The financial gates of Eurasia
On May 27, 2016, President of Kazakhstan gathered Foreign Investors Council members to discuss prospects for the development of the "Astana" international financial centre. According to his plan, the “Astana” international financial centre (AIFC) should become a magnet for attracting capital and financial gateway for the whole Eurasia. In turn, the Foreign Investors Council (FIC) members advised to be patient and move in stages toward this goal: the new Center should have a clear niche specialisation and aspire to leadership in the region.
The details of the ambitious project were presented to the participants of the meeting presented by its mastermind, Nursultan Nazarbayev. He reminded that the Republic is now at the stage of practical implementation of the “100 Concrete Steps to Implement Five Institutional Reforms” plan. In the last year alone 59 new laws were introduced to facilitate the implementation of this plan; they create the fundamentally new legal framework for the developement of the state and the society.
As a part of the plan the next phase of privatisation and decentralisation of the economy was launched in Kazakhstan. "We are planning an ambitious campaign to reduce the proportion of the State involvement in the economy and the expand the private sector. The goal is to reduce the participation of the State in the economy to 15%, which is the average in OECD countries", explained the President.
According to him, the list includes state stocks of shares in the ore mining and smelting and petroleum industries, power industry, transport and communications, infrastructure facilities, as well as many other branches. Legislative changes have been adopted to eliminate restrictions on the transfer of the assets at fair market value for Kazakhstani and foreign investors. The key mechanisms of the privatisation will be the placement of shares on the stock market and the public auctions. And the head of State believes this to be a great opportunity for deepening mutually beneficial cooperation with our country for the members of the Council and other investors.
The deals on the assets selected for privatisation and the IPOs of the “national champions” should become the first tools of the future financial centre. In addition, the idea is connected with the EXPO-2017. "The project is very difficult and at the same time, very important. I believe we are getting to it at the right time, and it was important to connect it with the EXPO-2017 world exhibition, its excellent infrastructure. This would be a great infrastructure place, comfortable for those who will come to work at the Centre. Looking to the future, we want to see the AIFC as the centra of attraction for the investment capital and the innovations in financial instruments. It aims to become the “financial gateway” to the whole of Eurasia. Our capital Astana will develop as a business, cultural and scientific Center, will have modern international transport and logistics system, including a new airport terminal”, the President shared, speaking of the plans.
However, the Kazakh leadership understands that the AIFC is unlikely to immediately compete with such universally recognised centers as Tokyo, London or New York. ‘We will probably not aim for this right now. To begin with, we must conquer our region where no such centres exist, and gradually demonstrate our ability to the other regions”.
Next, the President listed the "unprecedented, unparalleled in the post-Soviet space" conditions that are created in the AIFC to attract international players.
Firstly, the participants of the Centre and their employees will be exempt from paying taxes-both corporate and income-for up to 50 years. The simplified work and visa regime will be introduced for them as well. “Along with direct air connections we want to create with the leading financial capitals, we hope that Astana will rightfully become the aviation hub in the chain of the world's financial centers”.
Secondly, based on the experience of the world's financial centers, a special legal regime based on the English law principles shall be provided on the AIFC premises. "An independent court of the Centre will ensure transparency, fairness and the protection of the rights of investors and businesses. International judges who have earned authority and confidence will work here. To improve the business climate, an independent financial regulator - the AIFC Committee - shall be created”. To this end, the Parliament of Kazakhstan has already adopted a special constitutional law, which enables the AIFC work completely autonomously.
Thirdly, highly skilled professionals shall be involved in the work at the Centre. Along with skilled foreign workers who will ensure the transfer of knowledge and technology, the President counts on highly educated Kazakh specialists, educated in the world's leading universities, including the participants of the “Bolashak” programme. "We have been preparing for this. We have prepared 15 thousand young people, who have returned and are working in Kazakhstan, in the best universities. And now around 40 thousand young Kazakhstanis are being educated abroad. The new International University in Astana also produces 500 decent professionals annually”.
