DEVELOPMENT OF THE FINANCIAL SECTOR in THE REPUBLIC OF KAZAKHSTAN:

Anthony Espina & Usen Suleimenov

By Anthony Espina, Chairman of the Hong Kong Stockbrokers Association,
President of Goldride Securities Limited, Hong Kong
Usen Suleimenov, MIA( Master of International Affairs), Columbia University, New York, USA

The Government of the Republic of Kazakhstan has already taken a number of steps in creating the infrastructure needed for Kazakhstan to position itself as the financial hub for the Central Asian Region.  These steps included creating a state holding company “Samruk” to hold the shares in the large State Owned Enterprises (SOE’s) and a development fund “Kazyna” to encourage sustainable development, and establishing the Regional Financial Centre in Almaty “RFCA”.
In a review of the progress of the SOE’s, it became apparent that State’s assets in key sectors such as oil and gas, metallurgy, petro-chemistry, infrastructure should be combined to create a state corporation of the global rank, which is capable of implementing large scale projects.
Thus, in a package of measures announced on 13 October 2008, President Nursultan Nazarbayev signed a Decree on the merger of the two major state holdings “Kazyna” and “Samruk” into the National Well-being Fund “SamrukKazyna”.  SamrukKazyna will manage the state owned shares of “Kazatomptom”, “Eurasian Corporation of Natural Resources”, “Kazakhmis”, “Kazakh Mortgage Company”, “Kazakhstan Fund of Guarantees of Mortgage Loans”, “Housing Construction Bank”, as well as of seven Social-Entrepreneurial Corporations.
SamrukKazyna will operate along the lines of successful national holding companies such as “Temasek” in Singapore, and “Khazanakh” in Malaysia, and be engine driving regional industrial breakthrough.

Where Are We In The Development Of The Financial Sector?
One of the key initiatives in developing Almaty as the main financial centre in Central Asian Region is focused on creating favourable conditions for domestic and foreign financial institutions to act as the main providers of credit, insurance and financial services, and to facilitate the implementation of big regional projects.
The Kazakhstan Stock Exchange (KASE) was originally established as a currency exchange on 15 November 1993, 2 days after the launch of the national currency, the Kazakhstan Tenge.  In December 2006, the KASE was designated as the Special Trading Floor of the RFCA, and began trading as such on 27 February 2007.  Today, currency transactions account for approximately 25% of the trading turnover.  The KASE is also the primary trading platform for debt securities including short-term repos, and government and corporate bonds.  Besides currency and debt trading, corporate equities are also traded on the KASE.  However, equities account for less than 2% of the trading turnover.
Despite numerous concessions and incentives, Kazakhstan has only achieved limited success as a financial centre.  The credit crisis which hit Kazakhstan in 2006 was a re-play of the financial crisis which hit Thailand ten years earlier in 1996, and which subsequently became the Asian Financial Crisis.  To recap, local banks expanded rapidly in financing local development, and because they did not have the domestic deposit base to support this expansion, borrowed heavily from foreign financial institutions.  When the global financial crisis hit and foreign banks began calling in lines, the local banks were left high and dry.
Much of the plans to attract foreign financial institutions fell by the wayside as the economy adjusted to the contraction in credit.  With the entire world now embroiled in the Financial Tsunami, it is an appropriate time to re-examine the approach so that Kazakhstan is positioned to take advantage of the turnaround when it comes.

