Interview: Hisham Al Razzuqi, Ali Ahmed Al Zubaid, Maha Al Ghunaim
What are some lessons investors and regulators have learned from the global financial crisis?
ALI AHMED AL ZUBAID: The financial crisis has now caused investment clients to speak of operational income rather than complex financial instruments. They want to know how much cash you have on hand, instead of how many assets you have in your portfolio. The definition of worth itself has changed. Prior to the crisis, we had firms that leveraged 7-8 times their capital on a regular basis. Now market players realise that if you have a loan on your books you need to be able to pay it off without delay. That liquidity is very important for this purpose. This is well understood by the Kuwaiti central bank, which has mandated a company’s loans not exceed twice its equity, among other regulations aiming to ensure companies can meet their debt obligations.
HISHAM AL RAZZUQI: In the boom years, many investment firms in Kuwait were overleveraged and had few liquid assets. We had paper companies that bought and sold stocks but did not engage in any tangible, income-generating activities. Today, following the financial crisis, prudent investment firms recognise the importance of corporate governance, capital adequacy, strong internal control frameworks and an efficient management of liability and liquidity. Only institutions that incorporate these things into their business models and decision-making processes are likely to survive and grow. Operational income and cash flow have become more important in investment decisions, and investors are taking more precautions and doing due diligence. Market players and regulators appreciate the value of clear and enforceable standards, including measures that promote transparency and risk management. This is the impetus behind the new Capital Market Authority (CMA).
MAHA AL GHUNAIM: Everyone has learned something from the financial crisis, whether they be regulators, commercial banks, investment companies or investors.
Regulators have become more hands on and proactive in their approach. We have seen the establishment of a CMA in Kuwait, which was way overdue and obviously a step in the right direction. We have also seen more emphasis on corporate governance from regulators and market participants.
Commercial banks understand that being a lender comes with certain risks and they too have worked on enhancing their credit processes and risk analysis. They may be at a point today where they have become risk averse, which is an understandable reaction given the enormity of the global financial crisis.
Investment companies have played an important role in developing capital markets, by introducing new financial instruments and enhancing the debt market.
But in addition to having ventured into areas outside of their core values, many also have serious discrepancies in their asset liability book. Nowadays everyone is recasting their business model, focusing more on fee generation, moving away from being a principal investor, focusing more on cash earning power and leverage ratios and enhancing their shareholders’ equity.
Investors have also learned from this process and are going back to basics, calculating the internal rate of return in line with what is considered realistic – in contrast with the high-risk return atmosphere everyone was living in. This financial crisis is part of our evolution and should be able to make stakeholders wiser and more focused on the basic principles of success.
What is the current availability of financing in the post-crisis environment?
AL GHUNAIM: Limited bank financing is now the biggest challenge facing the country’s financial sector. This is evident in the domestic market for M&As. Firms need cash to engage in M&A activity, but private sector liquidity in Kuwait is still low following the crisis. Local banks normally fill this funding gap, but they have become highly risk averse. The distressed industries most suitable for M&A activity are precisely those to which banks are now most reluctant to lend the necessary funds.
AL RAZZUQI: Bank financing is now a regional issue, as many GCC nations have initiated capital-intensive infrastructure development plans. The region will require hundreds of billions of dollars in the coming years to upgrade transport networks, build schools, expand hospitals and improve oil production capacity. However, it is questionable whether regional banks have the capitalisation needed to finance such projects across every sector. Moreover, foreign banks have become more reluctant to enter the region since the financial crisis, an attitude not likely to change given weak growth prospects for the global economy. Nonetheless, financing for these projects will have to come from somewhere. There will be many opportunities for those with the capacity and will to continue lending. Within the institutional space, differentiation will be a key feature. Financially strong and well-managed institutions will attract cost-efficient financing, others will not.
AL ZUBAID: Banks in Kuwait are still lending to consumers, and we have seen an increase in automobile and mortgage financing to individuals. However, beyond this the lending environment is fraught with uncertainty. As in many other countries, Kuwaiti banks have limited cash reserves and are adopting much more stringent capital adequacy ratios. The crisis has led banks to become much more cautious with their lending policies, causing a tight credit situation. Yet, under the National Development Plan, there will be significant opportunities in the country for financial institutions to support major infrastructure projects. For lenders with cash, now is a good time to enter the market ahead of the competition. The demand for financing will only increase in the coming years as the development plan is rolled out.
How important is the establishment of the CMA, and what needs to be done to ensure its success?
