Short Selling Makes Quiet Start in Middle East After Saudi Debut

(Bloomberg) -- Saudi Arabia, the Middle East's largest share market, became the first in the region to introduce short selling last month. Investors have yet to test the waters.

Allowing the sale of borrowed securities is among steps the country is taking to make its market more attractive as it closes in on an upgrade to emerging-market status and readies a record initial public offering for state oil company Saudi Aramco. Still, since authorizing short selling on April 23, regulators overseeing the $438 billion Saudi stock market are still to record the first transaction.

Given the dominance of retail investors across the region, the cautious approach to the newly allowed strategy could be understandable. Few markets provide trading in futures or options contracts on stocks, for example. In Dubai, where futures contracts on some shares have been offered since September, volumes have been light. The Emirate, Qatar and Kuwait said earlier this year they aim to allow short selling, but details have been scarce.

The practice “would attract some new investors and provide additional liquidity,” said Akber Khan, senior director of asset management at Al Rayan Investment in Doha. “But perceptions of regulators and governments are key hurdles for the implementation.”

Bourse Chief Executive Officer Khalid Abdullah al Hussan told Bloomberg television Tuesday that the change allowing the trading strategy had just happened, “so it will take time for demand to grow in the market.”

Here are some of the factors at play as Middle Eastern markets gradually move toward embracing short selling:

Attracting Customers

Introducing short selling is critical in providing a wider range of sophisticated financial products that will attract international investors and win Saudi Arabia a place in MSCI Inc.'s emerging market indexes, said Bassel Khatoun, chief investment officer for Middle East and North Africa equities at Franklin Templeton Investments.

The decision is in line with the kingdom's pursuit of stock market accessibility and international integration, and could help it draw “a respectable share of flows,” he said.

Tight Liquidity

While short selling would offer trading opportunities for hedge funds, on a practical level, the low effective free float of many regional stock markets often makes it difficult to find cost-effective options to use the strategy, said Al Rayan's Khan.

“Market structures vary within the region, so enhancements would be on a case-by-case basis,” he said. “For the countries yet to qualify for global emerging market indices, ticking the required infrastructure boxes would be a first step. For others, improvements vary, from steps to improve transparency and disclosure to increasing daily trading liquidity.”

Getting Ready

Abu Dhabi's stock exchange announced in December that it aimed to implement short selling by the end of March. Last week, however, its chief executive officer told a local newspaper that more time is required to prepare market participants.

Operational issues tend to pose the main challenges, as brokerages and banks need to be fully prepared to offer the strategy while also ensuring back-office staff are up to speed, to avoid settlement failures and associated costs, said Racha Alkhawaja, head of institutional coverage at brokerage Mena Corp. Financial Services in Dubai.

Worth the Wait 

Investors welcome this change for Middle Eastern markets, even though its broad adoption may take time, said Michael Bolliger, Zurich-based head of emerging-market asset allocation at UBS Wealth Management, which oversees about $2.1 trillion for clients.

“This is another step in the right direction, signaling to international investors that the region is opening up its financial markets and that it takes measures to improve their depth and breadth,” Bolliger said. “We are still in the early stages of this process, but I am sure that over time and in combination with the ambitious reform programs, interest from international investors will grow.”

To contact the reporter on this story: Filipe Pacheco in Dubai at fpacheco4@bloomberg.net.

To contact the editors responsible for this story: Celeste Perri at cperri@bloomberg.net, John Viljoen