Saudi Arabia Capital Markets Guide PDF

Saudi Arabia Capital Markets Guide 2015

Global Investor/ISF Saudi A

rabia Capital Markets G

uide 2015

NomiNatioNs opeN NowNominations 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

1Global Investor/ISF Saudi Guide 2015

LETTER FROM THE CMA

Arriving on the world stageMohammed Aljadaan, chairman of the Capital Market Authority (CMA), says opening the Saudi stock market for foreign investment aims at attracting specialised investors to promote institutional investment and raise the level of the research and study of Saudi capital markets

There 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

NomiNatioNs opeN NowNominations 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

2 Global Investor/ISF Saudi Guide 2015

SAudi GuidE

Editor Alastair O’Dell Tel +44 (0)20 7779 [email protected]

Reporter Paulina PielichataTel +44 (0)20 7779 [email protected]

Contributors Sean Keating, James Gavin, Paul Golden and Ceri Jones

Design and production Keith Baldock

Publisher Will Browne Tel +44 (0)20 7779 [email protected]

Mena and emerging markets director Zara Mahmud Tel +44 (0)20 7779 [email protected]

Business development executive Tim Willmott Tel +44 (0)20 7779 [email protected]

Reprints Christine [email protected]

Publishing director Stuart Allen

Divisional director Danny Williams

Global Investor/ISFNestor House, Playhouse YardLondon EC4V 5EX, UKwww.globalinvestormagazine.com

Next publication August 2015

Global Investor Incorporating ISF (USPS No 001-182) is a full service business website and e-news facility with supplementary printed magazines, published by Euromoney Institutional Investor PLC.

Annual subscription rate US$1400 £825 (UK only) ¤965 ISSN 0951-3604

Chairman Richard Ensor

Directors Sir Patrick Sergeant, The Viscount Rothermere, Christopher Fordham (Managing Director), Neil Osborn, Dan Cohen, John Botts, Colin Jones, Diane Alfano, Jane Wilkinson, Martin Morgan, David Pritchard, Bashar AL-Rehany, Andrew Ballingal, Tristan HillgarthPrinted by Buxton Press

© Euromoney Institutional Investor PLC, London 2015

SubscriptionsUK hotline (UK/ROW)Tel: +44 (0)20 7779 8999Fax: +44 (0)20 7246 5200US hotline (Americas)Tel: +1 212 224 [email protected]

RenewalsTel: +44 (0)20 7779 8938Fax: +44 (0)20 7779 [email protected]

Customer servicesTel: +44 (0)20 7779 8610customerservices@ euromoneyplc.com

Contents 1 LETTER FROM THE CMA – CMA chairman Mohammed

Aljadaan sets out the importance of the QFI reform for the Saudi market

4 MARKET OVERVIEW – Paul Golden finds a well-diversified set of opportunities backed by a broadly favourable economic outlook

12 WHO’S WHO – James Gavin provides an outline of the key institutions in the Saudi legislative and regulatory framework

20 INVESTING IN SAUDI ARABIA – Paul Golden investigates how to build an asset management business in Saudi Arabia, including local partnerships and custody arrangements

25 SAUDI STOCK EXCHANGE – Adel S Al-Ghamdi, CEO of the Saudi Stock Exchange, outlines his vision for the market

34 CLEARING & SETTLEMENT – Ceri Jones sets out how to operate a business efficiently in a market that uses an unfamiliar T+0 settlement cycle

39 QFI RULES – The final CMA rules governing the QFI arrangements set out in full

47 FREQUENTLY ASKED QUESTIONS – The CMA provides more detail on issues pertinent to QFIs entering the market

54 LEGAL FRAMEWORK – Terence Cloney of K&L Gates explains the basis of Saudi law, from its sharia foundation and monarchical backing to practical implementation in the Capital Market Law and CMA powers

56 REGISTRATION PROCESS – James Gavin guides potential QFIs through the nuances of the CMA’s rules and interaction with governing institutions

60 CORPORATE GOVERNANCE – James Gavin considers the CMA’s long-standing efforts to improve corporate governance in the interests of shareholders and the market in general

66 KING ABDULLAH FINANCIAL DISTRICT – Paul Golden reviews the progress of the KAFD and considers its merits relative to its competitors in the region

69 INITIAL PUBLIC OFFERINGS – James Gavin investigates how QFIs can benefit from IPOs. While they cannot invest directly, the number of IPO funds is proliferating


MARKET OVERViEW

Wealth of opportunitySaudi Arabia is a well-diversified market with broadly favourable economic and demographic data. Paul Golden considers the investible opportunities for qualfied foreign investors (QFIs)

The 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.


MARKET OVERViEW

“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

“Saudi banks are well capitalised with

low gearing and are positioned for a

significant improvement in profitability over the

medium term” Kemal Ahmed, Investec


MARKET OVERViEW

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

02010 2011 2012 2013 2014 2015 2016 2017

GDP growth, constant 2010 USD

Our star shineswith your support

Our star shineswith your support

Together with our clients, we are building onour success and aiming for even greater heights

Together with our clients, we are building onour 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 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 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


MARKET OVERViEW

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.” ✷

“There are more than 30 million consumers in the Kingdom, 20 million of whom have very high purchasing power” John Sfakianakis, Ashmore


THOuGHT LEAdERSHiP: JAdWA iNVESTMENT

Proven performanceTariq al-Sudairy, managing director and CEO of Jadwa Investment, explains how his firm’s decade-long presence in the Saudi market helps generate 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.

“The opening the Saudi stock exchange will further enhance the status and visibility of Saudi capital markets within the global investment community”


THOuGHT LEAdERSHiP: JAdWA iNVESTMENT

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’s investment management team has

generated a proven track record of consistent

and differentiated performance”


WHO’S WHO

The 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.

Saudi Arabian Monetary Agency (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:• Handlingthegovernment’sbankingaffairs• Minting,printingandmanagingthevalueoftheSaudiriyal• Managingthegovernment’smonetarypolicytoensurestablepricesandexchangerates• Managingthecountry’sforeignexchangereserves• Promotingthegrowthandensuringthesoundnessofthefinancialsystem• Supervisingcommercialbanks,exchangedealers,insurancecompanies,financecompaniesand

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.

Important figuresThe Saudi Arabian legislative, regulatory and judicial systems all ultimately derive their authority from the monarchy


WHO’S WHO

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

Capital Markets Authority (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.

Most of the day-to-day management of

the financial system is handled by the central

bank, the Saudi Arabian Monetary Agency


WHO’S WHO

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. ✷

Saudi Stock Exchange (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.

Key bank and credit institutionsThe 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.


THOuGHT LEAdERSHiP: BLOMiNVEST

Open for businessGeorge Hanna, head of asset management at Blominvest Saudi Arabia, believes foreign institutional money will improve corporate governance

Though 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. ✷

We believe companies that are agile enough

to improve their corporate governance

will benefit from more investment flows


WHO’S WHO

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

The structure of the new court system

Source: Al Tamimi & Co


THOuGHT LEAdERSHiP: MACEEN CAPiTAL


iNVESTiNG iN SAudi ARABiA

Paths to prosperityInternational managers need to understand the merits of local partnerships and unfamiliar custody and settlement arrangements if they are to create a successful Saudi investment strategy, finds Paul Golden

International 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



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

“The challenge will be to find value stocks without

distorting the market and there are lesser-

known companies that offer this kind of value”

Rod Ringrow, State Street



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

“The CMA and Tadawul both recognise that an independent custody model is required to further enhance the financial services industry” Michael Slater, Northern Trust



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.” ✷

“With classification to emerging market status we expect the launch of passive strategies” Vijay Harpalani, Al Mal Capital


THOuGHT LEAdERSHiP: SAudi STOCK EXCHANGE

There 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: the investor riyalitySaudi Arabia is taking a very significant step towards global capital market convergence with the introduction of the QFI Framework. Adel S Al-Ghamdi, CEO of the Saudi Stock Exchange, outlines his expectations for the market going forward



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.