AL RAZZUQI: Enhancement of the regulatory framework is always positive. However, regulatory bodies must strive to be enablers and should work closely with other market participants. Going forward, the CMA must develop sound regulations that protect investors, yet keep rules flexible enough to accommodate entrepreneurship and promote market activity. If this balancing act is achieved, Kuwait may witness a substantial increase in both local and foreign investment. Indeed, attracting foreign direct investment (FDI) is perhaps the greatest contribution the CMA can make to the domestic economy. For now, Kuwait lags far behind other GCC nations in terms of FDI. Increased regulation will bring a level of security and confidence to the market, which is needed if the country wants to attract investors.
AL ZUBAID: Over the long term, the CMA will make the country’s financial sector more resilient, more transparent and more attractive to investors. In the short to medium term, however, the CMA will have a minimal impact for three reasons. First, many of those hired to work at the CMA have academic or legal backgrounds, but no professional experience, and thus will have trouble understanding issues that concern businesses. Thus, in the early years it will be difficult for the CMA to issue bylaws that address the complexities of modern business in an effective and appropriate manner.
Second, the CMA is taking shape in an uncertain domestic political environment characterised by widespread accusations of corruption. This may indirectly diminish the authority’s legitimacy. Third, the creation of the CMA comes amid an upheaval in the international economy, which will make the work of CMA regulators more complex and challenging. These are some of the challenges that the CMA will face in the short term, but it is important to keep the long-term benefits in mind while going through this transition period.
AL GHUNAIM: Kuwait was the last country in the GCC to create a dedicated CMA. This is quite surprising given the advanced state of our investment sector and overall economy. Nonetheless, being a latecomer means we do not have to reinvent the wheel. As the authority develops, it will already have established models from other countries to emulate. It is therefore essential for the CMA to learn from the experiences of other nations and duplicate international best practices.
A second, related point is that the CMA must acquire the right personnel – professionals with global experience who can take local capital markets to the next level. In terms of corporate governance, the Central Bank of Kuwait has taken measures to enhance reporting requirements. Last year, the central bank began requiring domestic financial institutions and investment firms to undergo in-depth internal audits. These will ensure market players adopt global standards for compliance and risk management procedures. It is also important to emphasise that what has happened in the investment sector in Kuwait is not necessarily the result of weak corporate governance. The sector has been faced with a number of unpredictable external shocks recently, including the Arab Spring, the downgrade of the US credit rating and the European debt crisis.
How optimistic are you that the National Development Plan can bolster the Kuwaiti economy?
AL RAZZUQI: I look to the future with optimism and have confidence in the National Development Plan. Kuwait is a growing economy that has run a budget surplus for over 10 years. We have political stability, freedom of the press and a vibrant parliamentary system. Overall, foreign investors are very comfortable here, and in the wider region. As infrastructure projects under the development plan enhance aspects of our country such as education, healthcare, housing and transport links with the GCC, I expect Kuwait to markedly increase its inward FDI. Moreover, as the GCC becomes more integrated, we may witness a rise in regional commerce and a true shift towards economic diversification. This diversification will be key to the future of not only Kuwait but to countries of the whole Gulf region.
AL ZUBAID: The National Development Plan will provide investors with significant opportunities in many areas, from logistics to construction and education. However, many feel the plan has simply taken disparate ministry projects and assembled them under one name. There is no centralising idea or policy coordination, which is something usually critical to the success of a national development plan. It is also likely political gridlock will impede the plan’s most ambitious projects. We have already seen delays since the plan’s approval in April 2010. Furthermore, many of the ministers responsible for overseeing and executing these projects have been removed or reshuffled in recent years. Thus, there is a lack of consistency of leadership at the management level, which causes further delays.
Despite its weaknesses, the plan is a step in the right direction, especially given the country’s young and growing population. We anticipate a surge in local demand for housing, education, and medical facilities.
By focusing on these areas and encouraging private sector participation, the government has demonstrated its understanding of the challenges facing Kuwait.
AL GHUNAIM: Kuwait has been frozen since the late 1970s, and the development plan signals a possible turning point in the nation’s history if implemented properly. With strong public finances and a sophisticated investment banking sector, Kuwait is capable of executing the plan successfully. We now need an infrastructure overhaul and a new approach to doing business.
Nonetheless, many in Kuwait are cautious. The development plan will require financing from foreign banks, and we cannot simply assume that investors will come here given the wide range of investment opportunities in the global economy. Thus, the plan will only succeed if it is accompanied by new bylaws that help mitigate risks and streamline local business procedures. For example, given that many projects under the plan will proceed on a build-operate-transfer (BOT) basis, it is essential for the government to work towards creating a more transparent BOT tendering process.
Another risk is a gridlock between government and parliament. This too can be solved by greater transparency. As the state encourages foreign and private sector participation in the economy, it can reduce suspicion among lawmakers by maintaining open lines of communication and anti-corruption initiatives.
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