After decades of waiting, last year’s opening up of Saudi Arabia’s stock market to direct foreign ownership proved underwhelming as overly onerous qualification requirements deterred non-Saudi funds from investing. But newly announced changes to these restrictions and qualifications, due to be implemented in the first half of 2017, should draw in more foreign money and in the longer term help the kingdom attain MSCI Emerging Market status.
Such a designation has swelled the valuations of major listed companies in recently upgraded Qatar and the United Arab Emirates, while smart foreign money is already eyeing many Saudi blue-chips following a near-20 per cent drop in Riyadh’s index over the past 12 months. “Most stocks are pretty cheap and good consumer businesses are trading at 10-13 times earnings, so it’s a matter of scrubbing the earnings and seeing how confident you are on what you’d be paying for these stocks,” says Adam Kutas, portfolio manager for emerging and frontier equities at Fidelity Management & Research in London, which invests in Saudi stocks through promissory notes. “You have some very good stocks in a very good market, so for me now is a better time to invest than for the past two to three years, especially in the consumer sector.”
Non-Gulf investors based outside the kingdom had been restricted to buying Riyadh-listed stocks through promissory notes or swaps, exposing them to counter-party risk and denying them voting rights. Foreign investors residing in Saudi Arabia and Gulf nations could directly own Saudi stocks, likewise institutions that were majority Gulf-owned. Then from June last year, qualified foreign investors, or QFIs, were permitted to trade Saudi stocks, but on strict terms. These will be eased following scant foreign activity on Riyadh’s bourse; in June, QFIs’ represented 0.1 per cent of the exchange’s turnover, for example.
The regulator plans to allow foreign institutions to own up to 10 per cent of a listed firm, doubling the current limit, although total foreign ownership in a particular company cannot exceed 49 per cent. Currently, QFIs must have at least $5 billion in assets under management, but this will be slashed to $1 billion, while other restrictions will be loosened so the likes of foreign sovereign wealth funds and university endowments can more easily invest. The settlement period for stock trades will be extended to two days (T+2). Currently, Saudi Arabia uses same-day settlement, which is costlier for investment managers because they require sufficient money in their accounts to cover buy-side orders from clients, an issue exacerbated by the Gulf’s Sunday-Thursday working week.
“Most of these changes are driven by international investor demand to make the market more attractive to foreign investors,” says Asim Bukhtiar, head of research and investment advisory at Saudi Fransi Capital. “What they want to do is lower the hurdles to make the market more investible and to get MSCI inclusion, which will make the Saudi bourse more attractive to passive money.” Bukhtiar says the “over-arching theme” of the changes is to increase transparency and disclosure. “The CMA (Capital Market Authority) is trying to do this gradually—it won’t be a one-shot or quick gain, but implemented over time.” The regulator also plans to permit securities lending and covered short-selling, a move that should ease market volatility. “Short selling is an important aspect of a mature market allowing improved price discovery,” says Bukhtiar.
The market reforms coincide with the National Transformation Plan, or Vision 2030, unveiled by Deputy Crown Prince Mohammed bin Salman in April, central to which is the floating of a small stake in Saudi Aramco, the state-owned oil producer. “In my experience you need that very large-cap, liquid company for foreign investors to participate in to give them the ability to have exposure to the country,” says Fidelity’s Kutas. “Whenever governments are getting foreign investors more involved and reducing their involvement in the economy by privatising businesses this is usually a very good opportunity for shareholders and private business to generate very good returns.”
In April, CMA chairman Mohammed Al-Jadaan told Bloomberg that Riyadh’s stock market would double in size, claiming this could be achieved by adding dozens of new listings and easing restrictions on foreign investors. Jadaan said the number of listed firms would rise to 250 from about 170 currently, predicting Saudi Arabia would also roll out derivatives trading and real estate investment trusts.
Achieving these aims is only a question of when, according to Jan Dehn, head of research at Ashmore Group, which is one of about a dozen QFIs. “The efforts underway as part of the 2030 Vision to diversify the Saudi Arabian economy are important,” says Dehn. “If these proceed as planned Saudi Arabia will be an even more nuanced economy than presently, where, in fact, the Saudi market is already surprisingly diversified.”
Other planned changes include expanding the bourse to permit junior listings so that the likes of venture capital companies and start-ups can raise financing through the equity market. Whether these and other entities choose to do so will depend on “how they feel about their access to capital and about the cost of capital that the markets—either from banks or capital markets—will offer relative to the returns they hope they can generate,” says Fidelity’s Kutas. “It’s a function of capital costs versus the opportunity that’s in front of them.”
Bourse sectors will also be altered to more align with global norms standards, for example introducing a separate healthcare index. Currently healthcare companies are included in retail. The reforms won’t necessary mean “the money will flow in just because you’ve seen changes to the law,” says John Sfakianakis, director of economic research at Gulf Research Center. “What also has to happen is a change in confidence and the macro economy. At the moment, Saudi Arabia is undergoing a significant slowdown, which is the result of low government spending and low non-oil private sector growth.”
The push to broaden the market should be helped further by a new Companies Law that came into effect in May which makes it easier to create and operate local limited companies and joint stock companies. “The new Companies Law helps companies owned by one or two individuals to expand the ownership to multiple people or go public, which in turn will help improve corporate governance,” says Anees Moumina, chief executive of Jeddah-based SEDCO Holding Group.
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