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 KAZAKHSTAN International Business Magazine №2, 2007
 Marriage of Convenience. KASE and ARFC Merge
Marriage of Convenience. KASE and ARFC Merge
It emerged in mid-June that the Board of the Kazakh Stock Exchange (KASE) had approved the decision to commercialise the stock exchange and merge it with the Almaty Regional Financial Centre (ARFC). As a result, the debate about the feasibility of the co-existence of the two stock exchanges in Kazakhstan has reached its logical end. However, the domestic stock market’s problems of a structural nature have not become fewer because of this event.
Long-expected Decision
Since the first days of its existence, the ARFC has aroused quite a controversial reaction from the professional community. On the one hand, the state’s desire to develop the stock market actively, offering generous tax breaks and preferences and partly privatising state assets through public sales on the stock market, should be welcomed; on the other hand, some uncertainty has caused concerns over the future co-existence of the KASE and the ARFC. Moreover, a number of oddities occurred, for example the requirement for the stock exchange’s players to set up new companies at the ARFC. Experts had repeatedly said that if professional market players had been actively involved in developing the project to set up the ARFC, many controversial issues could have been avoided. The decision to set up the ARFC’s special trading floor (STF) at the KASE, which became its operator, only added fuel to the fire. This started a process of damaging the liquidity of the domestic stock market because both the STF and the KASE are trading securities from the same issuers.
At the moment, the ARFC’s STF lists 14 issuers – Astana-Finance, Astana-Nedvizhimost, Bank CenterCredit, the Kazakh Mortgage Company, Tsesna-Astyk, EKOTON+, MAG, Kazakhtelecom, Kazkommertsbank, Kazkommerts International BV, Kazcat, Temirbank, ATF Bank and RESMI COMMERCE. Of 55 issues placed by these companies on the stock market, 15 are issues of shares and 40 are issues of bonds. The current volume of trade exceeds $43m at the ARFC. The market capitalisation of shares exceeds $5.3bn and that of bonds $3.6bn.
It was clear that hardly anyone could benefit from this alignment: for further development there had to be one integrated market, same rules, same players and one field of activity. As a result, the various parties sat down at the negotiating table. As early as mid-June 2007, at a special news conference, the chairman of the Agency for Regulating the Activities of the ARFC (ARA ARFC), Arken Arystanov, said that the Board of the KASE had approved the decision to capitalise it and merge it with the ARFC. He said: “We have agreed that we will jointly elect the board of directors. The problem is that a modern international financial centre needs a floor that meets international standards. If such a floor is set up, the state, in principle, will not need to get actively involved in this process.”
Mr Arystanov said that the important issue faced by the KASE management was a shortage of capital and the impossibility of increasing it without attracting new investors. In turn, this was caused by the fact that the stock exchange was non-commercial and did not make any profit for its shareholders. In this connection, the ARFC and the KASE intend to prepare a joint business plan to develop the stock exchange over the next three years, an operating system and rules of operation that are similar to those adopted by leading international financial centres. The board of directors of the united stock exchange will be made up proportionally of representatives of the Kazakh National Bank, the Financial Control Agency (FCA), the ARA ARFC, the president of the KASE, market players and independent directors.
Mr Arystanov stressed that the existing law on the securities market did not make it possible to set up a stock exchange as a commercial organisation. That is why the ARA ARFC initiated the relevant amendments to existing legislation. All the necessary rules and documents are expected to be prepared by the end of 2007 and the united stock exchange to start operations on 1 January 2008.
According to the ARFC’s estimates, a commercial stock exchange needs at least $15m in capital in order to operate properly. Since there are already enough entities that are ready to invest in it, Mr Arystanov believes, there is no need to attract capital from the state except perhaps at a very minimal level.
As a result, the notorious issue of finding money has been resolved. However, there is another concern. How will the commercialisation of the stock exchange impact its rates for players and issuers while private investors are, above all, interested in profits?
