Iran’s Capital Market to Grow New Skin

 

By Mahdi Goodarzi & Mojde Rezaee

Introduction

Since the JCPOA was hit, Iran’s economy, and therefore, Iran’s capital market have entered a new phase. Calling this market as one of the highest yielding emerging markets in the world, the head of Securities and Exchange Organization of Iran (SEO) assured investors, both domestic and foreign, that attempts are to uplift Iran’s capital market, providing the necessary foundations and infrastructures.

As the head of SEO added, upgrading the trading platform is the first step for developing the infrastructures and technologies, which was started by separating the trading platforms for TSE and IFB.  In addition to legal and tax motives as well as treating foreign investors the same as domestic ones, many other great steps have been taken to approach Iran’s capital market to global standards in order to encourage foreign investors to enter Iran.

The capital market movement indicates its tendency towards development and growth. Within the past year, incredible events have taken place, which have been covered before. The current article, however, will deal with the most important changes, signaling the market growth, at one glance. Such a forward moving trend will promise brighter days ahead of investors.

• Deepening the Debt Market

Taking into account the fact that modern financing instruments are mostly driven from the debt market, developing financial instruments in Iran’s capital market was started by offering Ijarah, Murabahah, and then Istisna sukuks; this led to the formation of debt market structure after Islamic Treasury Bills and Standard Parallel Salam were introduced, altogether adding to the market capacity. In a market-based financing system, debt securities issuance over the country’s GDP ratio provides us with an index to evaluate financing system development. Hovering around 2-3% during the past 2 years, this ratio has now hit 8-10%. The issued debt securities have also been very attractive for foreign investors. Table below takes a comparative look at the total issued debt securities in Iran’s capital market until 20 December 2016.

It is worth mentioning that during 2016/17, the debt market and fixed-income funds have been more prosperous than equity funds and investors have paid special attention to debt instruments in the debt market. The following table demonstrates that approximately $12 bn have been injected to such funds, which accounts for 98% of the total liquidity into all types of funds.

 

Presence in International Markets/ Sovereign Bonds

As one of the SEO attempts to play a more active role in international arena aside from holding fruitful meetings with regulators from Germany, Switzerland and South Korea and also joining the IOSCO, the Securities and Exchange Organization of Iran (SEO) now intends to facilitate the process of issuing bonds in international markets for the listed companies. According to an official, the first market will be South Korea and such debt securities will be denominated in euro. In this regard, the Central Securities Depository of Iran (CSDI) is in talks with the Korean Securities Depository (KSD) to provide the foundations specifically for launching clearing and settlement systems.

• Welcoming New Instruments

Options, as nearly all market practitioners and authorities believe, play a significant part in balancing and stabilizing the capital market, hedging risk and alleviating stress in the market. The more developed and advanced the capital market becomes, the more derivative instruments will be required to hedge the inherent risk of the market. Fortunately, the call option was launched, which will be soon completed by offsetting the position with put option along with short selling; this not only will deepen the market and adjust the value of trades, will also offer various strategies for market players. Having such instruments will result in new forms of information be published benefiting the analytical atmosphere and adding to investors’ financial knowledge. However, since this is new to our market, the occurrence of errors or mistakes is inevitable on its path moving forwards, which calls for low leverage for this item.

All in all, in order for this item to succeed, in addition to training and educating users, designing comprehensive software for risk management and introducing a market maker with a transparent strategy, issues like the base volume, fluctuation range and tickers’ halting period must also be reviewed. In this regard, a working group between the SEO, IFB, TSE, brokerage houses and market practitioners has been proposed to accelerate the full implementation of such instruments.

• A New Method Used in IPOs

After years of doing IPOs using the Auction method, which resulted in non-analytical price discoveries, the Book Building method was finally introduced.  Aimed at removing the problems faced at the time of IPOs and pushing investors toward market based analyses to find out the real value of a company, this new IPO method will provide investors with a fair and transparent atmosphere, preventing too much excitement in price discoveries in the market.

The first company which was initially offered by this method was Pakdis Company, in the Food and Beverage Sector, 10% of its shares, equal to 28 mn, were offered on IFB; with the price ranging from IRR 2200 to IRR 2310, eventually, the share price hit its high and each code received 570 shares at most. As the second of its kind, 10% of Rail Pardaz-e Seir Kosar, in the Transportation Industry, equal to 47,182,031 shares, was also offered on IFB with the price ranging from IRR 1900 to IRR 2090, whose price was finally set at IRR 2090; eventually, each code received 798 shares at most.

