2. NomiNatioNs opeN Now
Nominations close on 30 June 2015
www.globalinvestormagazine.com
Submissions for the annual
Global Investor/ISF Mena Awards are open.
Asset managers and financial service providers are invited to submit
nominations until 30 June 2015.
Go to the Global Investor/ISF website now for the full list of
award categories: http://bit.ly/1DPkprS
The awards will be presented during Global Investor/ISF Mena
Capital Markets Summit in Dubai on October 28, 2015.
Global Investor/ISF Mena Awards 2015
2015
3. 1GlobalInvestor/ISFSaudiGuide2015
LETTERFROMTHECMA
Arrivingontheworldstage
MohammedAljadaan,chairmanoftheCapitalMarketAuthority(CMA),saysopening
theSaudistockmarketforforeigninvestmentaimsatattractingspecialisedinvestorsto
promoteinstitutionalinvestmentandraisetheleveloftheresearchandstudyofSaudi
capitalmarkets
T
here are several objectives the Kingdom of Saudi Arabia aims to achieve by allowing qualified
foreign financial institutions to invest in listed shares. The Kingdom, a member of the Group of
20 (G20) and of the International Organisation of Securities Commissions (Iosco), was the last of
the major economies of the world to allow foreign investors direct access to its capital markets.
This reform means Saudi capital markets will become a part of the global market.
Since its establishment, the CMA has aimed to develop Saudi capital markets. The decision to
allow foreign investors to invest directly will achieve this aim through several short and long-term
objectives, which include bringing the expertise of specialised foreign investors to the local market
and promoting the CMA’s efforts to increase institutional investment in the market, according to
its strategy for 2015-19. In addition, specialised foreign investors, represented in qualified financial
institutions (QFIs), are expected to contribute to reducing the high levels of price volatility.
QFIs will also enhance market efficiency and motivate listed companies to improve transparency,
disclosure and governance. Moreover, it is expected that the level of study, research and evaluation
done on the market in general and on listed companies in particular will increase, which will in turn
provide more accurate information and fairer assessments.
As for authorised persons – financial institutions authorised by the CMA – this step will help their
businesses grow by serving a new category of clients. This will be accompanied by an increase in the
awareness activities and conferences that specialise in financial investment in the Saudi market, in
addition to raising general awareness of the capital market and how to invest in it.
As chairman, I emphasise that opening the market for foreign investment, in accordance with the
regulating rules (see pages 39-45), does not focus on bringing capital or liquidity to the market – the
local market does not suffer from a lack of liquidity and the average trading volume is considered
within acceptable global levels.
I also stress that the rules prepared by the CMA took into account other related regulations in the
Kingdom. In addition, the opinions of the public and the experts who participated in the 90-day
consultation period were also taken into account.
It is important to note the procedures set out in the Rules for Qualified Foreign Financial Institutions
Investment in Listed Shares that the CMA published on May 4 2015. The CMA allows only large and
experienced foreign financial institutions from jurisdictions with developed regulation to enter the market.
These rules are effective June 1 2015 and QFIs will be allowed to invest in listed shares from June 15.
Mohammed Aljadaan
6. 4 GlobalInvestor/ISFSaudiGuide2015
MARKETOVERVIEW
Wealthofopportunity
SaudiArabiaisawell-diversifiedmarketwithbroadlyfavourableeconomic
anddemographicdata.PaulGoldenconsiderstheinvestibleopportunitiesfor
qualfiedforeigninvestors(QFIs)
T
he fundamental reasons for investing in Saudi Arabia are compelling – economic growth is
set to remain an enduring theme, primarily due to its natural resources but also its youthful
demographics. The dollar-pegged riyal is a further attraction, while in early May MSCI confirmed
that its Saudi Arabia indices would launch as standalone market benchmarks from June 1 2015.
The Saudi market has traded at a premium to other GCC markets in terms of valuation for some time
because of its relatively superior companies and fundamentals, explains Kemal Ahmed, Investec
portfolio manager.
“That valuation gap has widened further in recent months as local investors anticipate what they
presume will be an influx of foreign investors,”he says. “Relative to wider emerging markets, Saudi
Arabia has also traded at a premium – although it did suffer heightened volatility in the six months
through March in the wake of the oil price decline.”
The MSCI will launch a series of related regional and capped indices, including the MSCI GCC Countries
International Index and the MSCI Saudi Arabia IMI 25-50 Index. MSCI’s Saudi Arabia indices will be
transitioned from its existing provisional Saudi Arabia indices.
Diversified market
With the exception of one or two names, the oil and gas sector is not directly represented in the
listed market. However, some direct beneficiaries of the country’s hydrocarbon resources are listed,
predominantly in the chemicals sector.
Among the most interesting investible sectors is banking. Saudi banks are well capitalised, have low
gearing and are positioned for a significant improvement in profitability over the medium term, says
Ahmed. “The Tadawul is arguably diversified, with banks comprising just over a quarter of the total
market capitalisation, chemicals another quarter and the other half retail, food, healthcare, religious
tourism, construction, insurance and other companies in a variety of sectors.”
Daniel Tubbs, global emerging markets portfolio manager at Mirabaud, observes that the “Saudi
premium”has both risen and fallen over the past 12 months, narrowing on the back of falling oil prices
before rebounding as foreign investors learned that they would have better access to the market.
“According to HSBC’s estimates, Saudi trades on a 2015 price-to-earnings ratio of 20.8 compared with
the GCC average of 17.6. The higher multiple is justified by the higher expected earnings growth from
the country.”
Tubbs describes chemicals companies as the best way to play any oil and gas exposure, but adds that
multiple attractive opportunities exist in financials, consumer and healthcare companies.
7. 5GlobalInvestor/ISFSaudiGuide2015
MARKETOVERVIEW
“The Saudi market is a large, liquid and diverse market that offers numerous opportunities and broadly
reflects the non-oil economy. We expect both domestic and international firms will benefit from the
increased trade and business generated by the market opening up.”
Renaissance Capital senior analyst Ryan Ayache suggests that the higher premiums may also owe
something to the crowning of a new King in January – when Salman bin Abdulaziz Al Saud succeeded
his half brother, King Abdullah. “The weakness in large Emea markets such as Russia and Turkey skews
the comparison somewhat. And these are the best peers to Saudi in some ways, along with South
Africa. But certainly no one is looking at Saudi on the basis of valuation gaps being closed,”he adds.
Renaissance Capital’s head of strategy, Dan Salter, adds that while Saudi oil and gas companies have
a clear supply advantage relative to their global peers, they are operationally less efficient and the
demand drivers in the sector tend to be global.
“Even if these companies achieve operational standards that match their developed market peers,
there is still no guarantee that demand will be there to support increased sales. As a result, we do not
think this is the best way to play Saudi. We have a structural preference for sectors that offer exposure
to infrastructure, services and consumer demand, as we view these as playing into themes that are
locally driven and where the demand is sizeable. We think healthcare, retail, insurance and travel all
offer exciting investment opportunities.”
Malick Badjie, Silk Invest’s executive director and head of investments, says that Bloomberg data
suggests valuations in Saudi will remain higher than in other GCC and emerging markets, although
earnings will start to improve by 2016, potentially closing the gap. “Since there is large pent-up
demand for foreign investors to enter the market, one would expect that
price-to-earnings would rise at least until domestic liquidity expands, which
would enhance trading and hence help the ratio to come down again.”
MSCI boost
Badjie does not expect the size of foreign fund inflow to reach its 10%
market cap limit when the market first opens, but says this will change
with MSCI inclusion. “A weight of 1.74% in the MSCI EM index would
translate to approximately $26bn inflows from global emerging market
funds. Eventually, more initial public offering listings and strong foreign
institutional demand should expand the market cap, which is positive.”
He adds that his preferred stories in Saudi are related to the consumer
sector, which benefits from the Kingdom’s mix of defensive cyclical growth
and demographic forces. Banks are a play on raising US interest rates.
The gap has closed with other emerging markets and, given the importance of Saudi Arabia in
the emerging market equity space, there will be further valuation reratings in the coming months,
according to John Sfakianakis, GCC regional director for Ashmore. He adds that there are considerable
opportunities in sectors that offer counter-cyclical themes such as retail, healthcare and food. “More
than 55% of the Saudi economy is non-oil based and the stock market is a reflection of the wider
economy. There are more than 30 million consumers in the Kingdom, 20 million of whom have very
high purchasing power.”
At the time of the July 2014 announcement to open up the Saudi market to foreign investors, it was
“Saudibanksare
wellcapitalisedwith
lowgearingand
arepositionedfora
significantimprovement
inprofitabilityoverthe
mediumterm”
KemalAhmed,Investec
8. 6 GlobalInvestor/ISFSaudiGuide2015
MARKETOVERVIEW
trading at a premium to both MSCI EM (+34%) and Qatar (+7%), but at a slight discount to Dubai
(–3%).
While the MSCI premium has changed little and remains at a high 28%, the gap between Saudi Arabia
and, in particular, Dubai, but also Qatar, has changed markedly, explains Amr Hussein Elalfy, managing
director and global head of research at MubasherTrade. “The premium to Dubai and Qatar now stands
at 21% and 24% respectively, although this gap has mostly been driven by lower valuation levels for
Dubai and Qatar vis-à-vis the Saudi market, which currently trades at a forward price-to-earnings ratio
of 16.6 versus 16.3 in July 2014.”
Falling oil prices have encouraged analysts to downgrade their estimates and therefore their valuation
and price targets for oil and gas stocks, although upside potential for materials – which includes
petrochemicals) – is only 4.7%, well below consumer and healthcare, which boasts upside potential
of 9.3%. Real estate and financials are the sectors that currently offer the lowest upside potential
according to analysts – just 1.2% and 0.2% respectively.
In terms of equities, around two-thirds of Saudi Arabia’s stock market capitalisation is concentrated
in financials (35%) and materials (31%), followed by consumer and healthcare (12%). “Compared with
other GCC markets, Saudi Arabia’s stock market is more diversified, but liquidity is mostly in the three
largest sectors,”says Elalfy. “In our opinion, the market is yet to fairly reflect the wider Saudi economy.
