July 2010

BAHRAIN IN FOCUS: Steady as she goes

bahrainA conservative regulatory regime has seen Bahrain fare well in the aftermath of the financial crisis, but what should be done to attract the next wave of investment? Nicholas Pratt talks to some of the local players about the best way forward.

Bahrain is one of the smallest financial markets in the Gulf region. The liquidity is very small and the flow to the listed markets is minimal. What liquidity there is tends to be driven by arbitrage opportunities. Otherwise it is a market dominated by government-backed pension funds and investors that come from a family wealth tradition that prefer to hold their stocks for a long time.

Bahrain is also the most regulated domicile in the Gulf region, which has its advantages and disadvantages. It is a well-organised and well-supervised market with very advanced laws and regulations and it has particularly stringent rules on insider trading.
However, when there was an incident of insider trading, it resulted in a blanket ban on trading and there was no activity for two whole months.

Any campaign there may have been for a lighter and more liberal approach to regulation would have been derailed by the financial crisis. Bahrain’s strict supervisory regime and the lack of international investors meant that it suffered significantly less than its neighbouring domiciles from the fallout that resulted and is therefore unlikely to be encouraged that such an approach should be altered in a hurry.

Reforming the market
If the Bahrain market is going to grow, the government needs to sponsor more listings and it needs to attract more retail investment into the market, say commentators. Unfortunately, many of the government entities that would be the best candidates for privatisation are not in the best of shape economically right now. Fortunately, the Bahrain Stock Exchange (BSE) is looking at possible reforms and has signed a consultancy agreement with the Singapore Exchange to provide overall guidance on the management and operations of BSE through training and knowledge transfer.

Securities & Investment Company (Sico) is one of the largest home-based investment companies in Bahrain. It formed in 1995 and has since gone on to steadily develop a Gulf-wide presence after recently opening its first brokerage in the UAE. It is also expanding the range of services it offers after recently signing a depositary participant agreement with the BSE that will allow it to offer custody services for BSE-listed securities to local, regional and international investors

“We have always had an expansion strategy in mind,” says Najla Al Shirawi, chief operating officer at Sico. “When the markets were good there was a rush for everyone to have a global presence, but we’ve learned that a well-thought-out process is important.” She says that the firm is well aware that the market moves in cycles and the central aim of any expansion plan is to use the post-crisis period to improve the infrastructure in order to be ready for the next upward cycle.

“We made a slight loss in 2008 but we were profitable in 2009 and this has continued with the first quarter of 2010 – a net profit of BD1.28m (€2.78m). For us it is about the balance between the prop book and the fee-generating business. We’ve been careful that we did not have any leverage, so following the financial crisis, we were able to invest at the bottom.”

Following the crisis, Sico invested in a comprehensive IT project that has taken roughly two years to complete. “We needed a core banking system that would match our future requirements for different strategies such as short selling and derivatives and also give us more straight-through processing and the ability to offer internet-based services for our clients.”

Risk management has also been an area of investment. “We applied for a wholesale banking license back in 2008 to give our institutional investors the assurance that we are tightly regulated and we have developed a risk management system on the same basis. A lot of the work has been on Basel II and pillar III and even though there was a lot of work involved, we are now seeing the benefit, says Al Shirawi.

She adds: “Post-crisis, investors are engaged in a flight to safety, especially on the asset management side. There are some investors that are looking for a broker that can offer them the ability to execute large block trades with minimal market impact, but the majority are interested in the long term. They want to see how the funds performed during the downturn and fortunately that is where we did very well in comparison to the rest of the market.”

Sico is now looking to get involved in Bahrain’s fledgling fixed income market, says Al Shirawi. “It is likely to be a very interesting asset class in the future so it will help us if we are in there from the beginning. So far we have seen mostly quality issues in the way of government bonds and this attracted a lot of mainstream investor interest as opposed to solely hedge funds. The corporates are interested because they see it as another way to raise funds and the binds are being priced attractively at the moment. It is still early days but investors realise that the property boom is over and they are looking for more diversification and better long-term prospects.”

According to Ramesh Bhaskar at Bahrain-based KPMG Fakhro, a partnership between the international accounting firm and the Bahrain-based conglomerate, the last 18 months has been very slow in terms of new fund launches. “We have four different groups in our funds unit – fund audit, fund administration, fund registry services and fund advisory services, which includes financial modelling and valuations.”

Cautious approach
The current market conditions across the globe, as well as the innate conservatism of the Bahraini regulatory regime, may not be conducive to encouraging new fund launches. For example, it can take up to two and half months to register a new fund, but, says Bhaskar, this cautious approach does have its benefits. “For investors, once the fund is registered and well regulated, they have the confidence to invest more. So while it may be useful to be flexible in good times, it’s better to be stringent during less good times because you end up attracting more investment in the long term.”

There has been a steady flow of international companies coming to Bahrain, says Bhaskar, particularly Ireland- and Luxembourg-based firms that see Bahrain as a centre for their Middle East operations and are looking to enhance what presence they may already have. The steady approach of the Central Bank of Bahrain (CBB) in registering new funds may be an issue for international players.

One of KPMG Fakhro’s key services concerns valuations, says Bhaskar, and as Bahraini investors begin to develop an appetite for more complex fund types, the valuations service is one area that Bhaskar envisages some opportunities. “Investors will want third-party support in order to become more knowledgeable about these complex funds and they will need help with their valuations. At the moment, valuations are done on a weekly basis at best, but the CBB will want to look at this and will eventually want to mandate daily valuations for certain fund types.”

Another prospective area of development in the Bahrain market is that of Islamic finance, says Bhaskar. “There is a growing demand for Islamic funds because, in the aftermath of the financial crisis, investors are interested in the responsibility that Islamic law provides. And I think Bahrain has a great opportunity to establish itself as a centre of Islamic funds. This is what the CBB should be looking at – how it can introduce some standardisation for what is a complex area.”

©2010 funds global

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