From the starting block

Securities Services

From the starting block

February 2019

Since entering two emerging market indices, Saudi Arabia has leaped from the starting block with the planned launch of a new derivatives market. A Deutsche Bank-hosted webinar took stock of what investors can look forward to as the country sprints ahead in 2019

It has been almost three years since Saudi Arabia unveiled its vision to make the country less dependent on oil and to diversify its economy. As part of Vision 2030 1 , a government plan to turn the country into an investment powerhouse, Saudi Arabia has been diligently implementing a number of domestic reforms and market liberalisation policies. These have included the creation of a central securities depository and the introduction of securities lending and borrowing.  And there is more to come in 2019, with this being a pinnacle year in the country’s journey.

In keeping with this momentum, the next 12 months are poised to be equally fruitful for Saudi Arabia’s capital markets with the launch by the Saudi Stock Exchange (Taduwul) of a derivatives market in the first half of 2019 2 and pipeline of highly anticipated IPOs. Setting the scene at the start of a market outlook webinar, Manoj Aidasani Head of Securities Services Gulf Cooperation Council (GCC) at Deutsche Bank said: “2019 is an important year in the journey of the Saudi Arabia capital market reforms - it shall be marked as the year of transformation to an emerging market”. The market appears to support Aidasani’s sentiment; the Tadawul All Share Index advanced to over just over 8,600 on February 18, 2019, up from closing 7,826 at the end of 2018.

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Along come the fund managers

Saudi Arabia’s transformation into a globally accessible capital market has been swift. Nearly four years after the country first began its capital market liberalisation programme, both MSCI and FTSE Russell incorporated the country - who’s local stock exchange (Tadawul) has the largest market capitalisation in the entire Gulf Cooperation Council - onto their respective emerging market (EM) benchmarks. And with S&P Dow Jones set to upgrade the country to emerging market status in March 2019, this should attract even more foreign investment. “Saudi Arabia is expected to account for 2.6% of the MSCI EM benchmark, which will lead to a huge windfall in flows, comprising, according to our estimates, of up to $40 billion in active and passive money,” said Salah Shamma, Head of Investment, MENA, Franklin Templeton Emerging Markets.

During the webinar, Shamma explained that these estimates are based on historical precedents observed elsewhere in other reclassified markets including the UAE, Pakistan, Russia and Malaysia, for example. “At present, foreign ownership in Saudi Arabia is around 1.8%, but we expect this to increase to 8%, bringing it into line with jurisdictions such as the UAE and Qatar where foreign ownership of domestic securities accounts for around 8% to 10%,” said Shamma. This substantive increase in foreign investment will have a huge impact on market liquidity in Saudi Arabia.


The foundations for a derivatives market

The establishment of a derivatives market is now penciled in for the first half of 2019. Setting this ambition in stone, Tadawul has already announced the launch of an index futures contract based on an index jointly developed with MSCI. Sree Kumar – Acting Chief Derivatives Officer – Tadawul, said more derivatives products will be made available in due course, thereby deepening the pool of tradable instruments and providing investment opportunities for institutional clients. The introduction of a derivatives market will help further advance liquidity in Saudi Arabia, and is likely to be pivotal in its market development. To support the derivatives market, the Tadawul is also targeting the launch of a CCP in the first half of 2019.


Further KYC reforms to come

Amidst all these investment reforms in Saudi Arabia right now, it is not surprising that institutional investors and industry experts might have overlooked the significance of the changes made to the country’s anti-money laundering (AML) provisions at the end of 2018. Charles Cohen, Head of Securities Services for Deutsche Bank in Saudi Arabia, described the know-your-customer (KYC) reform being pushed by the Capital Market Authority (CMA) as one of the largest transformational initiatives to happen in the country since it unveiled its Qualified Foreign Investor (QFI) framework in 2015, and the introduction of the T+2 settlement cycle in 2017.

Admittedly, Cohen said the proposed changes were not set in stone and were based on the draft translation of the Implementing Regulations. The market is also awaiting publication of the CMA’s guidance notes, he added. Nonetheless, he highlighted that the rules ease some of the exacting foreign investor onboarding requirements by streamlining the KYC and client due diligence (CDD) checks that are performed by the authorised person (AP). The proposals state that the AP can apply a risk-based approach to KYC and CDD, validating the identity of underlying clients using independent source documents and data, including publicly available records. Furthermore, rules in relation to the AP’s reliance on the CDD of a third party are subject to fewer conditions which will greatly speed up the market opening process for underlying clients.


New look Saudi Arabia

Given recent developments highlighted in this article, it would be fair to assume that Saudi Arabia’s capital markets will look vastly different in two years’ time.  Experts are confident that passive and active managers will continue increasing their portfolio exposures to the country, a development which has been abetted by the emergence of a derivatives market and the simplification of KYC/AML requirements during the account opening process.

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