Saudi Market Opens Up, but Gradually

DUBAI Saudi Arabia is inching toward opening up its equity market to direct foreign investment, but any move to grant international access is unlikely to unleash a flood of foreign money into the market.
Regulators of the Saudi stock exchange, Tadawul, the largest in the Arab world, are fine-tuning the draft of a law on Qualified Foreign Investors in the hope of attracting institutional fund managers to buy shares directly in the $400 billion market.
The market, which is equal in size to the combined value of the stock markets in the five other member states of the Gulf Cooperation Council, is large enough and liquid enough to be attractive.
But institutional professionals are likely to apply more scrupulous due diligence than the market’s current clientele of Saudi investors, resident foreigners and citizens of the other Gulf states, before taking significant investment decisions.
Until 2008, nonresident foreign investors were permitted to buy Saudi stocks only through mutual funds. Since then, a small window has been opened to the market through the permitted purchase of Saudi shares via swap agreements with authorized entities.
Saudi Arabia pumps more than 10 percent of the global oil supply, and with the price hovering above $120 a barrel, it does not need any immediate foreign direct investment. But the long-term plan to lower dependence on oil income, improve competitiveness of Saudi companies and create jobs is pushing it to embrace openness.
“Investing in Saudi Arabia is compelling for institutional foreign investors, given the massive government spending that is taking place in the country,” said Rami Sidani, head of Middle East and North Africa investments at Schroders Investment Management, who is based in Dubai. “Saudi Arabia has been following an aggressive strategy to diversify from one source of income, which is oil, and to do this they need to involve the private sector and attract foreign direct investment.”
Given the Saudi authorities’ measured approach to freeing up the economy, the largest in the Arab world, steps to attract international funds take months, if not years, to develop. After the Saudis opened up the swap investments in 2008, they followed in 2010 by introducing exchange-traded funds, index-based investment products that are traded like stocks, and allowing nonresident foreigners to trade in them.
This year, analysts and bankers expect enactment of the law on Qualified Foreign Investors. The Capital Market Authority’s announcement in January of rules to allow foreign companies to cross-list, though not directly related, is an indication that regulators are contemplating change.
A senior banker who examined the first draft of the Qualified Foreign Investors law in January and sent comments to the authorities said the Saudis were looking to benefit from global interaction. The banker declined to be identified because of continuing discussions with the authorities.
“They believe in the next couple of years, emerging markets will be the direction where asset managers will park their money,” the banker said, “and some Saudi-listed stocks will benefit with investment from foreign investors that will transfer knowledge and new ideas.”
The introduction of the swap agreements in August 2008 did not open the floodgates of foreign funds into the Saudi market, and the subsequent Lehman Brothers bankruptcy dented investor appetite in any stocks. Trades through swap agreements amounted to less than 1 percent of the volume on the Saudi exchange in February, while trades of Saudi retail investors exceeded 90 percent, Web site figures show.
The introduction of the Qualified Foreign Investors law is unlikely to change the status quo radically, because the Saudi authorities want to invite a selected group of foreign investors, those with assets under management of $5 billion or more, according to the law’s first draft.
“Hot money is their biggest concern, and that’s why they haven’t opened the market in the past,” said Paul Gamble, head of research at Jadwa Investment, a Riyadh-based diversified business firm. “By taking a qualified-investor approach, they hope to limit access to companies that will be in the market for the long term.”