SAUDI HOLDS THE KEY

Mor­gan Stan­ley Cap­i­tal In­ter­na­tional's (MSCI) re­clas­si­fi­ca­tion of UAE and Qatar from fron­tier to emerg­ing mar­kets was akin to th­ese two coun­tries win­ning a prize on the global stage.

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The decision of Mor­gan Stan­ley Cap­i­tal In­ter­na­tional (MSCI) to up­grade the sta­tus of the UAE and Qatar from fron­tier to emerg­ing mar­kets will pave the way for at­tract­ing for­eign in­vest­ments but Saudi Ara­bia's plans to open its bourse for for­eign in­vest­ments will ac­cel­er­ate the process.

“After years of an­tic­i­pa­tion, the UAE and Qatar have fi­nally been re­clas­si­fied from Fron­tier to Emerg­ing Mar­kets by MSCI. While lo­cal ex­changes and reg­u­la­tors have done the heavy lifting so far, the onus will now be on listed com­pa­nies to prove them­selves to a more in­ter­na­tional au­di­ence.”

MSCI be­gan con­sul­ta­tions as long ago as July 2008 after which lo­cal in­vestors watched the in­dex provider's an­nual June up­dates with bated breath. In June 2013, MSCI fi­nally an­nounced that Qatar and the UAE were to be up­graded at the May 2014 re­clas­si­fi­ca­tion.

Fol­low­ing the an­nounce­ment last year, ac­tive in­vestors be­gan po­si­tion­ing them­selves and helped Dubai's bench­mark in­dex rally 108% dur­ing the year, mak­ing it the sec­ond best-per­form­ing eq­uity mar­ket in the world (after Venezuela). Abu Dhabi and Qatar were also among the top ten per­form­ers. In the first five months of 2014, Dubai con­tin­ued its re­mark­able as­cent, climb­ing 51% to claim top spot among global eq­uity mar­kets. Qatar was in sec­ond place, ral­ly­ing 32%.

After tremen­dous ex­cite­ment, ex­ten­sive press cov­er­age and bil­lions of dol­lars of for­eign in­flows, the long-awaited up­grades are now be­hind us. But what hap­pens next? How will MSCI's decision af­fect th­ese mar­kets and the re­gion?

Im­pact vis­i­ble

Some im­pacts from the up­grade are al­ready vis­i­ble while oth­ers will take years to emerge. Quick wins in­cluded the vir­tu­ous cy­cle fu­elled by a jump in daily liq­uid­ity which squeezed bid-of­fer spreads, in turn at­tract­ing greater vol­umes and help­ing the cy­cle to con­tinue.

In the first five months of 2013, av­er­age daily vol­umes were QR254.8 mil­lion ($70 mil­lion) on the Qatar Stock Ex­change and QR655.2 mil­lion ($180 mil­lion) across both UAE ex­changes. In the first five months of 2014, this had tripled to QR848.12 mil­lion ($233 mil­lion) in Qatar and quadru­pled to over QR2.78 bil­lion ($765 mil­lion) in the UAE.

Height­ened in­ter­na­tional aware­ness of both coun­tries is another pos­i­tive, as in­creased press cov­er­age will ed­u­cate read­ers about in­ward in­vest­ment op­por­tu­ni­ties. The nar­ra­tive on Dubai will no longer just be a popular des­ti­na­tion for tourists and real es­tate in­vestors; Abu Dhabi's do­mes­tic spend­ing plans will en­joy greater ex­ter­nal at­ten­tion; while Qatar will see ar­ti­cles about more than just its own in­vest­ments abroad. Un­for­tu­nately for Qatar, the MSCI up­grade has co­in­cided with neg­a­tive press about the FIFA 2022 World Cup which has cer­tainly re­duced some of the ac­tive buy­ing ex­pected around the MSCI up­grade.

Lo­cal eq­uity mar­kets ex­pand

Over time, in­creased cap­i­tal in­flows will ex­pand lo­cal eq­uity mar­kets. Sus­tained high oil prices have meant re­gional banks are flush with cash and are look­ing to ag­gres­sively de­ploy their bal­ance sheets. In ad­di­tion, both cor­po­rate and sov­er­eign bor­row­ers took ad­van­tage of buoy­ant fixed in­come mar­kets in 2012 and 2013, se­cur­ing long-term fund­ing. In this en­vi­ron­ment, eq­uity rais­ing has been very limited so adding another op­tion to fi­nance am­bi­tious gov­ern­ment plans and as­so­ci­ated pri­vate sec­tor ex­pan­sion will be wel­come.

There will also be a re­cal­i­bra­tion of

share­hold­ers who – although will re­main mi­nori­ties be­cause of for­eign own­er­ship lim­its – will grad­u­ally bring in change, both neg­a­tive and pos­i­tive. Many in­ter­na­tional funds have long in­vested in the GCC and higher cor­re­la­tion to global mar­kets is ev­i­dent in many of the stocks they favour. For­eign own­er­ship will rise fur­ther but this may not al­ways be de­sir­able; UAE and Qatari eq­ui­ties will in­creas­ingly feel pain dur­ing times of sour global sen­ti­ment when top-down ‘de-risk­ing' drives in­dis­crim­i­nate sell­ing.

