It has been a momentous year for capital markets in the region, with a massive resurgence in initial public offerings (IPOs) in the GCC, the long-awaited upgrades of the UAE’s and Qatar’s exchanges finally going ahead, and Saudi Arabia preparing to open its market to foreign investors. But as 2014 draws to a close, there are concerns falling oil prices will cast a shadow over the year ahead.

Busiest bourse

The Saudi Stock Exchange (Tadawul) has been the standout market this year in terms of IPOs. Following four listings in the first nine months, it saw the second-largest IPO in the world as the kingdom’s biggest lender, National Commercial Bank (NCB), sold off 25 per cent of its shares in November. Only the offering of Chinese online trader Alibaba in New York was larger in 2014. At $6bn, NCB’s IPO was the biggest ever seen in the Arab world.

The enormous flotation came just months after the confirmation from the Saudi Capital Market Authority that it would allow foreign investors to participate directly in the kingdom’s stock exchange from 2015. Until now, non-Saudis could only gain exposure to the region’s largest and most liquid bourse through swap arrangements and exchange-traded funds. Currently, foreign ownership of Saudi stocks amounts to just $8bn, accounting for barely 1.4 per cent of the bourse’s total market capitalisation.

The opening up of the Tadawul to qualified foreign investors (those with at least $5bn of assets under management and that have been operational for a minimum of five years) represents a significant shake-up of the market with near and long-term consequences. There has been a sharp increase in activity since the announcement and it is expected to pave the way for Saudi Arabia to be included in the MSCI Emerging Markets (EM) Index, with some suggesting this could happen as soon as 2017.

MSCI EM Index inclusion could have a material impact on the Saudi market. The US-based index provider has previously stated that Saudi Arabia might comprise 4 per cent of the EM Index. Such a weighting would make it the ninth-largest market in the index, just behind Russia, notes the US’ Morgan Stanley in a report on Saudi equities issued in mid-August.

It would also become an instant index heavyweight in the MSCI EM Europe, the Middle East and Africa Index, with about a 19 per cent weighting, which would account for more than twice the weight of Turkey or Poland and close to four times the current combined weight of Qatar and the UAE.

In terms of the volume of likely institutional inflows into the Tadawul, the local Jadwa Capital estimates that, in the medium term, these could total a hefty $40bn-$50bn, more than five times the existing foreign holdings.

Market upgrades

Qatar and the UAE were upgraded from frontier markets to emerging markets at the end of May 2014. Although both rose in anticipation of the inclusion and then declined sharply in the aftermath of the upgrade, the improved status is expected to result in increased foreign institutional fund inflows.

The upgrades, which were announced in 2013, have contributed to the pick-up in IPOs in the GCC over the past year, together with a more positive economic outlook. The Qatar Exchange saw its first IPO since 2010 as Mesaieed Petrochemicals Holding Company raised about $881m in the first quarter. The UAE saw three IPOs during the first nine months of the year, including the first on Nasdaq Dubai since 2008 and the first on the Dubai Financial Market since 2009, which was followed by the $1.57bn listing of Emaar Malls Group.

Reforms to ownership rules are expected to further boost the markets. Qatar has relaxed ownership rules to encourage the growth of the Doha stock market. Foreign investors will now be allowed to own up to 49 per cent of Qatari companies, while GCC citizens will be treated as local (that is to say non-foreign) when it comes to the ownership of firms listed on the bourse.

The UAE has already introduced rules to stimulate new listings on its stock exchanges. Companies can now use existing shares when they list or raise fresh equity capital; and sponsors now have the right to decide how much capital they need and how many shares they would prefer to sell.

This is expected to make the UAE’s stock markets a more attractive option for companies considering an IPO.

Looking more broadly across the region, Tunisia has been the most active market for listings, with three IPOs during the year to September. Although the flotations of Delice Holding, Sotipapier and Cellcom were small compared with the big ticket deals seen in the GCC, they reflect a growing confidence in Tunisia as the country’s post-revolution political transition nears an end.