Like Ships at Sea
The “affair of the KASE and ARFC” has again shown that without creating a fully-fledged domestic stock market it is premature to discuss its regional and international integration, especially when there are many problems of a structural nature. The ARA ARFC’s development director, Gulnara Alimgaziyeva, told the First International Investment Forum (held in Almaty on 23-24 April) that the specific of the domestic financial market was that its components were unbalanced. For example, the lion’s share of funds for financing the real sector of the economy now comes from banks. Moreover, Kazakh banks do not engage in investment banking, issuing only classic loans. The first vice-president of the KASE, Idel Sabitov, believes that this separation, in general, is justified because by combining these two operations Kazakh banks would have faced additional risks.
At the same time, another major problem for the ARFC is to divert some of the commercial banks’ functions of funding the real sector to the stock market. At the moment, institutional investors, above all, pension funds, dominate this sphere. Their activities have their own peculiarities: pension funds bear huge social responsibility, because they have to pay people’s pensions so their risks should be minimised while investing in securities and the FCA strictly regulates pension funds’ investment activities. In order to generate interest from pension funds the issuer should have either quite high ratings from international rating agencies or its securities should be included in the highest category of the KASE’s listings. Moreover, in connection with the new requirements, pension funds should reconsider their portfolios of securities placed by Kazakh issuers which do not have international credit ratings or have ratings lower than BB- (on the Standard & Poor’s scale). In this situation pension funds are facing real shortages of appropriate issuers and, as a result, the real “zero” returns on dept instruments. One can now place at the KASE bonds at an interest not exceeding the annual inflation rate! However, if Kazakh blue chips (which meet existing criteria) can easily borrow in foreign markets, where rates are even lower, potential issuers cannot use “free money” because they do not have ratings. The only alternative for medium-sized and regional companies is unit investment trusts and individual investors. However, even though the assets of the former demonstrate impressive growth rates they remain a pale shade of pension funds and it will be hard to tear individual investors away from the highly-profitable property market. A paradox emerges here: investors are short of issuers, whereas issuers are short of investors.
Hey! Investors Wanted
One cannot rely on “foreigners’ help” – there are no foreign investors lining up on this structurally distorted market so far. No, of course, they will come if they are allowed to hold plum state assets or extractive companies. However, they will hardly be inspired by a policy to diversify the economy and develop non-extractive sectors.
Experts say that aggressive local investors should be encouraged from among unit investment trusts, banks and the population. Mr Sabitov forecasts that potential issuers will most likely hope for these assets while issuing their securities over the next five years.
In the meantime, the ARA ARFC is launching a large-scale PR campaign at the moment. This is bolstered by the government’s recent three-year programme (worth $50m) to teach basic financial skills to the population. With the aim of attracting issuers, players and individual investors from various Kazakh regions, the agency has already held presentations for the population in Mangistau, Atyrau, Aktobe, Kyzylorda, South Kazakhstan, Zhambyl, Karaganda and North Kazakhstan Oblasts and Astana and Almaty. Negotiations between regional administrations and the ARA ARFC have resulted in signing memorandums of understanding and cooperation. Based on these accords the agency intends to attract at least three issuers from each region to the ARFC by the end of 2007.
The ARA ARFC’s initiative to set up a national rating agency sounds very sensible because medium-sized Kazakh companies cannot afford to acquire ratings from Moody’s, Fitch Ratings or Standard & Poor’s at the moment. This approach proved to be sound in developed countries. Obtaining a rating from a national agency is the first step towards publicity and transparency. Ms Alimgaziyeva said that such an agency was expected to be set up as a joint venture with one of the three international agencies, however the negotiations had not yet been completed. The reason for this is understandable – Moody’s, Fitch Ratings and Standard & Poor’s are supranational organisations that value their reputations and the independence of their ratings, whereas the involvement of the state in such a joint venture will raise concerns over the objectivity of its ratings. In any case, the domestic agency will need a lot of time to win the trust of foreign investors.
