By Arab News
By Khalil Hanware
Saudi Arabia is expected to make a limited expansion of its stock market by allowing direct foreign ownership to investors with at least $5 billion under management.
The Kingdom, which has been considering opening up its stock market for several years, according to industry sources on Saturday, will be taking a step in that direction.
The imposed limit on the stakeholders will also allow each to hold a maximum 5 percent of a stock’s issued share capital.
The Capital Market Authority (CMA) and Tadawul have indicated to market participants the details of the proposed framework of foreign ownership, Reuters reported on Saturday.
Total direct ownership of each stock would not be allowed to exceed 20 percent of the issued share capital, a source familiar with the matter told Reuters.
Commenting on the foreign ownership report, Turki Al-Hugail, economic analyst, told Arab News: “Before such a step, market should be divided in two. One for large caps and one for medium/small caps with less floating shares.”
He said foreigners would look into promising companies and the blue chips in banking, petrochemical, cement and telecom sectors.
“Saudi market was very opaque in the past but with the CMA, conditions are improving gradually. Now we are better than where we were 4-5 years ago specially after the crash in terms of regulations,” Al-Hugail said.
Khan H. Zahid, vice president and chief economist of Riyad Capital, said: “Institutionalization of the Saudi stock market on the buy-side is a welcome step. Currently, the market is dominated (around 80 percent) by retail investors, who often tend to be small, unsophisticated, follow the herd, and engage in speculative trading unrelated to market fundamentals.”
He said institutional investors (mutual funds, life insurance companies, pension funds), on the other hand, tend to be more sophisticated, focusing on underlying fundamentals, and conducting all kinds of due diligence (e.g., fundamental research, meeting companies) before investing.
Moreover, he said, they also have to be responsible investors as they invest funds on behalf of clients (e.g., mutual funds investors, insured people and pension contributors). Thus, for example, they tend to follow clear and transparent investment strategies (e.g., asset allocation, macro strategies or sector focus).
Saudi Arabia already allows domestic mutual funds to invest in the market. The foreign investment rules being mulled could bring foreign mutual funds, life insurance companies, pension funds and other large institutional investors into the market, he added.
Restricting their size to large institutions would ensure that they also enhance market sophistication and knowledge.
“Given the strength of the Saudi economy, we believe that this move would generate a large increase in demand for domestic shares and thus have a positive effect on the market,” Zahid said.
Of course, the authorities would need to institute measures to prevent “hot money” flows or excessive volatility in foreign money flows because that makes monetary and exchange rate policy management difficult, he added.
The Saudi stock index closed at a four-month high on Saturday. The Tadawul All-Share Index closed 0.81 percent higher at 6,302.84 points with volume of 251 million shares on Saturday. The value of traded shares reached SR5.54 billion.
Paul Gamble, head of research at Jadwa Investment, said a greater opening to foreign investors would improve transparency and market efficiency. It could also re-energize the market. Volumes have been subdued for some time and share prices have fallen this year even though listed company profit growth in the first three quarters of the year was up by 25 percent year-on-year.
“There would definitely be a boost to share prices once something is formally announced and in the runup to the actual opening. If the greater opening allowed the Kingdom to join the major international indexes (Russell, MSCI, S&P) it could potentially trigger a very large inflow of foreign funds,” Gamble said.
However, Jarmo T. Kotilaine, chief economist at the National Commercial Bank, said this step, if and when it is realized, marks a quantum leap for the Saudi stock market even with the proposed qualifications.
Opening a market in a controlled manner is not rare. Many emerging markets have done it, including key players such as China, India, but also the other Gulf markets where limits still exist on foreign ownership. Nonetheless, they now are key elements in the emerging market universe.
“The ability of foreign institutional investors to directly tap the Saudi market should substantially increase the number of players with an active interest here, echoing the earlier experiences of China and India. Such access should boost market liquidity and reduce the costs incurred by foreign investors,” Kotilaine pointed out.
He said this increased interest should in turn result in greater attention paid by banks and investment houses to Saudi stocks and should stimulate the development of the market through better analysis and research. Such developments would have potentially significant positive implications also for the broader investor universe, including local and regional players.
The opening up to foreign institutions will likely prove fairly gradual in its impact, he said. These investors will build up their exposure based market analysis. Not all institutions will join in right away, since many have restrictive rules about only being able to invest in markets that meet certain technical and regulatory criteria that qualify them for inclusion in benchmark indices, such as the MSCI Emerging Markets.
In that sense, the proposed regulations are likely to be just the beginning of the process. However, Kotilaine said they will likely unleash drivers that will push the Saudi market in the direction toward inclusion in benchmark indices through better research and greater transparency.
“The Saudi market in many ways is the most attractive in the region, particularly for sophisticated investors such as asset management institutions. Thus, we believe any potential opening of the Saudi market to foreign institutional investors may lead to an expansion in the multiples (price) in terms of what investors are willing to pay for Saudi stocks. Therefore, initially at least, one would expect the market to react positively to any widening of access. Thereafter, we would expect the market to react in a more ‘efficient’ manner, given the higher percentage of sophisticated investors,” Farouk Miah of NCB Capital’s Equity Research said.
“The Saudi stock market is predominantly a retail-based market (vs. institutional) and to open up the doors for institutional foreign investors may provide more stability, efficiency and assurance to the market. We also believe this step may attract (or bring back) more local/GCC investors to the market,” he added.