Saudi index win is stepping stone, but Aramco IPO listing would make bigger splash

Saudi Arabia’s stock market is joining the big time. Index provider MSCI on Wednesday added the kingdom to its emerging markets benchmark. The elevation is well deserved, but a more important catalyst for internationalizing its capital market would be listing national oil champion Aramco.

Saudi merits the endorsement from MSCI. The country’s Capital Market Authority has brought in a mandatory corporate governance code, considerably relaxed rules for foreign investors, and raised settlement rules for the domestic Tadawul stock market toward global standards.

Based on the value of their freely traded shares, the 32 Saudi stocks included will account for 2.6 percent of the index, which comprises emerging market equities worth $5.3 trillion. As funds worth $1.7 trillion track the benchmark, that implies they will have to spend about $44 billion on Saudi shares to maintain an index weighting.

Throw in the FTSE Russell Emerging Markets Index, which added Saudi Arabia earlier this year, as well as the FTSE and MSCI global indices, and the overall inflow rises to $63 billion, according to Irfan Ellam, head of Equity Research at NCB Capital. By comparison, total portfolio and foreign direct investment into Saudi last year was just $25 billion, Capital Economics estimates.

Still, “passive funds” only account for about a third of the assets tracking those indices, Ellam reckons. Given that the Tadawul trades at over 16 times historical earnings – above the MSCI Emerging Markets Index’s average multiple of 14 – active managers won’t necessarily charge in.

And while there are now over 180 socalled qualified foreign investors who are entitled to own up to 49 percent of a Saudi company, overseas investment is still very low.

An Aramco listing would make a bigger splash. A stock offering worth $100 billion would lift Saudi’s emerging markets index weighting to more than 4 percent and likely inflows above $120 billion. An offering entirely in Riyadh – increasingly probable given regulatory and judicial obstacles to listing in New York and London – would really boost participation by foreign investors. Yet given the challenges to Aramco achieving its desired $2 trillion valuation, Riyadh may yet shelve the IPO. Then Saudi’s brave new capital world would suffer a setback – with or without MSCI.