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Middle EastApril 1 2017

Saudi capital markets play prime role in diversifying economy

In line with Saudi Arabia’s Vision 2030 blueprint to diversify the country’s economy away from oil, its capital markets are being liberalised and broadened to include regional and foreign investors. James King reports.
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Riyadh

Mohammed El-Kuwaiz, vice-chairman of Saudi Arabia’s Capital Market Authority (CMA), is not short of ambition. With a background in investment banking and management consulting, Mr El-Kuwaiz is at the forefront of Saudi Arabia’s efforts to reform the country’s economy through structural change and global economic integration. His aim is to transform its capital markets into a standout component of both the domestic and the regional economies, and in doing so spur the further diversification of the Saudi economic model.

Until now, Saudi Arabia’s equity and debt markets have been overshadowed by bank financing. But under the CMA plans, assisted by a new macroeconomic environment of normalised liquidity, a more balanced role for the capital market is expected to emerge. In turn, the aim is to wean the country off its dependence on oil and capitalise on its massive, latent potential in other economic sectors as detailed under Vision 2030.

“Change is running through the entire economy, from regulations to projects to the redesign of the social contract. There is a move towards a balanced budget that is based on internal economic resources as opposed to the ebb and flow of oil prices. We are working towards an economic model that is built on the private sector rather than government spending,” says Mr El-Kuwaiz.

Areas of advantage

As part of Saudi Arabia’s reform plan, the authorities have identified a number of areas of competitive advantage, including religious tourism, investment funds and the capital market. Accordingly, the CMA is at the forefront of plans to add even greater liquidity and depth to the Tadawul, the country’s stock exchange, as well as improve foreign investor access to equities listed on the exchange. In doing so, the aim is to position the Tadawul as a truly pan-regional exchange with global connectivity.

“There is an opportunity for the Saudi capital market to evolve from a local to a regional market. One of the most important features a stock exchange can offer is liquidity for both capital owners and capital seekers. If you look at the Saudi stock exchange, it’s the most liquid in the region,” says Tariq Al-Sudairy, chief executive of Jadwa Investment, a local investment firm.

Mr El-Kuwaiz points out that this regional advantage extends to a 5000-kilometre circumference around the Tadawul with no other comparable capital market falling within that zone. To build on this advantage, the CMA is taking steps to liberalise the country’s investment framework, improve settlement infrastructure and increase the role of small and medium-sized enterprises in the investment landscape.

Parallel market 

The launch of the Tadawul’s parallel market, Nomu, in February 2017 is a case in point. Designed as a parallel equity market with more flexible listing requirements, companies looking to list on Nomu need only have a minimum market cap of SR10m ($2.6m) and only offer 20% of their stock with no single investor owning more than a 5% share. This contrasts with a SR100m minimum market cap and a 30% listing size for the main market.

“The launch of the Nomu parallel market is a great way to expand the breadth and depth of the kingdom’s capital markets and to give business owners increased access to capital. It will also give investors the opportunity to diversify their holdings within the local economy,” says Mr Al-Sudairy.

Nomu is open to firms from across the Gulf Co-operation Council (GCC) region. By mid-March, the CMA had received enquiries from a number of companies considering listing on the parallel market, according to Reuters. On its second day of operation, Nomu had a traded value higher than most main boards in the GCC despite investment being restricted to qualified investors.

More generally, the CMA has also improved foreign investor access to the Saudi capital market through its qualified foreign investor (QFI) framework. In 2016 it lowered the bar for foreign investors looking to invest in all securities on the Tadawul by reducing the threshold for qualified investors’ assets under management to $1bn from $5bn.

Foreign participation

In addition, the new framework now permits an individual foreign investor to own 10% of the total shares in a listed company, up from the 5% allowed under the previous framework. Meanwhile, since January 1, 2017, foreign investors may now participate in initial public offerings (IPOs).

“So far we have received a lot of feedback on our second QFI framework and it is a lot more in line with what international investors are looking for. But what most international investors are now waiting for is the second leg of global capital market integration, which focuses on infrastructure. The centrepiece of this reform is changing the settlement cycle from T+0 to T+2,” says Mr El-Kuwaiz.

The Tadawul currently operates a T+0 settlement cycle, meaning that securities are transferred from seller to buyer on the same day. Most international exchanges operate a T+2 system, where a transfer occurs over two business days and is deemed the preferred settlement system for most cross-border investors. The implementation of these reforms, and others, is positioning the Saudi stock exchange favourably for inclusion in the MSCI Emerging Market Index.

“The transition to a T+2 infrastructure and the Tadawul’s eventual inclusion on the MSCI emerging markets index will be crucial in attracting foreign investment into Saudi Arabia and to raise the profile of the kingdom among the global business community,” says Mr Al-Sudairy.

Aramco IPO

Alongside these reforms, the upcoming IPO of part of state energy giant Saudi Aramco is likely to put the country’s capital markets firmly on the map. The value of the listing, which some estimates put at about $100bn, will vastly outstrip the $25bn raised by Chinese e-commerce giant Alibaba. One or two international stock exchanges are likely to be included with the Tadawul to facilitate the listing.

“The Aramco IPO is a message to the rest of the world that Saudi Arabia is open for business,” says one local senior investment banker, who asked to remain anonymous.

The energy giant is also expected to begin a multi-tranche $10bn domestic debt issuance programme. Market observers see this as a further step by Saudi Aramco to improve its transparency and open itself to investors ahead of any IPO. The move comes as the CMA works to stimulate the further development of a private debt market in the country, which has long been held back by, among other things, the abundant liquidity environment that has underpinned the market over the past decade.

“The steps we are taking with respect to the development of a tradeable private debt market start with a diagnostic of what has impeded its growth to date. Two of these problems were macroeconomic in nature and they have been rectified in the current environment. The third is regulatory, which the CMA is addressing,” says Mr El-Kuwaiz.

“While Saudi Arabia has offering rules and listing rules that pertain to both equity and debt, most of these regulations have been drafted and designed in an environment that targeted equity listing. The CMA is now modifying the offering and listing rules to better accommodate debt issuance,” he adds.

Cumulatively, these measures are being implemented with determination and speed. Most private sector leaders in the country expect the CMA’s efforts to bear fruit quickly. For the country’s economic growth agenda and diversification drive this can only be a good thing. With a young, energetic and determined leadership, the CMA is playing its part in ensuring that the Saudi economy achieves its objectives.

“Transitioning the Saudi economy to a more sustainable economic growth model requires serious structural reforms. This process will not be easy but it is a necessary journey if we want to achieve a more sustainable, diversified and vibrant economy,” says Mr Al-Sudairy. “The positive news is that what we’re seeing today is a serious commitment by the government to implement reforms to make that happen.”

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