Capital Market Development

Some benefits of an efficient capital market were summarised by Ramady (2010). First, an efficient capital market helps recycle capital surplus, which mostly comes from private sectors. Second, it encourages authorities to establish new and stricter risk management instruments, which helps ensure a secure investment environment for companies and investors. Third, a strong capital market, especially a stock market, helps produce other useful functions for the entire economy. The stock market can be used as a signal to managers regarding investment, can be a good source of finance, and can be a catalyst for corporate governance. Efficient stock markets, as reported by Ramady (2010), collect private funds and allocate them for corporate investment. This helps give firms access to cheaper capital than traditional bank finance, and reduces financial risk. Thus, an efficient capital market can help improve firms’ financial performance by providing cheaper fund resources than debt does. It also encourages managers to maximise their firms’ profit, which subsequently maximises shareholders’ value.

Public joint stock companies in Saudi Arabia are new to public investors. Prior to the 1990s, the only major investors in joint stock companies were the government and a few

-50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 G D P an d O il P ri ce C ha ng es Oil Price TOTAL GDP Total Non-Oil GDP Private GDP Gover GDP

wealthy citizens, who were sometimes the owners of the companies. As reported in the first shapter, Saudi Arabia’s official stock market began in the mid-1930s when the first joint stock company—the Arab Automobile Company—issued shares. However, the stock market remained informal until the early 1980s, when the Saudi Arabian government formed a regulated market for trading, together with the required systems to operate the market. In 1984, SAMA was given the responsibility of regulating and monitoring market activities.

After establishing SAMA in 1984, commercial banks started acting as brokers. The relatively high proportion of shares held by the government and the concentration of ownership in the few hands of private investors kept a low percentage of stocks in circulation. The lack of brokerage houses and an independent credit rating agency also constrained intermediation of information, which in turn forced investors to act based on rumours, rather than real information. The existence of such agencies is considered a key element in attracting national savings for investment in productive projects, which then creates the potential to establish more joint stock companies (Bakheet 1999). Since 2003, the regulations have been further improved. SAMA upheld the responsibility of managing the market until the CMA was established in July 2003 under the CML. From July 2003, CMA became the responsible agency for regulating and monitoring capital market activities.

Table 3.2 highlights the most important stages in Saudi Arabia’s stock market. The year 2006 was turbulent and will be long remembered among Saudi Arabian investors. It had peaks of 20,966 points and lows of 7,500 points. However, this collapse was a correction point for the Saudi Arabian stock market that led to more regulations and transparency, which created a more realistic investor outlook.

During the period from the 1930s to 1970s, the total number of joint stock companies had increased to only 14. This rise was mainly concentrated in the cement and electricity sectors. According to Al-Muharrami (2009), in the early 1970s, several foreign banks entered the Saudi Arabian market, attracted by the opportunities caused by the boom in the economy that had resulted from the increased oil revenues. By the mid-1970s, there were approximately 10 foreign banks working in Saudi Arabia. This encouraged the Saudi Arabian authorities to introduce a policy encouraging foreign banks to be converted into

publicly traded companies, with the participation of Saudi Arabian nationals. In order to fulfil this policy, the government established some agencies in the late 1970s, such as the Retirement Pensions Agency and the General Organization for Social Insurance, which helped found several companies by supplying start-up capital. These agencies were established after the government decided to be more active in improving and developing the primary stock market. Moreover, the Public Investment Fund started investing more of its capital in the formation of new joint companies.

Table 3.2 Stages of Growth of Saudi Arabian Stock Market

Stages Years Features of the Stage

First stage 1930s–1980s The Saudi Arabian stock market started with few

companies and banks. However, during this period, transactions were limited and occurred directly between the buyer and seller.

Second stage

1984–1994 The Saudi Arabian stock market became officially operated and regulated by SAMA. The number of joint stock market companies increased. In 1990, the first application was made of an integrated electronic system for trading, clearing and settlement, known as the electronic securities information system (ESIS). During this period, the stock market experienced difficulties because of the 1990 war.