Market highlights to dateIPOs

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

- 0

8

Ap

r -

08

Jul -

08

Oct

- 0

8

Jan

- 0

9

Ap

r -

09

Jul -

09

Oct

- 0

9

Jan

- 1

0

Ap

r -

10

Jul -

10

Oct

- 1

0

Jan

- 1

1

Ap

r -

11

Jul -

11

Oct

- 1

1

Jan

- 1

2

Ap

r -

12

Jul -

12

Oct

- 1

2

Jan

- 1

3

Ap

r -

13

Jul -

13

Oct

- 1

3

Jan

- 1

4

Ap

r -

14

Jul -

14

Oct

- 1

4

Jan

- 1

5

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)


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.

How will the market evolve?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


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



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


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 (31 March, 2015)

Money market$18bn, 60%

Local equity$6bn, 21%

Internationalequity

$4bn, 12%

Others$2bn, 7%

Subscribers by fund classification (31 March, 2015)

Money market44,585

Local equity168,357

International equity18,125

Others11,717

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



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.


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


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.


Much needs to be done to educate market stakeholders about the virtues of investing in mutual



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. ✷


THOuGHT LEAdERSHiP: HSBC

Emerging opportunityHSBC Saudi Arabia CEO Majed Najm operates one of the largest custody and institutional brokerage teams in the KingdomWhat 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. ✷


THOuGHT LEAdERSHiP: dEuTSCHE BANK

A game changer for Saudi Arabia and the region

The 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.


THOuGHT LEAdERSHiP: dEuTSCHE BANK

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. ✷

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


CLEARiNG & SETTLEMENT

Saudi 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

Counting on T+0 QFIs will have to cope with a challenging T+0 settlement cycle. While most would prefer T+2, fledgling mechanisms to deal with concerns are in place, finds Ceri Jones



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

“The permissibility of credit facilities for QFIs

and the introduction of the CMA’s Independent

Custody Model are important measures”

K Hammad Izz-e-Hamid, Deutsche Bank



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

“The regulators are exploring the idea of cash-lines because they see the limitations of T+0 for foreigners… But this is at its earliest stages” Sébastien Hénin, the National Investor



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

“Shorting is currently forbidden but sooner or

later it will have to happen” Slim Feriani, Mena Capital



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.” ✷

“Settling a trade on the same day it gets executed means that more managers will need pre-funding” Arindam Das, HSBC


QFi RuLES

Saudi Arabia’s rules for qualified foreign financial institutions investment in listed sharesIssued by the board of the Capital Market Authority, pursuant to its resolution number 1-42-2015, Dated 15/7/1436H (corresponding to 4/5/2015G), based on the Capital Market Law issued by Royal Decree No M/30 dated 2/6/1424H.

Part 1: General provisionsArticle 1: Preliminarya. The purpose of these Rules is to set out the procedures, requirements and conditions for the registration of qualified foreign investors (QFIs) with the Authority and the approval of their clients to invest in listed shares, and to specify their obligations and the obligations of authorised persons in this regard.

b. These Rules shall be read in conjunction with and in addition to the Capital Market Law and its Implementing Regulations, including, the Listing Rules, the Market Conduct Regulations, the Authorised Persons Regulations, the Merger and Acquisition Regulations and the Anti-Money Laundering and Counter-Terrorist Financing Rules.

c. These Rules shall not apply to Citizens of the Cooperation Council for the Arab States of the Gulf.

d. Subject to sub-paragraph b (1) of Article 7 of these Rules, QFIs and approved QFI clients are entitled to exercise all rights related to listed shares owned by them, including trading in rights issues.

Article 2: Definitionsa. Any reference to the “Capital Market Law” in these Rules shall mean the Capital Market Law issued by Royal Decree No. M/30 dated 2/6/1424H.

b. Subject to paragraph (c) of this Article, expressions and terms in these Rules have the meaning which they bear in the Capital Market Law and the Glossary of defined terms used in the Regulations and Rules of the Capital Market Authority, unless the contrary intention appears.

c. For the purpose of implementing these Rules, the following expressions and terms shall have the meaning they bear as follows unless the contrary intention appears:•QFIassessmentagreement:anagreementbetweentheassessing

authorised person and the QFI meeting the requirements set out in Article 12 of these Rules.•bank:afinancialinstitutionthathasalegalpersonalitywhichengages

in banking business.•assessingauthorisedperson:anauthorisedpersonwhohasagreed

with an applicant to assess its application for registration as a QFI, or an authorised person who has executed a QFI assessment agreement with a QFI.•insurancecompany:afinancialinstitutionthathasalegalpersonality

which engages in insurance business.•brokerageandsecuritiesfirm:afinancialinstitutionthathasalegal

personality which engages in securities business.•investmentfund:meansanyofthefollowinglegalpersons:

1) a sovereign wealth fund that is fully owned by a government entity, or by a legal person fully owned by a government entity.2) a pension fund in which its main objective is to collect fees or periodic contributions from participants or for their interest, for the purpose of compensating them according to a specific mechanism.3) a collective investment scheme aimed at providing investors therein with an opportunity to participate collectively in the profits of the scheme.

•approvedQFIclient:aclientofaQFIwhohasbeenapprovedinaccordance with these Rules.•Fundmanager:afinancialinstitutionthathasalegalpersonality

which manages the assets of an investment fund.•qualifiedforeigninvestor:aforeigninvestorregisteredwiththe

Authority in accordance with these Rules to invest in listed shares.•applicant:aforeigninvestorthatsubmitsanapplicationfor

registration to an assessing authorised person.•CitizensoftheCooperationCouncilfortheArabStatesoftheGulf:

natural persons who hold the citizenship of one of the Cooperation Council for the Arab States of the Gulf countries, or legal persons that (i) capital of which is majority owned by citizens or governments of the Cooperation Council for the Arab States of the Gulf; and (ii) holding the citizenship of one of the Cooperation Council for the Arab States of the Gulf countries, in accordance with the definition set out in the resolution of the Supreme Council of the Cooperation Council for the Arab States of the Gulf in its 15th session approved by the Council of Ministers Resolution number (16) dated 20/01/1418H.

Article 3: WaiversThe authority may waive a provision of these rules in whole or in part as it applies to an applicant, a QFI or any of their clients or an authorised person either on an application from any of the aforementioned persons or on the authority’s own initiative.

Article 4: Right to appealAny person subject to these rules may appeal to the committee in respect of any decision or action that the authority takes under these rules.

Part 2: Applications for registrationChapter One: Registration conditionsArticle 5: Registration

An applicant may not be registered as a QFI unless it meets each of the conditions prescribed by Article 6 of these Rules.


QFi RuLES

Article 6: The registration conditionsa. Type of the financial institution

1) The applicant must be a financial institution that has a legal personality which falls within one of the following types:

a) banks;b) brokerage and securities firms;c) fund managers; andd) insurance companies.

2) The financial institutions referred to in sub-paragraph a (1) of this Article must be licensed or otherwise subject to regulatory oversight by a regulatory authority and incorporated in a jurisdiction that applies regulatory and monitoring standards equivalent to those of the Authority or acceptable to it. For the purposes of this paragraph, the Authority may, at its absolute discretion, determine whether the regulatory and monitoring standards are equivalent to those of the Authority or acceptable to it, and the Authority shall provide authorised persons duly authorised to conduct dealing activities with a list of jurisdictions that applies regulatory and monitoring standards equivalent to those of the Authority or acceptable to it, and any update occurs to that list.

b. Size of the financial institution1) The applicant must have assets under management of SAR 18,750,000,000 (or an equivalent amount) or more. The Authority may reduce the minimum for these assets to SAR 11,250,000,000 (or equivalent amount).2) For the purposes of these Rules, assets under management include:

a) assets owned by the applicant or its group for the purpose of investment; andb) assets managed by the applicant or its group for the account of another person or persons.

c. Investment experienceThe applicant or any of its affiliates must have been engaged in securities activities and investment therein for a minimum of 5 years.