Morocco, meanwhile, was downgraded from emerging to frontier market during the year. But it accounted for a mere 0.1 per cent of the EM Index and was of marginal interest to investors targeting this category. Instead, it should be a chunky 6.7 per cent of the much smaller frontier index, where it will be seen as a major opportunity for the specialist investors who are focused on these markets.

By mid-December, however, confidence in the region’s bourses was being undermined by the continued erosion of global oil prices, with significant drops being recorded on exchanges in the UAE and Qatar. This could cloud the outlook for IPOs in the year ahead. Analysts had been forecasting another robust pipeline of listings, as market valuations returned to levels close to those seen before the financial crisis, with activity dominated by financial services and real estate firms. The current volatility is due to global macroeconomic influences rather than any substantive change in the short-term regional economic outlook.

Low rates

Indeed, the capital markets have proven resilient to instability in the wider region over the past few years. Investor perceptions of the risk attached to GCC debt and sukuk (Islamic bond) issues are broadly favourable, and this is reflected in low rates and spreads.

Local investors certainly seem comfortable with the risk. A significant proportion of Middle East and North Africa (Mena) fixed-income issues are placed in the region, even though the available pool of investors, other than sovereign wealth funds (SWFs), is relatively narrow.

On the borrowing side, governments appear set to remain major issuers of bonds, because they need to mobilise funds to cover fiscal shortfalls.

“Debt markets make a limited contribution to the financing of the private sector and are less developed than bank financing or the stock markets,” says Mohamed Damak, director for the Middle East and global head of Islamic finance at US-based analyst Standard & Poor’s (S&P).

“Consequently, although we expect the development of debt markets in the Mena region to continue in 2015, we do not expect them to become a significant source of financing for the economies of the area. In general, sovereign issues continue to dominate these markets.”

Many of those major commercial businesses that do issue bonds or sukuks are in fact largely owned by governments or ruling families. So, inevitably, perceptions of sovereign risk will remain a key influence on how investors view the outlook for Mena capital markets.

Most Gulf states continue to be viewed in strongly favourable terms, but the market’s view of the risks attached to less affluent Mena sovereigns is more mixed.

For Egypt, the outlook is slowly getting better, says Steffen Dyck, a senior analyst in the US’ Moody’s sovereign risk group. “Political and economic stability is returning in Egypt, and domestic and foreign investor confidence is improving – which formed some of the drivers behind our decision to change the outlook on Egypt’s Caa1 government bond rating to stable from negative on 20 October 2014,” he says.

“Improved demand for Egyptian debt was evidenced by the recent issuance of Suez Canal investment certificates to retail investors, which was met with high demand and yielded the equivalent of $8.5bn within one week.”

Moody’s sees the Egyptian Finance Ministry’s 12 October publication of its medium-term macroeconomic policy framework – which presents macroeconomic and fiscal goals for the next five years, with numerical benchmarks – as a demonstration of the government’s commitment to press ahead with fiscal consolidation.

Lebanon debt

By contrast, the outlook for Lebanon’s standing in the capital markets looks tough. “Lebanon’s B1 government bond rating reflects the country’s very high debt burden, external deficits and challenging political environment,” says Dyck’s colleague Gabriel Torres. “The negative outlook reflects the impact of Syria’s ongoing civil war on Lebanon’s economy, which has contributed to lower growth, larger fiscal deficits and a reversal in public sector deleveraging.”

S&P is reassured by the inflow of external transfers and has recently confirmed its rating for Lebanon as stable. S&P has also revised its outlook for Jordan to stable.

So the general feeling across the region’s capital markets is one of cautious optimism. Ratings downgrades will worry some markets, but it is likely that the index upgrades of 2014, and 2015’s opening up of the Tadawul will drive more IPOs and attract investor interest from abroad.