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19 March 2024

Gulf sell-off fuelled by credit, lax regulation

Asian share markets slipped as talks between Greece and euro zone finance ministers broke down. (Agencies)

Published
By Reuters

The sudden fall of Gulf share prices as the price of oil slides has given new impetus to governments in the region to improve financial regulation to reduce the credit-fuelled volatility that has afflicted their nascent stock markets.

The stock markets of the Gulf were among the best performers in the world earlier this year, but panicked selling in recent weeks has wiped out all the year's gains in Kuwait, Qatar, Saudi Arabia and the UAE.

Experts say the volatility is driven in part by weak regulation, which allows too much leverage when prices are going up, and too few brakes when prices start to fall.

The worst hit has been Dubai's benchmark, which has lost around a third of its value since November 25, the day before Opec began a meeting which held oil production at current levels despite an expected glut of supply in 2015.

The plunge has turned attention to the region's easy rules on leverage, which allow investors to increase their returns with borrowed cash when prices are rising, but speeds the fall when prices turn south.

Much of this year's surge on UAE stocks had been funded by lending, either from banks or through brokerage houses, which can force investors to sell shares to cover losses in a falling market, driving prices further down.

"The speed by which we see these daily drops can only be explained by banks liquidating big portfolios that were collateral for margin trading," said Mohammed Ali Yasin, managing director of NBAD Securities, adding there was no way to tell how much of the market was being traded on margin.

The UAE authorities have noted the negative impact, with a senior central bank official saying on December 9 it was studying proposals for new rules on bank lending against shares.

However, the path to implementing regulation in the Gulf region has traditionally been slow. UAE officials said in July they planned to tighten bourse rules after problems at Dubai contractor Arabtec, whose share price surged on leveraged trading, crashed and dragged the wider market with it.

Few brakes

Gulf stock markets still provide few of the automatic brakes found in other countries, which can slow a sudden slide and give market participants time to respond.

The Abu Dhabi bourse has been the first in the region to experiment with automatic circuit breakers: it announced on Sunday it would temporarily suspend trading in stocks that fell more than five per cent. The bourse's CEO told Reuters that a study period for the implementation had been sped up due to the current slump.

Kuwait has intervened to prop up its market by aggressively buying stocks through the National Portfolio Fund, a state fund set up during the 2008 market crash to help stabilise prices.

"The National Portfolio is the missing element now and can be the trigger to end the selling spree and narrow year-to-date losses," said Fouad Darwish, head of brokerage at Global Investment House.

Such intervention is thought to be rare in the Gulf, where state-owned funds such as Saudi's Public Investment Fund are believed to invest in local bourses solely to make money, not to steady prices.

Kuwait has discussed other action to improve market conditions but has not set any timeframe for changes to take effect, Finance Minister Anas Al Saleh said on Sunday.

In the UAE, National Bank of Abu Dhabi is the country's sole licensed market maker, and is authorised to provide liquidity and sustain trading volumes.

Otherwise, there have been few interventions to shore up markets, including in Qatar, now part of the MSCI Emerging Market Index, or Saudi Arabia, due to open its stock market to direct foreign investment for the first time in early 2015.

Short-selling

Gulf countries generally do not have mechanisms to allow short selling of borrowed shares, which allow investors to profit when prices are falling.

While short selling is sometimes blamed for worsening panicked sell-offs in other countries, some market participants in the Gulf say restrictions on the practice make volatility worse.

Without short selling, investors, especially the retail investors who dominate the indexes, have no way to make money in a bear market, so when prices fall, trading volumes dry up.

Trading volumes in Dubai took more than four years to recover after the 2008 market crash wiped off nearly 80 per cent of the bourse's value.

Regulators have been lukewarm to the idea of allowing short sales, partly as the practice depends on borrowing shares which runs contrary to some interpretations of Islamic principles, and partly because short sales could push down share prices further.

The UAE market regulator last year created a vague framework for short-selling by market makers on the local exchanges. It also allowed local banks and local units of international banks to conduct securities lending and borrowing, but only under tight restrictions.

Restrictions can be circumvented by some investors through international banks that offer off-shore securities lending to a limited number of clients, but the practice is limited due to strict foreign ownership limits on Gulf markets.