Trading rooms at the Mongolian Stock Exchange (MSE) appeared empty in the early afternoon of a December day in Ulaanbaatar. Most of the employees had left earlier to get ready for the corporate year-end party scheduled for the same evening. Above the empty desks, the quotes of Mongolian stocks scrolled by on the ticker. Only a handful of shares got actually traded in the morning session – as always.
"Liquidity is just not there," Altai Khangai, the MSE's chief executive, told bne in an interview a few days before tendering his resignation. "Although Mongolia has been on the radar screen of international investors for quite some time, they weren't able to enter the market due to lack of custodians, proper market legislation and infrastructure."
Only a couple of years ago, the MSE was tipped to become the next big story in emerging markets, with it stock market predicted to reach a market capitalisation of $45bn piggybacking the development of the country's booming mining sector.
The reality was somewhat different. The MSE still ranks among the world's smallest and illiquid stock exchanges. After peaking in February 2011, the blue-chip index has lost over 50% and total market capitalisation has fallen below $1bn. Only a few dozen of the 262 listed companies actually trade and daily volumes struggle to reach $150,000. Major international investors are nowhere to be seen.
With deeply reformed market legislation taking effect on January 1, the MSE has reached a turning point. The reform is expected to make up for most of the inconsistencies that have weighed down the exchange over the last years. The year has not started with a bang, as volumes were light as usual in the first trading sessions of 2014. And the resignation of Altai and his deputy, Saruul Ganbaatar, raised a few eyebrows and has thrown the institution into a delicate transition phase.
But local investors are still looking forward with renewed optimism, and the main Top 20 Index has steadily risen from the 52-week low hit on May 6, increasing more than 20% to stand at around 16,000 by end-January.
Liquidity is the key
The local brokerage Mongolian Investment Banking Group (MIBG) believes that "2014 is going to be the most exciting time in Mongolian equities" since 2009-2010, when the domestic exchange grew by more than 130%.
It bases this prediction on the new rules, introduced through a wide set of amendments to the 2002 Securities Market Law, that make it easier for international investors to get exposure to Mongolian equities, in a clear push to increase liquidity on the exchange.
"Today, the Mongolian capital market doesn't offer custodian banking services. That's the most important thing in attracting international capital. With the revised securities law, also custodians will be coming into place," Altai said.
Custodian banks are responsible for the safe keeping of assets. Global investors generally rely on custodians to administer their local holdings according to domestic regulations. As the new law opens the way for custody services, local financial institutions are expected to introduce them in the second half of 2014, paving the way for capital from international investors to flow in, boosting liquidity and hopefully the prices of undervalued assets. "If foreign custodians are in place in 2014, the MSE Top 20 could easily double to in excess of 30,000, from its current level of 15,500," Nick Cousyin of the local broker BDSec says.
The revised market law also widens the range of tradable securities to include, among others, derivatives and warrants; allows dual-listing of the many foreign-listed companies whose assets are mostly located in Mongolia; improves disclosure practices, which today go unnoticed; and sets up harsher fines for those who do not comply.
The reform, combined with the new London Stock Exchange's Millennium Exchange electronic trading platform that was introduced in 2012, might gain the MSE a place in the FTSE Frontier 50 index together with countries such as Argentina, Qatar and Vietnam. The exchange has been in the candidate watch-list since 2012 and "with the change of that law, hopefully we will be there," Altai said.
Provided the MSE eventually pulls it off, featuring in the FTSE Frontier 50 index would act as an additional catalyst for investment, as the index is a global reference for funds tracking frontier markets.
Going with the cycle
Beyond regulation and infrastructure, the fortunes of Mongolian shares appear strictly tied to Mongolia's economic cycle as a whole. "The MSE is a reflection of investor appetite for the sovereign story," MIBG's managing director, Chris MacDougall, says. "The country has taken a beating over the last 18 months. Poor legislative decisions, political posturing and negative commodities outlooks have weighed down on the economy. The MSE has also felt the pressure."
Mongolia has certainly not lived up to its expectations with the consequences of that felt across the board. Investments worth $6.6bn in the expansion of Rio Tinto's copper-gold Oyu Tolgoi (OT) mine, the country's largest mining development and a barometer of local business sentiment, still hang in the balance, as the government has locked horns with the British-Australian mining powerhouse over project finance details.
On a broader level, investors have been generally spooked by the authorities' continuous twists over regulations and licences, which further hurt investor sentiment toward the country. As a result, foreign direct investment was down 48% in the first three quarters of 2013.
So far, the government has managed to make up for flagging investor interest through an expansionary fiscal policy and loose monetary policy, and forecasts put economic growth for 2013 at around 12%. But that has proved to be little help for the MSE. "As long as this general attitude towards foreign investment changes, I don't see much increase in trading volumes," Mongolia Investment Corporation (MICC)'s president, Achit-Erdene Darambazar, says. "Investors' view is not as positive as it was a few years ago and also quotations of Mongolian companies trading abroad are not doing well."
The shares of Rio Tinto-controlled Turquoise Hill Resources, which is developing the OT project, lost 80% over the last two years on the Toronto Stock Exhange. In the same period, its subsidiary SouthGobi Resources, which owns and operates the Ovoot Tolgoi coal project, fell by 86%.
Mongolia is now at a crossroad. With the OT expansion still hanging in the balance and business sentiment deteriorating, economists are divided over the future of the resource-rich economy. The International Monetary Fund forecasts Mongolia will grow 9.6% this year, with a further slowdown to come in 2015 and 2016, when growth is expected at 5.8% and 3.8%, respectively. On the other hand, the Economist Intelligence Unit sees Mongolia posting 15.3% growth in 2014.
Given the country's tiny $10bn economy, it is clear that things can change on a dime in a matter of weeks. Should OT issue be fixed and the new, friendlier foreign investment law approved in October bear fruit, investment will flow in again, to the benefit of the MSE. Otherwise, even the improved market architecture will prove of little relief for Mongolian stocks.