Article 7: Approval of clientsa. A QFI may not invest in listed shares on behalf of any of its clients unless the client has been approved in accordance with these Rules.

b. A QFI client may not be approved as such unless:1) the QFI or the applicant is responsible for the management of the client funds when invested in listed shares;2) the client is neither a QFI nor approved QFI client of another QFI; and3) the client is either:

a) an investment fund which must be incorporated in a jurisdiction that applies regulatory and monitoring standards equivalent to those of the Authority or acceptable to it. For the purposes of this paragraph, the Authority may, at its absolute discretion, determine whether the regulatory and monitoring standards are equivalent to those of the Authority or acceptable to it, and the Authority shall provide authorised persons duly authorised to conduct dealing activities with a list of jurisdictions that applies regulatory and monitoring standards equivalent to those of the Authority or acceptable to it, and any update that occurs to that list.b) a financial institution that meets each of the conditions prescribed by Article 6 of these Rules.

Chapter Two: Registration proceduresArticle 8: Application for registrationa. An application for registration must be made by submitting an application in the form prescribed by the Authority to an assessing authorised person and be accompanied by the information and documents required under Annex 2.1 of these Rules.

b. The assessing authorised person must assess the application in accordance with the criteria and procedures set out in Chapter Three of this Part.

Article 9: Additional conditions to be met by applicant investing on behalf of its clientsa. Where an applicant intends to invest in listed shares on behalf of one or more of its clients, an application for approval of the client(s) in question as approved QFI clients must be made by submitting an application in the form prescribed by the Authority to an assessing authorised person and be accompanied by the additional information required by Annex 2.1 of these Rules to enable the assessing authorised person to assess whether the clients in question meet the applicable registration conditions as specified in these Rules.

b. The assessing authorised person must assess the application referred to in paragraph (a) of this Article in accordance with the criteria and procedures set out in Chapter Three of this Part.

c. The procedures in Chapters 2 and 3 of this Part (with the exception of Article 12) shall apply to the application referred to in paragraph (a) of this Article, save that:

1) references to the application for registration should be read as references to the application for approval of the client(s) in question as approved QFI clients;2) references to the acceptance or rejection of the application for registration should be read as references to the acceptance or rejection of the application for approval of the client(s) in question as approved QFI clients;3) references to the registration of the applicant should be read as references to the approval of the client in question; and4) references to the registration conditions should be read as references to the approval of the clients conditions.

Article 10: Accuracy of information and documents submitted to the assessing authorised persona. All information and documents submitted by the applicant to the assessing authorised person must be complete, accurate, up-to-date and not misleading.

b. An applicant must notify the assessing authorised person immediately of any material changes to the information or documents submitted previously.

Chapter Three: Determination of applicationsArticle 11: Determination by the assessing authorised persona. The assessing authorised person must provide a determination on the application for registration within 5 days of receiving all information and documents required by these Rules, unless the assessing authorised person and the applicant agree otherwise.

b. The assessing authorised person must not accept the application until after conducting the following:

1) taking the necessary steps to ensure that all information and


QFi RuLES

documents referred to in paragraph (a) of this Article are complete and accurate;2) ensuring that the application complies with the requirements prescribed by these Rules; and3) ensuring that the applicant (and, where relevant, each of its clients ) meets the applicable registration conditions prescribed by these Rules.

Article 12: QFI assessment agreementsa. An assessing authorised person, where it accepts an application for registration, must agree with the applicant a draft form of QFI assessment agreement meeting the minimum requirements specified in this Article.

b. A QFI assessment agreement must include the following minimum requirements:

1) a representation by the applicant that it meets the registration conditions stated in these Rules;2) an undertaking by the applicant to provide the assessing authorised person with all information and documents required under these Rules;3) an undertaking by the applicant to notify the assessing authorised person immediately of any event or circumstance requiring such notification under these Rules;4) a confirmation by the applicant of its consent that the assessing authorised person may disclose to the Authority or the Exchange information or documents which the assessing authorised person receives under these Rules or the Capital Market Law and its Implementing Regulations, and that such information may also be disclosed to other government agencies of the Kingdom in accordance with the relevant laws; and5) an undertaking by the applicant to abide by the Capital Market Law and its Implementing Regulations and the rules of the Exchange and other relevant laws.

c. All requirements specified in paragraph (b) of this Article must be in such form as the Authority may require.

Article 13: Notice of determination to the Authoritya. The assessing authorised person must provide the Authority with a written notice of its determination within 1 day of determining an application, including a written statement of the reasons for its determination in such form as the Authority may require.

b. Where the assessing authorised person has accepted the application, it must also submit to the Authority the following:

1) the documents and information referred to in sub-paragraphs 1 (f ); 1 (g); 1 (i); 1 (j) and 1 (k) of Annex 2.1 of these Rules. Where the client is an investment fund, only documents and information referred to in sub-paragraphs 2 (b/4) and 2 (b/5) of Annex 2.1 of these Rules need to be provided to satisfy this paragraph.2) the draft QFI assessment agreement (where relevant); and3) a written declaration in such form as the Authority may require confirming that:

a) the applicant (and, where relevant, each of its clients) meets the registration conditions stated in these Rules; andb) it has agreed with the applicant a draft form of QFI assessment agreement meeting the minimum requirements specified by Article 12 of these Rules(where relevant).

Article 14: Review by the Authority

a. Upon the Authority’s receipt of all applicable documents and information required under Article 13 of these Rules, the Authority shall notify the assessing authorised person in writing of this fact without delay.

b. The assessing authorised person’s determination to reject the application becomes final upon the receipt of the Authority’s notification referred to in paragraph (a) of this Article.

c. Subject to paragraph (d) of this Article, the assessing authorised person’s determination to accept the application becomes final upon the lapse of 5 days from the date of the Authority’s notification referred to in paragraph (a) of this Article, unless the Authority notify the assessing authorised person in writing that such determination is rejected before the lapse of the period specified under this paragraph.

d. The Authority, as it deems appropriate, may impose an additional period to review the determination of the assessing authorised person to accept the application and in which case it will notify the assessing authorised person in writing of this fact before the lapse of the period specified under paragraph (c) of this Article.

e. The Authority will notify the assessing authorised person in writing within the time period specified in the notice referred to in paragraph (d) of this Article that the determination of the assessing authorised person to accept the applicant shall be approved or not.

Article 15: Registrationa. Where the determination of the assessing authorised person to accept the application becomes final, the Authority will register the applicant as a QFI and notify the assessing authorised person in writing of this fact without delay.

b. Where the determination of the assessing authorised person is to accept the application and the Authority decides, following imposing the additional review period in accordance with paragraph (d) of Article 14 of these Rules, that the determination shall be approved, the Authority will register the applicant as a QFI and notify the assessing authorised person in writing of this fact within the mentioned additional review period.

c. An applicant becomes a QFI upon being registered with the Authority as such.

Article 16: Notice of registration or rejection of the applicationa. The assessing authorised person must within 1 day notify the QFI in writing that it has been registered with the Authority as a QFI following receipt by the assessing authorised person of notification of registration under Article 15 of these Rules.

b. Following receipt of the Authority’s notification of registration under Article 15 of these Rules, the assessing authorised person must:

1) accept the QFI as a client in accordance with the Authorised Persons Regulations; and2) sign the QFI assessment agreement agreed with the applicant under Article 12 of these Rules immediately, and submit a signed copy of the QFI assessment agreement to the Authority once signed by both parties.

c. The assessing authorised person must notify the applicant in writing on the rejection of the application where:

1) The determination to reject the application for registration becomes final; or2) The assessing authorised person receives the Authority’s


QFi RuLES

notification to reject the assessing authorised person’s determination to accept the application for registration.

Article 17: Record Keepinga. The QFI must retain, and make available to the Authority on request, the information and documentation required under these Rules for as long as it remains registered as a QFI.

b. The assessing authorised person must retain, and make available to the Authority on request, the information and documentation required under these Rules as long as the person remains registered as a QFI. Where the applicant has been rejected or where the QFI has had its registration cancelled or the QFI client has had its approval withdrawn under Articles 26 or 28 of these Rules, the assessing authorised person must retain, and make available to the Authority on request, the information and documentation required under these Rules for 10 years from the date of rejecting the application or the date of cancellation of registration.

