Oliver Belfitt-Nash in Ulaanbaatar -

The Mongolian Stock Exchange may have been the best performing stock market in the world in 2010, but issues of transparency and liquidity keep foreign investors at bay. But the arrival of the London Stock Exchange this year to help modernise and regulate the bourse promises a new dawn.

In 2010, the MSE's Top 20 index rose 138% over the year to make it the world's best performing equity market. In fact, Mongolia's stock market had the distinction of being the best performer in the world over the previous decade, up 1,600%. Such a performance should've been enough to attract droves of new international investors, but with the vast majority of shares in the pockets of very few investors and an average daily turnover of just $100,000 for the whole exchange, manipulation and insider trading are commonplace.

Such a situation is a product of how the MSE came into being. When Mongolia transformed its economy into a market-oriented one in 1990, a stock exchange was quickly set up and 334 companies appeared on the list to be traded. Citizens could buy shares in any company with vouchers handed out by the government, but the MSE acted as a privatisation mechanism rather than a functioning platform for trading. Now over half of these stocks have been suspended by the Financial Regulatory Commission (FRC) and only 20 or so are worth considering as a serious investment. "We must remember that these companies were forced to list, they had no choice," Saruul Ganbaatar, chief strategy officer of the MSE, tells bne. "It doesn't mean they are bad companies or are acting immorally now - they may actually just want to be private."

Some of the names listed on the exchange give a new meaning to the term "penny stock", with market capitalisations of no more than $3,000 and traded only once or twice every year. Others have such small free floats that one keen investor can send the stock soaring. For example, Sudut Joint Stock Company hit the 15% gain limit for eight consecutive trading days as its market value grew from $50,000 to $840,000 in the last three months. This provided investors lucky enough to find shares to buy with a 1,700% return. These numbers scream market manipulation, but that is not always the case. "The FRC has investigated such companies and while some are accused of manipulation, we have found that there are also players in the market who can see value and are genuinely building up positions," says Saruul.

Indeed, the country's stock market more than doubled its capitalisation at the start of this year when a few large investments from investors such as Firebird Management sent the index leaping to over 30,000.

London calling

Still, these are the signs of a young market that the new management is keen to purge. And so on January 18, the government signed an exclusive Strategic Partnership Agreement with the LSE to help it restructure and develop the MSE. "This is a giant project for the Mongolian Stock Exchange and for Mongolia," says Ganbaatar. "We have been working hard and fast to bring the MSE up to London's standards."

To attract foreign investors, the bourse needs to offer more than extreme volatility; there must be publicly available information on a company's activities, liquidity in the market, and reliable legal infrastructure that supports both companies and investors. "Millenium IT is the latest software used in the London Stock Exchange and we are in the final stages of testing for Mongolia," says Saruul. "This will upgrade all areas of the MSE - surveillance, clearing, the trading platform and the exchange platform, and allow us to link to foreign exchanges to open up the investor base."

On the legal side, a new "Company Law" was passed by parliament in November, which will ultimately give companies a choice: either adhere to the exchange rules, or delist and go private. Criteria include floating at least 30% of the company and disclosing the required data to the MSE on a regular basis. Companies have until July 2012 to choose, and seeing as most listed companies have under a 5% free float, there may be a mass exodus from public to private once the deadline arrives.

The biggest change for the MSE will come from the new "Securities Law," currently with the cabinet. This long-awaited legislation will be the sturdiest pillar yet in Mongolia's push to bring up its stock market to international standards and is expected to be approved by the new year. "The new law will be like an umbrella under which details can be finalised and narrowed down. It may not be perfect, but it will leave room to adapt to the changing market going forward," says Saruul.

The financial sector will have a large part to play in these changes, as Mongolia currently has no custodian bank and all data, shares and funds are kept by the Clearing House and Central Depository (CHCD). "Banks are being rated by international rating agencies and are in discussions with international custodian banks," says Saruul. "With the FRC's approval, they will be able to be a clearing bank and keep investors' funds, offering the relevant interest rates and security to investors. Settlement with be with the Mongolian Central Bank, offering maximum security to investors."

Upcoming IPOs by leading Mongolian companies and the planned continued privatisation of state-owned enterprises over 2011 and beyond should further support the MSE's performance, say analysts. In 2012, the government plans to list the $15bn coking coal miner Erdenes Tavan Tolgoi in London, Hong Kong and Mongolia. The company is around eight times larger than every other MSE-listed company combined, and will represent many firsts for the Mongolian market.

The MSE must be up to scratch by the time they go public, as elections loom in June 2012 and time is running short. "We are on the fast track," says Saruul. "We have an excellent relationship with Erdenes Tavan Tolgoi and I am almost certain all will go ahead as planned. The market is now full of opportunities and the MSE will have a driving role in realising them. It is a great place to be."