Fourthly, the Government expects that the high-tech infrastructure, created on the basis of Astana-EXPO 2017, will continue the main theme of the exhibition projects which are aimed at the development of the “green” economy. "The release of “green” bonds, the introduction of the “green” insurance”, the creation of a “green bank” - these are just a few options that can be used at the AIFC platform. I think this direction within the framework of the Centre has a great future”.
Fifthly, considering the specialization of Kazakhstan's economy, it is planned to create an AIFC-based platform for subsoil users similar to the stock exchange in Toronto, where everyone -both the big players and the “juniors” - will be able to raise capital for the development of their projects. In addition, favorable conditions for the development of the new financial technologies will be created in the AIFC - the flexible legal framework and the modern infrastructure in the form of a data center and incubators to test new technologies. “Our first priority is to attract financial resources into the economy, making the domestic financial sector an industry competitive on a global scale.
Nursultan Nazarbayev also remembered to list the benefits that Kazakhstan expects from the execution of the ambitious project. “Economic results of the AIFC activity must be expressed in accelerating GDP growth due to the inflow of direct foreign investment - that is what we are hoping for. The resulting cumulative effect for the country's economy from the creation of the Centre and its regional expansion, according to economists’ estimates, could amount to about $40 billion over the next 10 years. In addition, the creation of over 2 thousand workplaces for skilled professionals within the AIFC is planned as well”, said the President, listing the main benchmarks for the project.
Additional confidence in the project feasibility is based on the fact that Nursultan Nazarbayev is personally engaged in its’ promotion. “Last year, I have conducted negotiations in New York, London, Paris, Beijing, Qatar, where I met with the leading businessmen, the investors in these countries. I told all of them the same thing that I am telling you now, inviting them and explaining what we are creating here. They all supported the establishment of the AIFC, arrangements were made to invest in Kazakhstan and do business here.”
In this regard, the President invited members of the FIC to also take an active part in the establishment and the work of the Centre by actively promoting it abroad and helping to establish mutually beneficial relations with foreign financial institutions. “You, as the friends of Kazakhstan leading the largest companies in the world, can yourself talk about the same things that I'm telling you now in your countries in order to promote the importance and the interest of this new undertaking on the Eurasian continent territory”.
As the conclusion of his speech, the head of Kazakhstan noted that the influential leaders of the world’s major companies and financial organisations were invited to the AIFC Management Council, which he became the head of. “Just yesterday the first meeting of the Council was held, during which we have discussed the prospects of the establishment of the AIFC and also adopted the strategy and outlined the main vectors of development. Kazakhstan is ready to consider and support all your suggestions about the AIFC platform partnership. I am sure that our cooperation will create favorable conditions for sustainable social and economic development of Kazakhstan and the region”, said the President.
Fuel for the AIFC
The members of the FIC readily rose to take advantage of the President’s offer to share their vision and recommendations. In particular, David Barker, the EY company advisory services managing partner for the financial sector in the European, Middle Eastern, Indian and African sector, emphasised that the holding of large-scale privatisation programmes of Kazakhstan assets through the AIFC platform will demonstrate the possibilities of the new Center and give impetus to its further development.
However, he warned that privatization is a complex process. In determining the transaction value the State must carefully weigh a number of factors, such as the impact on the end-user services and the citizens of the country, the amount of funding involved, the total economic effect and the public importance, as well as the impact the deal would have on investors in the short and long term.
In this regard, he told about the international approaches to the classification of privatised assets according to their level of attractiveness. The first package are the so-called easy victories - the assets that are fully or partially State owned and operate in competitive markets, such as the market for international air travel, for example. Some of the biggest privatisation deals in Europe which have been successful for both the Government and the investors belonged to the "easy victories” category.
The second category are the “proven” monopoly companies or companies working in industries with a history of successful privatisation projects, such as municipal utilities. “The privatisation of such assets is more complex and may require structural changes, such as ensuring a competitive environment or the effective regulation of the market, as well as considerable preparatory work. The British Government can attest to the difficulty of preparing for the privatisation based on the example of the Royal Mail postal service: the price doubled on the first day of public offering, resulting in the investigation of this issue”, said Mr. Barker.