Chapter Four: Further requirements following registrationArticle 18: Commencement of tradinga. A QFI may not invest in any listed shares unless it:

1) holds a client account;2) holds an account with the Depositary Center; and3) has satisfied any other conditions as may be imposed by the Authority.

b. The requirements in paragraph (a) of this Article must be satisfied by each of the approved QFI clients.

Article 19: Approval of new QFI clientsThe procedures in Chapters 2 and 3 of this Part (with the exception of Article 12) shall apply where a QFI applies for any further clients on whose behalf it intends to invest in listed shares, save that:

1) references to the application for registration should be read as references to the application for approval of the client(s) in question as approved QFI clients;2) references to the acceptance or rejection of the application for registration should be read as references to the acceptance or rejection of the application for approval of the client(s) in question as approved QFI clients;3) references to the registration of the applicant should be read as references to the approval of the client in question; and4) references to the registration conditions should be read as references to the approval of the clients conditions.

Annex 2.1 Information and documents to be provided by applicants

1. Information and documents to be provided by applicants:

The applicant must provide the below information to the assessing authorised person, in such form as the Authority may prescribe:

a. Details of the applicant’s legal form and jurisdiction of establishment, supported by copies of relevant constitutional documents;

b. A description of the applicant’s business activities (which may be extracted from the applicant’s annual report or equivalent corporate documents, but should include confirmation of the period for which the applicant has been engaged in securities activities and investment therein);

c. Evidence of the applicant’s regulatory status;

d. A list of all controllers of the applicant, and provide details of the identity and ownership of each controller (if applicable);

e. A copy of the most recent annual report and consolidated accounts of the applicant and (where applicable) its group;

f. The identity of any affiliate;

g. Details of other account names or affiliations under which the applicant or its affiliates invest in the Kingdom, if any;

h. Details of all authorised persons of which the applicant or any of its affiliates or its clients on whose behalf it intends to invest in listed shares is a client;

i. Details of all of the following legal or regulatory sanctions imposed on the applicant or its affiliates during the 5 years prior to the submission of the application:

1) the suspension or revocation by a regulatory authority of any licence or permission in any jurisdiction or the imposition by a regulatory authority of any material restriction or condition upon any such licence or permission; and2) any criminal, civil or regulatory sanction or penalty imposed as a result of insider trading, market manipulation or other market abuse or misconduct.together with a declaration from the applicant that no other such sanctions have been imposed on the applicant or its affiliates during this period. If no legal or regulatory sanctions falling within the categories specified in this paragraph have been imposed on the applicant or its affiliates during the past 5 years, a declaration by the applicant to this effect.

j. Details of any pending or ongoing criminal or regulatory investigations or civil proceedings;

k. Details of any settlement regarding criminal or regulatory investigations or civil proceedings during the 5 years prior to the submission of the application;

l. Financial statements prepared and accredited by the applicant’s auditors in accordance with accounting standards prescribed by the relevant authorities in the applicant’s jurisdiction of establishment, and showing the applicant’s current financial position, including its capital, financial resources, revenues and expenses at the date of the financial statements;

m. Confirmation of its consent that the assessing authorised person may disclose to the Authority or the Exchange information which the assessing authorised person receives under these Rules or the Capital Market Law and its Implementing Regulations, and that such information may also be disclosed to other government agencies of the Kingdom in accordance with the relevant laws;

n. Confirmation by the applicant of its consent to disclose any information or documents required by the Authority or other government agencies of the Kingdom in accordance with the relevant laws; and

o. Such other documents or other evidence as may be sufficient to satisfy each of the registration conditions under these Rules.

2. Additional information and documents to be provided by applicants intending to invest in listed shares on behalf of its clients:

Where an applicant intends to invest in listed shares on behalf of one or more its clients, it must provide, in relation to each client for which approval is sought:


QFi RuLES

a. All the information and documents specified in paragraph (1) of this Annex insofar as they apply to each relevant client.

b. Where the client is an investment fund, only the following information need to be provided to satisfy paragraph (1) of this Annex:

1) details of the fund’s jurisdiction of establishment;2) the fund’s investment policy;3) a list of all of the fund’s controllers, details of the identity and ownership of each controller (if applicable);4) the identity of any affiliate;5) Details of other account names or affiliations under which the fund or its affiliates invest in the Kingdom, if any;6) Confirmation of the fund’s consent that the assessing authorised person may disclose to the Authority or the Exchange information which the assessing authorised person receives under these Rules or the Capital Market Law and its Implementing Regulations, and that such information may also be disclosed to other government

agencies of the Kingdom in accordance with the relevant laws; and7) Confirmation by the fund of its consent to disclose any information or documents required by the Authority or other government agencies of the Kingdom in accordance with the relevant laws.

c. A signed written confirmation from persons duly authorised to sign on behalf of the applicant, confirming that:

1) the client for which approval is sought meets the applicable registration conditions under these Rules;2) the applicant has the authority to manage the client’s funds, and the authority to take investment decisions based on its absolute discretion when investing in listed shares; and3) the applicant will notify the assessing authorised person immediately of any changes to the terms of its investment management that would alter or impede the extent of this discretion.

Part 3: Continuing obligationsArticle 20: Compliance with laws and regulationsA QFI and approved QFI clients must at all times comply with the applicable provisions stated in the Capital Market Law and its Implementing Regulations, as well as the rules and the regulations of the Exchange and other relevant laws.

Article 21: Investment limitsa. Investments of QFIs and approved QFI clients shall be subject to the following limitations:

1) Each QFI, together with its affiliates, or each approved QFI client together with its affiliates may own a maximum of 5% of the shares of any issuer whose shares are listed.2) Where a QFI invests on behalf of an approved QFI client, it must not execute a transaction which would result in the relevant client, together with its affiliates, owning more than 5% of the shares of any issuer whose shares are listed.3) The maximum proportion of the shares of any issuer whose shares are listed that may be owned by all foreign investors (in all categories, whether residents or non-residents) in aggregate is 49%, including interests under swaps.4) The maximum proportion of the shares of any issuer whose shares are listed that may be owned by QFIs and approved QFI clients is 20%.5) The maximum proportion of the shares of all issuers whose shares are listed that may be owned by QFIs and approved QFI clients in aggregate is 10% by market value, including any interests under swaps.6) Other legislative limitations on foreign ownership in joint stock companies.7) The limitations set forth in the articles of association or by-laws of the listed companies or any instructions issued by the supervisory or regulatory authorities to which these companies are subject.

b. The Exchange shall publish on its website, as determined by the Authority in this regard, the following information:

1) A statistic reflecting the ownership percentages specified in sub-paragraphs a (3); a (4) and a (5) of this Article.2) The limitations specified in sub-paragraphs a (6) and a (7) of this Article, according to the information received by the Exchange from

listed companies in this regard.

Article 22: Changing the assessing authorised person engaged by the QFIa. A QFI must have, for as long as it remains registered as a QFI, an assessing authorised person engaged by it, and must not engage with more than one assessing authorised person within the same period.

b. For the purposes of these Rules, a QFI has engaged an assessing authorised person if it has executed a QFI assessment agreement with the assessing authorised person and that agreement remains valid and in force.

c. A QFI’s registration shall not be revoked by reason of the lapse or termination by either party of a QFI assessment agreement, provided that the QFI engages a replacement assessing authorised person within 10 days. The replacement assessing authorised person shall without delay notify the Authority in writing of its appointment and submit to it a copy of the executed QFI assessment agreement.

d. If a QFI fails to engage a replacement assessing authorised person within the period prescribed by paragraph (c) of this Article, it must notify the Authority of this fact without delay, whereupon the Authority may either grant an extension or revoke the QFI’s registration.

Article 23: Disclosure requirementsa. A QFI must disclose annually to the assessing authorised person engaged by it the information and documents set out in Annex 3.1 of these Rules.

b. Subject to paragraph (c) of this Article, a QFI must immediately notify the assessing authorised person engaged by it if any of the immediate notifiable events set out in Annex 3.1 of these Rules occurs.

c. Where an immediate notifiable event set out in Annex 3.1 of these Rules has occurred and the QFI reasonably believes that disclosure of the event to an assessing authorised person in accordance with paragraph (b) of this Article would materially prejudice the operations and businesses of the QFI or a third party, the QFI may make an immediate notification to the Authority in substitution for the notification required under paragraph (b) of this Article.


