The introduction of swap agreements that permit indirect foreign investment in Saudi Arabia's stock exchange is a step toward opening the market to direct foreign investment in the Tadawul, said local bankers. “Next comes the removal of the swap contract and allowing foreign direct investment. There is no date. It could be months or years,” said Morgan Stanley Saudi Arabia managing director and chairman, Fahad Almubarak. “The next step is to allow investors to buy directly instead of through swaps but I don't think [the regulator] is in a hurry,” said one Riyadh-based banker. The swap agreements allow an authorized local firm to trade on the Tadawul on behalf of a foreign client. Its introduction has been seen by bankers as a significant move by the Capital Market Authority (CMA) toward opening the market to foreign investment. “This is very much the opening up of the market. It is absolutely going to facilitate foreign investment in the underlying shares,” said HSBC Saudi Arabia CEO Timothy Gray shortly after the introduction of swap agreements was announced on 20 August. Both Morgan Stanley and HSBC are authorized by the CMA to transact swap agreements with foreign investors. Previously, investors outside the GCC were banned from trading on the bourse, except indirectly through mutual funds. The introduction of swap agreements will allow international funds to stock pick, said Almubarak. “It is very significant as Saudi Arabia has been closed to direct investment in specific stocks. Significantly, it will allow them to pick stocks and decide on the duration and the amount. Now investors will receive the direct economic benefit,” he said. Morgan Stanley Saudi Arabia has received calls from mutual funds, pension funds and investment institutions interested in the swap agreements. These institutions are reviewing the swap contracts and conducting both technical and fundamental analysis of stocks, Almubarak said. With a combined market capitalization of about $450 billion, the Tadawul represents just under half of the total market capitalization of GCC local markets. The Tadawul trades some of the region's largest companies, including Saudi Basic Industries Corporation (SABIC), Al-Rajhi Bank and Saudi Telecom. And it has been the venue for at least one initial public offering (IPO) or rights issue every month this year, while the number of IPOs has dwindled on other markets. Abdullah Al-Rashoud, CEO of Riyadh-based KSB Capital identified petrochemicals stocks, such as Sabic, as “definitely” attractive to foreign investors because of their subsidized feedstock allocations, as well as stocks in the banking sector. Among these, he said Al-Rajhi Bank, Samba Financial Group and SABB would draw attention, with investors focusing on performance. The telecommunications sector and perhaps cement, would also appeal, he said. “There is a genuine intention to open the Saudi market to institutional and international investors,” said a Dubai-based investment banker, who looks at equities across the Middle East. He added that he is very positive about the Saudi Arabian market. Stocks that will appeal to international buyers include banking shares, which as a sector, has been relatively cheap, he said. “Investors will look at valuations,” he said. However, the timing of the CMA's decision to introduce swap agreements has been seen as a way to buoy the falling market in the short term with the injection of foreign cash. “The move on the Saudi market is to push the market up,” said another Dubai-based banker. On Sept. 2, the Tadawul All Share Index had dropped 23 percent since the beginning of the year. “I expect the CMA had to open the market to foreign investment,” said Hisham Tuffaha, head of research at Riyadh-based Bakheet Investment Group. “From the start of 2008 there has been a shortage of liquidity and turnover and an increase in the number of listed stocks. They opened the market but they don't want to make it direct,” he said. Now is a good time for foreign investors to come into the market but the Tadawul will compete for foreign funds with other emerging capital markets, such as the Shanghai index, Taiwan and Indian stock exchanges, said Tuffaha. “If foreign investors want to step foot into the region, they have to invest in the Saudi market. There are many large stocks in the market and now is a good time for foreign investors to get in. But there are many opportunities worldwide and we shouldn't amplify expectations of foreign inflows. There are advantages but it takes time and foreign investors would like to see the market be more stable,” he said. Tuffaha added that foreign investors had already found ways to access the market through funds and corporate portfolios. “The swap agreements give the CMA the ability to oversee foreign transactions. They get the advantage of the inflow with the advantage of monitoring the funds,” he said. Authorized entities must report swap transactions to the CMA on a daily basis. Investors in the swap contract will receive the economic benefits of owning the stock, such as dividends and stock splits, but will not hold voting rights. Those rights will reside with the authorized entity, which is not permitted to exercise them either. The CMA also reserves the right to change the terms of the contracts and to stop issuing swaps, according to an email sent by the CMA in late August to clarify how the agreements would work. One Riyadh-based lawyer criticised the introduction of swap agreements for limiting foreign investors to purely monetary participation in the market. “I'm not that excited by this [introduction of swap agreements]. That the underlying ownership and voting rights remain in the hands of a Saudi entity undermines the role of activist shareholders,” the lawyer said. He described the agreements a legal way for foreign investors to capitalize on the market. “We were hoping for a real opening up. This is a monetary thing. Investors can make or lose money but they can't participate. There will be a lot of companies that are seeking a stake and [would like to] have a holding, make a tender offer to shareholders and have a place on the board,” he said. The lawyer also questioned how the contracts would be enforced if, for instance, the authorized entity were to be taken over. “There is no precedent. No big trader is going to want to enter into the agreement without understanding the pros and cons and they don't know how the compliance will be interpreted,” he said. He said investors with faith that the CMA would protect their interests and those seeking a small holding would be interested in the swap agreements. Foreign investors remain barred from participating in IPOs which are reserved for local investors. “They won't open up IPOs to foreign investment. The only reason they have allowed foreign investment is to do with the low trading volumes. IPOs are covered many times and foreign investment is not needed,” said Tuffaha. He said the most likely initiatives in the future are measures to increase transparency that would make foreign investors feel more comfortable. These would build on earlier initiatives to boost disclosure, such as the publication of the identity of shareholders that hold at least a 5 percent stake in a company, which was introduced in mid-August, he said. The opening of the Saudi Arabian market has been step-by-step, said Almubarak. “Saudi Arabia has had a gradual opening process that allowed GCC nationals to participate and then resident foreigners, and then, the international community was allowed to invest through mutual funds. And now they can have the direct economic benefit,” said Almubarak. Regional markets have been slow to open to foreign investment, said Dubai International Financial Center Authority chief economist, Nasser Saidi. “The fear has always been in emerging markets that the increase in foreign investors would lead to volatility and short-termism in terms of investment. That view is starting to change,” said Saidi. In the immediate term, there is a concern that foreign investor interest in the Tadawul will draw liquidity away from markets elsewhere. “In the short term, it will probably be negative for some of the regional markets because the flows will go into the Saudi market,” he added.
