For the first time in Saudi Arabia’s economic history, the country’s $509bn stock exchange market, known as the Tadawul, is available for international trade. Despite being one of the world’s largest economies, Saudi Arabia is the last of the G20 countries to open its stock market to foreign businesses. It could transform the country and perhaps even the entire region, as capital flows into various industries and the transition to adopt international standards is made.
Granting foreign access to the Tadawul is the latest facet of the Saudi administration’s $130bn strategy to bolster non-oil industries and diversify the economy. As 90 percent of the Saudi economy is driven by the petrochemical sector, the recent volatility of the global market and plummeting oil prices has stressed the necessity of a new model and of achieving emerging market status more than ever before.
The Tadawul lists 165 publicly traded companies in industries ranging from agriculture to telecommunications, and of course, petrochemicals
Talk of the prospects for both foreign parties and the country itself has stirred since the decision was first unveiled in 2014 by the Capital Market Authority (CMA). While there has been growing anticipation within the international sphere, frustration over the lack of information also mounted as the self-set deadline approached. When June 15 came this year, the flurry of foreign investors expected by Saudi authorities did not occur, thus marking various challenges that still exist for the wealthy nation. That being said, the fiscal possibilities are vast and the stock market holds the key to unlocking this incalculable potential.
A new game
The Tadawul lists 165 publicly traded companies in industries ranging from agriculture to telecommunications, real estate, and of course, petrochemicals (see Fig. 1). According to the Tadawul 2014 Annual Report, real estate is the biggest sector and comprises 16 percent of the market.
Given the size of the Saudi economy, international participation is estimated to bring around $40bn of foreign capital into the economy; “it’s certainly the largest in terms of the GCC – it comprises more than 47 percent of the region’s GDP and it has the largest population base”, said Dr John Sfakianakis, Director of the Middle East at the Ashmore Group.
As expected, there are several clauses for foreigners that wish to trade on the Tadawul. Individuals are excluded; only companies are permitted, and sizeable ones at that. Firms must have $5bn in assets under management and five years experience in order to play the game. The idea being that if only serious players participate, the stability of the market is ensured. The CMA is also hopeful that these rules will attract investors with long-term objectives in the country and also limit the flow of hot money.
Foreigners, whether they live in the country or abroad, can own up to 49 percent of a single stock. Qualified foreign investors (QFI) can each have up to five percent of holdings in a single stock, with a 20 percent cap of foreign investment in a single stock. At present, there is a limit of 10 percent in terms of QFIs for the whole market. The country’s ‘negative-list’ – which catalogues businesses that forbid foreign participation – also extends to the Tadawul.
The real estate market in Islam’s holy cities, Makkah and Medina, are the most notable area of exclusion. While six companies have been specified as being off-limits, including Jabal Omar Development, Makkah Construction & Development and Taiba Holding, which, according to The Gulf Times, collectively account for approximately seven percent of the Tadawul All Share Index.
A key consequence of the liberalisation of the Tadawul is that the system will be subject to tighter regulations and will therefore benefit from greater transparency. As a result of the new framework, qualified investors will be able to vote in general assembly meetings and nominate board members, thereby highlighting one way in which corporate governance in the country’s private sector is expected to improve. As Sfakianakis predicts, “a direct effect for them will be to become more governance orientated from the regulatory standpoint and more transparent from the corporate standpoint.”
What is unusual in the Saudi case is that achieving greater liquidity is neither the focus of the shift, nor is it actually that important. At present, the Tadawul is already extremely liquid, particularly in comparison to other countries in the region. According to Reuters, Saudi Arabia trades around $2bn per day on average, thereby dwarfing the collected efforts of say Abu Dhabi and Dubai, which trade a combined volume of $150 to $200m. Instead improving the regulatory framework is the focus of the CMA, and is a core aspect in the goal to achieve the MSCI’s emerging market status. It is predicted that Saudi Arabia will achieve the MSCI emerging market index within the next two to three years – the impact of which could be pivotal in the country’s economic history. Saudi authorities understand the importance of achieving the index, not only as others in the region, such as Qatar and the UAE, have already done so, but also because it will fully incorporate the nation into the emerging market world. “I think there are two phases to the flow of money in Saudi Arabia, one is happening as we speak and it will continue to increase in volume and size over the next two years, and then the next phase of the inflow of money is going to happen because of MSCI inclusion”, Sfakianakis told World Finance.
