It is often the case with major regulatory changes in capital markets that results precede implementation, and indeed, the effects of opening the Saudi Stock Exchange (Tadawul) to qualified foreign investors (QFIs) were seen in the months leading to formal implementation of the new mechanism. The arrival of international asset managers like the Ashmore Group, the proliferation of new IPO funds and buoyancy of the main index in early 2015 were all ascribed to the QFI effect.
Timeline
The progression towards opening up the Tadawul to foreign investment began in 2008, when the Capital Market Authority (CMA) allowed the introduction of swap agreements. This innovation enabled foreign investors to stock pick and receive dividends, but their inability to claim voting rights and ownership of equities meant that this first stage of market liberalisation had only a modest impact on investor participation.
A more significant liberalisation was signalled in August 2014, when the CMA published new draft rules for foreign participation, and from June 2015 shares listed on the exchange were opened up to investment from QFIs. Then, in May 2016, the CMA announced it would loosen restrictions on foreign ownership in the stock market. The stake that a QFI is allowed to take in any company was raised, while foreign institutions’ minimum assets under management was lowered.
Quiet Start
Since June 2015, when the CMA opened the doors of the exchange to direct foreign investment, the noise surrounding the historic decision has receded. By the end of the year QFIs still accounted for a relatively small amount of stock market activity. According to the CMA, in the last week of the year the bulk of traded value by foreigners on the Tadawul was derived from foreign residents (68.2%), followed by swap holders (31.4%) and the recently approved QFIs (0.25%).
In terms of total traded value on the exchange, which includes institutions and individuals in Saudi Arabia and the GCC, as well as foreign participants, QFIs accounted for just 0.006% of the total.
In the first nine months after the CMA sanctioned investments by QFIs on the Tadawul, the response was muted. According to Jadwa Investment, between July 2015 and March 2016 the net capital inflow from foreign investors was SR794m ($211.7m), representing 0.1% of the total market capitalisation. The effect of the new regulation on exchange activity has been subtle, and QFIs accounted for just 0.08% of buys and 0.04% of sells for the week ending June 2, 2016. However, this should not be a disappointment to market observers. The CMA’s decision to take a conservative approach to the opening of the exchange is in keeping with its style of gradual reform.
By the second quarter of 2016 QFIs on the exchange were showing signs of increased activity, registering 4.6% of traded volume by foreigners in the first week of May, while trading via the old swap agreement model fell to 30% of the total. The high bar set for QFIs to enter the market was one of the main reasons the opening of the Tadawul to international investors did not generate greater inflows, according to Ahmad Nasralla, CEO of investment firm Maceen Capital.
“The opening of the market to QFIs has not attracted enough foreign investors for various reasons. One of the main obstacles has been the high capital threshold required for interested companies,” Nasralla told OBG.
Several Advantages
In its report for 2015, the regulator was clear in spelling out the advantages that an increasing number of QFIs will bring to the exchange, listing among other things the stability they will bring to the sometimes volatile market; the transfer of expertise to local financial institutions and investors; the enhancement of the performance of listed companies, particularly in the disclosure of financial information; the solidification of the Tadawul’s position as a leading market; and the promotion of research, studies and evaluations prepared on the market in general and companies in particular.
All of these goals are very useful in themselves, and taken together they should also greatly aid the longer-term ambition of the exchange to obtain a classification as an emerging market on global indices – most notably the influential MSCI index, which has already incorporated other growing exchanges in the region.
Capacity Building
The introduction of the QFI mechanism is as important from an institution-building perspective as it is as a means to attract capital. Nevertheless, the greater liquidity, knowledge transfer to market participants and exchange stability that increased QFI activity will result in remain desirable outcomes, and the regulator and authorities have already set about refining the new system to boost QFI volumes.
Opening Investment Doors
In May 2016 the CMA unveiled a draft of updated regulations designed to relax restrictions on foreign ownership. The draft regulations ease many of the restrictions currently faced by international investors looking to participate on the Tadawul. Significantly, the regulations lower the entrance barrier by reducing the minimum limit for the assets a QFI has under management from SR18.75bn ($5bn) to SR3.75bn ($1bn). This greatly expands the list of prospective investors, allowing for second-tier funds to buy into the market.
In addition, the CMA aims to lift the ceiling on the level of shares a QFI may hold in a listed company, with the maximum limit raised from 5% to 10%. However, the restriction on the total number of shares QFIs in all categories can own in a listed company will remain at 49%.
In May 2016 the CMA also announced it intends to introduce securities lending and covered short-selling. In addition, the regulator has broadened the range of permitted QFI and QFI client types that will be allowed to invest in the exchange to include government funds, university endowments and other entities approved by the CMA. QFIs may also choose to engage with a Saudi or non-Saudi portfolio manager. Lastly, the first half of 2017 will also see the exchange move away from its current system of T+0 settlement to a new T+2 framework. Taken together, these reforms bring the exchange into line with other emerging markets, and they are likely to result in increased foreign investor interest in the Tadawul.
Emerging Opportunities
According to some industry stakeholders, even after the reforms are implemented, other conditions will likely need to be met before greater numbers of foreign investors move into the market. “The initial opening up of the market to foreign investors saw a limited take up, but with the imminent changes to the rules we are expecting more interest,” Khalid Nasser Al Muammar, CEO of Saudi Hollandi Capital, a Saudi investment firm, told OBG. “The biggest move into the Saudi market by foreign investors is expected when we become part of the MSCI, which will lead to fund managers allocating a proportion of their portfolio to the Saudi market.”
The path to facilitate that move may be laid out in the near future, with the MSCI issuing a statement in June 2016 saying that the planned reforms by the CMA would improve Saudi Arabia’s chances of being rated as an emerging market. The exchange’s new rules concerning QFIs and their effective date will be published by the end of the first half of 2017, according to the regulator.
