In May 2019 Saudi Arabia’s stock exchange, the Tadawul, will begin a phased inclusion into global index provider MSCI’s Emerging Markets Index. This entry, which will include a second and final admission of Saudi stocks in August, is a notable waypoint not only for the country’s equity market, but for its wider development agenda under Vision 2030. As the Saudi authorities look to open the national economy to the world, milestones of this sort signify the early steps in a pivot away from oil-dependent economic isolation.
They also reflect the degree to which structural and regulatory changes are modernising the country’s capital markets. “One of the big requirements for Saudi Arabia’s capital markets was inclusion on MSCI’s Emerging Markets Index. Now that this has happened it has really put the country on the map,” says Zeyad Mohammed, head of capital markets at Saudi Fransi Capital.
Crowning achievement
Indeed, Saudi Arabia’s MSCI inclusion is regarded as a crowning achievement for the country. The Emerging Markets Index is tracked by about $1900bn in assets and is expected to materially alter the Tadawul’s investor base by bringing in more foreign and institutional investors to what is, at present, a predominantly retail investor universe. The MSCI Saudi Arabia Index is expected to have an approximate weight of 2.6% in the index, with the Tadawul being about the eighth largest constituent bourse.
“The inclusion of Saudi stocks in the MSCI Emerging Markets Index will facilitate investors’ accessibility to the local stock market and will attract foreign investments into Saudi Arabia,” says Vanessa Robert, vice-president and senior credit officer at Moody’s Investors Service.
MSCI inclusion was preceded by Saudi Arabia’s elevation to secondary emerging market status in fellow index provider FTSE Russell’s Global Equity Index Series. Its phased entry began in March 2018 and will conclude in March 2020. Similarly, the country began a phased inclusion in the S&P Dow Jones Emerging Market Indices’ Global Benchmark Indices, with a final inclusion phase scheduled for September 2019.
“All three of the world’s major index providers have included Saudi Arabia in their emerging market indices. It is being included gradually through a number of tranches and that is a process which will continue into the first quarter of next year. Our belief is that the addition of the Saudi capital markets will be transformative for the country as well as for the indices themselves,” says Mohammed El-Kuwaiz, chairman of Saudi Arabia’'s Capital Market Authority (CMA).
Significant inclusion
Indeed, for these global indices the inclusion of Saudi Arabia represents one of the largest single country additions (in terms of size and weight) to their ranks in decades. But for Saudi Arabia, these inclusions chime with the development of a more mature equity market. For one, the increased presence of foreign and institutional investors will temper much of the volatility linked to its dominant retail investor base. The number of qualified foreign investors in Saudi Arabia, for instance, reached 772 in March 2019, representing a fivefold increase from the previous year.
It will also increase the scrutiny of companies listed on the Tadawul, a dynamic that should promote an improved corporate culture across the country. “Now that the capital markets are opening up, Saudi Arabia must become accustomed to new investment behaviours that come with greater transparency and increased scrutiny,” says Mr El-Kuwaiz.
These landmark index inclusions are by no means outliers in the recent story of the Saudi capital markets. For its part, the CMA has pushed ahead with a number of notable reforms, including changes to the Tadawul’s trading settlement cycle, with other reforms in the pipeline for 2019.
“The pace of reform of the Saudi capital markets has been impressive. Over the past two years the CMA and Tadawul have introduced a T+2 settlement cycle, the independent custody model which allows institutional investors to use multiple brokers to execute their trades and now they are working on a clearing house and a derivatives market,” says Saudi Fransi Capital’s Mr Mohammed.
Central clearing
On this latter point, the development of central counterparty clearing, and subsequently a derivatives market, are both expected later in 2019. Together, these developments underscore the rapid maturation of the Saudi stock exchange.
“Central clearing is going to be quite important for Saudi Arabia for two reasons. One is that as we have moved to a T+2 settlement cycle, the need for central clearing has expanded. The second is that as we expand we want more products – and derivatives is one example of this. Having central clearing is crucial to a derivatives market,” says Mr El-Kuwaiz.
In response to these recent developments, various market players have adapted their offerings to meet the demands of a new and more sophisticated investor base. Saudi Fransi Capital, for instance, has devised a suite of new services for institutional investors in preparation for Saudi Arabia’s full inclusion in the MSCI Emerging Markets Index.
“We noticed a few years back that the market needed to be institutionalised. So we developed our own institutional relationship team. We also built our sell-side research team, a sales trading team and [as of 2019] can offer algorithmic trading, so any institutional investor coming from a global financial hub can get the best level of service here,” says Mr Mohammed.
Flotations abound
Meanwhile, the Saudi initial public offering (IPO) pipeline remains healthy. In 2018, 12 IPOs raised about SR5.3bn ($1.4bn). By the middle of April 2019 Saudi Arabia’s largest owner and operator of shopping malls, Arabian Centres Company, was due to list a 20% stake on the Tadawul and raise between $1bn and $1.2bn in the biggest transaction of its kind since 2014.
The chairman of Arabian Centres, Fawaz Alhokair, said in a statement: “By pursuing an IPO, we are laying the groundwork for the next chapter of our growth story and we are offering investors – both domestic and international – the opportunity to invest in a dynamic company and industry well positioned to benefit from the longer term structural growth path within the retail sector in the kingdom.”
The transaction will be seen as a further test of international investor appetite for exposure to Saudi Arabia, following the landmark bond issuance of state energy giant Saudi Aramco in early April 2019. Its first international bond sale saw Aramco raise $12bn but receive total orders to the tune of $100bn. Not only did this level of demand outstrip that of the Saudi state’s own international bond issuance, it also came close to matching some of the largest developed market bond transactions.
“I would say that the Aramco bond issuance illustrated the growing demand by the international community for exposure to Saudi Arabia,” says Mr El-Kuwaiz.
Other corporate debt transactions in 2019 have also proved successful. Saudi dairy giant Almarai issued $500m in a dollar-denominated sukuk in February, generating an order book that was 10 times oversubscribed. The deal represented the first international investment grade non-government-related corporate issuance from Saudi Arabia. Notably, more than 60% of the issuance went to non-Middle Eastern investors.
Progress is positive
Collectively, these transactions and others bode well for the development of Saudi Arabia’s debt markets, even if more work remains to be done. “There is strong progress in the development of the debt capital markets, including some recent corporate transactions. What is needed in the debt markets is more secondary market trading and distribution, both of which will come,” says David Dew, managing director of the Saudi British Bank.
Though challenges for Saudi Arabia’s capital markets remain, the direction of travel is encouraging. As the country embraces an increasingly global outlook, its capital market ecosystem has emerged as the standard bearer for the new Saudi Arabia – and there is little sign of this changing. In the coming months, the country is expected to enact cross-listing regulations that permit companies from neighbouring Gulf Co-operation Council markets – specifically Bahrain and Abu Dhabi – to list on the Tadawul. These developments represent Vision 2030’s first success story.