• Improving Disclosure Levels

Playing a significant part in every investor’s decision making process, financial statements in Iran are prepared based on Iran’s Accounting Standards, which although are partially backed by International Accounting Standards, are not fully in line with IFRS; this might turn understanding such information difficult for foreign investors. To tackle this problem, the first step was taken by the CBI in 2016/17 by obliging companies to release their financial statements respecting IFRS and apply criteria such as precisely estimating the required capital to cover credit and operational risks, disclosing assets and liabilities’ due dates, properly managing non-current facilities and running clients’ credit rating processes. This was followed by the SEO obliging blue chip companies to follow IFRS as well as binding manufacturing companies to monthly publish their production and sales reports.

• The Entrance of Venture Capital Funds

Taking into consideration the role of start-ups in global economies, the need to launch venture capital funds in Iran’s capital market was also deeply felt in order to make creative ideas commercial; the first steps have now been taken in Iran Fara Bourse and 5 VC funds have received the permission from the SEO; this, in the next phases, calls for supportive and transparent regulations along with a market for trading the stocks of such start-ups.

Lutous Parsian (an investment Bank) Venture Capital Fund, known as Rouyesh, as the first of its kind, was formed with IRR 500 bn in capital, in the field of healthcare, biotechnology and financial technology. In other words, among the projects covered are Royan Institute cellular treatments, a start-up in modern banking services and a start-up in the capital market services. Based on the fund’s articles of association and prospectus, each project is not allowed to be allocated with more than 20% of total resources of the fund. This fund is in fact tied to Royan Institute, a public non-profitable organization, which is dedicated to reproductive biomedicine and infertility treatments which now acts as a leader of stem cell research.

• Empowering the SMEs

The importance of having SMEs in the capital market is revealed when we know that more than 90% of the companies registered in the country fall within this category; however, they play far less than their capacities in the GDP, which mainly originates from lack of mechanisms directing resources to them. Considering the fact that small to medium sized enterprises contribute to 16% of the GDP and 45% of employment rate, an MoU was signed in the previous year between the SEO and IFB and the Ministry of Industry, Mine and Trade on the presence of the SMEs on IFB. In this regard, negotiations are underway to link SMEs’ managers with Iran’s Financial Center in order to be trained to produce standard financial statements. Another reason to develop such a market is the fact that foreign investors who enter the market are more inclined towards investing in and participating with private companies since decision making process is usually done more quickly and with less formalities. According to the CEO of IFB, near 100 companies have submitted their listing applications of which 6 are to be finalized and will start their activities before the current year ends.

As the first of its kind, 10% of Gameron Petro-Industrial Company’s shares, equal to 6 mn shares, were initially offered on the SMEs market of Iran Fara Bourse. Priced at IRR 30,000, only institutional investors and those individual investors with the minimum buy order of IRR 5,000,000 were allowed to participate in this IPO. As the second IPO in the SMEs market, 10% of Gaz-e Seke Company, equal to 4,919,000 shares, prices at IRR 1100 were offered in IFB only to institutional investors.

• Moving Towards a Securities-Based Exchange

Aimed at deepening the capital market and enhancing the financing process, Iran Mercantile Exchange has offered instruments, including Ijarah, Murabahah, Commodity Certificate of Deposit, Standard Parallel Salam and Projects Funds. In moving toward a securities-based exchange, commodity certificate of deposit has recently attracted much attention. Being approved in 2014, such certificates will be traded in the market through continuous auction method and settled in T+2. Besides, holders of such certificates can be granted facilities from the banking system collatorizing such securities.

Of advantages of using such instruments, managing the risks arising from fluctuations in raw materials and products prices, bringing about transparency in price discovery, lowering the gap between the manufacturer and consumer, standardizing products quality as well as creating a centered market for products and materials can be mentioned.

Relying on statistics, in 2015/16, 189,000 ton of corn were supplied based on certificates of deposits while in 2016/17, 305,000 ton of corn and 70,000 ton of barely were sold using certificates of deposits; besides, issuing such certificates for trading pistachio and saffron are to be finalized soon.

Conclusion

Having all been said, it seems that Iran’s Capital Market is taking steps to get closer and closer to international markets standards, despite the existing difficulties like lack of international custodians, credit rating agencies and obstacles in international money transferring. Although such problems have slowed the improvement speed down, all related bodies, affiliated organizations and agencies are determined to materialize this goal of deepening Iran’s capital market, signs of which were just briefly discussed.

DISCLAIMER:  This report has been prepared and issued by Agah Brokerage Firm on the basis of publicly available information, internally developed data and other sources believed to be reliable. The information contained herein is not guaranteed, does not purport to be comprehensive and is strictly for information purposes only. Agah does not assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. Any expressions of opinions are subject to change without notice. 

To contact reporters: Inter@agah.com