MSCI said it is consulting on the potential inclusion of its own Saudi Arabia Index in the MSCI Emerging Markets Index in move which in due course could give investors wider exposure to the world's largest oil company.

Overshadowed by the news in the same release about Chinese A-shares being included in its emerging market indices for the first time, the index provider said it would include the Saudi Arabian index in its annual market classification review next year when it will decide whether it should be included.

MSCI said it was considering including the index following the implementation of a new version of the rules for qualified foreign financial institutions in listed securities implemented by the Saudi Arabian Capital Market Authority (CMA) in September last year.

The Saudi market was only opened up to foreign investors in 2015 and BlackRock launched the first Saudi-specific ETF in September of that year. The US-listed iShares MSCI Saudi Arabia Capped ETF tracks the MSCI Saudi Arabia Investable Market Index (IMI) 25/50 Index.

Among what MSCI termed the "major enhancements" in the new rules are increased limits on foreign ownership for listed Saudi Arabian companies, the lowering of the minimum assets under management requirements applicable to qualified foreign investors and amendments to the list of eligible foreign investor types.

The net effect of the changes is that the number of foreign investors having entered the market as reported by the CMA and the Saudi Stock Exchange (Tadawul) had increased.

Subsequently, in April Tadawul implemented a new improved operating model which MSCI said had further enhanced the accessibility of the Saudi market, including expanding the settlement cycle, the introduction of a proper delivery versus payment (DvP) settlement provision, proper failed trade management and the introduction of short-selling and securities borrowing and lending facilities.

MSCI said it would now be consulting with international institutional investors to gather informed feedback on their own practical experience of accessing the Saudi equity markets, in particular focusing on how the reforms had improved the workings of the market.

Still going through a transition

It remains to be seen, however, whether the process will be at all smooth. Nizam Hamid, head of ETF strategy at Wisdom Tree pointed out that the market is still going through a transition in terms of market openness and access.

"To a certain extent these issues remain under consideration in terms of how effective the changes have been," he said.

The qualified foreign investor process remains something that is still being tested by asset managers, and while it is a large market it would still represent only 2.4% in the broad MSCI Emerging Markets index which is roughly a similar size to the current weight of Malaysia.

"At this stage it is too early to tell whether inclusion will be confirmed in 2018, and even if it were allowed it would be a two stage process in 2019 allowing investors to manage any transitions within their portfolios," Hamid concluded.

The vice-chairman of the CMA, Mohammed El Kuwaiz, somewhat jumped the gun when he declared in the Saudi press that he expected Riyadh to be upgraded to emerging market status "by the end of 2018."

The process will be complicated by the planned float next year of Aramco, the state-owned oil company which is also the biggest oil concern in the world. It is thought the company is seeking to perform a joint listing on both the domestic market and at least one other international exchange.

However, there are fears among investors that it will prove difficult to dis-entangle Aramco from the Saudi state where it performs the role of part state enterprise and part sovereign wealth fund.

James Butterfill, head of research and investment strategy at ETF Securities also points out that the unsettled long-term picture for the global oil market also clouds the issue, particularly given the current regional instability.

"Regarding Saudi Aramco, we are sceptical that OPEC and Saudi have the ability to control global oil supply as much as they have done in the past due to the US becoming the new swing producer," he said.

"There is therefore unlikely to be any sustained upside to the oil price above US$55 a barrel. This coupled with instability caused by increasing austerity in Saudi Arabia is likely to make Aramco a less appealing to the international investor."

The managing director and senior emerging markets strategist at BlackRock, Gerardo Rodriguez, said at the time of the providers Saudi ETF launch that it offered further diversification for investors seeking growth from emerging markets.

"As the largest economy and equity market in the Middle East, Saudi Arabia's recent opening could represent a compelling opportunity for those looking to broaden their exposure."