Third stage 1995–1997

(first ascending wave)

In early May 1995, the stock market began its first clear ascending wave. Starting with 1,140 points in 1995, it reached 2,001 points on 27 October 1997.

Fourth stage 1997–1999

(first correction wave)

This began with the first crest of the wave, with 2,001 points, and ended at 1,313 points on 2 March 1999. Asian crises, oil price decreases and increases of the interest rate on the Saudi riyal were some of the main reasons for this decline.

Fifth stage 1999–2002 This began at the bottom of the fourth period, with 1,313 points, and ended on 19 May 2002 with 2,942 points.

Sixth stage May 2002–

November 2002 (second correction wave)

This began at the top of the fifth stage with 2,942 points, and ended with 2,354 points on 24 November 2002. It continued for six months, during which time the index lost almost 588 points.

Seventh stage November 2002– February 2006

This began at the bottom of the sixth stage, with 2,354 points, and ended with 20,966 points on 25 February 2006. It lasted for three years and three months, during which time the index gained 18,612 points.

Eighth stage 26 February 2006–2010

On 26 February 2006, the stock market experienced its largest drop after its highest point of 20,966 points on 25 February 2006. However, this year led the stock

market away from its unrealistic activities towards more realistic ones.

Source: developed by the researcher based on literature explained above.

The late 1970s witnessed tremendous growth of the primary market, with a public offering of 19 new companies. This included a number of publicly held joint-venture banks that were owned by the public and major foreign institutions. These banks included Samba (which was known as Citibank), the Saudi British Bank (which was known as the British Bank of the Middle East), the Saudi Holandi Bank (which was known as ABN-Amro) and the Saudi Faranci Bank (which was known as Banque Indosuez).

According to Basheikh (2002), in the early 1980s, the numbers of transactions and marketability of securities in Saudi Arabia’s primary market increased. This was due to an increase in oil prices, which subsequently helped the government to finance many long- term development projects that were managed by joint stock companies. During this period, in 1984, the Saudi Arabian government decided to privatise 30 per cent of the Saudi Arabia Basic Industrial Corporation (SABIC), which was valued at approximately eight million US dollars (Al-Dohaiman 2008). Hence, the basic development in the primary stock market was strongly supported by the government.

Despite the development of the Saudi Arabian stock market from the 1930s to early 1980s, it remained informally organised until 1984. The official stock market began after Royal Decree 1320/8 was approved in 1983. According to Al-Abdulqader, Hannah and Power (2007), a combined ministerial committee—including the Minister of Finance, the Minister of Commerce and the Governor of SAMA—was formed to regulate and develop the Saudi stock market. The committee’s main responsibility was to protect investors and companies by enforcing effective share market rules. Other objectives of the committee included encouraging investment in the domestic economy in order to contribute to economic growth and to provide Saudi companies with a source of finance through issuing securities.

In 1984, the ministerial committee established and introduced new rules and regulations in order to secure the market. Some of these regulations included establishing a share trading system through commercial banks, creating a supervisory body for all securities trading, establishing a share control department under the authority of SAMA, and

establishing a Saudi Share Registration Company (SSARC). Moreover, SAMA established a share trading system to control and supervise the stock market. Commercial banks were intermediaries in the purchase or sale of shares on behalf of their clients, with a maximum of one per cent commission from each transaction.

As reported by Al-Abdulqader, Hannah and Power (2007), the ESIS was introduced in the second half of 1990. This development enabled buyers and sellers to enter any connected Saudi Arabian bank branch to monitor the price of a company and place an order that could be executed within seconds if it was within the market price range.

October 2001 witnessed the newest trend in Saudi Arabia’s stock market development. A new service was introduced by SAMA to trade and arrange shares in Saudi Arabia: the Saudi Arabian capital market. This new system provided a continuous, order-driven market, with continuously updated price, volume and company information. This facilitated an efficient and short trading cycle (Tadawul n.d.(b)).