Saudi Arabia’s decision to open up its stock market to foreign investors should direct further inflows into the region’s biggest and most active stock market next year, helping propel the kingdom further down a path of economic reform.

The long-anticipated move has set regional fund managers abuzz with excitement about gaining direct access to the Middle East’s largest economy, underpinned by large hydrocarbon resources and the Gulf states’ largest population.

Mohammad Al Tuwaijri, the Saudi chief executive of HSBC in the Middle East and North Africa, describes the move as “one of the most important moments in the history of Saudi financial markets.”
Fund managers are similarly hyperbolic about the transformative possibilities for the region’s equity markets, for so long overlooked by global investors as the global financial slump was compounded by Arab spring uncertainty.

Since the announcement, the Tadawul all-share index has already jumped four per cent after rising 46 per cent over the past couple of years on the strength of the oil-dominated economy.
Gross domestic product jumped 48 per cent over the past four years to a projected $779 billion (Dh2.8 trillion) in 2014, according to IMF figures.
“The Saudi market gives you exceptional emerging markets growth coupled with the high credit quality of developed markets,” says Bassel Khatoun, head of Mena equities at Franklin Templeton Investments. “That makes for a very interesting proposition.”

The country’s Tadawul stock market is a giant compared to its regional peers: its $560 billion market capitalisation is almost as large as the other five Gulf states put together, roughly on a par with Russia’s bourse.
Trading at 14 times price/earnings ratio, some say the Tadawul is overvalued when compared to other emerging markets.
But Mr Khatoun says this is compensated by its higher corporate earnings rate, averaging 15 per cent this year. He points to strong financial and petrochemicals sectors as offering value for foreigners. Other managers say the retail and health care firms will lure in overseas money.
The opening up raises the prospect of Saudi Arabia moving on to the MSCI Emerging Markets index, where it would account for about 4 per cent.

A Bank of America Merrill Lynch research report estimates that inclusion in the MSCI Emerging Markets index could translate into net inflows of between $13.3 billion-$26.6 billion.
Bankers say the Capital Markets Authority is already seeking proposals for upgrading trading systems and regulations ahead of the target for opening up in the first half of 2015.
Over the next month, the CMA is expected to finalise requirements to qualify overseas investors. Previously, it has indicated that it will require a minimum of $5 billion of assets under management, along with a five-year track record Opening up the region’s most tightly controlled bourse has been a slow process, first allowing banks to issue participatory notes for investors to bypass previous bars on foreign participation.
Reluctance to open has been rooted in the social service that the market performs. With 90 per cent of the market made up of retail investors, the kingdom’s stock market is a means to disseminate the state’s oil wealth throughout the economy.

The government now hopes that the entry of foreign money on to the stock exchange will help boost diversification efforts as Riyadh seeks to generate more non-oil sector growth to create jobs for its burgeoning youth population.
“It’s a great opportunity, yes, but this market is jealously guarded by Saudis, who won’t want to share the benefits,” says one regional fund manager.

Indeed, Qatar and the UAE, which were added to the MSCI Emerging Markets index in June, have provided salutary lessons for overseas investors.
Volatility on the Dubai Financial Market prompted by uncertainties concerning construction firm Arabtec has underlined the risks that foreigners can face regarding share price movements amid poor disclosure.
The Arabtec debacle wiped 26 per cent off the DFM before yo-yoing back 18 per cent, sparking disquiet among fund managers.
Saudi Arabia may share some of the same traits, but market participants say the Saudi regulator has played a more active role in maintaining market integrity.

Imran Mufti, law firm Hogan Lovells’ partner in Saudi Arabia, said the appointment last year of a “forward thinking” chairman of the CMA, Mohammad Al Shaikh, has sent more positive signals to the market. In 2009, the CMA fined a major investor for insider trading, and has more recently introduced new regulations limiting the potential for manipulation. The Saudi market’s size, liquidity and depth also minimises the scope for foreigners with balanced exposure to be caught out of the loop. “They put people on notice that they will pull you up for insider trading,” he said. “Transparency is there.”