What Does It Take To Become A Financial Centre?
To be sure, a number of incentives have been provided to attract more corporate equity listings and foreign participation in order to boost the development of the securities market.  These include:
1. The RFCA is a tax free zone for brokers and investors.  Income from executing client trades, market marking, underwriting, nominee services, etc. are free of tax for broker dealers.  Dividends, and capital gains and interest income on securities bought on the KASE are also exempted from tax.
2. Where companies seeking a listing on the KASE have to undergo an audit (where none were previously required) the initial audit fees are reimbursed by the Agency of RFCA.
3. To facilitate communications with international partners, the RFCA will operate in three languages – Kazakh, Russian and English.
4. An International Advisory Board, with well known financial experts, has been set up to ensure that RFCA adopts the best practices from the international community in developing the financial infrastructure.  An example of this is the establishment of special financial courts to arbitrate financial disputes.
5. Participants such as broker dealers are required to be registered with the Agency of the RFCA and licensed by the Financial Supervisory Agency (FSA).  All dealings must be on the special trading floor (i.e. KASE), and foreign participants must have a permanent office in Almaty.
6. Debt securities can be listed as long as they have credit ratings at or above the level recognized by the FSA as investment grade.
7. Companies seeking a listing must either comply with the requirements of the Listing Rules as defined by the FSA, or be already listed on one of the recognized exchanges.  Exchanges which are accredited by the Agency includes NYSE, NASDAQ, and Toronto in the North America; London Stock Exchange, Euronext, Deutsche Borse, BME Spanish Exchanges, Borsa Italiana, Swiss Exchange, and MICEX in Europe; and Tokyo, HK, Shanghai, Singapore, and Taiwan in Asia.
But is it enough to provide easy access and incentives?  According to TIME magazine, the world will revolve around 3 international financial centres – NY covering the Americas, London covering Europe, Middle East and Africa, and Hong Kong the Asia Pacific Region.  What distinguish these 3 from the many which aspire to be financial centres?

Lesson Number One: Location, Location, Location
Historically, financial centres grew out of the need to service the local economy.  In the case of London in the 1600’s, the trade in commodities with the far flung colonies and later commonwealth countries created the beginnings of joint stock companies to fund larger enterprises, and insurance to distribute the risks.  The well renowned merchant banks came out of the integration of trade and finance.  NY became powerful providing financial services the vast American hinterlands.
The financial services sector in Hong Kong grew out of the need to finance the trading activities of the Hongs (British trading companies).  As its’ share of world trade grew, many foreign banks established offices in HK which engaged in foreign exchange and money market transactions to fund the trade finance needs of their customers back home, making HK an international banking centre.
With the accumulation of financial expertise in Hong Kong, currently there are 285 banks operating in HK of which 200 are foreign registered, it was a short step to help their client companies seeking longer term capital to raise funds through IPO’s.  Finally, with the return of sovereignty to the China, HK re-invented itself as the preferred listing destination of Chinese enterprises.
In the 1980’s Singapore had for a time challenged the supremacy of HK as a financial centre by offering many incentives to financial institutions re-locating their headquarters to that city including tax holidays, seed capital for fund management companies, etc.  However, at the end of the day HK’s position on the doorstep to China, and its’ location and ease of transportation, won out and HK became the choice of fund management companies investing in the Asia Pacific region.
A financial centre is a bridge between investors and issuers.  HK has been playing the role of financial intermediary to China over the past decade.  Since the first Chinese company was listed on the HK Exchange in 1993, Chinese enterprises have raised over US$250 billion from the equity market in HK.  China recently announced that it has foreign currency reserves of US$1.9 trillion which means that the equity market in HK provided more than 12% of China’s foreign currency holdings.
Kazakhstan has vast energy and mineral resources available and is situated at the cross roads between the East and the West.  Natural resource companies need to raise capital and loans to develop the resources, to refine the raw materials, and to distribute the end products.  Meanwhile, banks, telecommunications, media and transportation companies will also need to raise funds in order to provide the infrastructure necessary for the economy to grow in tandem.