For example, real estate accounts for only 6% of market capitalisation with just a handful of traded
names.”
Macro outlook
However, for all the excitement about qualified foreign financial institutions being able to invest
in listed shares in Saudi Arabia from the beginning of June, the Kingdom is not without its social
and economic problems. Concerns over unemployment and the quality of education persist even
in the absence of widespread popular protest. According to the latest Ministry of Labour report,
unemployment among Saudis last year was 11% and the figure for young people and women was
much higher, despite the introduction of enforced quotas and unemployment assistance schemes.
Economic growth is set to decline to 4.6% in 2015 and 4.1% next year, according to the World Bank,
and the country’s large fiscal surplus is also disappearing, leaving it set for double-digit fiscal deficits in
2015 and 2016.
The World Bank’s Mena Economic Monitor, published in April 2015, cautions that regional security
issues could affect its future prospects. However, it also
estimates that approximately $786bn of reserves were
accumulated during the period of high oil prices, which
means the Saudi government is in a good position to engage
in counter-cyclical fiscal spending.
In January, Olivier Blanchard, International Monetary Fund
economic counsellor and director of research department,
observed that unlike many other oil exporters, Saudi Arabia’s
financial buffer will enable it to reduce government spending
relatively slowly.
While investment spending has been reduced by 13% in the
10
8
6
4
2
0
2010 2011 2012 2013 2014 2015 2016 2017
GDP growth, constant 2010 USD
9. Our star shines
with your support
Our star shines
with your support
Together with our clients, we are building on
our success and aiming for even greater heights
Together with our clients, we are building on
our success and aiming for even greater heights
www.alrajhi-capital.comwww.alrajhi-capital.com
Innovations in Islamic Finance – Euromoney 2015
Best Islamic Fund Manager – Global Finance 2015
Best Islamic Fund Manager – Global Finance 2014
Best Broker in Saudi Arabia – EMEA Finance 2014
Asset Manager of the Year (Saudi Arabia) – Global Investor 2014
Best Customer Service in the Middle East – Banker Middle East 2014
Best Mobile Trading Platform in the Middle East – Banker Middle East 2014
Best International Markets Brokerage in the Middle East – Banker Middle East 2015
Al Rajhi Petro-Cement Equity fund (MENA Equity Sector Energy) - Lipper Funds Award 2015
Innovations in Islamic Finance – Euromoney 2015
Best Islamic Fund Manager – Global Finance 2015
Best Islamic Fund Manager – Global Finance 2014
Best Broker in Saudi Arabia – EMEA Finance 2014
Asset Manager of the Year (Saudi Arabia) – Global Investor 2014
Best Customer Service in the Middle East – Banker Middle East 2014
Best Mobile Trading Platform in the Middle East – Banker Middle East 2014
Best International Markets Brokerage in the Middle East – Banker Middle East 2015
Al Rajhi Petro-Cement Equity fund (MENA Equity Sector Energy) - Lipper Funds Award 2015
ASSET MANAGEMENT INVESTMENT BANKING BROKERAGEASSET MANAGEMENT INVESTMENT BANKING BROKERAGE
CMA Licence 37/7068CMA Licence 37/7068
10. 8 GlobalInvestor/ISFSaudiGuide2015
MARKETOVERVIEW
Kingdom’s 2015 budget, it is still 81% higher than in 2010. Social spending has increased, which is one
of the main reasons for the fiscal deficit.
Home advantage
While there is a broad range of investable sectors in Saudi, Ayache believes local firms will enjoy a
competitive advantage – at least in the early stages of market liberalisation. “Local firms can trade the
market at far lower costs and can therefore also offer access to the market at lower costs. Moreover,
regulation makes it difficult for international banks to distribute products. Until costs and regulation
align, local participants are likely to be proportionately bigger winners.”
Badjie also describes the market as well diversified but not fully representative of the economy. He says
trading businesses, construction and upstream oil and gas are all underrepresented, while insurance
is probably overrepresented and expects local investment banks to retain their dominant position for
some time.
This assessment is based on the limitation on investment by foreigners to funds with a minimum of
$5bn assets under management and the fact that most of the major foreign trading desks are already
present in the Saudi market, so the more open market will represent a
case of business as usual. “The market share of local investment banks
is approximately 90% and I do not expect the opening of the market to
change that, although this will depend on the area of investment banking
that foreign institutions will have room to expand in.”
Sfakianakis says being local is a significant advantage. “The local players
have a lot to offer, yet the market is big enough to offer opportunities for
foreign players to participate as long as they understand the dynamics of
the Saudi market and its clients.”
Ahmed’s view is that foreign investors will do business with the providers
of the best fundamental research on Saudi securities. He says these
providers are likely to include both local companies and developed economy banks that have invested
significantly in building locally-based research platforms.
International comparison
Saudi is certainly not the first market to open to foreign investors using QFI-type arrangements. Tubbs
says one can look to the Chinese experience – where foreign investors could obtain QFI status and be
able to trade in the China A-share market for the first time – when considering how the Saudi market
might develop. “The immediate result was a very strong performance of the index, driven by both
domestic and foreign investors and a sharp pick-up in trading volumes. Over time the opening should
lead to higher aggregate volumes, better disclosure and dissemination of information and a larger and
more diverse investor base. We expect Saudi Arabia to benefit from all of these developments.”
The approach taken by the Kingdom reflects a desire not to attract speculative capital inflows that
would lead to large market volatility or disturb its fixed exchange rate regime, observes Badjie. “One
would expect a steady and gradual approach to easing foreign investment regulations going forward,”
he concludes. “Investors should also consider that local institutions have been buying heavily in
anticipation of the Saudi opening, so once it is opened, it is not necessarily the case that the market
will rise immediately.”✷
“Therearemorethan30
millionconsumersinthe
Kingdom,20millionof
whomhaveveryhigh
purchasingpower”
JohnSfakianakis,Ashmore
11.
12. 10 GlobalInvestor/ISFSaudiGuide2015
THOUGHTLEADERSHIP:JADWAINVESTMENT
Provenperformance
Tariqal-Sudairy,managingdirectorandCEOofJadwaInvestment,explains
howhisfirm’sdecade-longpresenceintheSaudimarkethelpsgenerate
outperformance
What impact will the planned opening of the Saudi stock exchange to foreign investors have
on the market?
Overall, we expect it to have several positive implications for the Saudi capital market, namely the
integration of institutional investors into the investor base, enhancing corporate governance practices
and enhancing the status and visibility of the Saudi market within the global investment community.
First, the entry of international investors will increase the ratio of institutional investors relative to retail.
Today, retail investors in the Saudi market account for more than 85% of traded volume in the market,
compared with 2% in the US, 34% in India and 60% in China. Interestingly, in China, retail participation
went down from 90% to 60% after market opening. This will naturally enhance the depth of the market
and moderate volatility as institutional investors tend to invest with a long-
term horizon and on the basis of fundamentals as oppose to speculative
trading.
Second, international institutional investors tend to reward companies that
apply corporate governance best-practice and build strong, professional
management teams.
Research in China indicates that valuations for firms ranked in the top 20%
in terms of corporate governance can be as much as 40% to 60% over
those ranked in the bottom 20%. The metrics include separation between
chairman and CEO, the ratio of independent board members, ownership
concentration and the shareholdings of the five highest-ranking executives.
We therefore expect the opening of the market to encourage publicly-listed companies to follow
the highest standards and corporate governance and transparency, invest in their organisational
capabilities, and challenge their management teams to continuously innovate and enhance capital
efficiency. In fact, in our private equity practice at Jadwa, we work extensively with our portfolio
companies to help them implement corporate governance, management and performance
enhancements ahead of their public listing.
Finally, opening the Saudi stock exchange will further enhance the status and visibility of Saudi capital
markets within the global investment community and enhance the quality of equity research and
coverage reports for the benefit of all investors.
“TheopeningtheSaudi
stockexchangewill
furtherenhancethe
statusandvisibilityof
Saudicapitalmarkets
withintheglobal
investmentcommunity”
13. 11GlobalInvestor/ISFSaudiGuide2015
THOUGHTLEADERSHIP:JADWAINVESTMENT
What appetite do you believe international institutional investors are likely to have for
Saudi equity exposure, beyond the synthetic methods already available?
It is difficult to predict the volume of foreign inflows into the Saudi market immediately after opening.
International appetite for Saudi equities at any given point in time will naturally be a function of the
market’s valuation levels and performance outlook.
Having said that, we generally expect strong inflows over time. First, the Saudi economy is growing
at a healthy rate – over 3% overall and 5% for the non-oil private sector – driven by the strong
fundamentals of demographics, domestic consumption, infrastructure development, and energy
competitiveness. The Saudi market is also the largest and most liquid exchange in the region. We
expect the Saudi market index to be included in the MSCI Emerging Markets Index within two to three
years of market opening.
At that point, the Saudi market will constitute roughly 2% of the MSCI Emerging Markets Index and
is therefore expected to attract significant flows from international index funds. By our estimates, we
expect the Saudi market to attract in the range of $25bn to $50bn from international investors over
this time horizon.
What opportunities do you expect Jadwa to gain from the opening?
The opening will be a positive development for the investment management industry in Saudi Arabia,
and for Jadwa in particular as an active investment manager in the market. We expect international
institutional investors to have strong interest in the Saudi equity market
given its scale, profile and growth prospects. We also expect that many of
these institutions will look to invest in the Saudi market through specialised
local investment managers that have the geographic focus and on-the-
ground understanding of the investment landscape to generate substantial
outperformance.
The advantages of a local investment manager are fourfold – physical
and cultural proximity allows for bettering understanding of the context,
regular meetings with companies, gauging market sentiment and investor
psychology, and interacting with government agencies to understand
regulatory developments. Within this context, what is good for the market
is good for Jadwa and vice versa. We believe the local investment management industry, and Jadwa in
particular, is well positioned to be international investors’preferred channel into the Saudi market.