How­ever, some of th­ese new in­vestors have con­sid­er­ably longer hori­zons ver­sus lo­cal re­tail that dom­i­nates GCC eq­uity mar­kets. UAE and Qatari com­pa­nies will be in­creas­ingly con­scious of de­mands to im­prove trans­parency and come up the in­vestor com­mu­ni­ca­tion curve if they wish to ben­e­fit from the sig­nif­i­cant for­eign cap­i­tal avail­able. Im­prove­ments to cor­po­rate gov­er­nance will be pos­i­tive but likely take sev­eral years to be felt.

The im­por­tance of Saudi Ara­bia

While at­ten­tion has been on UAE and Qatar, the real prize in the GCC would be to add the King­dom of Saudi Ara­bia (KSA) to the fold.

In early 2013, HE Mo­ham­mad Al-Sheikh was named Chair­man of the Cap­i­tal Mar­kets Au­thor­ity (CMA). His Western ex­pe­ri­ence is no­table as he stud­ied at Havard Law School, worked at a ma­jor US law firm and held a se­nior po­si­tion at the World Bank.

A few months after his ap­point­ment, the work-week was ad­justed to the re­gion­ally con­ven­tional Sun­day-Thurs­day, in­creas­ing over­lap with in­ter­na­tional mar­kets. In ad­di­tion, the CMA held con­sul­ta­tions with for­eign bro­kers to dis­cuss a frame­work al­low­ing cer­tain for­eign in­vestors ac­cess. Fren­zied spec­u­la­tion of im­mi­nent change fol­lowed but un­for­tu­nately so did si­lence from the CMA. An­tic­i­pa­tion of open­ing up the King­dom's listed com­pa­nies to di­rect for­eign own­er­ship has since waned, how­ever, this is un­likely to be the end of the road. Reg­u­la­tory change in Saudi Ara­bia is never rushed.

For Saudi to be el­i­gi­ble for a global eq­uity in­dex other changes are nec­es­sary, such as the T+0 set­tle­ment process. Although ex­tremely popular with re­tail in­vestors, which ac­count for 90% of daily vol­umes, in­ter­na­tional in­vestors may be less en­thu­si­as­tic.

How­ever, the coun­try's size and po­ten­tial are com­pelling. The QR2.73 tril­lion ($750 bil­lion) econ­omy should con­tinue to grow in the mid-sin­gle dig­its and ac­counts for almost half of the GCC's GDP. KSA's 28 mil­lion peo­ple rep­re­sent more than 60% of the re­gion and Saudis make up 75% of their coun­try's pop­u­la­tion; in stark con­trast to Qatar and the UAE where just one per­son in ev­ery nine are cit­i­zens.

While Qatar boasts the great­est pro­por­tion of mil­lion­aire house­holds in the world (at 14%) and Abu Dhabi's QR364,000+ ($100,000+) GDP per capita makes it one of the high­est glob­ally, Saudi's more mod­est GDP per capita of QR94,640 ($26,000) re­flects a de­mo­graphic closer to an av­er­age emerg­ing econ­omy.

Although the King­dom has its fair share of ul­tra-wealthy, it also has a large pro­por­tion of mid­dle class and lower in­come work­ers as well as the un­em­ployed. This brings to bear fa­mil­iar themes for global in­vestors, such as ur­ban­i­sa­tion and in­dus­tri­al­i­sa­tion which are limited in the re­gion. The Saudi stock mar­ket of­fers su­pe­rior breadth and depth ver­sus re­gional peers. One hun­dred and sixty four listed com­pa­nies (ver­sus UAE's 92 and 43 in Qatar) with an av­er­age daily vol­ume in ex­cess of QR8 bil­lion ($2.2 bil­lion) are more than dou­ble the UAE and Qatar com­bined. The Saudi Tadawul in­dex boasts 50 stocks which trade more than QR36.4 mil­lion ($10 mil­lion) a day.

Saudi Ara­bia also of­fers su­pe­rior di­ver­si­fi­ca­tion and is not just dom­i­nated by banks and real es­tate com­pa­nies, al­low­ing more nu­anced in­vest­ment. There are nu­mer­ous listed petro­chem­i­cal pro­duc­ers which ben­e­fit from some of the cheap­est feed­stock in the world, as well as dozens of con­sumer and in­dus­trial com­pa­nies which are key ben­e­fi­cia­ries of en­hanced gov­ern­ment spend­ing. In terms of sig­nif­i­cance, the QR1.638 tril­lion ($450 bil­lion mar­ket) cap­i­tal­i­sa­tion of MSCI Saudi Ara­bia com­pares to MSCI South Africa's QR1.53 tril­lion ($420 bil­lion) (˜7.5% weight in MSCI EM) and QR1.31 tril­lion ($360 bil­lion) for MSCI Mex­ico (˜5% weight). Im­ple­ment­ing for­eign own­er­ship lim­its would lower Saudi's in­dex weight, but with Qatar and the UAE al­ready in­cluded, the Gulf's over­all con­tri­bu­tion would be sig­nif­i­cant.

So while the UAE and Qatari eq­uity mar­kets bask in their up­grade to MSCI EM, the true com­ing of age for the re­gion will be if, or per­haps when, Saudi joins them

BY AK­BER KHAN Di­rec­tor of As­set Man­age­ment Al Rayan In­vest­ment

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