Clare Nuttall in Almaty -

Although the Kazakhstan Stock Exchange (KASE) is the most developed in Central Asia, its development has been slow compared to the country's banking sector. It now faces an uphill struggle due to intense competition from foreign exchanges for Kazakhstan's highly attractive pipeline of IPOs.

Kazakhstan's largest companies typically choose to list in London to gain access to high-quality international investors. Meanwhile, smaller Kazakh companies have been deterred from listing locally because of the high listing conditions set by the KASE. The latter is set to change from June 1 when new rules come into effect that will lower the bar for small and medium-sized companies listing.

The new listing rules are an important step in a four-year strategy plan for developing the stock exchange. Adopted in July 2007, the plan aims to reverse the trend for Kazakh companies to list on foreign exchanges. In order to address this, the KASE intends to become a trading floor where companies can raise at least $50m through an IPO.

But ambitions for the KASE go beyond merely creating an effective exchange for local issuers. Instead, the Kazakh government hopes to transform it into one of the top 15 Asian exchanges by 2015. "We don't want a Kazakh stock exchange; we want a major international stock exchange that is the gateway to the Central Asian market. We see London as our main competition," Arken Arystanov, Chairman of the Regional Financial Centre of Almaty (RFCA) told a recent conference. "We are already ahead of Russia by two to three years on legislation and investor relations. However, we are behind on retail investment, mutual funds and marketing work. Our aim is to complete all regulation and remove financial obstacles this year in preparation for a major expansion of the stock market in 2009."

While its main targets are local institutional investors, the KASE also plans to attract quality foreign investors, and to encourage retail investment on the exchange. "The stock market must be viewed by retail investors (including investment management companies servicing such investors) as the convenient and efficient floor to place money and speculate in financial instruments," the development plan states. The strategy also sets out plans for the introduction of new financial instruments, integration with world exchanges and the marketing of the exchange.

The first step in the plan was the commercialization of the exchange in late 2007. This paves the way for the IPO of the KASE itself, due to take place later this year. After the IPO, the KASE is expected to merge with the RFCA to create a single, strong regional market.

The RFCA was originally set up in 2006 because of dissatisfaction with the slow development of the KASE. However, this led to a situation where the market was split into two, with most issuers listed on the KASE while some were on the special trading floor of the RFCA. "It became clear that the RFCA and the stock exchange are a duplication," says Gregory Vojack, managing partner, Kazakhstan, of law firm Bracewell & Giuliani, which drew up the new listing rules. "Their merger will create one trading organization with one consistent set of listing rules similar to that used by the London Stock Exchange and other European exchanges."

Sub-prime effects

The sub-prime crisis that had such a devastating effect on Kazakhstan's banking sector could, some hope, actually be a stimulus for the KASE. Arystanov said recently he expects to see the market boom this year, with increases across the board in assets, market capitalization, trading volume and the number of issuers. Although the KASE president Azamat Joldasbekov is less sanguine, he forecasts that as companies, especially in the real estate and construction sectors, lose access to bank finance, they may look instead to a stock market listing.

"Previously, companies looked to borrow money to build their businesses rather than at the equity markets. Because there are liquidity issues with the banks, companies are having to look at alternatives to debt to build their businesses. One option is to list on the stock exchange," explains Vojack.

However, for the KASE to be an effective alternative source of finance, it will have to attract more investors. At present, Vojack says, "it's a relatively small exchange, and many of the listed companies are not very liquid."

Although relatively small, the KASE has nevertheless increased considerably in trading volume in recent years. After a slow but steady increase between 1999 and 2006, trading volume soared from $2.5bn in 2006 to $8.9bn in 2007. The main index of the KASE, KASE Shares, has increased by over 300% since the beginning of 2006. Despite a flattening out in the latter part of 2007, it has enjoyed modest growth in the opening months of 2008.

Activity on the KASE is much greater than that on Central Asia's other exchanges. In comparison to the KASE's market capitalization of $67bn, the Tashkent Stock Exchange (UzSE), for example, has a market cap of $2.75bn, and the Kyrgyz Stock Exchange (KSE) $144m. Average daily trading volume for stocks on the KASE is $140m; on the UzSE it's just $258,000, and on the KSE $375,000.

This disparity gives credence to the ambitions in Kazakhstan of turning Almaty into a regional financial hub for the Central Asian region - precisely the reason why the RFCA was set up. It's also envisaged that companies from Uzbekistan, Kyrgyzstan and the rest of Central Asia will list in Almaty, which will become a gateway to the region for international institutional investors. "The KASE is understood to be the best, in fact the only real stock exchange among the countries of this region," says Vitaly Kan, analyst at BTA Bank. "In the foreseeable future we expect foreign companies to list on the KASE. Kyrgyzstan and Uzbekistan have stock exchanges, but they are not as developed as the KASE, so there are benefits to listing on the KASE."

However, there are numerous obstacles that need to be overcome if this is to become a reality. Practical hurdles include Uzbekistan's lack of currency convertibility, which at present prevents its companies from listing abroad, as well as other regulatory issues in both countries.

There is also a psychological barrier, a natural resistance within the Uzbek and Kyrgyz business communities to the idea of working with a Kazakh "big brother" who stands between them and the international financial community. The Kyrgyz exchange, for example, has made overtures to foreign exchanges in the hope of setting up its own partnership agreement like the KASE has with the London Stock Exchange (LSE). For the meantime at least, companies that have larger ambitions than their local market and are in search of greater liquidity are more likely to look to London or other international exchanges than to Almaty.