Jadwa today has over SAR20bn ($5.33bn) in assets under management (AuM) across public equity,
private equity, real estate and fixed income investments. The majority of our AuMs are in Saudi and
GCC public equities, making us one of the largest investment managers in the Saudi stock market.
Since inception, Jadwa’s investment management team has generated a proven track record of
consistent and differentiated performance, grounded in fundamentals-based investing and a deep
understanding of the local market. Jadwa has consistently delivered top-quartile performance every
year, and the highest performance cumulatively since inception. In fact, we have delivered a five-year
average outperformance of 14.8% a year for our unconstrained strategy relative to the market index.
Over 60% of our AuM comes from institutional investors, reflecting their confidence in our ability to
deliver strong, consistent performance and service. ✷
“Jadwa’sinvestment
managementteamhas
generatedaproventrack
recordofconsistent
anddifferentiated
performance”
14. 12 GlobalInvestor/ISFSaudiGuide2015
who’swho
T
he Saudi financial system is subject to the same policy
and law-making processes as any other part of the
country’s economy and society. The King is firmly
at the top of the system, as both head of state and
prime minister. He is supported and advised by the Council
of Ministers (cabinet), which is led by the King, deputised
by the Crown Prince and otherwise consists of government
ministers.
Legislation
The Council of Ministers is responsible for drafting and
overseeing the implementation of government policies.
SaudiArabianMonetaryAgency(Sama)
The central bank is led by a governor. The current office holder is Dr Fahad Almubarak, who has
been in the job since December 2011. He is supported by a vice-governor, Abdulaziz Saleh Al-
Furaih, and five deputy governors who are in charge of different areas: banking operations (Hashem
Othman Alhekail); supervision (Abdulaziz Abdulrahman Alhelaissi); research and international affairs
(Dr Ahmed Abdulkarim Alkholifey); investment (Ayman Mohammed Alsayari); and administration
(Ali Abdulrahman Almahmoud).
The governor and vice-governor also serve as chairman and vice-chairman respectively of Sama’s
board of directors. The board includes three other members from the private sector. Currently they
are Abdulaziz Bin Zaid Al Quraishi (a former governor of Sama), Muhammad Obaid Bin Saeed Bin
Zagar and Abdulaziz Bin Muhammad Al Athel. All board members are nominated by the minister of
finance and approved by the Council of Ministers before being appointed by royal decree.
The central bank’s functions include:
• Handling the government’s banking affairs
• Minting, printing and managing the value of the Saudi riyal
• Managing the government’s monetary policy to ensure stable prices and exchange rates
• Managing the country’s foreign exchange reserves
• Promoting the growth and ensuring the soundness of the financial system
• Supervising commercial banks, exchange dealers, insurance companies, finance companies and
credit information companies
Unlike many neighbouring countries, Saudi Arabia does not have a sovereign wealth fund. Instead,
the central bank invests surplus money on behalf of the government.
Importantfigures
TheSaudiArabian
legislative,regulatory
andjudicialsystemsall
ultimatelyderivetheir
authorityfromthe
monarchy
15. 13GlobalInvestor/ISFSaudiGuide2015
who’swho
New laws and regulations are proposed by the relevant minister, agreed by a majority of the council
and then issued by royal decree. Laws come into effect once published in the official gazette, or at a
specified date thereafter. The current minister of finance is Ibrahim bin Abdulaziz Al-Assaf, who has
been in position since May 2003.
In addition, the Majlis Al Shura (consultative council) plays an advisory role. Its 150 members are
appointed by the King. It can propose new legislation and amend existing laws, but these do not
come into effect without the approval of the Council of Ministers and the King. The Majlis also has a
number of committees that consider issues in specific areas, including a
finance committee.
Regulation
Most of the day-to-day management of the financial system is handled by
the central bank, the Saudi Arabian Monetary Agency (Sama), which reports
to the Minister of Finance. The central bank was set up by royal decree in
April 1952 and its functions include ensuring the soundness of the financial
system and supervising many of the constituent parts of the system,
including commercial banks.
There are 12 local commercial banks operating in Saudi Arabia and a
further 12 foreign banks. The banking industry is regulated under the Banking Control Law of 1966.
Any applications for new banking licences are made to Sama, which reviews them and makes a
recommendation to the minister of finance. Licences are issued by the minister after being approved
CapitalMarketsAuthority(CMA)
The CMA is governed by a five-member board of commissioners who are appointed by royal
decree. The current chairman of the board is Mohammed Aljadaan, a founding partner of the
Aljadaan law firm in Riyadh. He was appointed chairman in January 2015. The CMA reports directly
to the Council of Ministers.
The principal role of the CMA is to develop, regulate and monitor the country’s capital markets
while ensuring that investors are protected, that the market operates in a fair, open and efficient
manner, and that the market is stable. It also issues licences to companies operating within the
capital markets. At the time of writing, the CMA had issued licences to 88 companies, covering a
range of services including share dealing, fund management, arranging, advising and custody.
In recent years the CMA has been working to enhance market transparency and improve the level
of disclosure among publicly listed companies. It has also been increasingly vocal about enforcing
existing regulations, all of which should enhance trust in the market.
Such efforts will of course become even more important once the market opens up to international
investors. Saudi Arabia will need to conform to international norms of transparency if it is to meet
expectations of how much foreign money flows into the market. Estimates of just how much
money may arrive as a result of the reform range as high as $50bn, although that is only likely to
happen if and when Saudi Arabia is promoted from frontier market to emerging market status by
international fund indexing companies such as MSCI.
Mostoftheday-to-
daymanagementof
thefinancialsystemis
handledbythecentral
bank,theSaudiArabian
MonetaryAgency
16. 14 GlobalInvestor/ISFSaudiGuide2015
who’swho
by the Council of Ministers.
In addition, the Capital Market
Authority (CMA) is in charge of
regulating and developing the
country’s capital market. Its remit
also covers the regulation of all share
listings on the stock market, and the
activities of stock brokers, investment
banks and investment funds.
The Saudi Stock Exchange (Tadawul),
was set up under the same Capital
Market Law as the CMA and is the
only venue authorised for the trading
of securities in the country. There are
currently 168 companies listed on
the market with a combined market
capitalisation of around $534bn.
The 12 commercial banks listed on
the market together form the most
valuable sector on the exchange, led
by National Commercial Bank (NCB), Al
Rajhi Bank and Samba Financial Group.
Before the qualified foreign financial
institutions reform came into effect, only Saudi and other GCC nationals were allowed to invest directly
in the stock market. Until this point, foreigners could only gain exposure via swap arrangements. ✷
SaudiStockExchange(Tadawul)
The Tadawul is by far the largest stock market in the
region, with a market capitalisation more than three
times that of the next largest, the Qatar Stock Exchange.
Companies listed on the stock market are divided
into 15 sectors. Banking stocks make up the largest
proportion by value and are worth more than a quarter
of the entire market. Insurance companies are the most
numerous, with 35 listed firms. Other significant sectors
include petrochemicals, telecoms and IT, and real estate
development.
New listings are relatively rare, with just six new
entrants to the market in 2014. These included National
Commercial Bank, which raised SR22.5bn ($6bn) from its
listing.
Trading on the market tends to be dominated by retail
investors, which can make it volatile. However, opening
the market to international investors should bring in
more institutional funds and could help to redress the
balance.
Keybankandcreditinstitutions
The Saudi banking sector is in strong shape overall, with credit ratings agencies reporting low levels
of non-performing loans, ample liquidity and a low cost of funding. The banks have been helped
by the fact that the economy as a whole seems to have coped well with the fall in oil prices in the
second half of 2014 and early 2015.
The most important commercial banks in the country are National Commercial Bank (NCB), Al
Rajhi Bank, Samba Financial Group and Riyad Bank. These banks are highly rated by the main credit
ratings institutions. They are also regarded as systematically important to the banking system and it
is widely assumed that the government would step in to support them if that was ever necessary.
Other major banks in the country include Saudi British Bank (SABB), Banque Saudi Fransi, Arab
National Bank and Saudi Hollandi Bank. Alongside the commercial banks, the government has also
established five specialist credit institutions that provide loans to Saudi nationals to encourage
activity in certain areas of the economy. These are the Saudi Industrial Development Fund, the
Saudi Arabian Agricultural Bank, the Real Estate Development Fund, the Public Investment Fund,
and the Saudi Credit Bank.
17. 15GlobalInvestor/ISFSaudiGuide2015
THOUGHTLEADERSHIP:BLOMINVEST
Openforbusiness
GeorgeHanna,headofassetmanagementatBlominvestSaudiArabia,
believesforeigninstitutionalmoneywillimprovecorporategovernance
T
hough not necessarily expected to have a direct impact on stock prices in the short-term, the
new trading regulations in Saudi Arabia are set to change the dynamic of the market. There will
be some major benefits to the market opening up, not least the potential for a lower cost of
capital funding and more varied sources of capital.
The Saudi Capital Market Authority (CMA) has provided a clear strategy towards increasing institutional
investor involvement in the market, reducing both the amount of trading in and the amount of retail
investor participation in the market.
Even though the Saudi stock market is well understood, with all the established research houses
present, there is still room for improvement. The CMA has already done a good job in in bringing
transparency to a standard that has not been seen before in the region. But there is more work to be
done.
When existing executives of companies start receiving questions from
international fund managers they will know that there are additional pairs of
eyes looking at what they are doing. This may take efficiency to an even higher
level. This is what we hope the main benefit will be for the Saudi market from a
structural point of view.
Blominvest has been active in Saudi Arabia since 2008 and provides a broad
range of financial advisory and investment services for public and private
entities in the Kingdom and the Middle East. It is dedicated to providing
customised solutions for all financial and asset-related matters by using the
vast expertise and profound know-how of its highly-qualified employees and investment advisers.
