Tackling FII volatility in Saudi stock market

Over the past five years, the Saudi securities market regulator, the Capital Market Authority (CMA) has taken several prudent measures to improve market micro-structure, increase investor confidence, and boost transparency. Among others, these steps include public disclosure of investors who own more than 5 per cent of a listed company and strict enforcement of timelines for reporting corporate earnings.

This progress has increased appetite for Saudi stocks among foreign institutional investors (FIIs). The question is whether such demand can be captured without risking heightened stock market volatility? Given the volatility associated with foreign portfolio investment, it is prudent of the regulator to adopt a cautious approach.

Since official data became available in March this year, net purchases by foreigners through swaps have totalled about $795 million (Dh2.9 billion). The CMA allowed swaps last year permitting non-GCC investors direct access to the Saudi market.

QFII

As a next step towards further liberalisation of the Saudi stock market, the Chinese Qualified Foreign Institutional Investor (QFII) regime offers a case study. In December 2002, the China Securities Regulatory Commission (CSRC) and the People's Bank of China (PBOC) jointly issued the QFII Regulation which, for the first time in China's history, allowed foreign investors to invest in the domestic securities market.

In China, a QFII is defined as any foreign fund management institution, insurance company, securities firm, and asset management company that meets the requirements stated in the QFII Regulation and obtains approval from CSRC and investment quota from the State Administration of Foreign Exchange (SAFE). Aside from qualitative requirements, qualifications of a QFII also include minimum assets under management and years of business operations.

A QFII can invest in publicly listed shares on the Shanghai or Shenzhen stock exchanges other than B shares, publicly traded treasury bonds, convertible and corporate bonds and other financial instruments approved by CSRC.

While the combined quotas for all QFIIs investing in China's capital markets amount to $30 billion, China has so far granted about $15 billion of this to QFIIs. These figures are less than 1 per cent of China's combined stock market capitalisation of $3.1 trillion for the mainland's Shanghai and Shenzhen stock exchanges, where QFIIs are investing.

Saudi Arabia can study the implementation and related impact on its stock market of a similar programme. To prevent stock concentration in the hands of a few investors, constraints can be imposed that restrict an individual QFII from holding more than 5 per cent of the total outstanding shares of any single Saudi-listed company. Similarly, the total combined shares held by all QFIIs may not exceed 15 per cent of the total outstanding shares of the listed Saudi company.

In order to discourage frequent trading by speculative funds into Saudi Arabia, certain conditions for repatriation of principal could be imposed. For example, a QFII could be permitted to repatriate its principal in stages, and the amount of each repatriation may not exceed 20 per cent of the total principal, while the interval between any two such repatriations should not be less than one month. In addition, when a QFII remits all or part of its principal out of Saudi Arabia, it will have to apply for a new investment quota in order to bring the principal back into the country.

Direct access to Saudi equities appeals to various types of investors globally. The continuous efforts of the Saudi government to diversify the economy and increase contribution from the non-oil sector are paying off. Despite the global economic slowdown, slump in oil prices and domestic credit issues, Saudi Arabia's economy has shown resilience. Although this year the Saudi economy is likely to contract by about 1 per cent, it is widely expected to grow by 4 per cent next year.

Global integration

At the state level, Saudi Arabia does not require FII funds. However, in an increasingly integrated global economy, for a G20 member like Saudi Arabia, the qualitative prestige factor is important. At corporate level, many Saudi companies can benefit from a more diversified international shareholder base through a QFII programme; their future fund-raising efforts can be easier and larger.

Current restrictions on non-GCC investors can be relaxed through such a programme that will allow international institutional investors to allocate capital to the Saudi stock market. Through a QFII programme with a combined quota of 2 per cent of market capitalisation, Saudi Arabia can continue to attract investment into the stock market and broaden its investor base.

The writer is head of Investment Management at Morgan Stanley in Saudi Arabia. The opinion expressed is that of the author himself and does not represent that of the organisation he represents.