A quicker and, importantly, reliable solution can be a proposal put forward by representatives of Fitch Ratings at one of the conferences. The point is that the state subsidises issuers to acquire ratings from an international agency (like reimbursing expenses on auditing introduced at the ARFC’s STF). This will increase the number of issuers capable of attracting pension funds without significant risks. It will also be easier for foreign investors to analyse their securities. The fact that all these three international agencies have already adopted national scales of ratings for Kazakhstan speaks in favour of this scenario.
Rivals Are Up and Watching
Meanwhile, an increasing number of stock markets are entering the fight for issuers from Kazakhstan. Representatives of the London Stock Exchange and Euronext have turned into genuine habitués of Kazakh conferences. A list of “hopefuls” has been appended by the Singapore and Hong Kong stock exchanges, as well as Russia’s RTS. Representatives of the latter talked about Russian depository receipts (RDR) – a new instrument invented by our neighbour specifically for foreign issuers. This programme is currently undergoing the final procedures of coordination and will be launched by the end of 2007. Moreover, Russian stock market specialists openly said that they eyed companies from Kazakhstan and Ukraine as the most likely and attractive issuers. Given that their pool of investors is incomparably wider and more diverse (the number of partners in unit investment trusts has been annually doubling in Russia over the past six years), Kazakh stockbrokers have food for thought.
Quite interesting, from the point of view of mechanisms that encourage the development of the financial centre, was a report delivered at the First International Investment Forum by the vice-president of the Stock Exchange of Singapore (SGX), Mr Simon Lim. The SGX, set up in 1960, is a leading Asian stock market in terms of foreign issuers (35%). That is precisely why this stock exchange positions itself as the “Asian Gateway” for companies from all over the world, including Kazakhstan. Part of Singapore’s know-how is that the stock exchange itself can do the broker’s job. After placement, it pays from internal subsidies for specialists who lead the issuers, prepare corporate and financial reports and post them on the stock exchange’s website (eight to 10 reports a year). Mr Lim said that these measures significantly simplified the companies’ access to investors.
However, the Hong Kong Exchange (HKEx) quickly showed the seriousness of its intentions. Less than a month after the Forum, the HKEx, the ARFC and the VIPromotion corporate communications agency held a separate conference, “IPO in Hong Kong”. A delegation from this Special Administrative Region of China included representatives of 20 companies – major players in the Asia-Pacific financial market, including 15 speakers.
Hong Kong is an international financial centre in China and the largest capital market in Asia. According to the Heritage Foundation’s rating, the Hong Kong economy has been rated the freest in the world for 13 years running. In May 2006, the capitalisation of the HKEx exceeded $1,000bn. In 2006, the HKEx came second in terms of total funds attracted in IPOs ($43bn). It was Hong Kong that placed the world’s largest IPO by the Industrial and Commercial Bank of China Ltd in October 2006.
The vice-president of the HKEx, Lawrence Fok, said that Hong Kong had the highest rate of market capitalisation to GDP – 595%! (For comparison, it is 221% in Singapore, 136% in the USA, 133% in the UK and 95% in Japan.) In addition, a larger proportion of issuers listed on the HKEx is made up of small and medium-sized companies. Issuers with market capitalisation of under $130m make up 55% of the total market. The point is that there are two stock floors in Hong Kong (as in London or other centres): the main one and one for start-up companies. It is pleasing that the ARA ARFC paid attention to this. Mr Arystanov said that Kazakhstan might also create an alternative floor for second-tier companies with softer requirements for issuers in the future. As for the HKEx, speakers from Hong Kong tried at the conference to detail all the nuances that issuers from Kazakhstan might face at this stock exchange. However, judging by the fact that half of the reports were aimed at extractive companies, it is clear that a real green light (and significant listing incentives) will be offered to this very same category of issuers.
Well, as the saying goes, saving drowning people is the problem of the drowning people themselves, it seems that local companies which are not “burdened” with natural resources do not have a real alternative to the local stock market.

Table of contents
Where Does the Brand Start?  Yevgeniy Zharkin 
Atlas Copco. Growth Strategy  Hans Hedensjö 
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