With high levels of liquidity in the marketplace, investors within Saudi Arabia have the resources and an increasing desire to break away from their traditional oil-based industries to a more diversified portfolio. For many years their only option was to invest overseas but, increasingly, Saudi Arabian investors are looking for domestic investment opportunities. Sectors of particular interest and growth include banking, telecommunications and the media.

Despite the Saudi stock market's strong start, the spectacular 52% decline of the Tadawul All Share Index (TASI) in 2006 may suggest to some that it is not yet a market worth investing in. To those who already invested, it is a harsh lesson learnt.

However, the decline of the TASI was not a great surprise to those who thought the market was overvalued as a result of high liquidity levels having driven the TASI upwards in the absence of other investment outlets. Due to this decline, the appetite of some investors may have abated somewhat; however, this decline has possibly resulted in a stronger investment appetite for long-term strategic institutional investors, including Kingdom Holding Company, which recently announced it had invested SR10bn (£1.37bn) in the Saudi stock market.

The capital market law

In July 2003, the Capital Market Law (CML) was enacted as one of Saudi Arabia's major economic reforms. The CML provides a unified and comprehensive regulatory framework within which the country's capital markets can develop. It contains detailed provisions setting out requirements to ensure transparency and accountability within the capital markets, as well as other provisions designed to eliminate market manipulation, insider trading and other unfair practices.

The capital market authority

The Saudi Arabian Capital Market Authority (CMA) was established pursuant to the CML and is responsible for applying the CML and issuing rules, regulations and instructions related to the capital markets. The CMA is a government organisation with financial, legal and administrative independence and its roles are similar in many respects to those of its overseas cousins.

To date, the six principal pillars of the regulatory regime introduced by the CML are:

- the securities business regulations, which establish the scope of regulation of securities business in Saudi Arabia on the basis of restrictions set out in the securities business prohibition and securities advertisement prohibition;

- the offer of securities regulations, which set out the regime governing exempt offers, private placements and public offerings;

- the listing rules, which set out rules related to initial public offerings (IPOs) and prospectus requirements, deal with matters related to secondary market offerings, set out continuing obligations for listed companies and establish rules related to corporate governance matters applicable to listed companies;

- the authorised persons regulations, which set out the rules that authorised persons must follow, including licensing criteria and requirements for authorised persons (firms) and registered individuals, conduct of business, systems and controls and matters related to client money and assets;

- the market conduct regulations, which deal with matters regarding market manipulation, insider dealing, untrue statements and stabilisation; and

- the investment fund regulations, which regulate the establishment of investment funds and the offer of funds in the kingdom.

A recent addition to the capital markets regulations is the code of corporate governance for listed companies in Saudi Arabia. As its name suggests, the code sets out the rules, guidelines and parameters regulating the management of listed companies in order to ensure compliance with the best corporate governance practices. In addition, the CMA is currently in the process of developing takeover regulations relating to listed companies that will allow the development of further M&A activities.

A further milestone has just been achieved through the announcement of the incorporation of the Saudi Stock Exchange, as called for under the CML. The exchange will take over the electronic share-trading system (Tadawul), which was originally operating under the supervision of the Saudi Arabian Monetary Agency (SAMA) and, although it came under the CMA's supervision, was still a department of SAMA. In addition, the exchange will be responsible for forming a securities depositary centre, which will be the only body authorised to handle the deposit, transfer, settlement, clearing and registration of ownership of securities traded on the exchange.

Listing timeline

The timeline to listing varies greatly from deal to deal. However, on average it takes between six and eight months to prepare a company and the documentation necessary for the application to the CMA for listing. It then takes a further 45 days for the CMA to approve the listing. In certain circumstances, however, approval by the CMA can take up to six months.

Recent developments

Prior to March 2006, only companies and citizens from the states of the Cooperation Council for the Arab States of the Gulf (GCC) were permitted to buy and sell shares directly on the stock exchange. Largely as a result of the TASI decline, the CMA announced in March 2006 that non-GCC citizens resident in Saudi Arabia would be permitted to do this. Non-GCC citizens resident outside the kingdom are still only permitted to invest through mutual funds. Saudi Arabian legislation does not regulate the offer of securities to investors outside the kingdom and non-Saudi citizens are still not permitted to take part in IPOs.

One area of great interest in the market is the CMA's current policy on price determination and book-building. Currently, book-building is not permitted although there is a growing feeling that this will change in the near future. Book-building is a process used by financial advisers and underwriters, together with issuers, to help them determine the price and the level of demand from investors by collecting bids from wholesale and retail investors at various prices, which are above or equal to the floor price. In addition to this anticipated change, it is expected that the CMA's current practice of approving the listing price will also be relaxed.

Pursuant to the listing rules, a company wanting to list on the exchange must be a joint stock company. Historically, the CMA approved offerings before the conversion to a joint stock company became effective. However, a recent proposed change in the CMA's policy would require that conversion must be effective prior to the actual offering of securities.

This is mainly due to the CMA's desire to reduce the time period between the collection of subscription proceeds and the commencement of trading. This effectively means that limited liability companies must convert to a joint stock company prior to the CMA approving an offering. Interestingly, this has resulted in a conflict between article 100 of the Saudi Companies Regulation, which precludes the sale of 'founder shares' in a joint stock company for two years after incorporation or conversion to that status. Despite this conflict the CMA has indicated it would approve a secondary offering in which founder shareholders would offer their shares to the public.

However, much uncertainty still remains in this area and legal advice should be sought in relation to this issue.

Outlook for the future

The new year was slow to bring about changes to the TASI's downward spiral, although renewed confidence in the market has resulted in the TASI closing 3% up at the end of February compared to the end of December 2006, with market capitalisation reaching SR1.27trn (£170bn). Listings remain buoyant, with a number of high-profile deals due in 2007, including the listings of the Saudi Kayan Petrochemical Company and Inma' Bank, which is expected to be one of Saudi Arabia's largest IPOs to date.

Karim Nassar is a partner at Baker & McKenzie in Riyadh. Carlo Buckley is an associate in London.