March 2016

The decision by the Saudi regulator – the Capital Market Authority (CMA) – to give large foreign investors the ability to gain exposure to listed securities on the Tadawul, the country’s stock exchange, was keenly awaited by investors. However, expectations ought to be tempered

“The CMA has issued a strategic roadmap for reforming the capital market. It is working towards increasing institutional investor interest in Saudi Arabia, They are working towards implementing regulation to strengthen the asset management industry and CMA is looking to reform the debt market by reforming the issuance and settlement infrastructure. Industry participants must be cognisant though that these market developments take time, and that material inflows will not occur on day one. However, over time, this will undoubtedly change,” said Manoj Aidasani, Head of Investor Services for the Gulf Corporation Council (GCC) region at Deutsche Bank, speaking at the Middle East Securities Forum 2016 in Doha, Qatar.

The CMA formally introduced its liberalising measures in June 2015. Foreign investors, which may include banks, insurance companies, sizeable asset managers, brokers and securities firms, with assets over $5 billion and five year track record are permitted to apply to become Qualified Foreign Investors (QFIs). QFIs must also demonstrate to the CMA that they are regulated in a jurisdiction which meets regulatory equivalence with that of Saudi Arabia.  “If the qualification criteria were revised by CMA there could be more investors who would qualify to invest in the Saudi Arabia market” commented Aidasani.

Traditionally, foreign investors engaged in swap transactions to gain exposure to domestic Saudi Arabian equities but this is changing. The reforms allow for QFIs to invest in the domestic market although it prohibits an individual QFI (and its affiliates) from acquiring more than 5% of a single issuer’s listed shares. Collective QFI exposure to a single issuer’s listed securities is capped at 20%. QFI exposure to the entire Tadawul market value is limited to 10%.

Saudi Arabia has made significant in-roads, particularly around the development of an independent custody model, said Aidasani. “The brokerage settlement model does not meet certain aspects of globally accepted best market practices,” commented Aidasani.

“The independent custody model was introduced in 2015 and it is currently up and running. Put simply, foreign investors can now appoint a global or local custodian bank to hold their assets in Saudi Arabia instead of relying on a local broker. However, institutions are allowed to choose between the independent custody model and the traditional model. We obviously prefer the former. It gives greater control to the custodian over assets.”

However, challenges do remain. Saudi Arabia continues to use a T+0 settlement system with no fails market requiring market participants to partake in same day delivery of securities. This exacerbates the risk of error trades as mistakes cannot be fixed prior to settlement.  Pre-funding remains an issue for some investors in the Saudi Arabian market compared to other markets where this is not an issue. “The significant issues with a T+0 market is the lack of time available time for clients, intermediaries such as sub-custodians and local brokers to interact with one another. Some market participants are advocating a migration to a T+2 timeframe,” highlighted Aidasani.

Some question if Saudi Arabia will receive Emerging Market Index status by the MSCI, the performance index provider for institutional investors. Experts had predicted this would occur around 2017 following the various reforms. This could boost external investment into Saudi Arabia, particularly from passive fund managers as was evidenced when the United Arab Emirates (UAE) and Qatar were elevated to Emerging Market Index status by MSCI.

Saudi Arabia is an attractive market for foreign investors. Tadawul data indicates Saudi Arabia’s economy accounts for half of the $1.6 trillion GCC economy.  It is the 19th largest economy in the world while the Tadawul’s market capitalisation at its peak was bigger than that of Malaysia and Indonesia, for example. The stock market is diverse, and there is widespread anticipation that a number of initial public offerings (IPOs) could occur over the coming year. It has been reported that the government is assessing a partial listing or full floatation of oil giant ARAMCO. A full stock market flotation of ARAMCO would create the world’s most valuable company.

“With the imminent capital market reforms and the scale of the Saudi Arabia stock market we are optimistic of further growth and opportunities present in Saudi Arabia. Deutsche Bank via its subsidiary Deutsche Securities Saudi Arabia has set up custody operations since 2010 and we are well positioned to benefit from the opportunity and to grow along with the growth of the markets,” said Hammad izz Hamid, Head of Investor Services, Middle East & Africa, at Deutsche Bank.

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