As of late 2012 Saudi Arabia’s Capital Markets Authority (CMA) was on the brink of implementing new legislation that would allow foreign investors to own stocks on the Saudi Stock Exchange (Tadawul).

The Qualified Foreign Investors’ Law (QFIL), which has been in development since 2008, is expected to be officially implemented in early 2013. The new law is considered to be a primary component of the government’s long-term economic diversification strategy. This plan aims to develop the Kingdom’s non-oil economy and private sector, boost the competitiveness of local companies and create local jobs.

Foreign investment under the QFIL is initially expected to be limited to large-scale institutional investors. That said, as the CMA’s institutional capacity continues to improve, and provided that listed firms are able to adapt quickly to the new regulations, the market could very well be opened further in the coming years.

Long Time Coming

The QFIL is the result of four years of development at the CMA. Prior to 2008, the only way that non-resident foreign investors could participate in the Tadawul was through the purchase of mutual funds. In 2008 the regulator introduced new legislation that allowed foreigners to participate in swap contracts on the market, whereby an approved domestic broker holds shares on behalf of a foreign asset manager, passing on dividends and profits.

While these arrangements allow a foreign investor to obtain exposure to the Saudi market, they carry a number of risks. For example, because the stock is owned solely by the Saudi company, foreign investors do not have any voting rights, which effectively excludes most institutional investors from the swap market.

Indeed, foreign participation in the market through swap contracts has been largely negligible. According to a July 2012 report released by HSBC, between April 2009 and April 2012 swap agreements accounted for a total of SR76.6bn ($20.4bn) worth of transactions, for an overall capital inflow of just SR4.8bn ($1.3bn). The overall value of transactions during the same period was SR3.5trn ($933.1bn), which means that swap agreements accounted for just 2.2% of the total transaction value during the two-year period.

In early 2010 the CMA introduced legislation allowing for the launch of exchange-traded funds (ETFs) on the Tadawul and indicated that non-resident foreign investors would be permitted to own them. ETFs, which are collections of equities that are usually designed to track an index, can be traded like securities and have become quite popular in a number of Western markets over the past decade. In the Kingdom, however, ETFs have attracted minimal attention. As of late 2012 only three of the funds had been listed, and these remain predominantly inactive.

Finally, in what was widely seen as yet another step towards further opening the market, and a precursor to passing the new foreign investment law, the CMA announced in January 2012 that foreign companies would be allowed to cross-list on the Tadawul. Initial focus will be on the Gulf region; however, this may be expanded to include companies from other countries.

A Changing Market

Unlike the CMA’s previous attempts to attract foreign investors to the Tadawul, which have been met with limited interest, the QFIL is widely expected to have a major impact on the market. According to draft versions of the legislation and local media reports, the QFIL will likely limit foreign ownership – at least initially – to investors with at least $5bn under management, with the goal of attracting institutional players and long-term placements. Additionally, an early draft of the law included the stipulation that, “the maximum proportion of the issued share capital of any particular issuer whose shares are listed that may be owned by all categories of foreign investors in aggregate is 49%, including interests under swap.”


It remains unclear whether or not the implementation of the QFIL will result in a rush of foreign participation in the Tadawul. To function as planned, the law will have to overcome a number of hurdles. Some risk management is build into the law itself; by limiting inward investment to relatively large-scale institutional investors, the CMA hopes to discourage large amounts of short-term capital moving into and out of the market. It is feared that this so-called “hot” money could potentially cause equity price volatility, which, in some cases, has been known to spread into the banking system either as excess liquidity or a lack thereof.

Another challenge facing the CMA is the low percentage of institutional investors in the domestic market. This imbalance has the potential to scare off many foreign institutional investors. In November 2012, for example, individual Saudi nationals accounted for 93.7% of the Tadawul’s total sell volume and 89.6% of the buy volume, according to data from the exchange. These figures are in line with the bourse’s overall investor base. By way of comparison, retail investors only account for a small percentage of activity in mature exchanges in London and New York. In general, a large retail investor base corresponds to higher market volatility.

The difference in trading days between Saudi Arabia and the global market represents another challenge. The Tadawul is closed for trading on Thursday and Friday, the Kingdom’s weekend, while most international exchanges are closed on Saturday and Sunday. This could potentially lead to a gap in prices between the Tadawul and global markets in some cases, especially at the beginning and end of the week.

Finally, the Tadawul’s performance over the past two years may discourage institutional investors, many of whom tend to shy away from all but the most stable and transparent markets. Perhaps most importantly, the government has yet to release many of the key details about the new law, including the fee and commission structure for foreign investors. The cost of participating will likely have a major impact in terms of take-up.

Driving Demand

Despite these issues, Saudi Arabia is currently considered to be a prime investment destination, as evidenced by the inward flow of foreign direct investment (FDI) over the past decade. Indeed, according to a recent report released by NCB, the largest Saudi bank by assets, GCC countries are expected to attract around $40.7bn in FDI in 2012. The bulk of inward FDI has historically been attributed to Saudi Arabia and this trend is predicted to continue.

The Kingdom’s strong fundamentals bode well for overall economic growth over the course of the coming decade. Saudi Arabia boasts an estimated 17% of global crude oil reserves and the second-largest crude oil production capacity in the world, behind Russia. As of mid-2012 foreign reserves were nearly equal to 100% of GDP, which means the Kingdom is fortified against future economic shocks. Additionally, the government’s ongoing infrastructure and housing investment programmes are expected to buoy the domestic construction and financial sectors (among others) through at least 2020. This suggests strong performance for the economy and promises to drive market interest.

In addition to Saudi Arabia’s overall economic strength, the Tadawul itself is considered to be one of the top markets in the Middle East. Market capitalisation reached SR1.4trn ($373.33bn) by the end of 2012 – up 10% from the same period in 2011 – making the exchange the largest in the region. Saudi has also led the region in initial public offerings (IPOs) in recent years (see analysis). In 2011 – which was a tough year for the Tadawul, by most counts – five new companies offered IPOs, which resulted in an additional $461.22m for the market. This was down substantially on 2010, when the market saw nine IPOs, worth around $1bn in total; however, the IPO market recovered in 2012 with seven new listings for a total value of $1.42bn.

Potential Benefits

Considering exposure to Arab capital markets is still relatively limited throughout the region – and up until this point exposure to Saudi Arabia has been virtually non-existent – the QFIL could potentially attract a substantial number of foreign investors. This would have a far-reaching impact on the market in a number of ways. Perhaps most importantly, an increase in institutional investors (in this case foreign) would likely result in increased efficiency and liquidity in the market. This new depth could potentially encourage investors to adopt longer-term positions.

Additionally, foreign institutional investors are likely to demand more and higher-quality information about the market and individual listed companies before they buy in, which could, in the long run, lead to improved transparency, corporate governance and a better regulatory and trading environment. Finally, an influx of new foreign investors could also eventually lead to the introduction of new market instruments.


At the international level, the implementation of the new legislation is expected to improve the Tadawul’s standing among regional and global exchanges. According to Saudi financial services firm Al Rajhi Capital, the exchange will likely be granted frontier market status at the prestigious Morgan Stanley Capital Index. This recognition would put the Saudi market at the same level as those in the UAE and Qatar. This designation could be further upgraded to emerging market status provided that the Tadawul continues to promote better efficiency and transparency.