Saudi Arabia to open stock market to foreigners

July 22, 2014, 1:09 PM UTC
Saudi youths walk together in a business
Saudi youths walk together in a business district in the Saudi capital Riyadh on February 18, 2009. Saudis have cheered King Abdullah's sweeping government shakeup as a bold step forward, after he sacked two powerful conservative religious figures and named the country's first-ever woman minister. The Saudi monarch announced the first major government shakeup on February 14 since he became king in August 2005, naming four new ministers, changing a number of top judiciary chiefs and shaking up the Ulema Council, the leading clerics whose interpretations of Islamic rules underpin daily life in the kingdom. AFP PHOTO/STR (Photo credit should read -/AFP/Getty Images)
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Here’s something for those of you who are looking for something a little more exotic: Saudi Arabia is going to let foreigners invest directly in its stock market from early next year.

That’s a big deal – with a market capitalisation of $530 billion and daily turnover of more than $1 billion, it’s one of the largest and most liquid emerging markets in the world, and will be a magnet for money from global investment portfolios looking for exposure to the Middle East region, where there are precious few markets which can combine that degree of scale with a modicum of political stability.

It’s a move which has been in the works for a long time, but delayed many times due to concerns about the loss of influence over local firms that goes hand-in-hand with more foreign ownership. So far, foreigners have only been able to get exposure to Saudi stocks through swaps and other indirect structures that have no enforceable rights either on the relevant companies’ profits or their governance.

In theory, liberalising the stock market will make it easier for companies beyond the oil and gas sector to raise capital, helping drive the authorities’ broader agenda of diversifying the economy away from energy and creating new jobs for its growing population. It should also expose local companies to a bit more market discipline, making them more efficient.

Another, somewhat intangible, hope that the presence of more stable, institutional investment will help reduce volatility in a market which has been dominated by flighty and easily-panicked domestic retail investors. Stability, however, is relative–even in Dubai, where institutional money is already invested, the market has swung sharply in recent weeks.

But for investors, concepts such as volatility and liquidity are likely to take a back seat behind the very real material ones likely to be enjoyed as foreign inflows push up valuations.

In the last year, stock markets in Qatar and in Dubai, the biggest financial marketplace in the United Arab Emirates, have rocketed after MSCI, a company that compiles benchmark indices for investment managers to follow, upgraded them from being “Frontier Markets” to “Emerging Markets”.

Frontier Markets are a small and exotic niche in the investment universe, while Emerging Markets is a much larger subset with hundreds of billions of dollars to deploy. The FTSE NASDAQ Dubai index is up 50% since the upgrade, while the Qatar QE all share index up 42%.

Designations such as “Frontier” and “Emerging Market” are typically in the hands of the big index-compiling companies like MSCI or Russell that put together benchmarks for fund managers to follow.

MSCI’s indices act as benchmarks for over $300 billion in Frontier funds and $1.5 trillion in Emerging Market funds worldwide, but none of them includes Saudi Arabia at the moment because direct investment from abroad isn’t possible.

Sebastien Lieblich, executive director for index research at MSCI in Geneva, told Fortune “there’s no set rule” that says Saudi has to progress from Frontier status to Emerging Market status.

“If they open sufficiently and the access is good enough, and the index broad enough, then they can make it directly into the Emerging Market category,” Lieblich said.