Lesson Number Two:  The Foundations
Before international investors will flock to invest in equities in Kazak enterprises, they must feel comfortable with the clarity of the regulatory regime, the efficiency of the dealing and settlement platform, and application of the rule of law in dispute resolution.
The opportunities are boundless.  However, with a population of only 16 million, Kazakhstan will need to bring in additional expertise to develop its resources and infrastructure.  Financial services professionals will come from around the world and not just CIS countries (Russia has only just started on its’ own road to financial development).  Therefore, the use of a common language in international finance will be essential in order to allow participants to easily communicate with each other across the globe.  More than likely, this will be English.
Tokyo was an international banking centre the 1980’s when HK was just starting out.  With its’ huge financial institutions funded by strong deposit base, Japan was a financial juggernaut.  However, many financial institutions decided to locate their regional head offices in HK because of easy access to financial services professionals, and ease of communications in English.
Using HK and Singapore as models, the Dubai International Financial Centre went so far as to re-write the laws using English common law as base and to invite British judges to sit on cases that come to court.  Equities are traded and settled in US dollars on the Dubai International Financial Exchange, and there are no restrictions on the free flow of capital.  As far as familiarity with the system is concerned, Dubai’s approach is hard to beat.
However, both Dubai and Singapore lacks the natural advantage that both HK and NY have i.e. a vast hinterland in China and America respectively.  Additionally, Dubai has competitors as a regional financial centre in Egypt, Bahrain, and Qatar, while Singapore is competing with Jakarta and Kuala Lumpur.  HK has a formidable competitor in Shanghai as a domestic financial centre.  But for the time being, Shanghai is hampered by China’s rules and regulations and the lack of convertibility of the Chinese currency.
And let us not forget about logistics and transportation.  As a regional financial centre, Kazakhstan has to be a hub in the physical sense with frequent direct connections with major cities and financial centres, and ease of travel for financial services professionals.
Kazakhstan has the benefit of starting from scratch in building a financial services infrastructure, and has the benefit of access to the best practices available because of its enormous wealth potential.  The structures that have been put in place, such as “Samruk”, “Kazyna”, and RFCA shows the willingness to streamline existing institutions, and to put the weight of the government behind the push for modernization in financial practices.  More importantly, it has the wealth to put its plans into practice, and the strength of will to overcome whatever obstacles may be in the way.

Lesson Number Three:  Play To Your Strength
In 2006, trading turnover on the KASE amounted to US$169 billion, a huge increase over the volume of US$10 billion in 2001.  During this period, GDP rose from US$18 billion to US$57 billion, international currency reserves increased from US$2 billion to US$ 26 billion, and Foreign Direct Investments doubled from US$2.7 billion to US$5.4 billion.
The KASE Index rose from 216 on the 1 January 2005 to over 2,048 by the end of 2006.  Market capitalization increased 14 times to US$64 billion.
So far notable IPO’s include KazMunayGas Exploration and Production, and the secondary listing of KAZAKHHMYS which was listed in London.  Kazakhstan has enormous resource potential with many in the early stages of exploration and production.  Within a few short years, we will see major local resource companies being listed on the KASE.
In addition to resource companies, a number of SOE’s under the control of “SamrukKazyna” will be privatized and spun off in accordance with the charter of the development agency which is to facilitate development but to return control to the private sector when the enterprises are self-sustaining.
In the near term, Kazakh enterprises will need to look to an offshore exchange for primary listing for reasons of funding and liquidity, and to give international investors comfort in the quality of the listing.  For example, early listings of Chinese enterprises were wholly listed on the HK Exchange which has rules and regulations that international investors are familiar with.  As domestic liquidity builds up, China began to maintain dual listings with the domestic portion on the home exchange for domestic investors.  The ultimate aim is to repatriate the listing to the domestic exchange as the liquidity and confidence builds up, and the domestic currency is freely convertible.

Lesson Four:  Build strategic Alliances
Due to the previous Soviet influence, Kazakhstan has looked to Russia and London (because foreign financial institutions in Russia are run out of London).  Many Kazakh enterprises have listed on the AIM, the junior market in London.  However, they have found that the subsequent trading is subdue, and opportunities for secondary fund raising virtually nonexistent.
China has 140 million domestic investors and foreign currency reserves of over US$1.9 billion.  Chinese investors will be a powerful force in international finance.  Although they are currently barred from investing abroad, China allows Qualified Domestic Institutional Investors (QDII funds) to invest abroad on their behalf.  The HK market as part of China will be the first beneficial of funds going overseas.
Kazakhstan shares a common 1400 km long border with China’s Xinjiang Region, and is only 250 kilometres from Urumchi.  There are daily flights to Almaty from Beijing and Urumchi, or one can choose to transit in Bangkok or Seoul.  From Hong Kong, there is the additional choice of travelling to Shenzhen and taking an internal flight to Urumchi.  Almaty, and the capital Astana, are only 2 time zones away from HK and Beijing, and 6 time zones away from London and Europe.
A pipeline is being built from the Caspian to Xinjiang in China which will be a major end buyer of Kazakh energy and mineral exports.  Kazakhstan and Xinjiang is separated only by the Tian Shan mountain range.  Therefore, it makes sense for Kazakhstan, in positioning itself as the Central Asian Financial Centre, to more closely align with Hong Kong and China than with Europe.  Kazakhs are Central Asian in outlook and attitudes which are more Asian than European.  We look very much alike and think alike.

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