Saudi Arabia could destabilise frontier market indices if it fails to qualify as an emerging market under MSCI rules.
The opening of Saudi Arabia’s $580 billion (€437 billion) stock exchange to qualified foreign institutional investors is planned for next year, and the index provider says the exchange is broad and deep enough for a potential inclusion in the MSCI Emerging Market index.
But if Saudi Arabia is not transparent about how it awards investor quotas, if it caps investment from foreign institutions, or if it sets up restrictive foreign ownership limits on stocks, the country might not qualify as an emerging market.
“Accessibility is the big question mark,” says Sebastien Lieblich, executive director of index research at MSCI.
If a country does not satisfy MSCI’s emerging market criteria, it would normally enter the MSCI Frontier Market index. However, Lieblich says the index provider will be cautious about qualifying Saudi Arabia as a frontier market because its weighting would be very large and its entry could destabilise the index.
If Saudi Arabia does not impose any foreign ownership limits, its weighting in the frontier market index would be about 60%. If it were to enter the emerging market index, its weighting would be 4.5%, similar to Russia.
Frontier markets have been a successful investment target over the past year, receiving large flows and outstripping returns from emerging markets. The MSCI Frontier Market index has risen nearly 20% by the end of July, compared to a gain of 6% in the EM index.
Lieblich says MSCI will listen to feedback from its institutional investor clients before making a decision about Saudi Arabia's index status, a decision which is unlikely to happen before 2017.
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