In mid-2011 Blominvest launched its first Saudi equity fund, which primarily invests in equity securities
listed on the Tadawul, either directly or through other funds. We have since launched two other funds
along with mandates for institutional clients. We have also recently issued an initial public offering
fund which has attracted very strong interest from both institutional and retail players.
At Blominvest, we believe companies that are agile enough to improve their corporate governance
will benefit from more investment flows, and more trusted institutional money coming into them.
Historically, corporate governance has not been a major element in our analysis. Mostly we have based
our analysis on qualitative factors, distilling major elements in the qualitative arena as they surface
from any given company’s financial statements. But going forward corporate governance is also going
to be a key factor.
Blominvest is very positive about the Kingdom’s prospects, and what the market opening to qualified
financial institutions will achieve. ✷
Webelievecompanies
thatareagileenough
toimprovetheir
corporategovernance
willbenefitfrommore
investmentflows
18. 16 GlobalInvestor/ISFSaudiGuide2015
who’swho
Saudi Arabia’s legal
system is based on
Islamic law, also
known as sharia law,
for both criminal
and civil cases.
Traditionally the
courts system was
centred around
the General Islamic
Court, which heard
the majority of
cases, including
those related to
land, family disputes,
personal injury
claims and criminal cases.
In addition, some types of cases were assigned to specialist tribunals. The most prominent of these
was the Grievances Board, which had jurisdiction over cases involving the government and most
types of commercial disputes. Other specialist committees included Sama’s Committee for Banking
Disputes and its Committee for Insurance Disputes, and the Ministry of Labour’s Commission for the
Settlement of Labour Disputes.
Under royal decrees issued in 2007, the courts system is undergoing radical reform. The new system
includes a range of courts of first instance including commercial courts which would take over
much of the work of the Grievances Board, and labour courts to replace the Ministry of Labour’s
role in deciding on labour disputes.
Above that there are courts of appeal, including ones for commercial and labour cases. At the top
of the system is a Supreme Court, which can review the appeal courts decisions. However, the
process of enacting the reforms has been drawn out and remains far from complete.
Saudi Arabia also reformed its arbitration laws in 2012. Under the new system, arbitration
procedures can be conducted inside or outside the country, with arbitrators agreed by the parties
involved, and with proceedings carried out in any language.
Saudi Arabia has signed the New York Convention on the recognition and enforcement of foreign
arbitration awards, but Saudi courts rarely enforce such awards from non-Arab states. As a result, for
those not wanting to go through arbitration in Saudi Arabia, venues such as the Dubai International
Financial Centre’s Arbitration Centre may be the best option.
Enforcing court judgments can also take many months. Judgments from courts in other Arab
League or GCC countries are usually enforceable in Saudi Arabia, but lawyers say that, in practice,
judgments from courts in non-Arab states cannot usually be enforced.
Supreme Court
Appellate Courts
Courts of First Instance
General
Courts
Criminal
Courts
Family
Courts
Commercial
Courts
Labour
Courts
Thestructureofthenewcourtsystem
Source: Al Tamimi Co
22. 20 GlobalInvestor/ISFSaudiGuide2015
INVESTINGINSAUDIARABIA
Pathstoprosperity
Internationalmanagersneedtounderstandthemeritsoflocalpartnerships
andunfamiliarcustodyandsettlementarrangementsiftheyaretocreatea
successfulSaudiinvestmentstrategy,findsPaulGolden
I
nternational asset managers excited at the prospect of direct access to the Saudi Stock Exchange
face two fundamental tasks – acquiring the required approvals and then maximising returns in an
unfamiliar market in terms of aspects such as custody and settlement as well as investment options.
The Capital Market Authority (CMA) has set up an admirably straightforward qualified foreign
investor (QFI) registration process but decisions need to be made at the outset.
The CMA regulations allow only approved persons to register, manage and sell asset management
products to the local market, although there is an exemption for international managers to service the
Saudi Arabian Monetary Agency (Sama), banks and insurance companies.
There are two alternatives for international managers looking to register funds with the CMA and
distribute within the Kingdom. The first option is to establish a CMA-registered entity or approved
person. As an approved person, the manager would be able to establish Saudi-domiciled funds and
private placements.
The second option is to work with a local approved person, who would act as a local distributor and
register the fund with the CMA. The international manager would be seen only as a sub-adviser to the
fund and would therefore not be allowed to sell in Saudi Arabia.
The Saudi definition of approved persons is not dissimilar to that of other markets, where approved
persons provide investment vehicles for local retail and institutional investors. Local Saudi funds
include cash, equity, fixed income, private equity and real estate, although the key structural difference
is that most managers will provide the same asset classes in both conventional and Islamic structures.
The CMA and the Saudi Stock Exchange (Tadawul) are implementing significant changes to how assets
are held in custody, which are due to take effect from June 15 2015. Custody is currently managed
through Tadawul as the ultimate custodian, while investors must utilise Saudi brokerage accounts for
custodial settlement and reporting. This model provides significant advantages for retail investing, but
there are certain obstacles for asset managers – both local and international.
“The CMA and Tadawul will continue to allow the brokerage-custodian model after June 15,”says
Michael Slater, country head Saudi Arabia, at Northern Trust. “However, both institutions recognise
that an independent custody model is required to further enhance the financial services industry. This
model, in cooperation with Tadawul, will be similar to international CSDs such as Euroclear, Crest and
DTCC, and will allow asset managers to use the independent custody model.”
Expected benefits include the use of multiple brokers, settlement, safekeeping and daily reporting. But
the domestic market uses a T+0 settlement system, which causes problems for international investors
because they need to have their securities transferred from their custody account and into their
23. 21GlobalInvestor/ISFSaudiGuide2015
INVESTINGINSAUDIARABIA
trading account on the same day to effect settlement. Nevertheless, according to Rod Ringrow, senior
managing director at State Street: “A delayed settlement system is planned for foreign investors, but I
am not aware of any plans to move from T+0 for the domestic market.”
Pricing potential
Renaissance Capital’s head of strategy, Dan Salter, believes the opening of the market has the potential
to make price discovery more efficient , giving a greater balance of international and domestic
investors, and thus possibly reduce volatility.
Malick Badjie, executive director and head of investments at Silk Invest, says the experience of the
UAE and Qatar would indicate the merits of a cautious approach as investors tend to build up their
positions ahead of the market opening, pulling up share prices in the market. “Foreign fund inflows are
also unlikely to improve significantly until the CMA works on delivery-versus-payment (DVP) trading
systems and there is an improvement in corporate access for investors.”
Amr Hussein Elalfy, managing director and global head of research at MubasherTrade, believes western
banks and investment houses will win most of the new business as a result of their global reach and
that western investment firms should see their exposure to the market increase gradually from the
current 1.13%, through swap agreements, towards the ceiling of 10% of total market capitalisation
under the new QFI rules.
“With foreign clients already present in the Saudi market through swap
agreements, we may start seeing more inflows, but only gradually given the
current limitations of the QFI rules. However, in the long run, participation of
foreign investors will develop further as they start putting Saudi Arabia on
their radar screens, especially once it is classified as an emerging market by
MSCI.”
All sectors of the market will be available to QFIs from June 1, although
there will be restrictions on ownership levels at certain “strategic”points. The
Saudi market is the largest within the Middle East and has approximately
170 tradable securities in 10 different sectors, which Slater says would seem
adequate to build a balanced Saudi portfolio.
The Saudi government has been encouraging more small and mid-sized enterprises to list and has also
been keen to privatise state-owned entities. However, Ringrow accepts that foreign ownership limits
could create challenges when it comes to building a balanced portfolio since foreign investors are
likely to be largely targeting the same stocks.
“The focus on big names will ease over time, but in the shorter term there are some big names that
non-GCC investors will want to get access to. The challenge will be to find value stocks without
distorting the market and there are lesser-known companies that offer this kind of value. There is very
little debt and non-riyal government debt.”
Funds which come with minimal fees and give ETF-type exposure will prove most popular with
international managers, says Muhammad Shabbir, head of equity funds and portfolios Rasmala
Investment Bank. “All sectors are accessible, barring a few real estate companies that operate in the
holy cities,”he adds.
Most funds benchmark themselves to large-cap indices, which are very concentrated in a few
“Thechallengewillbeto
findvaluestockswithout
distortingthemarket
andtherearelesser-
knowncompaniesthat
offerthiskindofvalue”
RodRingrow,StateStreet
24. 22 GlobalInvestor/ISFSaudiGuide2015
INVESTINGINSAUDIARABIA
industries, observes Afa Boran, managing director asset management at Amwal. “Banks aside, the other
industries do not provide the best exposure to these rapidly growing economies.”
An analysis of past returns suggests that there are some very well managed funds, he says. “But as
in most other markets, a large number of funds underperform their benchmark. In our view, this is
because fund managers fear underperformance, causing them to hug index stocks.”
There are a couple of medium-sized exchange traded funds (ETFs) in Saudi and UAE, but Boran
suggests since emerging markets are not as efficient as their mature counterparts, passive strategies
are not necessarily a suitable approach.
“Banks, petrochemicals and real estate make up 75% of the index,”he says. “Focusing on these sectors
will inevitably leave out many growth and high-return sectors that leverage the region’s attractive
demographics.”Energy is not expected to outperform other sectors as its return is highly correlated
with, and effectively capped by, the oil price.
Diversified portfolios
According to Vijay Harpalani, fund manager at Al Mal Capital, most sectors are accessible with the
exception of a few individual names. “If you look at two-year correlations between petrochemicals,
retail, real estate, telecoms and consumer staples, it ranges between 0.6 and 0.7, which is quite
acceptable. Given the size of the market, one can access a wide variety of funds with growth and value
styles across large, mid and small-cap categories.”
Passive asset management strategies are available – including some ETFs – but are limited in number
and mostly invested in international markets, whereas the local exchange is
predominately serviced through active funds. Saudi institutional investors
have a greater propensity to utilise passive strategies, again specifically for
international assets.
