Middle East: Saudi Arabia moves to attract foreign capital

The Saudi Stock Exchange (Tadawul) has completed its long-awaited transition to a T+2 settlement cycle for all listed securities, in a move that further eases foreign investor access.

T+2 allows investors to settle any acquisition or purchase of stock on the exchange up to two days after signing the transactions, as per international custom. Until the change of rule in April, investors in Saudi shares had to settle their transactions immediately. 

Many shied away from Tadawul as a result, even though it is the largest equity market in the Middle East and North Africa, with a market capitalization of over $400 billion. 

“It’s very, very helpful in attracting international investors,” Johan Hattingh, CEO of investment firm Ashmore Saudi Arabia, tells Euromoney. “It is a necessity to get international investors.”

The decision came as no surprise as the Capital Markets Authority had announced that it had granted Tadawul regulatory approval to amend the settlement cycle. But the exchange took its time to implement the change – the regulatory approval was made public a year ago. 

Khalid Abdullah Al Hussan, chief executive of Tadawul, says: “With these changes, we are determined that Tadawul will become an important new factor in global equity markets, both as a source of capital and an investment destination.”

Al Hussan’s words might appear over-enthusiastic; the new settlement rule is relatively small and technical in nature. But market participants see it as just the latest in a series of changes that may lead to Saudi Arabia’s inclusion in the MSCI Emerging Markets index.

The Kingdom’s long hoped-for inclusion would lead to a large influx of funds from international institutional investors. Lack of T+2 was one of the last hurdles to inclusion.

Asked about the likelihood of inclusion in the coming months, now that Tadawul has adopted T+2, Hattingh says: “I’m very positive about it, because what has been announced was actually part of the criteria for MSCI inclusion.” 

Hasnain Malik, head of frontier markets equity strategy at Exotix, is also positive, but sounds a note of caution. Of T+2, he says: “It’s one of the items on MSCI’s checklist that had not been ticked off.” 

But, he adds: “MSCI is not a formulaic thing. It’s not: ‘You do these 10 things and you’ll be part of MSCI’. All is done on a fairly murky poll of institutional investors without specifying precisely what needs to be done to gain access to that index.”

Malik continues: “It’s definitely fair to say that foreign institutional investors are spending a lot more time investigating the market. There’s been a hard core of foreign institutional investors there for some time, but they represent a very, very small part of the market and a very small part of the global emerging market funds under management.

“As soon as it becomes clear that Saudi will become a part of MSCI EM, and that’s also becoming an increasing probability, you’ll see much, much more foreign engagement by institutional investors, beyond fact-finding and investigation, to actually positioning their funds.”

The opening of Tadawul to international investors began in earnest in mid 2015, when the CMA authorized investors to buy Saudi stock directly. The conditions for entry were initially very strict. Only large qualified foreign investors could enter, they could only own small portions of any stock and could not invest in primary deals, only in secondary trading. Perhaps as a result, the expected influx of foreign capital did not occur.

Over time, the CMA has eased the rules for entry. Smaller investment funds were allowed in, and they were allowed to own more stock and participate in IPOs. As of April, according to Tadawul, more than 60 international financial institutions, representing more than $18 trillion in investable assets, had registered for access to Saudi Arabia. 

Tadawul has also introduced securities lending and covered short selling.

Malik says: “There’s no doubt that in terms of settlement, foreign ownership limits and of course the liquidity that is already prevalent in the market, it is now meeting most of the criteria that you’d expect it needs to accede to MSCI EM, but the exact timing of that decision is very much at MSCI’s discretion, on the basis of the investors they poll. The likelihood of that happening in an 18-month time frame is substantially higher today than it was 18 months ago.” 

Many observers of the Saudi market have suggested that the CMA is opening up Tadawul in anticipation of the flotation of Saudi Aramco, the state-owned Saudi oil company. The IPO could be the largest ever and would require the participation of international investors. But it is as yet unclear where the Kingdom intends to list its most valuable asset.