Market makers

The imposing rose marble building on Aiteke Street in Almaty, Kazakhstan's largest city, was built in the 1930s as the headquarters of the local Communist Party. In one of history's ironies, the structure today houses the stock exchange of this oil-rich republic.

On a drowsy late-summer afternoon, the Kazakhstan Stock Exchange, known as the KASE (pronounced KAHS-i-yah), is all but deserted. Rows of computers in the semicircular great hall are mostly idle, although four back-office workers slump behind monitors, one of which displays a game of hearts. On the main floor stands a Ping-Pong table; off to the side sits an exercise bike.

Kazakhstan's GDP -- $41 billion in 2004 -- has been climbing 10 percent a year on average since 2000, making it one of the world's fastest-growing economies. But what this richest of the old Soviet republics lacks is a functioning financial center. Now a powerful agent of change intends to fix that.

Nursultan Nazarbayev, who had been chairman of Kazakh-stan's Supreme Soviet before becoming the first elected president of the newly independent republic in 1991, is turning out to be an unexpectedly able and even visionary economic reformer. The authoritarian 65-year-old head of state is a champion not only of vigorous oil development but also of low inflation, a strong currency, modest state debt, sound banks and robust growth. Mindful of how vital a fully fledged financial system is to Kazakhstan's development, Nazarbayev is backing bold measures to transform Almaty into a rival to Moscow.

"By 2020, [our] banking and financial systems, which are today among the most advanced in the Commonwealth of Independent States, should turn Kazakhstan into the financial center of the Central Asian region," he declared to the Majilis, or lower house of Parliament, in September.

Kazakhstan's legislature is expected to debate and approve this month a three-part package of reforms that would establish the Regional Financial Center of Almaty as a tax-free special economic zone, allow financial players to trade such financial instruments as securitized loans and derivatives and streamline procedures for issuers and investors alike while doing away with registration and listing fees.

The idea is to create a flourishing financial bazaar that would compete with, and perhaps revitalize (or do in), the KASE. In contrast to that sleepy enterprise, which ostensibly trades only equity, the RFCA would offer a host of new products -- primarily bonds, special-purpose vehicles and derivatives -- while offering such inducements as lower fees and help with listing requirements to issuers.

"KASE's biggest problem is that nobody wants to do business there," says Madina Abylkasymova, the 26-year-old director of the Department of Public Policy Analysis at the Center for Marketing and Analytical Research and a promoter of the financial center. "Only a few companies place shares and bonds on the KASE. That is exactly the problem."

The KASE could certainly use a little energizing. The 59 companies listed on the exchange have a total market capitalization of 1.6 trillion Kazakhstan tenge ($11.8 billion), but they hardly trade; market participants estimate that barely 1 percent is free to trade. The exchange's stock and bond trading volume last year reached $7.38 billion, most of that bonds.

"In the absence of instruments, in the absence of specific players in the market because investors are strategic, the stock exchange can't do much now," says the KASE's deputy chairman, Bolat Babenov, with a shrug. His fond hope seems to be that the KASE may pick up spillover business from the new center, if the RFCA does indeed lure foreign investors and issuers.

The lack of an effective domestic capital market "is a really big problem," complains Magzhan Auezov, managing director of Kazkommertsbank, Kazakhstan's largest bank. "The securities market here can't provide for our needs." That was driven home this fall when one of the KASE's top ten companies, Kazakhmys, the world's third-largest copper miner, said it would also list on the London Stock Exchange.

Auezov's lament is vehemently echoed by Gaini Issabayeva, executive director of Halyk Savings Bank's Accumulating Pension Fund: "We need to be able to buy large portions of Kazakhstani stocks. We need more financial instruments. We need a liquid market."

Her $1 billion fund is the biggest of 14 state pensions that have amassed a combined $4 billion in assets and are piling up more at a $90 million-a-month clip. Like them, the country's four-year-old National Fund, which collects money from the oil and mining industries to set aside for future generations, is forced to invest its more than $5 billion at home.

In theory, the RFCA would give the funds a place to put their accumulating cash -- and would provide precious liquidity. The funds would be able to invest in companies from all over Central Asia. "We want to get the Russians to come to us [to list] rather than us going to them," says the Center for Marketing and Analytical Research's Abylkasymova.

Yet skeptics question whether Russians and other Central Asians can be persuaded to come to what they perceive to be a backwater. Though long Kazakhstan's cultural capital (and its political capital until Astana replaced it in 1997), Almaty, with a population of 1.3 million, resembles a gritty industrial burg, despite its abundance of walnut trees.

"If they build it, will they come?" asks one foreign banker of the proposed financial center. He notes that Moscow and Kiev are a long way from Almaty, in kilometers and in culture.

President Nazarbayev's faith that upgrading Kazakhstan's financial infrastructure will nonetheless pay off is evidenced by the pair he has put in charge of the project: Kairat Kelimbetov, minister of Economics and Budget Planning -- whom the International Monetary Fund once described as "minister of everything" -- and Anvar Saidenov, the respected chairman of the National Bank (whi ch owns 22 percent of the KASE).