Finally, the last and, presumably, the hardest category to work with is the “new wave”. These are companies that have traditionally been working in the public service sector, where protective measures and impacts can be indirect, for example through taxation and legal regulation. These assets include services or income streams that can be merged into a single corporate structure with the privatisation at the further stages. The speaker called the information services in the field of meteorological and road systems an example of such an asset. This kind of privatisation have only recently started in Europe.
According to the EY representative, in general it is important that the assets chosen for privatisation could work in a competitive environment for the effective conduct of the privatisation program. During the privatisation of natural monopolies tariff regulation acceptable for private investors must be ensured. In addition, the existence of "long money" is important for the infrastructure assets is important, because they are characterised by long payback periods, high capital costs, as well as regulatory and currency risks.
In conclusion, he first of all advised to conduct a business transformation and to improve the quality of financial statements of Kazakhstan's quasi-governmental companies, which would positively affect the valuation of assets, as well as to choose the correct time and the optimal method of sale - by a private transaction, public offering or hybrid deal.
Stock market for chrome
A number of specific proposals were expressed by the Chairperson of the Board of managers of the ERG Group Alexander Mashkevitch, who turned out to be the only representative of the materials sector putting anything forward at the meeting. The first is the establishment of the stock trading in hedging instruments at the AIFC platform.
“We believe it is necessary to create a system that would allow exporters to minimise losses from the downturn of product prices, even if, in the case of their potential growth, there will be a certain shortfall in profits. Stability should become the main link of the “production-export” chain”.
He explained that if a company wants to hedge the price of their products today, it should apply to financial intermediaries abroad. Significant amounts are also obligatory, which significantly increases the cost of hedging. And, as believed by Mr. Mashkevitch, a strong internal exchange market on the AIFC platform will allow an expanded access to it, reducing the input barrier, and the new favourable legislative, fiscal and technological conditions at the Centre platform can be used for trading in the hedging instruments.
The second proposal made by the representative of ERG concerned the long-term investment market tools development. “Production is a very capital-intensive process with long term of return on investment. And today not only the ERG but most of the companies in the industry are in dire need of long-term, affordable means. The raw material tycoons count on the AIFC exchange to become a platform for the attraction of such money through, for example, the mechanism of guaranteed State foreclosure of a certain part of the emitted volume of long-term financial instruments.
Mr. Mashkevitch assured that this would immediately create an ETF Securities market, and the State could then recover its investment by selling the guaranteed amount purchased. In addition to that it may issue bonds on its own with the subsequent direction of the attracted money to the long-term funding -up to 15-20 years - of the domestic production. And convert its claims into tradable instruments that will be sold to investors after the implementation of the project.
But perhaps the most interesting were the third and fourth suggestions by Alexander Mashkevitch. Recalling that Kazakhstan has traditionally ranked second in the world (after South Africa) for the production of ferrochrome, he complained that its’ sales - as non-exchange goods - are carried out at formula-based prices using regional (China, Japan, Europe) price indexes and benchmarks. Such a system does not reflect the realities of the market demand and supply in ferrochrome, and because of it a lot of the world's iron ore producers have become bankrupt or close to it due to the downturn on the prices.
“In this kind of a situation it becomes highly relevant to change the pricing of ferrochrome. And the establishment of the Kazakhstani Chrome Exchange at the AIFC platform, similar to the Malaysian Tin Exchange, could be another effective tool in this regard. Moreover, the traditional exchange-traded metals - copper, zinc, lead, aluminium - can also be traded at the new platform .
However, the creation of the metal exchange requires not only the existence of the trading platform itself, but also a system of warehouses to accommodate the goods, and they should be located in close proximity to the markets of consumption. “In case of ferrochrome those are China, Japan, Korea, Western Europe and the United States. We can do the creation of the storage facilities on the border with China. The issue of construction of a logistic terminal in Aktau sea port for supplying ferrochrome and other Kazakh metals to the consumers in the Middle East and the Mediterranean regions should also be addressed. Thus the establishment of the Kazakhstan Chrome Exchange will be an additional impulse for the further development of the country’s transport and logistics infrastructure.
