems so they have disregarded a couple of conditions that were imposed to ‘graduate’ them to emerging-markets [status]," says Rami Sidani, head of investments for the Middle East and North Africa at asset manager Schroders. "You don’t want to open up when the world is burning around you, and you prefer to be insulated in times of crisis." According to Sidani, induction into the emerging markets group could channel as much as US$70 billion into the Gulf stock markets.

MSCI’s snub, however, shouldn’t be a show-stopper, if the speed at which Dubai’s financial markets have evolved over the past decade is anything to go by. "In 2000, the Dubai market was over the counter. And public companies would come out with their earnings once a year," recalls Haissam Arabi, CEO of Gulfmena Alternative Investments, a Dubai-based asset and hedge fund manager. "You would have to go to the general assembly to get answers to your questions because companies wouldn’t even meet with you." Now, most listed companies have dedicated investor-relations teams and publish financial reports throughout the year. Several listed companies issue earnings guidance and are covered by heavyweight investment banking analysts.

The Wake-up Call

For a number of years, however, few companies in the region felt an urgent need to make such changes. The oil price rally that kicked off in 2002 helped Gulf stock markets bloom. But when the asset bubble burst in 2008 amid plummeting oil prices, a tanking property sector and a banking sector crippled by the credit squeeze, the wake-up call couldn’t have been louder.

In the relatively short time that they’ve been operating, the region’s bourses are distinctly different than their counterparts elsewhere. Most Gulf states lack pension systems, and mutual funds are minuscule. As for their sovereign wealth funds, among the richest in the world, they tend to park their petrodollars in international equities with foreign asset managers rather than invest them at home.

What a visitor to a local stock exchange will find are white-robed Gulf nationals gliding across the region’s stock market floors, seeking tips from friends and colleagues on hot stocks and chatting away the hours with eyes glued to trading screens. Short-term retail investors represent more than 80% of the investor base. They are also responsible for holding back the development of the region’s bourses, according to some capital markets experts.

Foreign investors, meanwhile, are few and far between. "Although we have opened to international investors, it has not been of the variety that is a long-term investor. We’ve attracted relatively short-term investors and hot money, so that’s why we need to look more closely at providing access to long-term investors," says Nasser Saidi, chief economist of the Dubai International Financial Centre Authority and executive director of the Hawkamah Institute for Corporate Governance.

Being included in MSCI’s emerging market index would help on that front. But in June, it cited foreign ownership restrictions as one of the main reasons impeding the inclusion of Qatar and the UAE in its emerging markets index. (The other main reason is the region’s dual account structure, which requires institutional investors to set up separate trading and custody accounts.)

The Gulf bourse that is the most amenable to international investors is NASDAQ Dubai, the region’s first exchange open to investors and issuers of any nationality. But since its launch in 2005, it has struggled as a newcomer from the West to attract any investors, foreign or otherwise, says Jeff Singer, NASDAQ Dubai’s CEO. That’s now expected to change. In December last year, Dubai Financial Market (DFM), the city-state’s older, much larger bourse, said it would acquire NASDAQ Dubai. Along with greater liquidity, lower brokers’ fees and other benefits, the acquisition also marks a shift in attitude about the importance of retail investors in the Gulf. "Dubai Financial Market thought taking over NASDAQ Dubai would probably be the only way for NASDAQ Dubai to continue as a trading floor on its own because of [the latter’s] lack of retail investors,’ says Mohammed Yasin, the chief executive officer of SHUAA Securities, the brokerage division of Dubai-based investment bank, SHUAA Capital.

Retail investors execute 70% of all transactions on DFM, compared with 20% on NASDAQ Dubai, Essa Kazim, DFM’s executive chairman, told Bloomberg when the acquisition plans were announced in December.

All this is good news for NASDAQ Dubai, which will continue to operate separately from DFM while sharing platforms and back-office technology and promoting itself to investors outside Dubai. For example, "Saudi companies, some of the big names, will be interested to list on NASDAQ Dubai, especially if they see liquidity has increased and they have a new customer community," says Mohammed Yasin, CEO of SHUAA Securities, the brokerage division of Dubai-based investment bank, SHUAA Capital.

The value of equities traded on NASDAQ Dubai has been increasing this year, and rose 9% year on year — to US$51.3 million from US$47 million — in the first four weeks following its operations outsourcing to DFM in July. The proportion accounted for by individual investors also increased. But the volume in the four-week period, beginning on July 11, fell 18% to 107 million shares, from 131 million the year before. Measured by percentage change, the figures for both total value and total volume were the best performing of any UAE stock exchange over that period, according to the company.

The union between Dubai’s two bourses is also expected to lead to a merger with the Abu Dhabi Securities Exchange, the UAE’s third exchange. A tie-up of all three bourses could bolster the country’s chances of graduating to MSCI’s emerging market status and make the UAE home to the second-biggest stock exchange by market capitalization in the Gulf region, after Saudi Arabia, which accounts for more than 45% of the region’s total market capitalization. Total market capitalization of all Gulf stock exchanges exceeds US$700 billion.

