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Capital Markets

Capital markets: Foreigners on Saudi stock market next year

China-style system; Test trades completed

Saudi Arabia is preparing to open its stock market to direct investment from outside the Gulf for the first time, Euromoney has learnt.

Sources involved in the preparations say a Chinese-style system of giving access to qualified foreign institutional investors (QFIIs) could be implemented early next year.

Banks and investment firms have conducted test trades in recent weeks for sales of publicly traded stock to investors based outside the Arab Gulf countries. The local Capital Markets Authority (CMA) has overseen the process, testing the functioning of the system at the local exchange (the Tadawul) and ensuring market participants understand the necessary checks, according to the sources.

Euromoney understands limits could be similar to the Chinese system, although qualification criteria have not been finalized. In China, to qualify, foreign investors must be institutions in business for at least five years and with at least $5 billion under management. Saudi Arabia might now replicate these limits.

The regulator is also expected, as in China, to set limits to the holdings of QFIIs, both in terms of the proportion of stock held in single companies, and the minimum and maximum absolute amount of investment in the exchange as a whole. In addition, in Saudi Arabia existing rules prevent foreigners from owning local companies in fisheries, land transport, Mecca real estate and other sectors. Listed firms focusing on these sectors will therefore remain off limits to foreigners.

It is hoped that opening the market to foreigners will be an important step towards inclusion in global emerging-market indices, bringing in global insurance firms and pension funds that track these indices. In the longer term, it is hoped the QFIIs could lead to a market based more on economic fundamentals and professional equity research. In the absence of a large pension fund and insurance sector in Saudi Arabia, retail investors predominate on the exchange.

Aside from the desired boost to the market’s global prominence, one analyst says opening access could bring an initial surge of optimism among local investors. "There has been sufficient preparation for the market to open," says another source at a firm that has worked with the authorities on the scheme.

Nevertheless, as the authorities will be keen for a QFII scheme to be seen as a success, they might wait for more clarity on the eurozone sovereign debt crisis before going ahead.

From mania to lethargy
Tadawul all-share index, 2005 to 2011
Source: Jadwa Investment

A scheme to allow foreigners economic exposure to the market via swaps was introduced in August 2008 – shortly before the collapse of Lehman Brothers. Investors from outside the region still hold only around 2% of the market’s capitalization, which has disappointed some. The Saudi authorities are, moreover, perennially worried about destabilizing reform, and the dominance of retail investment means developments at the stock market are highly politicized. Those expecting imminent change in Saudi Arabia are often disappointed: a long-delayed new mortgage law is a case in point.

The CMA, in characteristically Saudi style, has avoided speaking publicly about the preparations, and those involved have also been asked to avoid speaking to the media about the developments.

One source says the authorities might be keeping quiet about the preparations, as political opposition to opening the market to foreigners could be seen to be easier to overcome if the new rules are valid as soon as they are announced. The regulator took a similar approach when it allowed indirect access to the market via swaps in 2008.

“International investors will be very interested in the Saudi market, as the country has a good story to tell. It has a young population, and a government with adequate resources to drive growth”

Walid Khoury, HSBC

Nevertheless, even firms not involved directly in test trades have been advised to make preparations. Banks have had to work to adapt their own technology systems on a global and local level, and to look at where they would need to hire to build a brokerage team capable of more sales to investors outside the region. Investment banks have asked lawyers, for example, to find ways to allow access to institutions, such as trusts, which are not recognized as legal entities in Saudi Arabia. "Opening up to qualified foreign institutional investors, as China has done, would be a natural evolution for the Saudi stock market," says Walid Khoury, chief executive of HSBC’s Saudi investment banking unit. "International investors will be very interested in the Saudi market, as the country has a good story to tell. It has a young population, and a government with adequate resources to drive growth."

Separately, HSBC is working to introduce a Shariah-compliant exchange-traded fund to track the top 20 Shariah-compliant Saudi stocks.

And ETFs are an alternative way for non-Gulf investors to access the market, with Khoury saying they are a good way to experiment before investing directly – if access is finally allowed.

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