QFi RuLES

d. The QFI must provide without delay to the Authority any information, documents or written explanation as it may request.

e. All information and documents disclosed and notifications made to the assessing authorised person or to the Authority under this Article must be complete, accurate, up-to-date and not misleading.

Annex 3.1 Information and documents to be disclosed by QFIs to assessing authorised persons

1. Information and documents to be disclosed annually

a. A copy of the QFI’s (and where applicable its approved QFI clients) annual report and consolidated accounts.

b. Any material changes to the information provided by the QFI under Annex 2.1 of these Rules or furnished subsequently in connection with; (1) the granting or maintenance of the QFI’s registration; and\or (2) the approval of its approved QFI clients.

2. Immediate notifiable events

a. The commencement of insolvency proceedings against the QFI or any of its approved QFI clients in any jurisdiction;

b. The commencement of criminal or legal or regulatory proceedings

against the QFI or any of its approved QFI clients in any jurisdiction;

c. Any breach or anticipated breach by the QFI or any of its approved QFI clients of the investment limits and restrictions set out in sub-paragraphs a (1); a (2); a (6) and a (7) of Article 21 of these Rules;

d. Any breach or anticipated breach by the QFI or any of its approved QFI clients of any obligations under these Rules;

e. The QFI or any of its approved QFI clients becomes a client of another authorised person for the purpose of investing in listed shares;

f. Any material change that affects its status or activities to:1) the business of the QFI or any of its approved QFI clients;2) the regulatory status or permissions of the QFI or any of its approved QFI clients in its home jurisdictions; and3) the identity of any controller(s) of the QFI or any of its approved QFI clients.

g. The QFI becoming aware that it or any of its approved QFI clients no longer meets or will no longer meet the registration conditions stated in these Rules; and

h. Any restructuring of the QFI or any of its approved QFI clients.

Part 4: Authorised persons obligationsArticle 24: Obligations of authorised persons and their eligibilitya. An authorised person must not consider any applications for registration in accordance with these Rules or engage with a QFI unless such person is duly authorised to conduct dealing activities.

b. An authorised person must not accept a QFI as a client for the purpose of investing in listed shares unless it is satisfied that the QFI is duly registered with the Authority in accordance with these Rules.

c. An authorised person that was a party of a QFI assessment agreement must notify the Authority immediately upon the laps or termination of such agreement.

d. An authorised person must at all times comply with the applicable provisions stated in the Capital Market Law and its Implementing Regulations, as well as the rules and the regulations of the Exchange and other relevant laws.

e. The Authority may impose any conditions and/or limitations that it sees fit on authorised persons in relation to their dealings with QFIs.

f. An assessing authorised person must pay such fees as determined by the Authority for the registration of applicants and/or the approval of clients.

Article 25: Monitoring of QFIsa. An assessing authorised person that is engaged with a QFI, must review on an annual basis whether such QFI (and where applicable, its approved QFI clients) continues to meet the applicable registration conditions stated in these Rules and complies with all of its obligations under these Rules.

b. If an assessing authorised person finds at any time that a QFI by which it is engaged (or any of its approved QFI clients) no longer meets the applicable registration conditions stated in these Rules or has breached any of its obligations under these Rules, the assessing authorised person must report such findings to the Authority in

writing without delay.

c. An assessing authorised person must report to the Authority in writing immediately after being aware of any of the following events in relation to each QFI by which it is engaged:

1) Details of the commencement of insolvency proceedings against the QFI or any of its approved QFI clients in any jurisdiction;2) Details of the commencement of criminal or legal or regulatory proceedings against the QFI or any of its approved QFI clients in any jurisdiction;3) The QFI or any of its approved QFI clients becomes a client of another authorised person for the purpose of investing in listed shares;4) Any restructuring of the QFI or any of its approved QFI clients; and5) Any material changes to the information provided pursuant to sub-paragraphs 1 (f ), 1 (g), 2 (b\4) and 2 (b\5) of Annex 2.1 of these Rules.

Article 26: Cancellation of a QFI’s registration or withdrawal of approval of approved QFI clientsa. Where an assessing authorised person receives a request from a QFI to cancel its registration or withdraw the approval of any of its approved QFI clients, it must submit a request to the Authority to that effect (a “cancellation or withdrawal request”).

b. Where the cancellation or withdrawal request relates to the cancelation of the QFI`s registration, it must be accompanied with a confirmation from the QFI that it does not, nor does any of its approved QFI clients, own any listed shares. If the cancellation or withdrawal request relates to the withdrawal of approval of one or more of the QFI`s approved QFI clients, it must be accompanied with a confirmation from the QFI that the clients in question do not own any listed shares.

c. The Authority may issue a notice rejecting the cancellation or withdrawal request submitted under paragraph (a) of this Article within 2 days of receiving such request, giving reasons for the


QFi RuLES

rejection.

d. If the Authority does not issue a notice under paragraph (c) of this Article within 2 days of receiving the cancellation or withdrawal request from the assessing authorised person, the cancellation of the QFI registration or the withdrawal of approval of its approved QFI client (as the case may be) shall be effective.

e. The assessing authorised person must give the person who made the cancellation or withdrawal request a notice confirming that the request has been rejected or has become effective as applicable.

Article 27: Powers of the Authority in relation to authorised persons engaged with QFIsa. The Authority may at any time by issuing a written notice prohibit an

authorised person from engaging with QFIs.

b. The Authority may require an authorised person to provide the Authority without delay any information, documents or written explanation relating to the authorised person dealings with QFIs.

c. The Authority may require an authorised person, or its representative, to attend before the Authority to answer questions and explain any aspect of its dealings with QFIs.

d. If the Authority considers that circumstances amounting to an emergency requires it do so, it may assume any assessing authorised person’s rights against a QFI upon sending written notice of such fact from the Authority to the relevant QFI and the assessing authorised person.

PART 5: Powers of the Authority in relation to QFIsArticle 28: Powers of the Authority in relation to QFIs and approved QFI clientsa. If the Authority considers that any of the events specified in paragraph )d) of this Article has occurred in relation to a QFI or any of its approved QFI clients, or is likely to occur, the Authority may:

1) require the QFI to provide such information, documents and\or written explanation as the Authority requires in respect of the matters giving rise to its consideration;2) require the QFI or its representative, to attend before the Authority to answer questions and explain any matter the Authority considers relevant;3) carry out any enquiries that it considers appropriate;4) take any steps to verify any information furnished by the QFI, including by communicating with overseas regulatory authorities;5) suspend the QFI’s registration or prohibit the QFI from dealing on behalf of one or more of its approved QFI’s clients for such period as the Authority requires ;6) cancel the QFI’s registration, or withdraw the approval of any of its approved QFI clients;7) prohibit the QFI from dealing on behalf of one or more of the approved QFI’s clients in listed shares; and8) exercise any of its other powers under the Capital Market Law.

b. Suspension or cancelation of registration or prohibition of dealing on behalf of approved QFI clients or withdrawal of their approval under sub-paragraphs (5), (6) or (7) of paragraph (a) of this Article shall be effective immediately upon sending a written notice of such fact from the Authority to the QFI or the relevant authorised person.

c. The Authority may publish the identity of any institution whose registration has been suspended or revoked or whose approval has been withdrawn.

d. The events referred to in paragraph (a) of this Article include the following:

1) the QFI or any of its approved QFI clients no longer meets the conditions, obligations or requirements stated in these Rules;2) the QFI has not fulfilled the requirements of paragraph (a) of

Article (18) of these Rules within 60 days of its registration;3) the approved client of the QFI has not fulfilled the requirements of paragraph (a) of Article (18) of these Rules within 60 days of its approval;4) an insolvency event has occurred in relation to the QFI or any of its approved QFI clients;5) the QFI or any of its approved QFI clients has breached any of its obligations under the Capital Market Law and its Implementing Regulations and/or any other laws of the Kingdom;6) the QFI has obtained its registration or the approval of any of its approved QFI clients on the basis of incomplete, false, outdated or misleading information;7) the QFI or any of its approved clients has been the subject of any material legal or regulatory sanction in any jurisdiction;8) any restructuring of the QFI or any of its approved QFI clients; and9) any other event that the Authority believes necessitates its intervention in order to protect investors or safeguard the functioning of the capital market within the .

e. Following revocation or suspension of registration, the investor in question may not purchase (whether for its own account or for the account of its approved QFI clients) any listed shares.

f. Following revocation or suspension of registration, the investor in question may not dispose of shares held in its account (and\or in the accounts of its approved QFI clients) with the Depositary Center without the prior consent of the Authority.

g. Following the withdrawal of approval, a QFI may not purchase listed shares for the account of its client in question.

h. Following the withdrawal of approval, a QFI may not dispose shares held in the account of its client in question with the Depositary Center without the prior consent of the Authority.

i. Following the prohibition from dealing on behalf of an approved QFI client in listed shares, the QFI may not purchase listed shares for the account of its client in question, or dispose shares held in the account of its client in question with the Depositary Center without the prior consent of the Authority.