"Having a working stock market would make it easier to offer an alternative source of funding, and it would add competition to bank loans," points out Saidenov. The 43-year-old has a master's degree in financial economics from the University of London and has worked for Halyk Bank and the European Bank for Reconstruction and Development.

Kelimbetov, 36, says Almaty's regional financial hub draws inspiration from those of Dubai, Dublin and Singapore. He and Saidenov reconnoitered all three to study their comparative advantages. Singapore offers unique products, a prime location and a stable political and financial environment, they concluded. Dubai, the first Arab financial center dedicated to attracting Middle East wealth, possesses a relatively sophisticated legal system. And Dublin, they decided, owes its allure chiefly to providing the lowest costs for financial dealings in Western Europe. One crucial feature -- government decisiveness -- was common to all three. "This condition will be satisfied in Kazakhstan, too," Kelimbetov notes.

The potential benefits to his country of Almaty's becoming a financial center are compelling, says Kelimbetov, a Moscow State University graduate who honed his English while taking management courses at Georgetown University in the late 1990s. He cites Dublin's success: Since the Irish capital's International Financial Services Centre opened 15 years ago, more than half of the world's best-known companies have registered to do business there -- though the center's first decade was something of a struggle.

Kelimbetov's cluttered office at the Economics Ministry in Astana is piled with foreign consultants' reports on the financial center project. The ultimate aim of the center, he explains, is to reduce Kazakhstan's dependence on oil by providing the means and the mechanisms for it to diversify into other industries, such as food processing, textiles and transportation.

Kelimbetov and Saidenov say it is imperative to establish the financial center soon to mount a timely challenge to Moscow. Nazarbayev has instructed Prime Minister Daniel Akhmetov to monitor the project personally and to push through the enabling legislation. Kelimbetov says he expects to hold a conference in Almaty at the start of 2006 to introduce the RFCA. The target opening date: the end of January.

Initially, the center will trade bonds, exchange-traded funds and special-purpose vehicles. Investors should find currency derivatives for hedging especially welcome. The center's temporary domicile will apparently be vacant buildings near the KASE, but plans call for grander quarters nearby. Eventually, the center will add an equity market. In addition, it will cater to Muslims, who comprise half of Kazakhstan's population, with shari'a-compliant Islamic notes and Sukuk bonds.

"We want to make it cheaper and easier for small and medium-size enterprises to raise funds here," Saidenov says. The pitch: Kazakhstan's financial center will offer issuers the chance to build up a credit history through modest deals -- as little as $10 million -- of three to five years. To encourage midsize companies to list, the center will pay for an internationally recognized audit and a credit rating, as well as waive listing fees.

Tax breaks offer a further inducement. Kazakhstan will spare companies participating in the financial center from corporate income taxes. Investors using the center won't have to pay local capital gains taxes.

As appealing as this may sound, selling the financial center to cautious Kazakhstani businessmen will take some doing. "There is reluctance on the part of medium-size companies here to sell shares on the stock exchange," concedes Saidenov. "They have a feeling that they will lose control of their companies."

To promote the formation of more midsize enterprises -- just the sort that the KASE and the pension funds need -- the government plans to embark sometime next year on a second round of privatizations. In the first round, in the 1990s, it spun off the companies now listed on the KASE. This time Finance Minister Arman Dunayev wants to hive off business units of state conglomerates, such as the national railway, Kazakhstan Temir Zholy, and the state oil and gas company, KazMunaiGaz. This activity should add impetus to the financial center. Indeed, Johannes Bšrner, a manager at Boston Consulting Group, one of the government's chief advisers on the center, calls the privatizations "simply an add-on" to it. Floating even some of the forthcoming IPOs on the RFCA could be a lure to outside investors. "That's an easy lever to pull," explains Bšrner, "and it forces investors to come to us."

However, Kazakhstan's current shortcomings as a financial destination aren't only on the supply side: Demand also lags. The "common people," says central banker Saidenov, "are not used to buying shares -- they prefer bank deposits."

The biggest obstacle, though, to Almaty's aspiration to become Central Asia's premier financial center can be stated in one word: Moscow. For a start, in sovereign credit standing Russia has caught up with the once higher-rated Kazakhstan; Fitch Ratings now gives both countries a below-investment-grade BB­. Still, according to a recent IMF report, Almaty is three to five years ahead of the Russian capital market in reforming financial regulations. Kazakhstan's banks are generally acknowledged to be better run and in better condition than Russia's.

Boston Consulting's Bšrner does not envision the financial center drawing hordes of Russian blue-chip companies. But he does foresee a bustling market in Almaty in midsize Russian and regional enterprises issuing bonds or securitized loans for $30 million to $50 million. "They're not interesting to London investors," he says, "but for Kazakhstani pension funds, that's just about the size they can digest." He predicts the center will hit $8 billion in annual bond issues in five years.

For Kazakhstanis, that would be a decent start, but only that. Given their country's sprawling geography, they are inclined to see things on a vast scale. "We believe that if we move fast, we can be an international center," says Abylkasymova. "But first, we need to establish ourselves as a regional center of excellence."

On a cautionary note, perhaps it's worth pointing out that Kelimbetov, an admirer of Brazilian writer and mystic Paulo Coelho, author of the novel The Alchemist, is himself enthralled by alchemy. He'll need more than a little of it.