Harpalani acknowledges that the level of sophistication in the Saudi market
is relatively low as a result of the dominance of retail investors, but he
expects this to change gradually with the influx of highly sophisticated
institutional money.
“Derivative instruments are not available in the Saudi market and are not
likely to be launched any time soon – although foreign investors are allowed
to take exposures in cash equities via P-notes and swaps,”he adds. “But with
reclassification to emerging market status, we expect to see the launch of
passive strategies.”
Having access to a local partner is advisable to help investors navigate the intricacies of the market,
says Ringrow. “This does not necessarily have to be an asset manager – it could be a law firm or a
consultancy with access to market intelligence.”
Ringrow suggests that there are a number of additional noteworthy factors within the Saudi capital
markets. “We expect to see an increase in IPO activity in the market over the next two years. And, the
CMA has been a vocal proponent of joining the MSCI Emerging Market Indices. These changes will
assist retail and institutional investors to further enhance their portfolios.”
There has been much debate about the future of synthetic products (P-notes) and total return swaps
“TheCMAandTadawul
bothrecognisethatan
independentcustody
modelisrequiredto
furtherenhancethe
financialservices
industry”
MichaelSlater,NorthernTrust
25. 23GlobalInvestor/ISFSaudiGuide2015
INVESTINGINSAUDIARABIA
after June 1 2015. Salter suggests that these products will take some time to disappear since not all
foreign investors will qualify for QFI status from day one and those that don’t will be likely to continue
to use the synthetic product route.
Synthetic stagnation
The future prospects of synthetic products and total return swaps are even more difficult to assess
since the latest CMA rules release does not make it clear what will happen to the participatory notes
(P-notes), except for the fact that they will be included when calculating the foreign shareholdings in
percentage terms, adds Badjie.
John Sfakianakis, GCC regional director for Ashmore, expects P-notes to transform into more direct
investments over the coming years as part of the natural evolution of an emerging market. “The
market is also going to become more institutionalised, as we have seen happen in China over the last
few years.”
Daniel Tubbs, global emerging markets portfolio manager at Mirabaud, agrees that while those
companies that achieve QFI status will most likely opt for owning the
underlying assets, other investors may choose to remain invested via
synthetics, either as part of their mandate or if they do not receive QFI
status.
There will be a need for P-notes for some time as large investors take time to
set up direct access and also for foreign investment institutions that do not
qualify for direct access, agrees Investec portfolio manager Kemal Ahmed.
“We believe the participation of foreign institutional investors in the market
will bring much needed price discovery and formulation to the market.
However, domestic institutional investors are likely to provide considerable support and form a base
for price stability.”
Elalfy accepts that the swap system has a number of disadvantages compared with the QFI system.
These drawbacks include higher commissions – which can be as much as twice as high for foreign
investors when compared with those paid by Saudi or GCC clients – and the fact that foreign investors
using the swap system bear the broker’s credit risk since swap agreements are held under the broker’s
name.
“Also, the swap system only provides foreign investors with economic interest in Saudi securities,
whereas the QFI system will give them voting rights similar to other shareholders. That said, we believe
foreign ownership through swap agreements will continue to exist after the implementation of the
QFI system since some foreign clients may not be able to meet the QFI rules.”
According to Elalfy, opening the Saudi market will bring both benefits and risks. “Opening the market
to international investors will help increase the participation of institutional investors with a long-
term view and enhance market efficiency, which could attract more companies to list and thus raise
transparency within the market.”
But this move may also expose the market to the high volatility of global markets, he concludes.
“Performance could become more correlated to global markets, thus exacerbating volatility levels at
times of global crises.”✷
“Withclassificationto
emergingmarketstatus
weexpectthelaunchof
passivestrategies”
VijayHarpalani,AlMalCapital
26.
27. 25GlobalInvestor/ISFSaudiGuide2015
thoughtleadership:SAUDISTOCKEXCHANGE
T
here are two myths about the Saudi stock market.
The first is that Saudi individuals – sophisticated
investors and retail investors – are the dominant
force within the market. Whereas this is emphatically
true in terms of their trading activity, which typically
represents around 90% of monthly trading value, it is
certainly not true in terms of stock market ownership,
which currently represents around 34% of total market
capitalisation.
The second myth is that foreigners cannot invest in the
Saudi stock market. To date, non-Saudis own 7.7% of total
market capitalisation – a composition consisting of GCC
investors (2.7%), resident foreign investors (0.4%), strategic
foreign shareholders (3.6%), and non-resident foreign
investors participating through the Saudi equity swap
framework (1.1%).
There is, however, no doubt that Saudi nationals are the
most privileged participants in the Saudi capital market.
Although resident foreign investors and GCC investors have
very similar rights, they currently do not have the right to
participate in initial public offerings (IPOs) and public debt
offerings.
It is worth highlighting, as chart 1 demonstrates, that since
the introduction of the Saudi equity swap framework in
August 2008, non-resident foreign investment behaviour
through this framework has been very encouraging. Indeed,
these foreign investors have accumulated net positions of
around SAR7.8bn as at the end of March 2015, equating
QFI:theinvestorriyality
SaudiArabiaistakingaverysignificantsteptowardsglobalcapitalmarket
convergencewiththeintroductionoftheQFIFramework.AdelSAl-Ghamdi,
CEOoftheSaudiStockExchange,outlineshisexpectationsforthemarket
goingforward
28. 26 GlobalInvestor/ISFSaudiGuide2015
thoughtleadership:SAUDISTOCKEXCHANGE
to around $2.1bn at historical
cost (not current market value).
This is a promising indicator
for the future of the stock
market as we continue to
liberalise further through the
qualified foreign investor (QFI)
framework.
GCC investors have behaved
much in the same manner as
non-resident foreign investors,
whereas resident foreign
investors can be described
as net traders based on the
pattern of their monthly
investment behaviour.
Markethighlightstodate
IPOs
Since the introduction of the Capital Market Law in 2003 until the period ending Q1 2015, the Capital
Market Authority (CMA) has approved 100 IPOs raising total proceeds of $31.1bn. In total, 59 of these
IPOs were mandatory (government-induced IPOs), while the remaining 41 were discretionary IPOs
(private companies).
In 2007 the CMA approved an unprecedented 26 IPOs in a single year, 19 of which were mandatory,
and most were actually greenfield insurance companies. The remaining seven were discretionary IPOs.
2008 was also a significant year in terms of value offered. Again, these were mainly mandatory IPOs,
attributed largely to PetroRabigh, Ma’aden, Alinma Bank and Zain.
In 2014, the Saudi stock market had another groundbreaking year, this time on the international stage,
resulting from the listing of the National Commercial Bank, which was considered the second-largest
IPO conducted globally during the course of that year.
It is worth noting that 74% of all IPOs listed on the Saudi Stock Exchange, in terms of value, were
mandatory, with the banking industry representing around 40% of value offered, comprising Alinma
Bank, NCB and Bank Albilad. When compared with the total size of the universe of IPOs conducted
since 2003, both mandatory and discretionary, these three IPOs represent a very significant 30% of
value offered.
Debt offerings
60 debt offerings were conducted since the introduction of the Capital Market Law in 2003, raising
total proceeds of around $42.4bn, exceeding that raised through IPOs. Of these 60 offerings, 48 were
conducted by way of private placement offered exclusively to sophisticated and institutional investors,
according to available data, while the remaining 12 were offered publicly.
SAR (5) bn
-
SAR 5 bn
SAR 10 bn
SAR 15 bn
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
Jan-13
Apr-13
Jul-13
Oct-13
Jan-14
Apr-14
Jul-14
Oct-14
Jan-15
GCC investors Resident foreign investors Non-resident foreign investors
The chart illustrates the
investment behaviour of
non-Saudi Investors
since 2008
Non resident foreign
investors have
demonstrated positive
investment behaviour
since the introduction of
the swap framework in
August 2008,
accumulating
SAR7.8bn ($2.1bn)
worth of net long
positions to date
at historic transaction
prices
A micro view of accumulated non-Saudi positions in the stock market since 2008
Accumulated positions by non-Saudis
at historical transaction cost
(Jan 2008 – Mar 2015)
Source: Internal Analysis of Published Data (31st March 2015) – Data coverage begins in Jan 20080+
Introduction of
swap
framework
Note: Largest monthly
inflow through the
Swap framework was
witnessed in April, 2015
(SAR 2.5bn or $666m) Further efforts are required to foster longer-term investment behaviour from resident foreign investors
Chart 1: Accumulated stock market positions (non-Saudis)
29. 27GlobalInvestor/ISFSaudiGuide2015
Issuers from the financial
services and petrochemicals
sectors raised a combined
$23bn, or 54%, through this
funding channel, while a single
issuer, namely the General
Authority of Civil Aviation,
singlehandedly represented
19% of the total offering size
with two private placements
of $4bn each in 2012 and 2013
respectively.
There is much to be done to
stimulate further issuances in
the debt capital market, and
various initiatives focused on growing it, primary among which is the establishment of a sovereign
yield curve to act as a pricing benchmark for local issuers.
Mutual funds
263 mutual funds have been registered with the CMA since the introduction of the Investment Funds
Regulations in 2006, the majority of which underwent a reregistration process due to the change of
regulatory jurisdiction over this asset class from the central bank (the Saudi Arabian Monetary Agency
– Sama) to the CMA.
By the end of Q1 2015, total assets under management (AuM) peaked at around $30bn,. However,
as chart 2 suggests, the number of mutual fund subscribers in this market reduced from 500,000 to
240,000 from 2006 to March 2015. It is certainly a significant drop in terms of interest from subscribers,
and a number of initiatives included in the CMA’s and the Saudi Stock Exchange’s five-year strategic
plans are geared towards developing this market further over the coming years.
Money market funds are by far the largest segment of our mutual funds market, representing 60%,
or $18bn, of total AuM. Local equity funds, the second-largest constituent, represent 21%, or $7bn, of
total AuM. The reverse is true in terms of number of subscribers, with 69% of total subscribers investing
in local equity funds and 18% in money markets funds, predominantly institutional investors.
