While the GCC countries generally enjoy a high standard of living and prosperity, they are still behind the curve when it comes to its capital markets. The definition of capital markets predominantly means equity markets primarily in this region due to the lesser role played by the debt market. Notwithstanding, there is an immediate need to modernise the GCC capital markets in a way that it can deliver its true function–efficient capital allocation.

While there are myriad factors that can contribute to these modernisation efforts, the five most important factors are:

1. Integrate the Markets: GCC stock markets, like GCC states, are not a homogenous group. With Saudi Arabia’s market cap pegged at over $500 billion and that of Oman pegged at $18 billion, the comparison is never apples to apples.

Several efforts to unify GCC on many fronts including customs, currency, etc. achieved only partial success primarily due to political differences. In spite of this, unifying the capital markets and creating one stock exchange representing all GCC markets that trades both equities and debt can be a great step towards modernising. This will obviate the need to reinvent many things including state-of-art technology needed for a modernized stock market.

A unified GCC stock market can be worth more than $1 trillion in market cap and can list nearly 700 stocks, making foreign investors take a serious note of this region.

2. Institutionalise the markets: The major worry about GCC stock markets is the lack of institutional investors and therefore predominant presence of retail investors. The domination of retail investors is not bad per se, but the absence of credible long-term institutional investors is a serious worry.

While institutional investors provide the much needed stability and liquidity to the markets and can significantly deepen the market, they are presently quite under represented. Such institutional investors include sovereign wealth funds, mutual funds, pension funds, hedge funds, foreign institutional investors, insurance firms etc.

However, regulators and policy planners can take proactive steps in strengthening market microstructure in a way it can start appealing to institutional investors. Restrictions like foreign investment can be a big negative towards this process. Requiring market participants to adopt sound corporate governance codes can be a big positive.

3. Strengthen Information Base: A critical missing link here is the ability to obtain stock market-related information from websites. A diligent investor should sift through several pages (in English and Arabic) in order to even assemble some meaningful basic information about listed companies and markets. Technology can assist in this effort to seamlessly provide information across companies, sectors, family groups, etc., and this initiative can be taken by the respective stock exchanges.

4. Improve Liquidity: The main casualty of the global financial crisis has been the stock market liquidity for GCC markets.

After hitting a peak of $1.6 trillion in 2006, value traded for GCC stock markets hit a low of $296 billion in 2010. At the end of 2013, total value traded was placed at $475 billion. It may be a long time before GCC stock markets return to the volumes of 2006. Even extrapolating IMF forecast for GDP and its linkage to market cap, the turnover value is expected to touch $875 billion by 2019, still a far cry from the peak of 2006. Liquidity is a key dimension for the survival and growth of the brokerage industry and can be a key input for foreign investment. It is also an important factor for including GCC markets in global indices like the MSCI Emerging market index. At present, the UAE and Qatar have managed to enter this prestigious club but notable absentees still include Saudi Arabia and Kuwait.

5. Provide more tools for Risk Management: GCC stock markets are inherently more volatile than their emerging market peers primarily due to their nascent stage of development. Hence, managing this risk or volatility is a key underpinning for institutional investor entry. A buy and hold environment may not enable this.

Availability of broader tools like derivatives (options and futures) can provide the needed tools for managing this volatility. Derivatives are often viewed with trepidation in the region primarily because of its debilitating effect in the Global Financial Crisis. However, a good tool in the hands of a bad person does not make the tool bad. Proper checks and balances can make this serve the original purpose for which it is invented — to hedge risk and protect downside.

Modernising GCC capital markets can lead to several improvements that can be tangibly measured, including:

• Increasing the role of capital market in the overall economy as measured by the market capitalisation to GDP ratio. Currently it stands at 58 per cent while many countries in the world enjoy a ratio of over 100 per cent.

• Enabling GCC markets to find a place in the MSCI Emerging Market index. At present, only UAE and Qatar have this coveted status.

• Increasing the foreign institutional investment especially long-term investors like pension funds and endowments.

• Improving the new listings, which is at the core of market development.

All of these results are measurable. Can we then think of making these the Key Performance Indicators (KPIs) for our regulators and policy planners?

— M.R. Raghu, CFA FRM, is Head of Research for Markaz