08 September 2022
At a time when global markets are sliding because of high inflation, rising interest rates and geopolitical shockwaves from the conflict in Ukraine, the Gulf Cooperation Council (GCC) markets, led by Saudi Arabia, are thriving on high oil prices, entrepreneurial fervor and business-friendly government incentives. In the past few years, the Saudi Exchange, with a market capitalization of $3.2 trillion, has grown to be amongst the dozen largest stock exchanges in the world.
The Kingdom has come a long way from early 2006 when a stock market crash wiped half the value from the Exchange’s market capitalization as the broad TASI index fell approximately 65% over the course of the year. “I remember that crash vividly because it coincided with the first year of my investment banking career,” said Wassim Al Khatib, CEO of Citigroup Saudi Arabia.
The best practices found at more mature market ecosystems remained underdeveloped in Saudi Arabia in the early 2000s. “Back in those days there were fewer than 100 listed companies in Saudi Arabia, and trading was predominantly led by retail investors with very limited institutional participation,” recalled Al Khatib.
For almost a century, Saudi Arabia—the largest economy in the Middle East—has been a global leader in oil & gas production, export, and trading. But only in the last couple of decades has it developed a substantial capital markets ecosystem.
Indeed, in the early 2000s retail traders accounted for more than 95% of daily trading volumes on the Tadawul (as the main market is known), compared to 10 to 15% in US markets. Many of these investors were from the middle class with little or no investment experience. A sizable proportion took out loans to buy more shares on margin to capitalize on the momentum of the bull market.
“The Capital Market Authority (CMA), the regulator, was still a relatively new entity, and things like equity research, coverage and international reports on the Saudi economy were barely available back then,” Al Khatib said. When the CMA and SAMA, the central bank, took corrective actions to apply brakes to the overheating market, the significant adjustment took place.
Enter Saudi Vision 2030. Introduced in 2016 by Saudi Arabia’s Crown Prince Mohamed bin Salman, the national plan has served as a direction of travel for practically all aspects of the Kingdom’s developmental initiatives. Among them is the Financial Sector Development program, which “aims to develop a diversified and effective financial sector to support the development of the national economy, diversify its sources of income, and stimulate savings, finances and investments.”
Armed with rejuvenated energy and a developmental carte blanche, the CMA significantly stepped up its regulatory prowess through a series of reforms designed to enhance confidence and transparency in the administration and development of the capital markets ecosystem of the Middle East’s largest economy.
These included allowing and incentivizing foreign investors to participate in the Saudi growth story through the establishment of the Qualified Foreign Investor (QFI) program and through the reduction of the assets under management (AUM) threshold of potential institutional investors looking to enter the market from $1 billion to $500 million. Another important reform was aligning technical practices with international markets. Payment for a securities transaction is typically required within two business days, for instance, a practice referred to as T+2.
“In Saudi Arabia, transaction settlements used to be on a T+0 basis as recently as a few years ago. The shift to T+2 aligns with most of the rest of the world. This simple yet transformational reform made it much easier for institutional investors to continue to move into the market,” commented Al Khatib.
In Q4 2021, the percentage of trading value conducted by foreign investors on the Main Market was almost 12%, compared to approximately 5.5% a year earlier in Q4 2020.
Mashael Alkheraiji, Financial Consultant at Alkheraiji Law Firm, added that “new products and features—such as REITs, futures contracts and debt market trading—are constantly being included. Moreover, the fluctuation limit mechanism for newly listed stocks was amended to 30% (from 10%) for the first three days of trading. I expect further initiatives and developments to continue in the market, such as including exchange-traded options, listing government-related REITs, facilitating dual-listings and continuously enhancing the listing process.”
Roughly two-thirds of Saudi Arabia’s population is under the age of 35. Many are technologically savvy, and entrepreneurial ventures in Saudi Arabia have grown substantially over the past decade. As such, in 2017, the Saudi Exchange launched a parallel market called Nomu, which is Arabic for “growth.” Nomu gives smaller companies an opportunity to tap into additional funding pools, separate from private capital avenues such as private equity or private placements.
“This allows market participants to better understand how the market values and appraises the value of those companies,” said Al Khatib. “What the market is telling us is that there is a solution for any size business. As long as potential issuers satisfy a minimum set of requirements, the Exchange will always serve as a good platform to facilitate funding solutions.”
Not to be forgotten are the debt capital markets, wherein Saudi Arabia has been active only since 2017. According to a 2021 report by S&P Global, investors will likely continue be attracted to the Kingdom’s sovereign issuances with a slow but steady increase in corporate issuances starting with government-related entities, followed by a few top corporates. In 2017 the Kingdom launched a monthly local currency sukuk issuance program, thereby building a liquid local currency government bond market and yield curve. (Sukuk are bonds compliant with Islamic finance law.) Ratings agencies such as S&P, Moody’s and Fitch have developed tools to help inform investors about the various local credit opportunities and enhance transparency between Saudi local currency issuances as the Kingdom continues to develop its debt capital markets.
In early 2019, the Kingdom attained “emerging market” status—as measured by MSCI, FTSE Russell, and S&P Dow Jones—leading to tens of billions of dollars of inflows through both passive and active funds.
