No More Shall We Swap?

Although the informal trading of shares in joint-stock companies can be dated back to the 1930s, the market remained unregulated until a 1984 decree that gave the Saudi Arabian Monetary Authority (SAMA), or the central bank, authority over regulating the capital markets more tightly. The Saudi Stock Exchange, or Tadawul, was brought to life in 2001, while its regulator, the CMA, came into existence in 2003. Since then, the Tadawul has grown in leaps and bounds, with new instruments being added, such as corporate sukuks, while limited foreign access to the markets has also being gradually encouraged. The sukuk market, though encouraged, remains comparatively small, with just SAR32.51 billion ($8.67 billion) listed as tradable on the exchange, with little secondary trading activity.

EQUITIES

The Saudi Stock Exchange, or Tadawul, showed strong growth of 25.50% for the main Tadawul All Share Index (TASI) over 2013, while for 1H2014 a further jump of 11.45% was recorded. June saw a sell off in the index, down 3% for the month and finishing at 9,513.02, likely related to investor confidence concerns flowing from the restructuring of Arabtec in the UAE. However, July saw those concerns fly away, with the TASI surging by 7.38%, and closing the trading month at 10,214.73. The overall market capitalization for the Tadawul came in at SAR1.95 trillion ($518.70 billion) in 1H2014. The value of shares traded via the Tadawul shot up an impressive 47.64% over 1H2014 when compared to the same period a year before, equaling SAR1.12 trillion ($299.53 billion), while the number of shares traded also rose 31.23% over the same time to 38.51 billion shares. At mid-2014, shares in some 161 companies were being traded on the Tadawul. By market capitalization, the top five sectors were petrochemicals (29.5%), banks and financial services (21.4%), telecoms and IT (10.9%), agriculture and food industries (5.9%), and cement (5.4%), forming as a group over 73% of the market.

The market saw four new initial public offerings (IPOs) over 1H2014, including the Saudi Marketing Company, Umm Al Qura Cement Company, and Abdulmohsen Alhokair Group for Tourism and Development. However, the pipeline of IPO candidates is looking far more intriguing going forward, with Saudi Arabia’s largest bank by assets, National Commercial Bank (NCB), also looking to take itself public in the latter half of 2014, or early 2015. The NCB offering is being advised by the Saudi arm of HSBC and Gulf International Bank’s investment banking wing, while the size of the transaction has been mooted at raising some $4 billion for a 15% stake. However, by mid-2014 such estimates for the IPO would appear to be on the low side, as it would place the full market cap of NCB at well under that of its nearest rival Al Rajhi Bank, despite a near one-third difference between the total assets of the two.

Other potential candidates mentioned for the IPO route include Sulaiman Al-Habib Medical, a major healthcare provider in the Kingdom, and ACWA Power, a water and power mainstay. Due to the size of the potential NCB offering, however, the other IPO candidates will likely choose to space out their own listings to ensure sufficient liquidity remains on the table. And that is very much the case for five of the six subsidiaries created from Saudi Arabian Airlines (Saudia) in 2006, which are also looking to launch IPOs over the short to medium term. The first of its units to IPO was Saudi Airlines Catering, which raised $347 million from the market in 2012 for a 30% stake.

FOREIGNER, MINE

On July 22, the Saudi Cabinet announced its approval for regulatory changes to be made to allow foreign institutional investors with “full” access to the Tadawul in 1H2015. GCC nationals have held similar rights to Saudis in accessing the capital markets since 2007, as have foreign residents in Saudi Arabia (2008). However, non-resident foreign investors have only been allowed to buy Saudi stocks in recent years through a “swap” principle or via exchange traded funds (ETFs). Essentially, foreign institutional or individual investors arrange a swap agreement with an authorized Saudi entity, such as a brokerage firm, for the latter to purchase shares on the Tadawul, for the former that will be held according to the terms of an agreement that cannot have a duration of more than 4 years. While the economic benefits of the shareholding are transferred to foreign investors—such as share price rises and dividends—the voting rights of the shares cannot be exercised by the investor or the authorized Saudi entity through which the shares were purchased. This complicated affair has failed to entice foreign investors. Swap trades by foreign entities made up only 1.4% of the value traded on the Tadawul over 1H2014, and just 4.15% of total market capitalization.

While the opening up of the exchange to foreign investors will be welcome, it will likely be done in a cautious style. A draft CMA set of rules that looked at the matter in the past outlined that only foreign institutional investors with at least $5 billion in assets under management, and a track record of at least 5 years of operations would initially be allowed in, according to Bloomberg. Furthermore, foreign ownership limits, whether by institution, or as a group, would also likely be introduced to ensure Saudi control over the listed companies. A Global Research strategy paper opined that the number of institutional investors allowed in the market might initially be capped at 10 licenses. Moreover, each one would be allowed to hold no more than a 5% stake in a listed company, while as a group the ceiling for foreign shareholdings would be capped at 20%.

The reason for this initial caution can be understood when studying the market. One aspect of the Tadawul is the high percentage of individual investors in the market. Such investors formed 89.9% of value traded on the exchange over 1H2014, versus just 8.7% for institutions, indicating the potential for a more volatile level of trading in the market, as well as the risks associated for individual investors, the lion’s share of whom are Saudi nationals. The volatility seen in neighboring GCC stock exchanges that have more liberal rules on foreign share purchases has likely given the authorities a sound reason to pause for thought. Restricting the initial foreign entrants to institutional investors who could perform a better price support and market maker role may help the exchange during times of perceived volatility.

As well, the potential IPO pipeline facing investors in the Kingdom may well have swayed sentiment at the state level. With so much liquidity needed to soak up the projected IPO deals, the presence of large foreign institutional investors may assist in keeping money on the table for the future.

However, two main issues will need to be considered. Firstly, the level of transparency and corporate governance that listed companies need to provide to their shareholders, and secondly will be the actual level of free float that such IPOs, and potentially even SPOs, will leave for investors to get involved with. The family control that many companies still like to enjoy is very much related to both of these aspects, though such traditions are hard to change in young markets such as the Tadawul.