Dubai: The winds of economic transformation shaping in the Gulf region and improving transparency and corporate governance are attracting the attention of key emerging market index makers and global investors to the regional equity markets.
Recent developments such as the discussions around the potential inclusion of Saudi Arabia and Kuwait in FTSE Russell emerging market index and the possible inclusion of Saudi Arabia in the MSCI emerging market index next year could be triggers for global fund managers consider GCC stocks in their portfolios.
FTSE annual country classification review results are expected to be released towards the end of September. “We continue to expect positive news from the FTSE country classification review. FTSE will announce its decision on whether to include KSA and Kuwait in its EM index at the end of September, and we remain cautiously optimistic following the recent market reforms that both countries have undergone,” Michael Malkoun, an analyst at Arqaam Capital said in recent note.
Discussions on potential FTSE Index inclusion of Saudi Arabia follows the recent entry of the Kingdom’s market in the upcoming (June 2017-June 2018) review cycle for MSCI Emerging Markets. If successful, this could mean Saudi Arabia will be added to MSCI Emerging Markets at end-May 2019, in time for the Saudi Aramco’s initial public offering (IPO).
Both these developments are expected to lift the fortunes of both Saudi Arabia and Kuwait-listed stocks and regional equities. Analysts say Kuwait appears to now meet all the inclusion criteria, but liquidity is weak. As of the March update, Kuwait met eight out of nine criteria that FTSE requires a country to meet for inclusion into the secondary emerging markets index. The only criterion that Kuwait missed was the settlement cycle that was changed in April, while also upgrading its DVP [delivery versus payment] framework, which means that Kuwait should now meet all of the criteria, assuming that FTSE approves of the new model.
Foreign ownership limit
Saudi Arabia has made significant progress in market reforms in the recent years along with a host of fiscal reforms that has attracted global investor attention to Saudi asset classes. In September 2016, the Saudi Arabian Capital Market Authority (CMA) implemented a new version of “Rules for Qualified Foreign Financial Institutions Investment in Listed Securities”. Major enhancements in this version included the increase of foreign ownership limit levels applicable to listed Saudi Arabian companies, the lowering of the minimum assets under management requirements applicable to Qualified Foreign Investors and amendments to the list of Qualified Foreign Investors eligible investor types.
These changes have resulted in an increase in the number of Qualified Foreign Investors having entered the Saudi Arabian equity market as reported by the CMA and the Saudi Stock Exchange (Tadawul).
In April 23 2017, Tadawul followed up by implementing a new market operating model. The new model includes, among other noted improvements, the expansion of the settlement cycle from T+0 [same day] to T+2 [transaction plus two days], the introduction of a proper DVP settlement provision, proper failed trade management, and the introduction of short selling and securities borrowing and lending facilities.
Despite these reform efforts, analysts say Saudi Arabia is further away on the FTSE matrix. Saudi failed two out of nine requirements, and had a restricted rating on another two.
“In our view, the issues should have now been addressed following the April market infrastructure reform that was headlined by a change in the settlement cycle to T+2 from T+0. However, investor limits remain a concern for us and could be reflected in the criteria if this becomes an issue for FTSE’s investors,” said Jaap Meijer, Head of Equity Research at Arqaam Capital.
Analysts say FTSE’s and MSCI’s decisions will rest on whether foreign investors feel the current level of opening is sufficient, given the 49 per cent foreign ownership limits and investor qualification requirements; in addition, some of the market framework changes such as stock lending and short-selling have yet to be tested.
Exposure
Foreign ownership of Saudi equities is currently very low at just 4 per cent of the total market capitalisation. Analysts estimate that inclusion in MSCI EM would trigger at least $2.3 billion (Dh8.4 billion) of inflows from passive funds out of an estimated $90 to $100 billion of emerging markets dedicated passive assets under management (AUM).
Currently, active emerging market funds in aggregate hold a small (0.15 per cent) amount of Saudi Arabia in their portfolios, down from a peak of 0.3 per cent in August 2015. Saudi Arabia’s inclusion could come as a boost for other regional equity markets this would give more exposure of the regional asset classes to global investors.
Foreign room and liquidity are key issues for some Saudi financials. Analysts do not see any major liquidity restrictions for most of the Saudi stocks; however, they say that some stocks, namely SABB, ARNB, BUPA, and ALAWWAL all have very limited foreign room, meaning that they would not qualify for the FTSE indexes. In addition stocks like BSFR, SAMBA, and SOCCO would only meet the liquidity requirements if inclusion is phased.
Inclusion in FTSE index is expected to be phased and should begin a year later. Should FTSE make a favourable decision to include both countries this review implementation is expected to begin a year later over two phases, during the September 2018 and March 2019 reviews.
