The decision of the Saudi Capital Market Authority (CMA) to open the Saudi stock exchange to foreign investors has induced a lot of excitement and optimism in the market.
In this article, we discuss what the change is all about, why it is important, how it is likely to be implemented, and what will be its impact on various stakeholders.
What? Why? How?
So what exactly is going to happen? On July 22, 2014, the Saudi government announced that the Tadawul All Shares Index (TASI) will be open to direct foreign institutional investment from the first half of 2015. This would mark a welcome departure from the current state of affairs, where foreigners can purchase Saudi stocks only via trades conducted through international banks and by making a small number of costly and time-consuming exchange-traded funds (ETFs). As a result of these restrictions, foreign investors currently own less than five percent of the Saudi market, and account for a meagre one percent of the volumes traded on the TASI, which is dominated completely by local retail investors. But once these restrictions are eased in 2015, foreign investors will be able to participate much more freely in the Saudi market, and own and trade stocks of public companies in the kingdom.
Why is the change important? With a capitalization of $530 billion, the Saudi capital market is much bigger than its regional peers (Dubai and Abu Dhabi combined have a market cap of about $235 billion, Qatari listed companies are worth $196 billion and Egypt’s market is about $69 billion), and also boasts of superior liquidity – the daily average turnover at TASI is $2 billion, which is once again much ahead of the trading volume in other Arab nations. And to add to these points is the fact that the Tadawul is home to the some of the largest companies & IPOs in the region, belonging to diverse sectors ranging from petrochemicals to banking to telecommunications to retail and real estate. Therefore, from an investor standpoint, the TASI is one the biggest market which is currently closed to foreign money; therefore, its proposed opening to foreign investors is perhaps the most significant investor-friendly step taken by a Middle East or GCC nation in many years.
However, the Saudi government is not taking this step simply to appease investors. Instead, this move is a part of the kingdom’s long-term strategy to reduce dependence on oil revenues, and strengthen the non-oil sector of the largest economy in the Middle East. The decision also comes close on the heels of Qatar and the UAE getting included in the MSCI emerging market index, and Saudi authorities surely don’t want to be left behind on this front, so an indirect aim would be to get the TASI listed on the MSCI frontier or emerging market index.
The importance attached by the market to this move can be gauged from the fact that the TASI jumped 2.8 percent to a six-year high on the day the announcement was made. Also, the IMF boosted its 2015 GDP growth forecast for KSA from 4.1% to 4.6%, based on expectations of strong private sector performance.
How will the change be implemented? The CMA is yet to come out with a definite plan, but it is obvious that the roll-out to foreign investors will a slow and gradual process to avoid volatility in the market, and also to test waters in a phased-out manner.
One of the reasons that this change has taken so long to come is that Saudi authorities have been very protective of the companies in the kingdom, and have been averse to foreign investors taking control of key listed companies. Therefore, we can expect the CMA to impose caps on the amount being invested. While official numbers are yet to be announced, the market expects that foreign institutions will not be allowed to own more than 10% of the Saudi market and more than 20% of a Saudi company.
Further, to start with, a limited number of investment licenses are likely to be granted to qualified investors only, in order to avoid a sudden influx of foreign money into the Saudi companies. Such investors likely to be chosen based on the size of their assets under management (AUM) and global investment management experience, with most expectations pointing to an AUM bar of at least $5 billion. Retail investors are unlikely to be given licenses for buying and trading in the first phase of the roll-out.
Finally, most experts believe that the KSA is likely to follow the route adopted by emerging markets like China and Taiwan, where a free and open market is regulated by government officials. Also, oil and gas companies may be kept out of the purview of the initial roll-out to ensure that the Saudi government retains control over firms currently generating majority of the national revenue.
What are the implications of opening-up of the market to foreign investors?
- On the KSA economy: Saudi Arabia’s economy is likely to get a double boost from this move. First, the influx of foreign capital will boost the overall GDP, and push along the diversification to non-oil revenues that will ensure sustenance of growth. Secondly, a well-diversified and growing economy will help tackle the high level of unemployment, especially among the youth, in the country. As cited earlier, the IMF has already increased its 2015 growth forecast from 4.1% to 4.6%, expecting economic diversification to drive growth.
- On the Tadawul Index (TASI) and the overall capital market in the kingdom: The index will become the gateway to foreign fund inflow worth ~$50 billion into the country, strengthening its case for inclusion into MSCI’s emerging market index. Even though such an inclusion unlikely to take place before 2016, the TASI will account for three to five percent of the index, when eventually included. The move will also boost trading and IPO activity on the TASI, and will also result in production of higher quality equity research in the region.
- On Saudi Companies: Most large Saudi companies are cash rich, so obtaining additional funding will not be the biggest gain for them. Instead, such companies will benefit from shareholder activism and improved corporate governance and accounting standards that are likely to be implemented to meet the high standards expected by foreign investors. These companies will also benefit from receiving guidance and expertise from globally experienced investors, on operational as well as strategic issues. For medium-sized companies, influx of foreign capital will lead to lower financing costs and improved valuation. Further, working with global investors will allow companies in the KSA to think global, and will help them execute their international expansion plans (regional or global) in a better manner.
- On Investors: The move will give investors much awaited access to the largest economy in the GCC and in the Middle East. Huge foreign reserves, a low-risk sovereign credit quality, and an emerging-market like growth potential make the KSA an especially attractive destination for foreign investors. Additionally, through the TASI, it will give them access to leading firms across industries, such as Samba Bank, Saudi Basic Industries, Saudi Industrial Investment Group, and Yanbu National Petrochemical Company. Not only do these companies have a huge “upside” potential, most Saudi companies also have better corporate governance standards as compared their peers in the Middle East.
- On Other Asset Classes: The current move is aimed at opening-up of the equity market. However, if the move is successful, it could prompt the government to open even the bond (or Sukuk) market to such investors. Even though such a follow-up move will take a long time before being implemented, the opening-up of the local Sukuk market would give foreign investors access to companies that sold 42 billion riyals ($11.2 billion) through a dozen sales in the past year, according to Bloomberg.
Overall, if implemented well, this move has huge positive implications not just for the KSA, but also for all other countries in the GCC and the Middle East, as discussed above. However, investors are keeping a close eye on the announcement since policymakers in the kingdom have put off such plans in the past. Therefore, it is important that the CMA comes out with a well-defined roll-out plan with actual dates and timelines to alleviate investor concerns, and implement what will be a landmark change in the way capital markets operate in the Arab World.