MSCI Middle East chief sounds Saudi warning

The Middle East head of index provider MSCI has issued a reminder that Saudi Arabia’s stock market won’t be included in its equity indices until the summer of 2017 at the earliest, countering bullish forecasts for foreign investor inflows.

The Capital Market Authority (CMA), Saudi’s market regulator, announced earlier this year that foreign investors would be allowed to invest directly into the country's largest stock exchange, the $560 billion Tadawul All Share Index, from next year. It has not released a precise date or details on what type of investors will be eligible.

Based on the current size of the Saudi market, MSCI estimates it would comprise 4% of the total index if it entered the MSCI Emerging Markets index and 63% of the total in the MSCI Frontier Markets index. Inclusion in the emerging markets index would imply flows from foreign investors of about $50 billion.

Up until now overseas investors have been prevented from investing directly in Saudi Arabia, although they can do so via swap agreements with licensed Saudi intermediaries.

Analysts have predicted foreign portfolio inflows into Saudi Arabia of between $30 billion to $50 billion when the market opens. “But these will depend strongly on the country’s inclusion in MSCI global indices,” said Hammad Izz-e-Hamid, of the securities services for the Middle East and Africa at Deutsche Bank.

For his part, Robert Ansari, MSCI’s executive director and Middle East head, said: "Entry to the MSCI index would not be until 2017 at the earliest."

He explained that Saudi was not formally under review by MSCI, meaning the earliest it would engage its clients would be in the June 2015 annual market classification review.

Assuming there is sufficient support for putting the market under review, then there would follow a year-long process of canvassing investors' opinions on what needs to change in the capital market and securities servicing infrastructure for them to be comfortable investing. This must then be fed back to Saudi authorities.

If the requested reforms are carried out and investors voice their satisfaction in a review the following year, in June 2016, then MSCI would not announce Saudi Arabia's inclusion until a year later, June 2017.

Investors will want to see that their requested reforms are carried out. "The quantitative criteria are essentially met, with the exception of the free-float adjusted market cap, but there are a number of qualitative criteria that are equally important to investors," Ansari pointed out.

He said the requirement to settle trades on the trade date (T+0) may be acceptable to investors initially. But they would expect it to move in line with global norms –  T+1 or T+2 – over time.

But it may not. "Similarly the absence of pre-funding [the requirement that a certain percentage of the trade must be pre-funded in the investor's account] may be a show-stopper," said Ansari.

But Arindam Das, regional head of securities services for the Mena region at HSBC, downplayed the significance of these qualitative requirements and expressed the view that investors would have few objections come next June. “The process is driven by investors and how willing they are to enter the market,” he said.

One appeal of Saudi Arabia is that it offers foreign investors who are seeking exposure to the Middle East a chance to diversify portfolios away from a concentration on energy companies and banks into other sectors.

“Consumer demand is a strong investment theme in the Middle East,” said Husayn Shahrur, executive director of Mena equities at NBK Capital.

“In addition to the strong fundamental story, investors benefit from relatively low correlation with international markets, compared with the other leading sectors in the region. Saudi Arabia offers a large number of liquid listed companies in the consumer sector that investors can access.”