Plans for new regulations on direct foreign investment in the Saudi Arabian stock market have been outlined, setting out requirements and limits for oversees buyers seeking to buy into the region’s biggest exchange.
On August 21 the Capital Market Authority (CMA) released detailed information on opening up the Saudi Stock Exchange (Tadawul) to foreign investors, following on from the Saudi cabinet’s approval for the initial proposal in late July.
Although this marks a further liberalisation of the market, a series of caps on trading will restrict the ownership levels within individual companies and overall foreign participation on the exchange.
Setting a ceiling
Currently, foreign non-GCC investors are only allowed to invest on the Tadawul indirectly through mutual funds, corporate portfolios and swap arrangements. Local brokers buy the stock on behalf of the foreign purchaser, remitting the earnings from the shares, creating a more expensive process than direct cash transactions.
In its draft, the CMA has set a ceiling on the level of share holdings a qualified foreign investor (QFI) can acquire in any single company at 5% with a 49% ownership limit of shares within a firm by all foreign investors, including residents and non-residents, swaps and QFIs. The regulator has also proposed a cap that only 20% of issued shares of any one listed company can be owned by QFIs, while swaps and QFIs can represent only a maximum of 10% of the Tadawul’s total stock market value.
The new regulations require any QFI to have at least $5bn in funds under management and have been operating for a minimum of five years. This will rule out small-scale overseas investors buying into the market, while targeting large-scale institutional investors.
Allowing direct foreign ownership and gearing the exchange toward institutional investors will be a key milestone for the development of capital markets in Saudi Arabia and the wider economy, according to analysts at Jadwa Investment. The move will help reduce volatility that is generated by the larger risk appetite and short-term investment outlook of retail investors, which largely dominate trading activity at present.
“The opening up of the Saudi stock market, we believe, is therefore an initial step in the longer term objective of gradually moving towards more developed stock markets, where institutional investors are more prevalent over their retail counterparts,” said Jadwa Investment analysts in a note published at the end of August.
Emerging market status
The combined market valuation of the Tadawul is around $530bn at present, representing about 45% of the total capitalisation in the MENA region. Jadwa Investment forecasts a $40-50bn injection from total foreign inflows beyond the short term.
The initial response to the reform was positive. The Tadawul rose some 10% up to the end of August, hitting a six-year high on August 26 with a surge in the value of shares bought by foreign investors via equity swaps. Since the release of the detailed draft regulations the market has eased off its highs of late August, possibly as investors digest the operational limits the CMA plans to put in place.
Even with the caps, investors will see the opening of the Tadawul to foreign buyers as a significant opportunity. Over the past decade, and despite the downturn in the wake of the global financial crisis, the exchange has shown a return of 120%, according to an HSBC report, issued in mid-August. Investors will also be lured by the strong fundamentals of the Saudi economy and outperformers such as the world’s biggest petrochemical firm, Saudi Basic Industries Corp (SABIC).
“The opportunity set for foreign investors is too significant to pass up given the quality of the corporations and market breadth relative to other frontier markets in the Middle East that come with a higher risk premium attached,” Neil Azous, founder of research firm Rareview Macro LLC, told Bloomberg.
That potential will be consolidated if the Tadawul gains MSCI Emerging Markets status by 2017, as is largely expected, and a step up from its current standing of frontier market. This could have a positive impact on Saudi Arabia’s ability to attract foreign investment and capital to the exchange, with the raised MSCI index rating indicating greater stability and depth to a market.
Local concerns allayed
The CMA’s decision to set firm boundaries on ownership levels within individual companies and on the exchange as a whole will also reassure the owners and managers of local firms who had expressed concerns over being swamped by a tide of overseas capital.
Media reports in July suggested moves to open up the market would hit the flow of initial public offerings (IPOs). Concerns were raised that directors would be reluctant to go public if there was a possibility that large blocks of shares could be bought by foreigners – with many companies in Saudi Arabia family-owned or with high levels of family involvement – resulting in foreign membership on company boards or in management.