Foreign investment (FI) is an integral part of an open and effective international economic system and a major stimulant to economic development. However, the benefits of FI does not ensue automatically and/ or evenly across countries and sectors. Host countries generally have implemented national policies and the international investment plan designed specifically for attracting FI to a larger number of countries, individuals and entities as well as, for reaping the full benefits of FI for development. Market size, infrastructure quality, political/economic stability, and free trade zones are known to be some of the most influential factors that stimulate FI. The Kingdom of Saudi Arabia for example, has pushed to increase FDI in recent years as part of the Vision 2030 plan to end absolute reliance on fossil fuels, and it is aiming for USD 100 billion in annual FDI by 2030. Moreover, Saudi Arabia adopted seven “Guiding Principles for Investment Policymaking”, including non- discrimination, investment protection, investment sustainability, enhanced transparency, protection of public policy concerns, ease of entry for employees, and the transfer of knowledge and technology; and the Saudi Arabian General Investment Authority was upgraded, becoming the Ministry of Investment”1.
On one hand host countries are faced with the task of the need to establish a transparent, broad and effective enabling policy environment for investment and to build the human and institutional capacities to implement them. On the other hand, foreign investors (states, corporates, multinationals or individuals) are faced with task of choosing the best ways to invest in foreign countries or entities to avoid the risk associated with such investments whilst reaping the benefits that stems from such investments. Investors interested in foreign investments generally take one of two paths: foreign portfolio investment (FPI) or foreign direct investment (FDI).
This paper focuses on the importance of FI, advantages and disadvantages of FDI and the methods a non-resident foreign investor can invest in foreign countries through FDI and FPI and how these methods are differ in KSA.
Meaning and importance of FDI and FPI
Foreign portfolio investment (FPI) refers to the purchase of securities,bonds, and other financial assets by investors from another country. Foreign portfolio investment (FPI) is used by companies or institutions as a means of diversification through purchasing the stocks and bonds such as pension funds, of a foreign country2.
FDI on the other hand, stands for Foreign Direct Investment. it is an investment scheme where entities or individuals invest in business interests located in a foreign country. Usually, FDI occurs when an investor sets up a foreign business operation, or they acquire a foreign business asset in any foreign company3.
The key to foreign direct investment is the element of control. Control represents the intent to actively manage and influence a foreign firm’s operations. This is the major differentiating factor between FDI and a passive foreign portfolio investment4.Therefore, the threshold for establishing controlling interest in a FDI per guidelines established by the Organisation for Economic Co-operation and Development (OECD), is a minimum 10% ownership stake in a foreign-based company.
A passive foreign investment on the other hand, is where a corporation, entity, located abroad, exhibits either one of two conditions, based on either income or assets:
At least 75% of the corporation's gross income is "passive"—that is, derived from investments or other sources not related to regular business operations5.
At least 50% of the company's assets are investments, which produce income in the form of earned interest, dividends, or capital gains6”.
But there are situations where this principle is not always implemented. For example, if a direct investor owns less than 10 percent of the shares or voting power of an enterprise but is considered to have an effective voice in the management7. In Saudi Arabia, foreign companies or entities can trade on the stock exchange; they are eligible to acquire up to a 49% ownership of any listed company. However, foreign individuals cannot8.
There are four main types of FDI, namely:
Horizontal FDI: Horizontal FDI involves investment of funds in a foreign company belonging to the same industry which is either owned or operated by the FDI investor.
Vertical FDI: A vertical FDI happens when a particular asset is made within a regular supply chain within a company, which may or may not inevitably belong to the same industrial category. Vertical FDIs can be further categorized into two groups; which are forward vertical integrations and backward vertical integrations.
Conglomerate FDI: This is where individuals or entities make investments in two entirely different companies belonging to completely different industries, the transaction is termed as a conglomerate FDI. As such, the FDI is not connected directly to the investor’s business or company.
Platform FDI: The last type falling under foreign investment is called platform FDI. In the instance of a platform FDI, a business extends into a particular foreign country, but the commodities manufactured are exported to third country.9 Table 1 below provides the major advantages and disadvantages of FDI
Table 1: Advantages and Disadvantages of FDI
Methods for Investing
Investors can make FDI in a number of ways. Some common ones include establishing a subsidiary in another country, acquiring or merging with an existing foreign company, or starting a joint venture partnership with a foreign company.
Methods FPI includes
- The depositary receipt(DRs) gives investors the opportunity to hold shares in the equity of foreign countries held by a bank in the country and gives them an alternative to trading on an international market.10 DRs are categorized into 2 types; i. “When the foreign firm is involved with the issue, they are termed sponsored DRs, and investors receive the voting rights for the shares their DRs represent. ii. When the foreign firm is not involved, they are termed unsponsored DRs, face less strict reporting requirements, and the depository bank retains the voting rights on the shares”.11
- Global depository receipts (GDRs)are usually denominated in U.S. dollars and are issued outside the issuer’s home country, which can also be sold to U.S. institutional investors.
- American depository receipts (ADRs) are denominated in U.S. dollars and trade in the United States. Global registered shares (GRS) are traded in different currencies on stock exchanges around the world.
- A basket of listed depository receipts (BLDR) just like common stocks, is an exchange-traded fund (ETF) that is a collection of DRs.
According to the capital market Authority of KSA, foreign investor who is non-resident in the Kingdom of Saudi Arabia can invest in the securities through one of the following12:
- As a qualified foreign investor, according to the Rules for Qualified Foreign Financial Institutions Investment in Listed Securities, which allows the investor to invest in all listed securities.
- As an ultimate beneficiary in swap agreements, according to the Authority’s circular issued in this regard, which allows the investor to invest in all listed securities.
- As a foreign strategic investor, according to the Instructions for the Foreign Strategic Investors' Ownership in Listed Companies, which allows the investor to invest in listed companies shares.
- As a direct investor, which allows the investor to invest in the parallel market, debt market, in addition to investment funds13.
Conclusion and Recommendations
Investors generally need to structure their investments according to the level of risk they are willing to take and their anticipated returns. They must also consider other issues like interest rates, the economy, political environment, etc. For example, when investing in international market,
an investor who is concerned about a bad economy in a country it intends to invest in, should consider investing in credit linked bonds.
An investor who is concerned about declining interest rate should invest in inverse floater.
An investor who is concerned about rising interest rate should invest in floating rate note
An investor who is engaged long term investment that will generate in the future (not presently) should invest in deferred bonds.
Both FDI and FPI are the most common ways to hold an investment in a foreign country. It is paramount to be able to differentiate both to enable a prospective foreign investor to make the best choice. In conclusion, Table 2 provides a simple guide to investors who intend to venture into the international market.
Table 2: Differences between FDI and FPI
