The opening of Saudi Arabia's bourse to direct foreign investment may create billions of dollars of business but international banks and fund managers are cautious about expanding their operations in the kingdom.

Regulatory obstacles and uncertainty about the size of fund inflows are deterring foreign firms from undertaking any quick build-up in their staffing and office space in Riyadh.

Instead, 10 days before the bourse opens on June 15, most plan to delay any decision on significant expansion of Saudi operations. Initially at least, many intend to handle any new Saudi business remotely, via regional offices in Dubai.

Rami Sidani, head of frontier investments at Schroders, said its Middle East office in Dubai had the resources and analyst coverage necessary for handling Saudi business.

Schroders is not for now applying to the Capital Market Authority to invest directly in Saudi stocks because it has already been able to buy them indirectly through participatory notes, he said.

Other fund firms may seek licences more aggressively but regulatory issues, such as the unresolved question of how P-notes might be converted into direct stock holdings, will deter some, he added.

"Saudi is very keen on attracting international investors to the market and positioning it in a competitive way compared to other emerging markets. In order to do that, they will have to tackle the challenges."

LICENCES

Many foreign firms have been slow to establish themselves within Saudi Arabia because of regulatory barriers around markets and factors such as difficulty in obtaining visas for foreigners.

Fewer than a dozen big international banks and securities firms have units that can deal in Saudi stocks.

The opening of the $566 billion stock market, the largest in the Arab world, could help to change that isolation. Tens of billions of dollars of foreign equity investment could enter in coming years, analysts estimate.

For the next year, however, inflows look set to remain modest - perhaps tens of millions or a few hundred million dollars a month, not enough to justify a big expansion of Saudi operations for most firms.

Saudi equity valuations are currently high by global standards and oil prices low. A key boost to the market would be its inclusion in MSCI's emerging market index, but MSCI says this wouldn't happen before June 2017.

Also, the CMA is imposing ceilings on foreign ownership; for example, foreigners can't own over 10 per cent of the market's value.

Such curbs help to explain why, since Riyadh announced its intention last July to open its market, only one major foreign fund manager has opened a new office there: Ashmore, which has a Saudi head count of 12.

Ashmore plans to apply this month for a direct investment licence, but other big institutions have not revealed their intentions. Bankers think up to a dozen licences could be awarded initially; the CMA declined comment.

Many companies say they see long-term potential in Saudi Arabia but want to see how the market fares before any big expansion.

"We look at Saudi Arabia as a very important growth market for us in the Middle East and are very interested in expanding our investment banking operations here depending on how the market develops in two to three years' time," said Credit Suisse Saudi Arabia chief executive Abdulaziz bin Hassan.

P-NOTES

Much may depend on how authorities choose to treat P-notes. Foreigners already indirectly own an estimated 1.5-2 per cent of the market via P-notes and other swaps.

If authorities don't create a cheap way for P-notes to be converted into underlying shares, many people may keep investing indirectly. Transaction costs for P-notes are three to four times those for direct share purchases, but P-notes don't count towards some foreign ownership ceilings, making them attractive.

Foreign institutions may have little incentive to build operations in Riyadh if can continue to invest indirectly through P-notes.

Another indirect channel to invest in Saudi stocks, initial public offer funds, is expanding; eight such funds have been licensed this year.

Saudi Fransi Capital, an arm of Banque Saudi Fransi , has expanded its operations this year in anticipation of the market opening - by creating a subsidiary in Dubai, which it will use as a base to handle foreign investors. – Reuters