Halfway house

Riyadh’s regulators appear increasingly cautious about opening the Saudi Stock Exchange to foreign investors. Published in The Gulf, June 2012

The Saudi Stock Exchange (Tadawul) has been having a turbulent year. The main market index, the TASI, gained more than 1,500 points in the first three months of the year, a rise of 24 per cent year-on-year, but since then it has dropped in value by 10 per cent.

Anticipating the ebb and flow of a stock market, and trying to understand the underlying factors, is something that can make or break individual investors or entire institutions. But one factor that could have a significant impact on the future direction of the Tadawul is particularly hard to decipher: knowing if and when the regulators will allow foreign investors in.

The market has been gradually modernising in recent years. Swap agreements have been available since August 2008 and exchange traded funds (ETFs) made their debut in early 2010, but allowing international institutions to put their money into the market would be far more significant.

This reform has been talked about for years, and there have been some indications that it might be getting closer. In January, for example, the Tadawul said it would allow international firms listed on other exchanges to also list their shares there, known as cross-listing. And at the end of April, the Tadawul signed an agreement with index provider MSCI which will see data from the Saudi market used in a number of indices.

However, there have also been some contradictory indications. At a meeting with executives from listed companies on 3 April, Abdulrahman al Tuwaijri, chairman of the Capital Market Authority, struck a cautious note.

“It is still within our strategy, but it should be done in an orderly and gradual manner to make sure it does not impact the market’s stability,” he said, in remarks reported by Reuters news agency. “This gradual manner will happen, but we need time to make it happen in a safe and orderly manner. We also need to make sure it will not have any negative impact on the market.”

According to Jarmo Kotilaine, chief economist at the local National Commercial Bank (NCB), there is a sense that Riyadh is getting more cautious, not least because the market has been performing relatively well this year. Despite the dip since early April, the TASI is still up more than 10 per cent for the year to date.

“It looks like the conversation has become less ebullient and more cautious,” says Kotilaine. “The basic message remains they will move ahead but it will be a very gradual process. One of the appeals of opening up to foreign investment was that the Tadawul seemed to be stuck in the doldrums for a number a years. Now this has changed. So it seems less urgent.”

Another reason for delay is concern about the weakness of some economies around the world and the risk of importing volatility to the market. With the Saudi economy buoyant from high oil prices and high government spending, there is little pressure on the authorities in Riyadh to act quickly.

“They don’t need the foreign money,” says Paul Gamble, head of research at the local Jadwa Investment. “There’s a lot of liquidity here. It’s not like the other markets in the GCC where trading has become very sluggish. They don’t want to do it at a time when they think market conditions would be volatile and, given they have no pressing need to do this, I think they’ll watch and wait for a period when they are comfortable.”

Even when they do open up to foreign investors, most expect it to happen in a gradual way, with Riyadh adopting a similar method to that used in China. That would involve a system of qualified foreign institutional investors (QFIIs), with a limit on the total amount of money they could invest in the market. There are also likely to be restrictions on the number of shares that foreigners can own in any one company and some, such as the Makkah Construction & Development Company, may be entirely off limits.

Initially at least, the demand from international institutions is likely to be limited by the absence of the Tadawul in some key global market indices, such as the MSCI Emerging Markets Index. Despite the recent deal between the Tadawul and MSCI, it is likely to be several years before it would be included in this index, which is used by many investors to guide where they put their money.

And while the Tadawul may be the most diverse of the Gulf markets, only a few areas are likely to prove attractive to investors, principally the banking sector, which offers exposure to the entire economy, and the petrochemicals industry.

“What you’d want from the Saudi market is some exposure to oil,” says Said Hirsh, Middle East economist at London-based Capital Economics. “You won’t be able to access Saudi Arabia’s crude oil capabilities [directly] but you can access those that are affected by it. So the most attractive sector is going to be anything related to petrochemicals or plastics, because that is related to oil.”

There are some potential, long-term advantages for the market if regulators do decide to open up to foreign capital. Beyond offering in a new source of funding for Saudi companies, it should also increase the proportion of shares held by institutional investors and, in the process, reduce the volatility of the local market which is currently dominated by retail investors. However, that doesn’t mean that share prices will rise.

“Opening up to foreign investors is a good thing, but hopes that this will see values go up are misplaced,” adds Hirsh. “Foreign investors might increase liquidity, but they could be selling as well as buying. It just means there are higher volumes in the market.”

After testing some systems last year to allow international investors to take part in the market, most observers say that the authorities are at least now ready to open up. The difficult part is knowing who might decide to give the go-ahead and when.

“What we saw last year is that systems were trialled to introduce the kind of QFII system they have in China,” says Gamble. “We think these systems are now there and ready to go and if the authorities choose to open up they could do so fairly quickly. Expectations of a rapid opening have been dashed but things are ready to go when it’s decided it’s the appropriate time to do so. It’s difficult to know because the decision making process is not clear.”