According to Mazen Al Sudairi, Head of Research at Al Rajhi Capital and a prominent economic commentator, “since the inclusion of Saudi Arabia in the MSCI index, the participation of foreign investors in the Saudi market increased substantially. Foreign ownership in Saudi companies, based on free float M-cap, increased from 2.4% in November 2015 to 15.3% in November 2021. Passive funds tracking MSCI are likely to include companies in the Saudi market to rebalance their portfolios. One estimate is that the inclusion … attracted capital inflows of around $45 billion to the Kingdom. So far, the inclusion has had a positive impact in terms of foreign participation, valuations and the overall liquidity of the Saudi market.”
Al Sudairi added, “the average turnover in the Saudi markets has increased from $930 million in 2018 to $2.2 billion in 2020. The valuations too have improved for the companies in the Saudi market, with the average P/E improving from 16.6 in 2018 (one year before the upgrade) to 23.5 in 2020 (one-year post-implementation).”
Alkheraiji believes much of the growth in capital markets activity for smaller companies can be attributed to government incentives such as the TOMOH-Elite program. This particular program incentivizes SMEs to list their shares by providing them with certain financial incentives, training programs, and access to a network of local and international investors and advisors. Food delivery app Jahez, which listed its shared on Nomu in 2021, was one of the beneficiaries of this program.
“This has led most IPOs on the main exchange and Nomu to generate huge coverage from both institutional and individual investors, reflecting the significant liquidity potential of the market,” says Alkheraiji.
Wassim Al Khatib, CEO of Citigroup Saudi Arabia: By looking at the entire ecosystem—participants, regulators, the Exchange, investors and others—the Saudi Exchange delivered the goods.
In 2021, nine companies listed on the main market, including ACWA Power, Tadawul and STC Solutions, compared to three companies in 2020. In 2021, 14 companies listed on Nomu, up from two in 2020.As for debt capital markets, the pace of reforms and activity has been steadily picking up. According to S&P Global, there was “an increase in listed debt issuances by Saudi corporates, particularly government-related entities, which represented about 90% of the roughly $26 billion listed corporate bond and sukuk issuance in 2019 and 2020. In 2020 the CMA started allowing non-resident foreign investors to invest directly in listed and non-listed debt instruments.” As far as accelerating both the pace of reforms and the global relevance of Saudi Arabia’s capital markets, the $29.4 billion IPO of Saudi Aramco was a gamechanger. Until 2019, financial information about the world’s largest energy and chemicals company was scarce at best. Listing Aramco on the Saudi Exchange was one of the specific goals of Vision 2030 and cast the eyes of the investment world on both Aramco and the Kingdom.
Alkhatib recalls, “by looking at the entire ecosystem—participants, regulators, the Exchange, investors and others—the Saudi Exchange delivered the goods. The world was impressed with the readiness of the Exchange’s technological infrastructure, the sophistication of its platform, and ultimately its ability to host of one of the largest IPOs in the world. That gave Tadawul a huge boost in terms of international visibility, putting it on the global—not just the regional—map.”
Since then, Aramco’s IPO paved the way for a tidal wave of Saudi companies looking to tap the public markets in spite of challenging economic conditions. BinDawood Holding, for example, one of the leading grocery retail operators of hypermarkets and supermarkets in the Kingdom, listed in 2020 during the first year of the COVID-19 pandemic. Nahdi Medical Company, the Kingdom’s market leading pharmaceutical chain, raised $1.34 billion—a month after the outset of the conflict in Ukraine—when it listed 30% of its shares in 2022, making it the Kingdom’s largest IPO since that of Saudi Aramco. Brunswick advised on both transactions.
Those in the know are adamant that there is still much more to come. According to Alkhereiaji, “in December 2021 Tadawul and CMA received over 50 listing requests in both the main market and Nomu. As long as market conditions remain attractive this trend will help further increase the depth and liquidity of the Saudi market.”
Commenting on where we are today, Al Khatib says: “Today, there are more than 200 listed companies, and the market has shifted away from being heavily dependent on energy and banks, to being more diversified across different sectors, including consumer goods, insurance, real estate, retail, F&B, manufacturing and multi-asset investments.”
According to the International Monetary Fund, the Kingdom is projected to grow at 7.6% in 2022, making it one of the largest growth rates in the world at a time when other global and G20 economies are experiencing recessionary conditions. Saudi’s debt-to-GDP ratio is expected to fall to 25.9% in 2022, from 29.2% in 2021, as per budget estimates.
ESG reporting has grown rapidly in recent years, as more global investors become attuned to the sustainability of the companies they invest in. In 2021 Tadawul launched its new ESG Disclosure Guidelines to help Saudi Exchange-listed companies report their ESG performance at the highest standards.
According to Al Sudairi, “corporate governance has been improving as a result of the introduction of these new measures on disclosure and transparency reporting. A more stakeholder-focused approach that takes society into account has also been key to the growth of many Saudi corporations. Encouraging environmentally friendly practices is on the rise with the Saudi government looking to achieve net-zero status by 2060.”
What does tomorrow hold for investors in search of yield in Saudi Arabia? Al Khatib said, “The two sectors I would be keen to focus on, and in which Citigroup has already been playing a meaningful global and regional role, are tech and renewables. These sectors in particular feed straight into the Kingdom’s aspirations of being a more digitalized and tech-based economy, while also being more climate-friendly and compliant with internationally credible ESG standards. Taken in conjunction, these topics have become increasingly central to the agendas of policymakers, businessmen, and decisionmakers to ensure the Kingdom is ready to be part of the new transition.”
Jamil Fahmy and Ikram Al Yacoub, both Saudi citizens, are Gulf-based Directors at Brunswick.