Saudi swap move an irresistible lure

This August saw what many observers have heralded as an historic moment for Saudi Arabia's stock market as it took one more step towards opening the Tadawul to direct foreign investment. When Morgan Stanley Saudi Arabia became the first investment bank to broker a "swap agreement" with a non-resident foreign investor it caused a noticeable frisson among UAE market watchers. There has been no shortage of hype surrounding the move by the Saudi Capital Market Authority (CMA) to open the door to investment from outside the GCC just a little bit wider, but how significant this step will prove to be in the longer term is unclear.

A swap deal allows a foreign individual or company to buy stocks on the Tadawul via an authorised Saudi firm. Previously, the only way investors from outside the GCC could trade on the bourse was indirectly through mutual funds, but now a raft of international banks and brokerage firms, including Morgan Stanley, Goldman Sachs Group and Deutsche Bank are expected to offer foreign clients access to the market through their Saudi operations. Under the new arrangements, foreign investors will be entitled to all returns related to their share purchases, and will take on the economic exposure, just as they would in any other market.

While this is certainly a significant step towards direct foreign investment in the Tadawul, many believe that the appeal of swap agreements is limited, and their potential impact on other regional markets not as consequential as first thought. So, while received wisdom has long since held that the Tadawul, the Gulf's largest market with a capitalisation of some $440 billion, is an irresistible lure for foreign capital, the reality is not so straightforward. Many investors would be delighted to grab a stake in some Saudi publicly-traded blue chip companies, particularly those in the petrochemical sector, but others are likely to be more circumspect in their approach to the Saudi market.

Transparency

Corporate investors in particular will take into account their inability under the present scheme to buy their way into the boardroom or make a tender offer to shareholders; with other emerging markets competing for foreign investment (such as Shanghai and India) this becomes an increasingly important issue. And, although there have been initiatives of late aimed at boosting the transparency of the market, many investors will seek further moves in this direction before they feel comfortable about investing in it.

There's little doubt that the introduction of the swap agreement system will have a beneficial effect on the Saudi bourse. The reform-minded hope that it will act as a stimulus to further change; the Saudi investor is typically a private individual without access to accurate financial information, often trading on rumour, which has led to problematic market volatility. Saudi companies seeking foreign investment will be encouraged to be more forthcoming about their financial status, and any improvement in financial reporting standards is likely to improve market stability. The anticipated influx of foreign capital will also provide a boost to a Saudi bourse that has seen a 23 per cent drop in value since the beginning of the year.

Indeed, some analysts maintain the CMA was compelled to open the market to foreigners, indirectly at least, as a result of an increase in the number of listed stocks coupled with low trading volumes and a lack of liquidity in the market. Whether the hand of the CMA was forced or not is a moot point; the timing of the swap agreement initiative may have been influenced by financial circumstances, but it is clearly part of a longer term strategy of opening up the Saudi market.

The writer is Middle East specialist, Oxford Business Group's Regional Editor in the GCC.