Thursday, June 10, 2010

Central Bank of Kuwait - New Regulations on Investment Companies


AlQabas published a summary of key elements in a recent Central Bank of Kuwait general circular to investment companies subject to its supervision.

Here are the main points.

The new regulations were approved by the CBK's Board of Directors on 8 June 2010.  More details to be advised later. 
 
They apply to both parent and affiliate/subsidiary investment companies.  And on a consolidated basis.

Three key ratios are at the heart of the new regulations.
  1. Leverage Ratio:  Total Liabilities to Equity may not exceed 2:1.  Liabilities are "all" liabilities except for general and specific provisions.   This definition appears to include accounts payable, other liabilities, etc.  Not just debt to financial institutions or bondholders.  Total Equity excludes Treasury Stock and losses.  What's not clear is the treatment of  "fair value" and similar reserves. representing unrealized profits.  Those familiar with "history" in the area know that a lot of financial firms got in trouble by borrowing against "fair values" which later reversed.  And in some cases may never have existed in the first place.  Declaring profits against these fair values, paying bonuses and dividends against them, etc.  So the treatment of this element in equity is key.  Probably a limit on the amount of fair value that can be included in "Equity" is one solution.  What I'm thinking of is something similar to Basel II's treatment of the components of equity - Tier 1, Tier 2, and Tier 3.  Otherwise, "clever" bankers may discover  or manufacture hidden value in their balance sheets and thus undo the constraint. 
  2. "Quick" Ratio:   Liquid assets equal to 10% of Total Liabilities must be held.  Liquid assets are those than can be liquidated within a month and are composed of cash and deposits with the Central Bank and other financial institutions; Kuwait Treasury Bonds and similar Government paper including Central Bank of Kuwait paper;  other sovereign debt rated BBB or above.  Ratings must be from S&P, Moody's, or Fitch.
  3. Maximum Foreign Debt Ratio:  No more than 50% of Equity as defined above.  Foreign debt appears to be defined by location of the creditor (credit from "non residents") not the currency in which the debt is denominated.   At a leverage ratio of 2:1 then only 25% of debt can be to non residents.
The new regulations and ratios apply as of 30 June 2010.  If a firm is not in compliance, it must make efforts to improve its compliance with the final date to meet all the requirements no later than 30 June 2012.
  

8 comments:

Laocowboy2 said...

I am trying to source a copy of the circular. In the meantime I see some practical problems for those companies with an investment company licence that have foreign subsidiaries - which are in turn likely to have local borrowings.

That said, the move is welcome (if a little late - stable doors and all that).

Abu 'Arqala said...

Laocowboy2

If you manage to obtain a copy and are inclined, let us know what's in it.

Thanks

Anonymous said...

Go to CBK.gov it has all the circulars,

Anonymous said...

this is bullshit because:

* the central bank is not, in any way implicit or explicit, guaranteeing 'investment companies' as they do with banks. hence it was always caveat emptor.
* this forces speculatively inclined investment companies to morph into other forms of companies that dont fall under central bank supervision. think americana, national industries and a host of other non-financial companies using their balance sheets as prop trading accounts.

and this is the most important point:

* the authorities, because of their reticence to really punish violators and white-collar criminals with jail time and worthwhile penalties, are always coming up with cockamamie, vacuous plans that have little chance of working and will be entirely exposed by the next crisis.

Abu 'Arqala said...

Anonymous

Thanks for the tip on the CBK directives but I couldn't find those for investment firms. Just for conventional banks and Islamic banks.

Abu 'Arqala said...

Anonymous

Thanks for you comments.

Yes, regulators are always a step or two behind those who want to avoid regulations.

And fighting regulatory arbitrage - whether geographical, legal form or otherwise - is a never ending struggle.

One answer - and like all others is likely to only be partially successful - is for the Central Bank to team up with the MOIC. Have the MOIC enforce the corporate purposes embodied in the Memorandum and Articles of Association. I suspect that for many companies prop trading and extensive investments are ultra vires.

Another would be to define a company as a financial firm when its financial assets exceed some percentage of total assets. Say 10 or 15%. And then in those cases require that it obtain a financial license if it wants to exceed that level. Or force it to reduce its financial assets.

The Rageful Cynic said...

I'm trying to understand your concern about the leverage ratio, I get your point about fair value reserves and how they might not actually be "fair", but this element makes up a relatively small portion of equity (say around 5%) so is it really that big of an issue, do u think?

Wouldn't the unrealized losses take care of eradicating that "fake value" from the full equity number?

My issue is with the foreign exposure limit, a cursory glance at CBK's data on the sector shows that as a whole foreign exposure is about 20% or so percent, but the issue is that CBK should make it compulsory for firms to report these figures in their financials. Some firms report denomination of debt, but thats it.

The point of these measures is not just to regulate the investment sector activities, but it should also be to raise confidence in investors and analysts; what good is it if we can't see the numbers and figure it out for ourselves?

Abu 'Arqala said...

TRC

As usual thanks for weighing in.

Good point on the foreign debt disclosure.

As to my point on fair value, I was being characteristically elliptical.
I didn't make a distinction between Fair Value through Profit and Loss and Fair Value Reserves (which don't pass through the Income Statement).

You're correct that for many firms the FVR is a small component of equity. One such firm would be Global. But FVTPL was roughly 1/3 of 2007 and 2006 gross revenues.

When there were unrealized losses that would net out the earlier value. My point was pre-emptive. To prevent a firm from borrowing against 100% of unrealized gains. Once it does and the values reverse, the loans are still outstanding - which causes the problem.