Part 6: Closing provisionsArticle 29: Publication and entry into forceThese Rules shall become effective on 14/8/1436H (corresponding to 1/6/2015G).



FAQs

Your questions answeredThe CMA provides further explanation about the rules for qualified financial investors (QFIs)

How is investing through the QFI Framework different from investing through Swap Agreements?

The QFI framework offers the legal ownership of Saudi-listed shares under the name of the investor in the Depository Centre, after which investors will be able to exercise their rights as shareholders including voting rights, appointing a representative to the board of directors of the companies in accordance to the Companies Law, and trading rights issues in accordance to CMA regulations including the QFI rules. By contrast, the Swap Agreements Framework provides non-resident foreigners with economic benefits only, rather than the legal ownership of the underlying shares.

Are existing swap agreement clients allowed to apply to become QFIs or approved QFI clients?

Yes, provided that all the swap’s underlying shares are transferred to the QFI or approved QFI client account in accordance with issuance from the CMA.

Are QFIs and approved QFI clients subject to the Income Tax Law?

Yes, in relation to the 5% withholding tax from the total dividends distributed by the listed company.

Who is responsible for the withholding tax on dividends distributed to QFI and QFI clients?

Listed companies are responsible for withholding tax from dividends that such companies distributed to QFIs and approved QFI clients.

Can QFIs or approved QFI clients participate in initial public offerings (IPOs)?

QFIs’ and approved QFI Clients’ participation in IPOs are subject to the relevant IPO prospectus.

Can QFIs and approved QFI clients vote in general assembly meetings? Can they nominate representatives for the board of directors of listed companies?

Yes, in accordance with the Companies Law.


FAQs

Can GCC citizens and foreign residents participate through the QFI Framework?

No, both GCC citizens and foreign residents, by virtue of the rights already offered to them, can invest directly in Saudi-listed shares.

What are the QFI registration conditions set out in the QFI rules?

The conditions are:• Theapplicantmustbeafinancialinstitutionthathasalegalpersonalitywhichfallswithinoneofthe

following types: banks; brokerage and securities firms; fund managers; and insurance companies.• Theapplicantoranyofitsaffiliatesmusthavebeenengagedinsecuritiesactivitiesandinvestment

therein for a minimum of five years.• TheapplicantmusthaveassetsundermanagementofSAR18.75bn($5bn)ormore;however,CMA

may reduce the minimum to SAR11.25bn.• Theapplicantmustbelicensedorotherwisesubjecttoregulatoryoversightbyaregulatory

authority in a jurisdiction that applies regulatory and monitoring standards equivalent to those of the CMA or acceptable to it.

What are the jurisdictions that apply regulatory standards acceptable to the CMA?

CMA will provide Authorised Persons (APs) who have a dealing licence with the list of jurisdictions that apply regulatory and monitoring standards equivalent to those of the CMA or acceptable to it, and any update that occurs to that list. These standards include that such jurisdictions satisfy all international financial standards and the requirements of anti-money laundering and counter-terrorist financing rules.

Can central banks apply for registration as QFIs or approved QFI clients?

Yes, if they meet the conditions specified in the QFI rules.

What are the conditions for approving a QFI Client?

A QFI client may not be approved as such unless:

The QFI or the applicant is responsible for the management of the client fund when invested in listed shares; and the client is neither a QFI nor an approved QFI Client with another QFI.

The client is either an investment fund, which must incorporated in a jurisdiction that applies regulatory and monitoring standards equivalent to those of the CMA or acceptable to it, or a financial institution that meets each of the conditions prescribed in the rules for registering a QFI.

Who is responsible for submitting the QFI client’s approval request to the Assessing Authorised Person (AAP)?

The QFI applicant or the registered QFI is responsible for submitting the QFI client’s approval request.

Who is an AAP?

An AAP is a person authorised by the CMA to conduct securities business, and has agreed with an applicant to assess its application for registration as a QFI, or an AP that has executed a QFI assessment agreement with a QFI.

How should the AAP submit the request to CMA?


FAQs

The AAP should send the request to the CMA in printed as well as electronic copies.

What licence should the AAP have in order to assess a QFI’s registration request?

The AAP must be authorised by the CMA to conduct dealing activities.

What is the required timeframe for the purpose of providing the determination to the CMA on the foreign applicant’s application?

The AAP must submit its determination on the request received from the QFI within five days of receiving all information and documents required by the QFI rules, unless the QFI and AAP agree otherwise.

How long does it take to be registered as a QFI, or to be approved as a QFI Client?

The overall application process may take up to 11 days from the AAP’s receipt of all information and documents required, unless the QFI and AAP agree on a different period of time to provide a determination on the application. Moreover, the CMA, as it deems appropriate, may impose an additional period to review the AAP’s determination to accept the application.

Is the AAP required to inform the QFI that it has been registered with the CMA?

Yes, the AAP must give the QFI a written notification that it has been registered with the CMA, and the AAP must also notify the applicant, in writing, in the case that the application is rejected.

Does the CMA impose fees for QFI registration or approving QFI clients?

CMA is currently considering the fees that might be applied to register the QFI and for maintaining such registration, and for approving the QFI client and maintaining such approval. In addition, the CMA does not consider imposing fees for registration or approval during 2015.

When does the CMA’s five-day period specified to review the AAP determination to register a QFI or approve a QFI Client begin?

The five-day period begins on the day the AAP receives CMA’s notification of receiving all the information and documents required by Article 13 in the QFI rules.

In the case that the request for registering a QFI or approving a QFI client is rejected, can the applicant reapply an application?

Yes, the applicant can reapply an application and there is no specific timing before the resubmission.

In what language should the information and documents required by the QFI rules be submitted?

Arabic is the official language in the Kingdom. The information and documents attached to the application may be submitted in the English language. In case of any discrepancy between the Arabic text and the English text, the Arabic text shall prevail.

Can a QFI and its QFI clients have different AAPs?

No, a QFI and all of its QFI clients must have the same AAP.

Can an approved QFI client apply to be registered as a QFI?


FAQs

Yes, an approved QFI client may submit an application for registration, however, the CMA shall not register the applicant as long as it is a QFI client of another QFI.

When will a QFI be eligible to commence trading?

A QFI may commence trading in any listed shares upon satisfying the following: holding a client account; holding an account with the Depository Centre; any conditions as may be imposed by the CMA.

A QFI may invest in any listed shares on behalf of any of its QFI clients upon satisfying the above mentioned requirements by the QFI client in question.

The term client account is defined in the Glossary of Defined Terms Used in the Regulations and Rules of the CMA as: “An account at a local bank which is in the name of an authorised person and fulfils the conditions required by the Client Money Rules”.

How can the applicant satisfy the registration or client approval requirements, the client account opening requirements and the requirements for opening an account with the Depository Centre?

The CMA worked in coordination with the relevant authorities to facilitate the establishment of a unified platform for the CMA approval requirements and the account opening requirements and the requirements for opening an account with the Depository Centre and bank account, to facilitate the fulfilment of such requirements, and the applicant will only need to provide the required information and documents in this regard to the AAP, provided that the concerned AAP takes the necessary actions in accordance with the producers issued by the CMA in this regard.

