Not the Stock Approach

In examining the listing of Saudi Arabia on the EMCI Index, it is useful to briefly consider the underlying reasons than led to it. In step with the 2016 launch of Saudi Arabia’s Vision 2030, the Kingdom has taken a market-friendly and diversified economic path. Notably, it has been welcoming of foreign investors, among others by introducing 100% ownership of foreign-owned companies within the KSA, easing foreign ownership of listed entities, and shifting from T+0 to T+2 trade settlement in its capital markets. Meanwhile, the introduction of VAT created a further source of state revenues, helping to tip the balance toward non-hydrocarbons. That said, the likely listing of behemoth Aramco—for which Saudi Arabia foresees a USD2-trillion valuation—can only raise interest levels.

Shoring-up the Playing Field

In 2H2018, the Saudi Stock Exchange (Tadawul) launched the Central Counterparty Clearing House (CCP), an intermediary entity that guarantees the settlement of transactions. This settlement guarantor paved the way for more diversified investment options with the arrival of such new assets as derivatives, making for a more appealing market.

Inclusion on MSCI

The MSCI Emerging Markets Investable Market Index (IMI) is home to large, mid, and small-cap companies in 26 EMs. And inclusion of stocks from the KSA’s MSCI Saudi Arabia IMI 25/50 Index to the MSCI Emerging Markets Index is a tangible consequence of financial modernization. As analysts were quick to point out, the arrival of the KSA was part of wider moves at diversifying the EM index that also saw the door opened to Chinese equities. The KSA’s inclusion is a two-step process commencing in June 2019 with the MSCI Saudi Arabian Index. It accounts for roughly 2.6% of the MSCI Emerging Markets IMI, having introduced close to 70 stocks to the mix. Diversification is again at the heart of the endeavor, and the Saudi index is over 75% comprised of financials and materials. Note that in 2019, three out of five tranches of Saudi stocks also entered the FTSE emerging-market index. As of July 2019, the Saudi index had risen by around 14% YtD. And not resting on its laurels, Saudi Arabia has also moved to ensure its real estate investment trusts (REITs) are in step with international best practices through inclusion in global indices.

The consequences?

Upon inclusion the sentiment-driven party was rather short-lived, albeit due to geopolitics, rather than fundamentals. The factor was bellicose moves from Washington against Iran. And falling off a May peak of 9,361.96, the benchmark Tadawul All Share Index shed 10%. Yet a rebound spelled a six-month rise of 13.1%. The bullish market view is that the August follow-up inclusion could mop up USD7.8-7.9 billion.

Aramco-a-go-go?

If the deal goes to plan it seems that Saudi Arabia would in one fell swoop rise to the seventh-biggest constituent of the MSCI Emerging Markets Index. Bank of America Merrill Lynch calculates that Saudi stocks would account for 4.6% of the index. It will be in third place following the August phase of MSCI inclusion.

The Tadawul, critics have claimed, has often been buoyed by state entities beyond market scrutiny raising question marks over valuation. So, perhaps the key takeaway from the inclusion story is the KSA’s wish, however likely in reality, to step away from the opacity that has hindered investor interest in the past.