Howwillthemarketevolve?
IPOs
Supply-side stimulants
Policy dynamics: There are various market and policy-related stimulants that I sense will boost the flow
of IPOs. For example, it is believed the recent introduction of the Council of Economic Affairs and
Development, chaired by Prince Mohammad bin Salman, will accelerate public offerings of a number
of state-owned enterprises.
The recently promulgated Finance Companies Control Law also requires all Sama-licensed finance
thoughtleadership:SAUDISTOCKEXCHANGE
Based on the available
data, there have been
60 debt offerings since
the promulgation of the
CML in 2003
60 debt offerings since the promulgation of CML in 2003 – total proceeds of $42.4bn
-
2,000
4,000
6,000
8,000
10,000
12,000
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 YTD 2015
-
2
4
6
8
10
12
14
$m Private Public Total number of offerings Offers
Offering composition by classification (since CML)
Private
$28,168m, 66%
Public
$14,271m, 34%
Financial services
$11,636m, 27%
Buiding and
construction
$1,601m, 4%
Energy and utilities
$6,933m, 16%
Petrochemicals
$11,533m, 27%
Agriculture and food
$1,467m, 4%
Civil authorities
$8,056m, 19%
Other
$1,213m, 3%
Offering composition by sector (since CML)
Total proceeds of
$42.4bn have been
raised over the period,
more than 66%
of these offerings by
value were conducted
by way of private
placements
Issuers from the
financial services and
petrochemical sectors
represent 54% of total
offerings conducted by
value
GACA’s two offerings
(Civil Authorities)
represent 19% of total
offerings (by value)
Source: Internal analysis and CMA Data (31 March 2015)
48 private placements
12 public offerings
GACA, Tasnee,
BSF, SABB
others
GACA, RB, SABB
SHB, Marafiq,
others
Chart 2: Capital market profile – debt
30. 28 GlobalInvestor/ISFSaudiGuide2015
thoughtleadership:SAUDISTOCKEXCHANGE
leasing and real estate
financing companies to
undergo an IPO, with the
conditions for such offerings
to be determined by a special
ministerial committee in
accordance with Council of
Ministers resolution 259, and
in light of the requirements of
the CMA’s listing rules.
Market dynamics: Establishing a
tiered stock market structure
by introducing an small and
medium-sized enterprise
market, and possibly a venture
market, creates a unique
opportunity to broaden the number of our market constituents by introducing more risk capital
opportunities to our various stakeholders. This is something currently being studied with our regulator.
Other efforts are being exerted to develop a robust cross-listing framework. Indeed one of the key
responsibilities that will lie with the exchange imminently is the development of listing rules for all
types of securities. We are hopeful that we will have these rules in place in 2016, which will include
clear cross-listing requirements.
Demand-side stimulants
On the demand side, the real estate taxes to be imposed on owners of undeveloped land is
anticipated to trigger a flight of capital from the real estate sector into the capital market as an
alternative investment venue.
Another element of demand will come from qualified foreign investors. Although they may not be
able to take part in IPOs, they will certainly want a broader range of investments in the secondary
market to invest in. Demand for IPOs from our local investors has generally always been very
strong. Indeed the IPO of National Commercial Bank, the second-largest IPO globally in 2014, was
oversubscribed by $76.8bn – 12 times.
Debt offerings
Supply-side stimulants
Policy dynamics: A number of factors are anticipated to come into play to stimulate further issuances
in the debt market. The recently promulgated Real Estate Financing Law is one such example. The
implementing regulations of this law requires the establishment of the Real Estate Refinance Company
with a prescribed share capital of around SAR5bn. The company is authorised to securitise mortgage
obligations and issue them into the capital market.
Another important dynamic, which could set the stage for significant private sector issuances, is
the strategic use of the anticipated government budget deficit as a pivot point to issue new Saudi
government development bonds. If the government does indeed decide to fund the deficit by
263 funds have been
registered with the
CMA since the
introduction of the
Investment Funds
Regulations (IFRs) in
2006
263 fund registrations since the introduction of IFRs in 2006
AuM by fund classification (31March, 2015)
Money market
$18bn, 60%
Local equity
$6bn, 21%
International
equity
$4bn, 12%
Others
$2bn, 7%
Subscribers by fund classification (31March, 2015)
Money market
44,585
Local equity
168,357
International equity
18,125
Others
11,717
Although assets under
management are at
their all time high in
2015 – nearly
$30.0bn – the number of
subscribers has halved
since 2006
Nearly 60% of total
AuM are concentrated
on money market
instruments, from 18%
of subscribers, while
21% of total AuM is
focused on local equity,
from 69% of subscribers
Source: Internal analysis and CMA data (31 March 2015)
$bn Assets under management ($m) Total number of subscribers Subscribers
-
5
10
15
20
25
30
35
2006 2007 2008 2009 2010 2011 2012 2013 2014 Q1 2015
-
100,000
200,000
300,000
400,000
500,000
600,000
Chart 3: Capital market profile – mutual funds and ETF offerings
31. 29GlobalInvestor/ISFSaudiGuide2015
THOUGHTLEADERSHIP:SAUDISTOCKEXCHANGE
issuing new sovereign bonds, this would obviously increase supply, but it would also serve to create a
sovereign yield curve to act as a much-needed pricing benchmark for local issuers. It is worth noting
that Saudi Arabia has one of the lowest debt to GDP ratios in the world, standing at close to 2%, very
strong and stable sovereign credit ratings, and a very healthy fiscal cushion of around $740bn. The
government has significant room to manoeuvre.
The CMA is also currently developing rules for special-purpose entities, which should ease the
implementation of complex Sukuk structures in the debt market.
Market dynamics: With 66% of all debt offerings – by value – being privately placed with sophisticated
investors, there are a significant number of securities out there that are not visible to market
stakeholders. I would argue that this prompts the need for a professional debt market to act as a
trading venue for these securities. Such a venue would serve to enhance transparency and potentially
increase secondary market activity in these instruments. Ultimately, trading in such a market would
necessarily need to be restricted to sophisticated investors.
Demand-side stimulants
On the demand side, there has always been significant demand for debt products, particularly from
government-related entities, from the banking sector and from mutual funds. So demand has really
never been an issue – the underdevelopment has always been about supply.
Mutual funds and ETF offerings
Supply-side stimulants
Policy dynamics: Policymakers are working on a number of initiatives to promote a savings and
investment culture within our society, with the aim of redirecting the less savvy retail audience away
from the stock market and into more diversified investment vehicles in the form of mutual funds.
Only recently the CMA began to take further action, in line with its strategic plan, to incentivise this
migration into funds by increasing the institutional tranche in IPOs from 50% to 60%, of which 90% is
dedicated to mutual funds with the aim of making them more attractive to retail investors.
Market dynamics: With the entry of QFIs into the market, it is also likely that we might see a number of
IPO ETFs and funds being introduced to attract local and foreign stakeholders. QFIs in particular may
find this to be a useful investment channel for the purposes of gaining exposure to IPOs, which are
currently restricted to Saudi investors.
The inclusion of the Saudi market into major country indices should also encourage the launch of a
number of Saudi funds and ETFs. Additionally, and because mutual funds and ETFs have no restrictions
on foreign ownership, QFIs could use this channel as a vessel to gain more exposure to Saudi equities
without impacting their single stock ownership limits.
The Saudi Stock Exchange is also keen to create a central distribution venue for mutual funds on our
platform. This should allow fund managers to reduce their distribution costs – because not all fund
managers have a distribution network, particularly non-bank affiliates. Concurrently, these cost savings
should serve to reduce subscription fees on investors, making it more attractive for them to subscribe.
Demand-side stimulants
Much needs to be done to educate market stakeholders about the virtues of investing in mutual
32. 30 GlobalInvestor/ISFSaudiGuide2015
thoughtleadership:SAUDISTOCKEXCHANGE
funds, particularly retail investors. The Saudi Stock Exchange has a major role to play in fostering this
awareness. To this end we will be developing a series of educational infomercials in the second half of
the year which we plan to disseminate through all forms of mediums including TV and social media
channels. We are hopeful that this will stimulate further demand.
Special focus: the QFI framework
On May 4 2015, the CMA approved the final draft of the QFI rules. The rules have been designed to
facilitate direct single stock access into the Saudi market to a specific segment of the foreign investor
community. The rules do not apply to resident foreign investors and GCC investors.
The QFI framework was specifically tailored to attract sophisticated, longer-term value investors who
take an active role in shaping the direction of the companies in which they invest. This enhanced
sophistication should accelerate our market’s convergence towards higher standards of corporate
governance, investor relations, issuer disclosures and analyst research.
It is important to note that the objective of developing and introducing the framework was never
about increasing foreign investment flows into the country, but rather to influence and enhance our
practices, market behaviour and infrastructure.
In terms of the features of the framework, non-resident foreign investors must first qualify in order to
participate through the framework, and there are a number of registration conditions that must be
fulfilled in order to achieve qualification. For example, the investor must be a specific type of institution
– a bank, securities firm, insurance company or a fund manager. The investor must also be operating
from a jurisdiction with regulatory oversight which is at least equivalent to that of the CMA’s. The
investor must also have AuM of at least $5bn and an investment track record of at least five years.
Once qualified, the investor must pre-fund all transactions to be conducted on the exchange. This is
due to the need to settle these transactions on the day they take place (T+0). Once funded, QFIs can
proceed to invest. However, they must comply with a number of ownership limitations prescribed in
the rules. The burden of compliance with these limitations falls on the QFI and the broker executing on
behalf of that investor. Having said this, the Saudi Stock Exchange will be facilitating the QFI framework
in a number of ways, namely by systematically enforcing a number of these foreign ownership limits,
and by reporting foreign ownership headroom on a daily basis.