Is a QFI or an approved QFI client required to obtain authorisation by the CMA in relation to carrying on dealing as principal activity to invest in shares listed in the Saudi Stock Exchange?

The QFI and approved QFI client are not required to obtain authorisation by the CMA in relation to carrying on dealing as principal activity to invest in shares listed in the Saudi Stock Exchange.

Is a QFI required to obtain authorisation by the CMA in relation to carrying on managing activity to manage the QFI client’s fund when invested in shares listed in the Saudi Stock Exchange?

QFI is not required to obtain authorisation by the CMA in relation to carrying on managing activity to manage the QFI client’s fund when invested in shares listed on the Saudi Stock Exchange.

Can a QFI send trading orders though an international broker that is not registered as a QFI?

If the international broker’s role is to send orders issues by the QFI to the AP, then there is no need to register the international broker as a QFI. Provided that international broker has the authority to send such orders.

Does the ownership limit of 49% of any listed company include the strategic foreign investors in such company?

Yes, all foreign investors (in all categories, whether residents or non-residents), including the strategic investors, cannot own more than 49% of the issued shares for any listed company, including interests under swaps.


FAQs

What are the responsibilities of APs, QFIs and approved QFI clients with regard to the ownership limits in listed companies?

APs must comply with the relevant rules set out in the Capital Market Law and its Implementing Regulations, in particular the Authorised Persons Regulations, Market Conduct Regulations and the QFI rules.

QFIs must comply with the investment limits specified in paragraphs (a/1), (a/2), (a/6), and (a/7) of Article 21 in the QFI rules, both for investments in their account and investments on behalf of their QFI Clients accounts.

Are there any restrictions on QFI or an approved QFI client when exiting the Saudi Stock Exchange?

Other than the restrictions mentioned in the QFI rules, there are no restrictions on the QFI or the approved QFI client when exiting the Saudi Stock Exchange

Can a QFI engage with more than one AAP at the same time?

No, a QFI may not engage with more than one AAP at the same time.

Can a QFI or any of its approved QFI clients become a client of another AP for the purpose of investing in listed shares?

Yes, without prejudice to the responsibility of the QFI for the management of its QFI clients’ funds when investing in listed shares, and its authority to take investment decisions.

Can an approved QFI client engage with more than one QFI?

No, an approved QFI client may not engage with more than one QFI at the same time.

Can a QFI or approved QFI client establish discretionary portfolio management (DPM)?

A QFI can establish DPM with an AP in relation to its investments, however, a DPM may not be established in relation to a QFI clients’ investments.

How can a QFI change its AAP?

A QFI can engage with a replacement AAP within 10 days after the lapse or termination of the QFI assessment agreement with the replaced AAP. The replacement AAP shall without delay notify the CMA in writing of its appointment and submit a copy of the executed QFI assessment agreement to the CMA. If the QFI fails to engage with a replacement AAP within the 10-day period, the QFI must notify the CMA of this fact without delay, whereupon the CMA may either grant an extension or revoke the QFI’s registration.

Can the QFI trade listed shares during the 10-day period after the lapse or termination of the agreement?

Yes, the QFI can trade listed shares in that period taking into account its responsibilities to comply with the rules.

In case the QFI replaces the AAP, would the approved QFI clients move with the QFI?

Yes. When the QFI replaces the AAP, its QFI clients must move with the QFI.


FAQs

When should an AAP notify the CMA to cancel the QFI registration or withdraw the approval from QFI clients by sending a cancellation request to the CMA?

If an AAP finds at any time that a QFI with which it is engaged (or any of its approved QFI clients) no longer meets the applicable registration conditions stated in the rules or has breached any of its obligations under the rules, the AAP must report such findings to the CMA in writing without delay.

Is the QFI eligible to apply for cancellation of registration with the CMA or the request to withdraw the approval of one of its QFI clients?

The QFI may submit a cancellation or withdrawal request to an AAP so long as the request is accompanied with a confirmation from the QFI that it does not, nor does any of its QFI clients, own any listed shares including any rights related to it. If the cancellation or withdrawal request relates to the withdrawal of approval of one or more of its QFI clients, the request must be accompanied with a confirmation from the QFI that the clients in question do not own any listed shares including any rights related to it. The AAP must then submit a request to the CMA to that effect.

Will the contractual relationship between the AAP and the QFI be affected if the CMA’s decision is to decline the request to cancel the registration of the QFI or withdrawal of the approval of its clients?

Declining the request for cancellation of the registration or withdrawing the approval from its clients should not affect the AAP’s decision whether to maintain the contractual relationship with the related QFI and its clients or terminate such a relationship.

Does cancelling the registration of a QFI result in withdrawing the approval from its clients?

Yes, cancellation of the QFI registration results in withdrawing the approval from its clients. Such clients may move to another QFI provided that the approval of new QFI clients’ requirements are satisfied.

What is the settlement cycle for shares listed in the Saudi Stock Exchange?

The settlement cycle for shares listed on the Saudi Stock Exchange is T+0, and the CMA has no intention to change the mentioned settlement cycle at the current time.

Will the Depository Centre allow the APs licensed to conduct custody activities (without dealing licence), to be connected with the Depository and Settlement System, in order to enable them to offer independent custody services for investors in the Saudi listed shares?

Yes, the Depository Centre allows APs with a custody licence to be connected with the Depository and Settlement System, so that they can offer custody services to the investors and perform all related tasks. Therefore, investors in the Saudi-listed shares are able to appoint an independent custodian different than the broker that executes their trades.

Can the QFI and approved QFI clients have financing from local banks to fund their investments?

Yes, pursuant to the applicable producers set forth by the CMA and the Saudi Arabian Monetary Agency in this regard. ✷

Investing in Saudi Arabia

Made easy

A world ofopportunities

Discover a world of investing opportunities in Saudi Arabia with the Kingdom’s “Best local markets brokerage”As an investor looking for direct access to the Saudi market for the first time, you know how important it is to work with the right local authorised partner to help you gain regulatory qualification and be ready to trade and make decisions when the market opens. Saudi Hollandi Capital can provide you with that support.

Backed by the Kingdom’s longest-established bank, Saudi Hollandi Capital’s highly experienced bi-lingual brokers can not only guide you through the QFI process but also execute your trades through whichever channel suits you best. Whether you prefer online, tablet or phone trading, our proven world class service and tailored functionality is second to none. Which is why Banker Middle East magazine recently named us “Best local markets brokerage” for Saudi Arabia.

Get in touch and see why so many investors already trust us to help them make the most of the investment opportunities here.


LEGAL FRAMEWORK

This note describes very generally certain aspects of Saudi Arabia’s legal system that will concern an offshore financial institution that registers under the QFI rules as a qualified foreign investor (QFI) or is approved as a QFI client.

The Saudi Arabian government and sharia law

Saudi Arabia is a hereditary monarchy. All executive, judicial and regulatory authorities of Saudi Arabia are ultimately responsible to the King. Saudi Arabia is a sharia law jurisdiction. Sharia law has four principal sources: • TheHolyQuran• TheSunna,comprisedofwhattheProphetMohammedwasreported

to have said, done or approved and, in general, elaborating and explaining many of the general rules of the Holy Quran

• Ijmah,ortheconsensusofIslamicscholarsonanyparticularmatter.• Qiasoranalogy.

The King is the sole authority empowered to issue laws, which deal with matters not covered in, but which must be consistent with, traditional Sharia jurisprudence. Often, such laws will expressly authorise a department of the Saudi government, such as the Capital Market Authority (CMA), to issue implementing regulations.

The judicial system

The General Courts are the country’s basic courts, but their jurisdiction has been circumscribed over the years as jurisdiction has been ceded to specialised courts. Saudi Arabian courts apply Saudi Arabian law in all cases.

The doctrine of precedent does not exist in the Saudi Arabian judicial system. Judges seek to render justice in each case in accordance with applicable religious and legal principles. The rulings and judgments of Saudi Arabian courts are generally not published and are not available to the public.