In conclusion, the head of the ERG proposed to introduce the investment residency principle similar to Dubai in the AIFC. “The State has already prepared several major bonuses for participating in the AIFC. We all know them, and they are weighty enough. But I suggest to consider investment program for individuals which would allow them to get the tax residence of the the Republic of Kazakhstan on the condition of certain types of investment (depending on the choice of the investor) that will make the AIFC even more attractive for investors. " As a pro argument Mr. Mashkevitch recalled that Dubai drew in almost 2.5 million individuals investors due to income tax exemption for the individuals, and the United Kingdom received 6.8 billion pounds from taxpayers for 2011-2013 years only due to the principle of enumeration, in which investors’ income received abroad was not taxed.
Time and success factors
The investment bankers among the FIC members, while generally supporting the optimistic leadership of Kazakhstan, drew attention to the fact that the development of an international financial centre requires patience and a step-by-step approach. Jorg Bongartz, Managing Director and regional Manager for Central and Eastern Europe of Deutsche Bank AG, said that the success of Dubai and Singapore is the result of concerted and joint efforts, both by market participants and the public authorities, for a long time - much more than a decade.
“In addition, the most successful strategies for the development of financial centres were distinguished by their openness and the fact that they welcomed the participation of a wide variety of professionals and institutions in their development. But such openness and accessibility also implies that any special legal, judicial or tax treatment is provided for such financial center and must be extended to all interested market participants, both domestic and foreign players”.
At the same time the most successful initiatives to establish financial centres apply a step-by-step approach, where at first human capital and other resources are concentrated on providing only one or two services. And then, if successful, introducing other services. “We therefore consider it appropriate to review the development schedule and financial center of Astana, currently envisaging the simultaneous development of now six different areas with only limited synergetic effects”.
In particular, according to Mr. Bongartz, asset management is a typical service of the advanced financial market, which typically joins the other services at a later stage when the environment is ready, the innovations experience is accumulated and a wide range of financial instruments in all market segments is present. “Managing companies need a legal framework in which they must work to be already proven in its stability and fairness. And if such evidence had not yet been submitted, they will transfer only a small portion of the assets entrusted to them into such unverified environment as a newly established financial center. Therefore, our clear recommendation is to be very careful and selective in asset management specialists who will take measures to localize their services in Astana at a more suitable stage”.
Ian Koulbern, Chief Executive Officer of Deloitte CIS, also agreed with this viewpoint and noted that the establishment of an international financial centre could be compared with a marathon race, but never with a sprint.
His company's experience in similar projects in Qatar, Dubai and Abu Dhabi proves that the establishment of the necessary infrastructure for financial centers is time-consuming. However, the high-quality implementation of the project cannot be achieved without it. “The establishment of an international financial centre in Singapore took half a century and became the impetus for the economic transformation of the entire country. Thanks to the extensive reform and significant investments, the City-State has turned into a major world financial center, which regularly tops the successful business rankings”.
He also believed that the stake of the AIFC on the Islamic financial sector development and the "green finance" in the region is really justified. But the market is underdeveloped in Kazakhstan right now. Therefore the representative of Deloitte advised to pay special attention to not only the establishment of an effective legal and regulatory framework, but also training of market participants and the general public in the benefits of Islamic finance.
In turn, the Chairman of the Board of Directors of JP Morgan Chase International Jacob Frenkel identified two main points, thanks to which the AIFC would be able to quickly reach a competitive level. Firstly, the Centre should be organized in such a way that investors have obvious incentives to work and create businesses. “To this end the major financial centers typically create many development institutions, open representative offices abroad, provide grants to various conferences and resort to other methods of stimulation to induce people and companies to make the first move and organise at least some kind of presence in the Centre. Needless to say, competitive regulatory framework is also critical with this background.
Secondly, the AIFC must focus on active promotion of key sectors of Kazakhstan's economy. “Instead of trying to claim the role of universal global financial centre, the AIFC must define a key focus of its competitive strategy in such a specific and narrow way, that being the “first in class” is guaranteed”. Astana is unlikely to become the leading financial center of Eurasia in a day, but the “big fish in a small pond” principle can be sufficient”, he concluded.