Analysts and traders have long contended that it doesn’t make sense to have three equity markets in a country with a population of about five million, especially at the current low trading volumes and today’s weak investor confidence.

While the UAE markets are heading toward consolidation, the small archipelago state of Bahrain is getting ready for its second exchange. The Bahrain Financial Exchange, owned by Indian exchange operator Financial Technologies, plans to start operating later this year, offering a gamut of multi-asset products, including Sharia-compliant products.

All the stock exchange re-strategizing is a key part in the growing rivalry among Gulf countries to become regional financial hubs. But getting all the pieces in place hasn’t been easy. Consider Qatar. The peninsula state created the Qatar Financial Centre in 2005 and two years later announced plans to merge its three financial regulators. Then in 2008, NYSE Euronext agreed to buy 25% of the Doha Securities Market, which was renamed the Qatar Exchange in 2009. Qatar’s plans hit a speed bump with the global financial crisis, leading it to shelve the plans to unify its financial regulators and NYSE Euronext to reduce its stake in the Doha bourse to 20% in 2009.

Going Global

But embracing foreign investors in Bahrain, Qatar and the UAE is one thing; it’s another in Saudi Arabia, which "is probably the most sought after market in the Middle East and North Africa by international investors, because it is a very active market and has high volumes," says SHUAA’s Yasin. It has also been ramping up efforts to improve its markets, imposing steep fines on companies that violate governance rules, withdrawing financial licenses and allowing foreign investors to participate in exchange traded funds (ETFs), which were listed there for the first time this year. But to the disappointment of many, "Saudi Arabia is not a market hungry for international investments — at the moment, at least."

To a much greater degree than other countries do, Gulf countries impose much greater restrictions on foreign ownership of listed equities. Friendliness to foreign investors varies from country to country, even from city to city. The Saudi Stock Exchange, the region’s biggest and most liquid bourse, is regarded as the most difficult market for investors who aren’t local. In 2008, it at long last allowed non-resident foreigners to buy stocks through swap agreements, a mechanism that allowed foreigners to buy into listed stocks through local intermediaries. Before, non-resident foreign investors were allowed indirect participation through certain funds.

Could Saudi’s reticence eventually work in the other Gulf bourses’ favour by giving them time to bed down their reforms? Perhaps. Since the 2008’s court order, for example, Kuwait Stock Exchange signed a deal with the NASDAQ OMX Group to roll-out a new electronic trading platform for equities, bonds and derivatives, which is due for initial startup in 2011. This year, Kuwait’s parliament approved a much-delayed bill to set up a capital markets authority that the other five Gulf states already have, and its bourse is tightening up its regulatory regime, often suspending trading in companies for failing to report earnings on time or to clarify leaked information to the county’s rumour-rife newspapers, which remain the main source of company news for many local investors.

See-through Companies

Despite the efforts of Kuwait and others to win investor confidence, concerns about transparency and corporate governance have been hard to overcome. A 2009 Hawkamah report of Gulf-listed companies found that they lag international peers in terms of the quality of their market communication and disclosure. The report gave the Gulf an average score of 3.87, which is an 8.3% improvement from the previous year’s score but is lower than the average score of 7.59 given to a sample of international listed companies. Some Gulf companies in the study don’t have websites and others only publish disclosures in Arabic. Others don’t have investor-relations departments, according to the report. "If you look at things like insider trading, it is still not considered criminal behaviour across the Arab world," says Hawkamah’s Saidi.

When it comes to oversight, the line between the regulated and the regulator is often blurred, especially in cases when the heads of companies are public figures or influential sheikhs. "In some regional markets, some of the public companies’ boards are stronger than the regulators," says SHUAA’s Yasin. "This takes away from their strength and ability to govern the markets for which they are responsible."

Along with a more rigorous regulatory regime, experts say the Gulf’s stock exchanges also need to find ways to allow international and local investors to remain in the market, rain or shine, which can help slow a bubble’s formation or increase activity when markets are in the doldrums. Short-selling, which is currently only allowed on NASDAQ Dubai, is one such way. "These markets are hot markets at certain periods of time because they enjoy excess liquidity and we happen to be pegged to the U.S. dollar, which provides double whammy stimulants and you get an inflation in the money supply," says Gulfmena’s Arabi. "Shorting reduces these bubbles and when the markets typically tank, those who short it, create a demand in the market and that cushions the drop."

Though not entirely recovered from the depths to which they plunged in 2008, the Gulf’s stock exchanges are expecting better times ahead, especially as they benefit from increased spending by governments eager to stimulate growth stunted by the global recession and the drop in oil prices from the 2008 peak. "Gulf markets stand out as a safe haven against the current uncertainty prevailing over global financial markets," observes Schroders’ Sidani.