Dubai: Last month, MSCI Inc, a leading provider of global equity indexes, announced the inclusion Saudi Arabia to the upcoming (June 2017-June 2018) review cycle for potential inclusion of Saudi Arabia in 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).
The kingdom has made significant progress in market reforms in the recent years along 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 delivery versus payment (DvP) settlement provision, proper failed trade management, and the introduction of short selling and securities borrowing and lending facilities.
“Following the introduction of these major enhancements to the accessibility of the Saudi Arabian equity market, MSCI will be consulting with international institutional investors to gather informed feedback on their practical experience of accessing the Saudi equity markets and in particular on the effectiveness of the recently implemented enhancements,” MSCI said in a statement.
- Dr Marie Owens Thomsen, Global Head of Economic Research for Indosuez Wealth Management
Analysts expect inclusion of Saudi Arabia in MSCI Emerging Markets will be a game changer for Saudi equities and will boost allocation of global investors in the Middle Eastern equity markets.
“Using the provisional list of constituents and latest prices, we estimate that Saudi Arabia could have a weight of 2.5 per cent in MSCI EM, making it the ninth-largest country in the index and the third-largest in EMEA,” Daniel Salter, Head of Equity Research at Renaissance Capital wrote in a recent note.
Investment flows
Saudi Arabia remains a large regional market with a trigger. Following the inclusion of the UAE and Qatar markets in the MSCI Emerging Markets, inflows following the announcement could be large. Bank of America Merrill Lynch estimates that Saudi Arabia’s MSCI weight could be as high as 2 to 3 per cent and even higher when Aramco is included into Saudi market index.
Analysts say MSCI’s decision 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.
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 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.
“Saudi Arabia’s inclusion in the MSCI Emerging Markets stock index will be a welcome boost for capital markets in the region. The Kingdom’s potential upgrade to emerging market status in 2019 will give access to more international investors and bring greater liquidity to the region’s largest market. This will benefit the local banks and financial services’ industry in addition to supporting the Kingdom’s 2030 vision to diversify the economy away from oil. It’s a welcome move for Saudi and will have a positive impact for the wider Gulf region,” said Fawad Tariq Khan, General Manager of Shuaa Capital.
Some analysts say post-MSCI inclusion the potential weight of Saudi in the index could surge up to 5 per cent in the future. “The potential size in the index is 2.5 per cent but with the privatisation of Saudi Aramco, the weight could rise to 5 per cent. Middle East and North Africa (Qatar, UAE and Egypt) currently represents 2 per cent of the index,” said Dr Marie Owens Thomsen, Global Head of Economic Research for Indosuez Wealth Management.
According to Franklin Templeton Investments, the 20 markets that have been added to the MSCI EM since 1994 have seen an average increase in performance of around 60 per cent over the subsequent 1-2 years, with a median 27 per cent outperformance of the index. In the 12 months before the actual inclusion of Qatar and Dubai, those markets rallied 48 per cent and 115 per cent respectively. “Saudi Arabia could also be subject to an inclusion into the FTSE EM index by September 2018. These developments are unambiguously positive for Saudi Arabia,” said Thomsen.
