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.