International listings

Even Kazakhstan's own largest companies have made an international IPO a priority ahead of listing on the KASE. Seeking access to top-quality investors and international exposure, the country's largest banks, natural resources companies and real estate giants have flocked to the LSE.

Commenting on the decision to hold its IPO in London rather than Almaty, Miguel Perry, CFO of Kazakhstan's only FTSE-100 company, ENRC, says: "We listed in London to get the advantages of being on an international market alongside other international mining companies, which are a good peer group for us. This also enforces good standards of corporate governance and transparency." Halyk Bank's chairman and chief executive, Grigory Marchenko, also cited the "high quality of international investors" the bank attracted in its December 2006 IPO.

The KASE is also seeing increased competition from other international exchanges who want a bite at the IPO pipeline for state companies. At the 2nd Annual Central Asian Investment Conference in March this year, conference sponsors NYSE Euronext aggressively promoted themselves as an alternative to London for Kazakh companies. Asian exchanges such as Hong Kong are also contenders, as are the Moscow exchanges.

However, the Kazakh government is putting its considerable weight behind the KASE, using its position as a shareholder in major Kazakh companies to induce them to list on the local exchange, with the aim of increasing activity on the market and making it more attractive to investors.

ENRC, for example, dashed hopes of a dual IPO in London and Almaty by choosing to list initially on the LSE, but followed this with a KASE listing three months later. "We understand that the government will undertake a retail offering, sell part of its shareholding, a small part but part of it, to generate liquidity in our market and to inject a local shareholder culture within Kazakhstan," says Perry.

Similarly, the Mangistau Electricity Distribution Network Company (MEDNC) announced in May that it was making a public offering of 20.4% of its total share capital. The offering was aimed as much at stimulating the stock market, as at raising funds.

Smaller prey

Even so, there is no immediate prospect of the KASE being able to offer the kind of liquidity that Kazakhstan's big banks and natural resources are looking for. This makes the decision to relax the rules for smaller companies in order to encourage them to list a shrewd one.

"For big companies, it's better to be listed on foreign stock exchanges because these stock markets are more capacious and liquid, and it's possible to obtain more capital," says Vitaly Kan, securities analyst at BTA Bank. "However, there are benefits for medium sized companies. The KASE is a much cheaper and quicker option. We also expect it to become easier for companies to access foreign capital through the KASE. There are not many foreign investors at present, though some Russian companies have expressed an interest in obtaining shares and bonds of Kazakh companies, but this will change."

The rules were drawn up by the State Agency for Regulation of Operations by the RFCA, and came into force on June 1. They divide companies into three tiers - "blue chip", medium sized and start-ups - each with different listing requirements, and are designed to make it easier for small and medium-sized companies to list on the KASE. Previously, as BTA's Vitaly Kan points out, the conditions for listing on the KASE "were set very high, and it was only possible for banks and big companies like KazMunaiGaz E&P and Kazakhmys to meet them."

In addition to lowering the financial bar, the key change for medium-sized companies and start-ups concerns the number of years of audited accounts they need to produce. "Producing audited financial statements for more than one or two years can be very difficult for smaller companies," points out Bracewell & Giuliani's Vojack. The planned changes to Kazakhstan's tax code, which are expected to lower and simplify the corporate income tax rate, are also expected to make it easier for smaller companies to list.

But even if the new rules persuade more companies to list on the exchange, there remains a stumbling block: more investors will need to be attracted to the exchange if it's to become liquid and to be a good source of funding for smaller companies. After all, on London's AIM market many companies are not particularly liquid.

The KASE's development strategy envisages ways of improving this - through new financial instruments to encourage retail and other investors. Unlike in neighbouring Kyrgyzstan, the KASE's liquidity problems do not stem from a lack of money. Revenues from natural resource exports are increasing due to high prices on world markets. The country has also been accumulating money in private pension funds, which now contain over $7bn.

The lack of financial instruments to invest on the stock exchange has meant that investments have mainly been channeled either into government and fixed-interest bonds, the over-heated real estate sector or abroad. Meanwhile, entrepreneurs have looked to the banking sector or to loans from family and friends in order to expand their businesses.

Having said this, the number of local institutional investors, who include Compass and Centras Securities, are growing. "There are some great investment funds and pension funds are also increasingly active," says Vojack. Visor Capital forecasts that around 12 mutual funds affiliated to commercial banks and industrial groups will be created by the end of this year.

The KASE's development strategy envisages the creation of new financial instruments for trading. To this end, its plans include launching a currency swap market, and enabling the listing of shares of unit investment funds. It will also examine ways of reanimating the currency futures market. As the market for shares develops, the KASE will start preparations for the launch of a derivatives market for the KASE Shares index and the ETF (Exchange Traded Funds) market.

It also hopes to turn the Kazakh population into active investors on the stock exchange. To encourage this, the RFCA has launched the "National Share Game," where potential retail investors make virtual trades on the KASE - testing their skills at playing the stock exchange without risking their money.

If all this seems over-ambitious, it should be noted that in less than a decade, Kazakhstan evolved from a nation where people kept their savings under the mattress to the home of the CIS's most sophisticated banking sector. The KASE is hoping to emulate a similar revolution on the stock market.

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