Regional equities are doing well by opening up to foreign investors

At a time when the headlines are dominated by talk of global protectionism, it is a welcome development that this region appears to be opening itself up to foreign capital. While US equities that rallied on the arrival of Donald Trump are now turning lower as trade tensions heat up, regional equities are largely holding up on account of reforms designed to attract foreign investors into them. The Tadawul is up 10 per cent yearto-date while the Abu Dhabi Securities exchange is up 6.5 per cent and the Kuwait index by 3.5 per cent. The major global indexes, however, are recording losses with the S&P 500 down 2.5 per cent and the German DAX and the Japanese Nikkei having lost around 5 per cent so far this year.

Late last month, the FTSE decided to include Saudi Arabian equities in its emerging markers index. According to the index compiler, the country is expected to have an index weight of 2.7 per cent within the FTSE Emerging Market index. The decision will be implemented in five tranches starting in March 2019 and could lead to passive inflows of as much as $5 billion. MSCI, another index provider, is expected to take a call in June 2018 on including Saudi equities in its EM index. If the MSCI follows in the FTSE’s footsteps, that could lead into an additional passive inflows of as much as $10bn.

An entry into broadly tracked indexes would mark the culmination of a series of capital market reforms initiated in Saudi Arabia over 2016 to 2018. These included the simplification of the qualified foreign institutional investor registration process and changes to the settlement and custody model. The first three months of 2018 saw foreign investors as the net buyers of Saudi equities every week since the start of the year. On an aggregate basis, they have bought equities to the tune of 7.3bn Saudi riyals in the first quarter of this year.

Saudi Arabia is not alone in chasing foreign capital inflows. Kuwait, which was classified as secondary emerging market status in September by the FTSE, has made several changes to gain the same status from the MSCI. The FTSE decision is likely to result in passive inflows of about $800 million into Kuwaiti stocks. As part of the reforms, the stock market in Kuwait was divided into three segments with the Premier Market composed of the largest and most liquid companies.

It is worth noting that the period between announcement and actual implementation is generally positive for equity markets given flows from active investors. For the record, Qatar and the UAE received inflows of $2.7bn combined in the year leading up to their inclusion in the MSCI EM index in 2013.

The benefits of such inclusions into broadly tracked indexes go beyond immediate short-term inflows. They also attract a new set of investors into the economy, the majority of whom are relatively sophisticated financial institutions. Once invested, these institutions tend to progressively drive positive changes in terms of transparency, corporate governance and financial reporting standards, which often translate into reduced risk premiums and enhanced valuations over longer periods of time.

While the authorities in the region were largely driven into many of these reforms by the need to diversify their energy-dependent economies, the pace and intensity of the steps taken to date suggest the majority of the region’s countries are now on irreversible paths towards opening up their economies to a wider set of reforms and international investors. At a time when other countries touted as beacons of free trade are retreating into themselves, the initiatives in the Mena region are a welcome development that should ultimately be a positive for their markets as well as for the investors in them.

The majority of new foreign investors are relatively sophisticated financial institutions