A significant step to convergence
The QFI framework is a living framework that will evolve over time. It brings the Saudi market a
number of steps closer to international best practices. Further steps towards convergence have also
recently been effected, including the CMA’s recent approval of the Saudi Stock Exchange’s proposal
for the independent custody model, which serves to empower investors, enhance investor protection
and, more importantly, segregates the role of brokers and custodians, thereby creating a more
competitive landscape for these entities within our market.
Over the coming period, the Saudi Stock Exchange plans to enhance its XBRL-based IFSAH reporting
platform, and strengthen bilingual issuer disclosures. Although 45% of all company announcements
disseminated through the exchange are bilingual, we will continue to work tirelessly with issuers to
improve this ratio as we go forward. We will also continue our efforts to improve our XBRL taxonomy
to ensure financial disclosures are more comprehensive and more useful to analysts and institutional
investors. ✷
33. 31GlobalInvestor/ISFSaudiGuide2015
Thoughtleadership:HSBC
Emergingopportunity
HSBCSaudiArabiaCEOMajedNajmoperatesoneofthelargestcustodyand
institutionalbrokerageteamsintheKingdom
What do you see as the biggest overall impact from the Saudi market opening?
The opening of the Saudi Arabian stock market translates to the foreign investor community gaining
direct access to almost half the market capitalisation of Mena. Obviously there will be significant
incremental flows over time, but the real value will be the contribution to enhancing the levels of
institutional involvement and therefore the level of sophistication – it is already a very liquid stock
market but it is mainly retail-dominated. It is also likely to prompt more foreign investors to look at
Mena capital markets closely, resulting in incremental flows for the entire region.
How will the Saudi market change due to the presence of QFIs and more institutional flows?
The Saudi market is dominated by retail investors, comprising 90% of activity. More institutional inflows
would increase the level of sophistication in the market, leading to market stability, reducing volatility,
and changing the nature of the liquidity. This should also contribute to greater institutional participation
in the market, and a general upskilling of all participants – brokers, custodians and research development.
How important will the changes to execution and custody be for participants?
Custody is a key component that contributes to maintaining the confidence of foreign investors.
The local authorities recognise the needs of international institutional investors and make constant
enhancements to their offering to adapt to such needs. For example, to reduce counterparty exposure
that clients have to brokers, the authorities are implementing the Independent Custody Model,
which provides custodians greater control over client assets. Similarly, equity execution standards are
expected to rise given that foreign institutional investors will demand the same levels as elsewhere.
What can HSBC contribute, given its extensive securities services capabilities in the Kingdom?
Given the nature of HSBC Saudi Arabia, and through our shareholders HSBC (49%) and SABB (51%), we
are uniquely placed locally to express the needs and opinions of the foreign institutional community.
At the same time, given our strong local presence and activity, we are also very well positioned to
interpret and articulate local policy developments and changes to foreign investors. We are also
well placed to leverage the experience of our shareholder (HSBC) with respect to its involvement in
different capital markets across the world, to drive positive change in the Saudi market.
Will the opening of the Saudi market transform other markets in the region?
The Saudi stock market is the largest in the Middle East, with a market capitalisation of over $500bn,
comparable to that of Russia or South Africa, and larger than Turkey, an average daily turnover value of
about $2.28bn during 2014, the highest in the region, and higher than Russia, South Africa or Turkey, and
about 170 stocks listed across 15 sectors. We expect MSCI to review the market for inclusion in its Emerging
Market Index, possibly in 2017, thereby leading to significant activity, interest and inflows in the market. ✷
34. 32 GlobalInvestor/ISFSaudiGuide2015
thoughtleadership:DeutscheBank
Agamechanger
forSaudiArabia
andtheregion
T
he world is coming to Saudi Arabia, or, at the very
least, the Kingdom’s financial markets just got
more accessible. What was, in effect, the last of the
significantly-sized international capital markets,
which was historically closed to investors, has just opened
its doors. It is an exciting time for the Saudi Arabia stock
market (Tadawul) and for financial institutions operating in
the Kingdom.
Just consider some of the fundamentals and you can
see that the landmark decision to allow qualified foreign
investors (QFIs) into the market should create a plethora
of opportunities. Saudi Arabia’s equity market is valued at $575bn, making it comparable to Russia,
Malaysia, Mexico and Indonesia. And the market trades well over $2bn a day, which means it is more
liquid than the United Arab Emirates and Qatar. Saudi Arabia’s contribution to regional liquidity is
around 65%. Equally important are the demographics of the region – the population is relatively
young, which bodes well for future consumer demand.
Interest mounting
Opening up this market has created waves of interest from our clients all around the world. But in
some ways, these are early, tentative days and perhaps expectations should be tempered. The rules
being implemented are very clear – a QFI must have at least $5bn in assets under management and
a five-year track record. Some market watchers are asking if the regulators have set the benchmark
too high, but this has not deterred clients from making enquiries about the possibilities of the Saudi
market.
Generally, we believe the $5bn threshold is a reasonable level to allow an orderly opening-up of the
markets. This seems to be aimed at achieving a manageable launch process and to ensure there is a
high degree of credibility behind the more liberal market environment.
35. 33GlobalInvestor/ISFSaudiGuide2015
thoughtleadership:DeutscheBank
In fact, the overall Saudi approach to opening its market has been very pragmatic and not far removed
from similar exercises in other emerging economies. Perhaps, over time, the threshold may be reviewed.
Eventually, we can expect to see a significant rise in foreign ownership of Saudi stocks. Since 2007,
citizens of the Gulf Cooperation Council have been able to access the market, and since 2008,
foreign investors have had access via swaps and promissory notes. Prior to this, 90% of turnover was
domestically-driven, with foreign holdings accounting for little more than 1.5% of the market.
But we may have to wait for genuine momentum to set in, despite forecasts that around $35bn to
$40bn of foreign cash may flow into the market. It is likely that Saudi Arabia may be reclassified as
an emerging market over the next year or two, and then it may qualify to be included in the MSCI
Emerging Market Index. Although MSCI has compiled a Saudi Arabian benchmark equities gauge for
international investors, it may take until 2017 before it becomes part of the emerging market basket.
Because of the size of the Tadawul, there will be no need to enter the index through the traditional
frontier process.
As the borders open, there are also opportunities for financial institutions already resident in Saudi
Arabia. Deutsche Bank’s presence dates back to 2006. We operate under a full banking licence, granted
by the Saudi Arabian Monetary Agency in 2004 and through our securities
entity Deutsche Securities Saudi Arabia.
One-stop shop
This has enabled us to become something of a one-stop shop for our clients
in Saudi Arabia and more broadly across the Middle East and Africa. We have
formed some important relationships in the Kingdom and have completed
a number of important transactions. It is a market to which we are, and have
been, very committed, so the latest developments are especially motivating
for us. We have also played our part in working with local regulators
and industry bodies on the various stages in making Saudi Arabia more
accessible.
Inevitably, there will be challenges. The Saudi T+0 settlement and the pre-
funding of cash and securities could cause some difficulties, along with the
absence of trade confirmation and delivery-versus-payment systems. Market
intermediaries are working to simplify the process.
The opportunities?
Where do we see the opportunities? The custody market should
undoubtedly receive fresh impetus as securities traffic increases and transaction volumes rise.
Furthermore, we expect to leverage off our market-leading FX capabilities together with our
integrated brokerage solutions. The market may become more competitive as new investors stream in.
There is also something very different about the liberalisation of Saudi Arabia when compared with
other large markets that are becoming more accessible to foreign investors. China – which launched
its own qualified institutional investor scheme – and India, for example, have considerable scale, but
per capita wealth is very low. Other markets in the region have the wealth, but not the scale. In the
case of Saudi Arabia, it has both scale and wealth. It is not too difficult to understand why people are
so enthused about this game-changing development in the region. ✷
Wehaveformedsome
importantrelationships
intheKingdomandhave
completedanumberof
importanttransactions.
Itisamarkettowhich
weare,andhavebeen,
verycommitted,sothe
latestdevelopmentsare
especiallymotivating
forus
36. 34 GlobalInvestor/ISFSaudiGuide2015
clearingSettlement
S
audi Arabia is one of the last larger capital markets
to open to foreign investors, but taking advantage of
this development will test qualified foreign investors
(QFIs). Foreign investors have been able to access
the local equity market via mutual funds since 1999, swaps
since 2008 and ETFs since 2010. However, the new regime
will require QFIs to cope with T+0 settlement, as resident
foreign investors have done since 2006.
This immediacy of settlement will require a major
adjustment by the back offices of foreign buy-side firms.
They will have to perform all their pre-settlement activities
in the shorter timeframe, including CCP netting activities
and the entire process of initiating, transmitting, matching
and funding settlement instructions, which will need to
be advanced before the start of the process. The reduced
settlement cycle will also impact payment systems, and
security, forcing some participants to update their real-
time data and application backups.
“The T+0 settlement is a challenge, but not a show-
stopper for the market to have a successful launch,”says
Arindam Das, HSBC regional head of securities services,
Mena. “Settling a trade on the same day it gets executed
means that more managers will need pre-funding, that is
CountingonT+0
QFIswillhavetocopewithachallengingT+0
settlementcycle.WhilemostwouldpreferT+2,
fledglingmechanismstodealwithconcernsarein
place,findsCeriJones
37. 35GlobalInvestor/ISFSaudiGuide2015
clearingSettlement
putting in place funds to settle a trade even before they trade. It would
otherwise be very difficult for investors to transfer the money that
quickly to global custodians, then to sub-custodians and then to match
the instructions with the broker.”
Pre-funding problems
Pre-funding creates a number of uncertainties, however. For example,
as funds cannot be sent instantaneously they will need to be in the
cash account of the client with the local custodian account ahead of
any trade. Investors cannot be sure how much money they will need to
use – it depends on market movements. Some international investors
will be reluctant to send funds ahead as it leaves excess cash, possibly
in a range of countries, lying idle. However, in this respect, Saudi is
preferable to some other countries given the riyal is pegged to the
dollar and investors are therefore not significantly exposed to currency
fluctuations.
