* Regulator says to publish draft rules, hold 90-day consultation
* Major economic reform in world’s top oil exporter
* Authorities want to diversify economy beyond oil
* Saudis expected to follow quota model similar to China
* Reform was delayed by concern over volatility, politics (Updates with MSCI statement, stock moves, shareholder activism)
By Angus McDowall and Andrew Torchia
RIYADH/DUBAI, July 22 (Reuters) - Saudi Arabia plans to open its stock market, the Arab world’s biggest, to direct investment by foreign financial institutions in the first half of next year, the market regulator said on Tuesday.
The opening of the Saudi market, capitalised at about $530 billion, is one of the most keenly awaited economic reforms in the largest oil exporting nation. The bourse would be one of the world’s last major exchanges to begin welcoming foreign money.
“The market will be open to eligible foreign financial institutions to invest in listed shares during the first half of 2015, with God’s permission,” the Capital Market Authority said in a statement.
Saudi authorities want to open the stock market to create jobs, diversify the economy beyond oil and expose local firms to more market discipline. They have been preparing the reform for years and have completed most technical preparations.
But the government has delayed implementing the reform, apparently concerned about causing volatility in the market as well as the political sensitivity of allowing foreigners to build large stakes in top Saudi companies.
Currently, foreigners other than citizens of nearby Gulf states are limited to buying Saudi stocks via swaps involving international banks and through a small number of exchange-traded funds, which are expensive and inconvenient options.
Foreigners are at present believed to own no more than about 5 percent of the Saudi market, and to account for a smaller fraction of stock trading turnover.
Potential foreign interest in Saudi stocks is huge, because of the country’s strong economy - the International Monetary Fund on Monday raised its forecast for Saudi growth this year to 4.6 percent - and the presence of some of the region’s top blue-chip firms.
These include Saudi Basic Industries Corp (SABIC), one of the world’s largest petrochemicals groups, and National Commercial Bank IPO-NACO.SE, the kingdom’s biggest lender, which plans an initial public offer of shares later this year that could be worth $4 billion to $5 billion.
“This is a massive move for Saudi and for the region,” said Rami Sidani, head of Middle East investments at Schroders, a top European fund manager, which already has about $250 million invested in Saudi Arabia through indirect means.
He added that the country “will definitely attract massive inflows”.
The Saudi market index jumped 2.8 percent to a six-year high on Tuesday in response to the news, bringing its gains so far this year to 17 percent. SABIC rocketed 6.9 percent.
Foreign investors are estimated to own about 15 percent of other, much smaller stock markets in the Gulf such as Dubai. If foreigners raise their ownership of Saudi Arabia to that level, it could mean an inflow of some $50 billion into the country.
In practice, Saudi authorities are expected to use a tight regulatory framework to ensure that inflows are slow. The CMA said it would publish next month draft regulations for the reform; there would then be a 90-day public consultation period.
Proposals circulated by Saudi authorities to the financial industry in the past have indicated Saudi Arabia will follow a model similar to China, Taiwan and some other major emerging markets in opening its bourse.
Qualified foreign investors, awarded licences based on factors such as the amount of their assets under management, would be given quotas for their investment in the market, while there would be ceilings for foreign ownership of companies.
Under one set of proposals, foreign institutions would need to have at least $5 billion of assets under management globally to obtain licences; each institution could own no more than 5 percent of a Saudi firm, and all foreigners combined could own no more than 20 percent.
A senior Saudi banker, declining to be named because of the sensitivity of the issue, said he expected only a “handful” - perhaps 10 - investment licences to be awarded initially, and that authorities would then grant more licences gradually as they monitored the impact on the market.
Most cash-rich Saudi companies do not need foreign money; the main benefit to them, authorities believe, is that they would gain activist foreign shareholders who could provide management guidance and help to internationalise the firms.
Because it is closed to direct foreign investment, the Saudi market has been excluded from major international equity indexes compiled by companies such as MSCI, even as Qatar and the United Arab Emirates were upgraded earlier this year.
Opening the Saudi bourse would be expected to lead eventually to its inclusion in such indexes, helping to make the Gulf a mainstream destination for international investors. Sidani estimated Saudi Arabia could ultimately account for around 3 to 5 percent of MSCI’s emerging market index.
“This is a potential game changer for the region - a very important milestone that people have been waiting for,” said Salah Shamma, co-head of regional equities at U.S. fund management giant Franklin Templeton.
MSCI said on Tuesday that it might make a decision as early as June 2015 on whether to add Saudi Arabia to its emerging market stock index. The pace of past index changes suggests actual inclusion might then take place in 2016.
Following regulatory reforms in the past couple of years, the Saudi market is one of the most stable and tightly regulated in the Middle East, fund managers say. It has avoided the wild swings seen in recent months in markets such as Dubai. (Additional reporting by Nadia Saleem, David French an Yara Bayoumy in Dubai and Carolyn Cohn in London; Editing by William Maclean and Anna Willard)