Saudi Arabia’s efforts to reform its capital markets seem to have finally paid off. On June 20, MSCI, a leading provider of global equity indices, upgraded the kingdom from standalone to the status of an emerging market.
Billions of investment dollars will flow to the country as a direct result. More broadly, this decision vindicates the financial changes enacted by Saudi regulators in recent years and further heightens the kingdom’s appeal to international banks.
It has been a long time coming. As far back as 1997, Euromoney reported that Saudi Arabia’s capital markets would: “Require reform and liberalization if the kingdom is to build a dynamic economy on what is left of its oil wealth” and cited Saudi bankers eager for change. It has taken 20 years for the transformation to occur. The inclusion in MSCI’s emerging market index recognizes that evolution.
UBS believes MSCI’s decision could attract as much as $45 billion of capital inflows to Saudi Arabia, $10 billion from passive investors and $35 billion from active ones. FTSE’s inclusion of the kingdom in its own emerging market index earlier this year could attract a further $5 billion.
The Kingdom’s Capital Markets Authority has worked hard for this. It raised foreign ownership limits, eased registration limits for qualified foreign investors, enhanced the clearing and settlement process and introduced securities lending and short selling. More recently, it established a central counterparty company to prepare the market for derivatives trading and enabled the listing and trading of government debt instruments.
The change is drastic. Just over three years ago international investors could not invest directly in the Saudi Stock Exchange. Now they can participate in secondary trading and IPOs alike, nominate board directors and vote in annual general meetings.
Not everyone will be happy with this development. The stock exchange used to serve as an unofficial means of wealth redistribution. Millions of Saudi retail investors would buy into share sales deliberately offered at heavy discounts, allowing many to make immediate, and often substantial, gains.
The recent arrest of activists, even as women were given the right to drive for the first time, shows how Saudi leaders can give with one hand only to take with the other
But Saudi Arabia eventually came to the realization that it would have no money left to redistribute if it continued to rely on oil as the sole engine of its economy. This led to the drive to expand the non-oil private sector and to attract capital from abroad to support this development. Vision 2030, the vast reform programme championed by the kingdom’s crown prince, Mohammad bin Salman, is the blueprint for this effort.
And the Vision has certainly convinced the banking sector of Saudi Arabia’s promise. Banks that had long been out of the country, or had never had a presence there, are seeking licences to enter. Citi this year opened a new office in Riyadh, 14 years after leaving the country. First Abu Dhabi Bank also secured a licence. Others, such as Credit Suisse and Standard Chartered, seem eager to follow.
The research conducted for Euromoney’s Awards for Excellence 2018 confirms the extent to which Saudi Arabia has become a focal point for emerging market bankers. Rarely is so much banking energy devoted to a single emerging market and, as a result, competition is fierce.
For now, Saudi market veteran HSBC retains its position of best investment bank in the country, but that is likely to be challenged in coming years.
With Iran unable to fulfil expectations raised three years ago because the US is walking away from the Joint Comprehensive Plan of Action, Saudi Arabia is now the Middle Eastern market offering the greatest potential for international banks.
That still does not make the kingdom an ideal market in which to conduct business, however. Bin Salman’s extrajudicial purge, said by the Saudi regime to be targeting corruption and by critics to be a means of getting rid of potential political rivals, demonstrated how little the rule of law counts in the kingdom.
Moreover, Vision 2030 itself, upon which the banks’ hopes rest, increasingly seems overambitious. This is in part because the goals appear extravagant for such a short timeframe and because Saudi Arabia does not have the administrative capacity to deliver such a comprehensive overhaul.
In another area of reform, women’s rights, the recent arrest of activists, even as women were given the right to drive for the first time, shows how Saudi leaders can give with one hand only to take with the other – a sign that Saudi Arabia’s transformation will likely be anything but linear.
Still, being included in MSCI’s emerging market index is a great step forward for the country and certainly vindicates bank boardroom perceptions of Saudi Arabia as today’s banking El Dorado. By next year’s award season, we should have a better sense of whose efforts to penetrate this market have paid off.