The system for trade confirmations or affirmations lacks structure,
and the time zone differences pose additional limitations to receiving
trade confirmations and generating settlement instructions across
the securities settlement chain. It will prove difficult, for example, for
a sub-custodian to receive settlement instructions from the global
custodian and match it with the broker’s
allegement – an instruction against an account for which no completely
matching instruction can be found – in time for the settlement to happen
in the market. The lack of clarity is compounded by the absence of delivery-
versus-payment (DVP) systems.
“If we find out after the market settlement that an institution’s trade does
not match with what the local broker says then there has to be a process
to reverse the settlement or resolve the discrepancy,”explains Das. “I do not
expect this to happen often, but for trades where it does happen it is clearly
a challenge.”
To date, it is typical for local brokers to act on behalf of custodians, although
the independent custody model is allowed. This is set to develop with the
introduction of a new model that will recognise custodians as members
of the exchange, and give them better control over client assets in their custody. Under the proposed
dual account structure, a separate custody and trading account will give the custodian an overview of
an investor’s shares in both the trading and custodian accounts, which will be useful for investors who
have only one custody account but trade with multiple brokers. “However, still there are considerations
around the movement of securities under the dual account concept and cash transfer timings that can
have an impact on the efficient end-to-end flows,”adds K Hammad Izz-e-Hamid, securities services,
Middle East and Africa, Deutsche Bank.
He believes institutional investors will be well served by working with established custodians in the
market. “Immediate solutions to overcome the challenge of settlement instructions may be addressed
by for example relying upon broker allegements to auto-create post-settlement instructions to settle
“Thepermissibilityof
creditfacilitiesforQFIs
andtheintroductionof
theCMA’sIndependent
CustodyModelare
importantmeasures”
KHammadIzz-e-Hamid,
DeutscheBank
38. 36 GlobalInvestor/ISFSaudiGuide2015
clearingSettlement
the trades,”he says. “Any such arrangement can be formalised with all
stakeholders in the market.”
Operational complexity
A paper submitted by BlackRock in January 2015 in response to Saudi
Capital Markets Authority (CMA) consultation highlighted some of
these difficulties, pointing out that “the existing requirement to settle
at T+0 coupled with the dual account structure creates a high degree
of operational complexity in a no fail market. This could be a significant
deterrent to foreign investors in the Saudi market. In our experience with
other markets in the region requiring a dual account structure, the sub-
custodian has failed to move shares to the trading account almost every
single time we have had sell transactions, leading to operational events,
costs and complexity”.
The BlackRock paper also sought “clarity around settlement time
constraints and deadlines, as well as the communication and protocol to
ensure we do not fail”. It then goes on to ask for clarification on deadlines
such as by what time the SAR has to be in the account in order for the
sub-custodian to inform the stock exchange of funds available for that
day’s trading? Could wire transfers for transactions executed at the end of the
trading sessions be processed the same day, and what is the settlement time
window after the end of the trading session?
The paper concludes: “In the longer term, we would suggest that the CMA
reviews the unintended consequences of the requirement to prefund positions
in Saudi securities via the T+0 rule on liquidity and foreign participation in the
domestic capital market.”
Cash-line construction
In a market that is 80% driven by retail investors who want to be able to get
their cash immediately, the settlement schedule is unlikely to be changed.
However, the Saudi authorities are working up plans to make cash-line
provision available for investors under the QFI route, involving a credit line or
borrowing from local banks, as an alternative to prefunding. It is envisaged that
many QFIs will prefer this solution.
“The regulators are exploring the idea of cash-lines because they see the limitations of T+0 for
foreigners and want to provide a good framework for business to fill the funding gap. But this is at its
earliest stages,”says Sébastien Hénin, head of asset management for the National Investor, the oldest
fund manager in Abu Dhabi. “In my view they will be very cautious and take things step-by-step.
“[Meanwhile] some brokers will have to provide funds to fill the gap between T+0 and T+2, with the
broker settling on behalf of the client and collecting the money. There will be some competition
between brokers to get market share, and it will not be based on fees as much as on the availability of
this funding.
“The Saudi regulators and market infrastructure are alert to these concerns and are shaping the
“Theregulators
areexploringthe
ideaofcash-lines
becausetheyseethe
limitationsofT+0for
foreigners…Butthis
isatitsearlieststages”
SébastienHénin,
theNationalInvestor
39. 37GlobalInvestor/ISFSaudiGuide2015
clearingSettlement
landscape to ensure ease of functioning,”agrees Izz-e-Hamid. “The
permissibility of credit facilities for QFIs and the introduction of the CMA’s
Independent Custody Model are important measures to this effect.”
Different, but not unique
Nonetheless, investors are wary of these practices as they do not align
with international best practice. “However, they are not completely
unique,”adds Das. “China A-shares have a similar settlement cycle.
International investors who are more familiar with emerging and frontier
markets will be more comfortable with these practices, as they may have
faced such practices in other markets.
“Over a period of time investors get used to a different market model.
Also, it is a question of risk appetite of certain investors. Sometimes an
investor may find the market very attractive and if they have a good
broker and a good custodian, then they may be more willing to take the
risk.”
The $5bn AuM size restriction on QFIs does suggest that buy-side
firms eyeing the market are unlikely to be using obsolete modes of
communication and transaction processing, and outdated technology that cannot deal with trade
reconciliation. It is the small, privately-owned foreign institutions with less to invest in IT that are also
more likely to be deterred by the requirement to provide the assessing authorised person (AAP) with
the past three years of financial statements when being assessed for QFI eligibility.
Of those interested in the market, around 30 to 40 are likely to be dedicated emerging markets teams
that either work for a specialist EM asset management firm, or within larger organisations that manage
$5bn plus, and the large ETF providers that manage trillions of dollars and, like Blackrock, are set to
launch dedicated Saudi ETFs over the next few months. These are best
placed to deal with the T+0.
Perhaps 20 or so global macro hedge funds may also apply for direct
access to Saudi equities. But as well as representing the biggest hot
money risk, these are the ones that may not have the systems to cope.
Today, foreign holdings account for only 1.6% of the value of the Saudi
market and this holding is exclusively through swaps. Opening up the
market to foreigners will boost inflows in the short term. But the big inflows will come when Saudi is
included in the main emerging markets indices, a development estimated at mid-2017 at the earliest.
To join the MSCI index, eligibility criteria for foreign investors will probably need to be relaxed further.
“My understanding is that one of the objectives is to be classified as an emerging market under the
MSCI index,”says Sébastien Bietho, CEO of Alcognis, a consulting firm focusing on securities finance.
“Having efficient and well-functioning securities lending is an important requirement to be considered
for inclusion in the MSCI Emerging Market Index. For the moment we only have the QFI requirements
to trade on the Tadawul – the details of the organisation, requirements and regulation of the securities
lending market are still to be issued.”
However, the T+0 settlement cycle might be a barrier to the development of an efficient and active
“Shortingiscurrently
forbiddenbutsooneror
lateritwillhavetohappen”
SlimFeriani,MenaCapital
40. 38 GlobalInvestor/ISFSaudiGuide2015
clearingSettlement
securities lending market. From the front-to-back processes and systems perspectives, international
investors are set up to settle securities lending trades on a T+0 basis. However, issues arise from the
cash market being T+0. This means the time span between the borrowing requirement and the actual
borrow trade is very short and almost impossible in practice.
Cash desks and securities lending desks are usually separate and the information of a borrow
requirement needs some time to reach the securities lending trader that will execute the borrow.
Usually the borrow requirement generated by a trade on T will be known by the borrowing desk in T+1
for action the same day and settlement date in line with the delivery obligation.
Of course this delay could be shortened, in theory, by enhancing systems and operations. That said,
some contingencies cannot be avoided. First, one needs to control the sequence of settlement
within the day, settling the borrow first and then the sell. Since the Saudi market is open from 11am
to 3.30pm, the borrow trade must be done within a very short time after the borrowing requirement
generation. This is generating a major risk, as there can be no delay to ensure a specific borrow has
settled. Second, when a borrowing requirement comes very close to market close, there is a no way a
securities lending desk will be able to borrow the security and settle before the cut-off.
The other major issue relates to the securities lending lifecycle. It is very unlikely that processes and
systems will be in place to execute recall requests in a period shorter that T+1. Even if this was feasible,
the borrower would need to locate the securities with another lender. There is no guarantee that the
required security will be found, in which case it must be bought on the market. Those actions require
time. With markets open all day it would be a challenge to manage the whole
process. In four and a half hours it becomes unfeasible.”
Shorting support
“Shorting is currently forbidden but sooner or later it will have to happen,”says
Slim Feriani, managing partner, CEO at Mena Capital, a Middle East-focused
boutique. “Once the genie is out of the bottle and the markets open up to
the rest of the world, eventually they have to adopt the practices of the main
markets.
“There are likely to be teething problems with the market opening. But it has
been timed for the quiet period of Ramadan and the fact that the authorities
did not delay it until after the summer shows there is political will to make it happen. There is also
some competition with Qatar and the UAE, which were promoted to emerging markets status by MSCI
last year, and now we hear Kuwait is also keen.”
The market is already highly liquid at $2.5-3bn daily – some two-thirds of the rest of the Gulf countries’
turnover put together – so it will be difficult for the new inflows to make an impact.
“Furthermore,”Hénin points out, “it is not mandatory for foreign investors to invest in the market
straight away. It is not as though passive managers are obliged to invest owing to inclusion in the MSCI
for example. Some will take time to put people on the ground.
“The authorities have taken steps to improve governance by making examples of directors who they
have fined for insider dealing and companies for filing late financial statements and many companies
have hired investor relations press teams to communicate with shareholders. Foreigners will not be
surprised with current social or financial habits. The challenge is definitely T+0.”✷
“Settlingatradeon
thesamedayitgets
executedmeansthat
moremanagerswill
needpre-funding”
ArindamDas,HSBC