In turn this status presents a host of opportunities for Saudi Arabia, a new standing for the country within the international framework and will grant it a more powerful voice on the global economic stage. Moreover, it is logical for an economy the size of Saudi Arabia’s to have emerging market status, which plays a role in laying a new path for the future of the country.
MSCI status will be a game-changer for Saudi Arabia, as it will further ease the obstacles preventing foreign investors from joining the Tadawul, while also making it safer for them to do so. The UAE achieving MSCI Index in June illustrates the catalytic transition that can also be expected for Saudi Arabia; it changed what could be invested in and the amount of holdings that a foreign company can have – it essentially changed the way that the UAE’s stock market operates. For Saudi Arabia, inclusion will enable the market to benefit from a reinforced investment landscape, inspire greater confidence and become increasingly attractive for investors.
Existing challenges
When the market opened in June, the initial reaction hoped for by the CMA did not transpire. Not only had investors not flooded the market, but stocks even fell, highlighting existing challenges and the trepidation of foreign companies. Some industry experts attribute this to an over-valuation of listed companies as a result of high earnings. Others blame administrative issues with licensing and a requirement to settle money up front, as opposed to two days following the investment. At face value, these issues will indeed prevent some investors from entering the Tadawul, but they are only short-term hindrances.
The obstacles are actually more complex and pertain to the ideological. “I think the challenge is getting to know the country and going beyond the stereotypical view that many people have about Saudi Arabia, the concerns whether it is related to geopolitics or visiting the country”, Sfakianakis explained. In-depth research is therefore required by foreign investors in order to gain a better understanding about the economy and the industry of interest, as well as the country itself. “I think it’s important for investors to develop interpersonal ties and relationships so that they see for themselves what the country yields. This plays a very important part of formulating ideas, because the region, especially Saudi Arabia, is based on these network ties and local knowledge”.
“There is always this drive to diversify the economy – it’s easier said than done”, added Sfakianakis. “But Saudi Arabia is more than oil, this is an important point that people forget. First of all, Saudi Arabia doesn’t get impacted as a result of a fall in oil prices, the average Saudi in the street doesn’t feel the price of that.” Despite oil prices being reduced by half, the incumbent regime has maintained the same levels of public spending by making withdraws from vast large reserves that were earned from the oil boom of the 2000s. Moreover, the share prices of petrochemical companies have not dropped by 50 percent either – highlighting an economy that is far more varied and robust than many people assume.
“I would say that for the investor, the diversification story is important and the reason for that is that Saudi Arabia is all about the demographics – it’s all about the individual who has benefitted from the changes that have taken place over the last ten years – they have entered the labour market more actively and more gainfully, and as a result they have a higher purchasing power”. As Sfakianakis explained, regardless of low oil prices, the purchasing power in Saudi Arabia remains extremely strong. This is underscored further when comparing the purchasing power of other emerging markets that lag behind on a per capita basis.
The Saudi economy has a long way to go, there is still a lot of work to be done and it will take patience and perseverance. However, the basis is there – and a strong one at that. The government has a formidable level of capital reserves and it continues to earn a great deal of revenue from the energy sector, regardless of the current price. Furthermore, it is unlikely that prices will remain at their current levels, with many experts predicting an increase over the course of the next two quarters.
There are a number of strong industries in the country, such as real estate development, healthcare and plastic manufacturing – with the greater focus and funding that these sectors are receiving, they are likely to grow considerably in the coming years and spill over into neighbouring states.
Saudi Arabia acts as the epicentre of the Gulf; this role will only be consolidated further as the economy strengthens and diversifies. With a new premier at the helm, the country seems to be on course to achieve this feat, the opening of the Tadawul being a historic step along this road. The MSCI Index will be next and when it does occur, not only will Saudi Arabia’s economic transformation transpire, the whole region will begin a new economic chapter.