Courts in Saudi Arabia do not grant equitable remedies, such as specific

Key issues for QFIsTerence Cloney, Counsel, K&L Gates, sets out the structure of Saudi Arabia’s legal system


LEGAL FRAMEWORK

performance and injunction, but award only money damages for proven losses that arise directly from a harm that is done or from a breach of contract, to the extent such damages can be quantified in money terms. They do not award consequential or punitive damages.

The Capital Market Law

The Capital Market Law (CML) governs the securities business in Saudi Arabia. It created the CMA to regulate the capital markets in the Kingdom.

The CML established the Committee for the Resolution of Securities Disputes, a specialised tribunal having jurisdiction over cases arising under the CML and related regulations, such as the QFI rules. Decisions of the committee are subject to appeal to an Appeals Committee. Both bodies function as courts, with formal rules of procedure and processes that lead to judgments which may be enforced in accordance with applicable law. Some these judgments are now published.

Rights of a QFI

Under the QFI rules: “QFIs and approved QFI clients are entitled to exercise all rights related to listed shares owned by them, including trading in rights issues”. Under applicable law, listed joint stock companies and their directors have certain obligations and duties to shareholders. Similarly, shareholders have various legal rights, including rights with respect to dividends, information and participation in shareholder votes. A QFI will be entitled to these rights to the same extent as a Saudi shareholder is.

CMA powers in relation to QFIs

The QFI rules afford the CMA broad powers to investigate and sanction QFIs and QFI clients for breaches of the rules. More generally, the CML empowers the CMA to investigate and prosecute violations of the CML.

The CML and the Market Conduct Regulations prohibit market manipulation and insider trading. The CMA actively monitors the Saudi securities markets and enforces these provisions, which can be the basis for fines and criminal proceedings. In recent months, the CMA has been referring market manipulation and insider trading cases to the Bureau of Investigation and Public Prosecution for prosecution as criminal offences.

As a member of the International Organisation of Securities Commissions and a signatory to its Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information, the CMA has the ability to consult and exchange information with securities regulators in other jurisdictions regarding enforcement and other matters. This arrangement can facilitate investigations or remedial actions that the CMA may wish to undertake with respect to a QFI or QFI client.

Contract issues

Saudi Arabia does not have a commercial code that governs interpretation of contracts. Generally, courts in Saudi Arabia will give effect to written agreements entered into by competent parties. However, any term or provision of an agreement that is inconsistent with sharia will be unenforceable. The two most relevant limitations on freedom of contract under sharia arise from the unenforceability of obligations to pay interest or amounts in the nature of interest, and obligations that are uncertain, contingent or unknown. ✷


REGiSTRATiON PROCESS

Navigating the new marketThe CMA has made the registration process clearer and smoother for QFI launch. James Gavin considers the process and interaction with the CMA

The application and registration process in the Kingdom is not materially changed by opening the Saudi stock market to qualified foreign investors (QFIs). Following the opening of registrations with the Capital Market Authority (CMA) from June 15 2015, the Saudi Stock Exchange (Tadawul) is the only stock exchange in the country through which trades are

executed and share registration is secured and dematerialised through the Securities Depository Centre.

A QFI intending to invest in the market is required first to obtain a QFI registration from the CMA before setting up accounts through its local service provider, whether a custodian or a broker.

An application for registration must be submitted, and assessed by, an authorised person (AP) licensed by the CMA to carry out the activity of dealing in securities, known as an assessing authorised person (AAP). An AAP is defined as an authorised person in the market who possesses a dealing licence from the CMA.

As Yazan Abdeen, head of regional liquid assets and lead Mena fund manager at Sedco Capital, explains, a client of a QFI who intends to invest in the Saudi Arabian market must also obtain a QFI registration from the CMA as a QFI client (QFIC). The registration application for QFI or QFIC must be completed by a designated AAP according to procedures set out in the QFI rules.

“It is important to note that a QFI or QFIC may only appoint or designate one AAP at a time and subsequently engage with multiple APs in the market for its trading and settlement purposes,” says Abdeen.

Smoother registration

The changes introduced by the CMA are seen as beneficial to the registration process, providing greater clarity and smoothing the process. For example, there is no longer a requirement for the AAP to be

independent of the applicant. In other words, foreign investors can now apply through their licensed Saudi subsidiaries, if applicable.

Also, there is no longer a requirement for the AAP to accept the application if the applicant meets all registration conditions. This means that the AAP will have the discretion to reject an application for

The changes introduced by the CMA are seen as beneficial to the registration process, providing greater clarity and smoothing the process



commercial reasons even where the applicant is eligible for QFI status. The new rules allow the AAP to agree with the applicant to extend its review period of the application beyond the five days prescribed by the rules.

The rules also grant the AAP more powers. For example, the CMA no longer has the discretion to force the AAP to accept the application if the AAP’s initial decision was to reject it. The CMA, however, retains the discretion to change the AAP’s determination if it initially approved the application.

The AAP will not approve the assessment unless the applicant agrees to enter into a standard QFI agreement. The AAP’s determination of an application must be submitted to the CMA within one day thereafter and becomes final three days after submission, unless extended by the CMA.

Evolution not revolution

The overriding aim of the reforms is to provide a speedy and transparent registration process that meets the needs of the regulator and investors alike. Where the determination of the AAP to accept the application becomes final, the CMA will register the applicant as a QFI and notify the AAP in writing of this fact without delay.

The CMA remains the governing body of the market. While it might use third-party service providers, it remains the sole market regulator.

Change will be evolutionary. Abdeen says: “We can see the Tadawul recently undergoing significant evolutionary steps towards creating an independent custody model in the market with the legislation passed in May. Finally, we do expect that the settlement cycle will change in the Kingdom from T+0 – which requires prefunding – to T+2, which will allow eventually the delivery-versus-payment (DVP) structures that are a major requirement for MSCI to include Saudi into it Emerging Market Indices.”

Some foreign investment managers had earlier expressed concern about the T+0 arrangement. For example, in a statement issued in January 2015, US asset management giant BlackRock noted that Saudi Arabia’s requirement that transactions settle at T+0 thereby – with the attendant pre-funding of cash and securities – coupled with the dual account structure would cause challenges, with a high degree of operational complexity in a no-fail market.

BlackRock viewed T+0 as a potentially 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

Shareholder dialogue explainedShareholders have the right to demand a variety of information from the company and have a clear right to participate (either in person or via proxy) in the general assembly meetings (GAM), to add items to the GAM agenda and call for a GAM as well as having a clear right to nominate, vote for, and remove board members. Cumulative voting has been introduced as a means to nominate directors. Changes to the company’s articles of association require extraordinary assembly approval, with a constituting quorum of 50% of the capital and approving quorum of two-third. Shareholders have pre-emptive rights to new share issues.

Related party transactions (RPT) have to be announced on the Saudi Stock Exchange, or Tadawul, website. A board member can’t have any interest whether directly or indirectly in the company’s business and contracts, or participate in any activity that may likely compete with the activities of the company, without a prior authorisation from the general assembly, which to be renewed each year. And RPT has to be examined by external auditor before presented to the general assembly.

Source: CMA



sell transactions, leading to operational events, costs and complexity,” it said.

Interaction with the CMA

Achieving a smooth and successful registration process is one thing. Ensuring effective interaction with the regulator over the longer term will be a key concern for QFIs, as much as it would be in any market. Fortunately, the CMA has demonstrated a willingness to engage with international fund managers and asset servicing firms when determining its new regulatory framework.

That openness is likely to continue under the leadership of CMA chairman Mohammed Aljadaan, who has been at the helm since the start of 2015. There are specific channels and means of communication through which international firms and asset managers should interact with the CMA.

“International asset managers that are applying to become QFIs in Saudi need not interact directly with the CMA. They need to have a local AAP. Currently, local brokers are undergoing the process of clearing QFIs,” says Abdeen.

The relationship with the CMA will doubtless evolve and deepen over time for most foreign operators. One investment manager contacted by Global Investor/ISF says that as things stand, the Saudi regulator is not yet as approachable as it might be, and that certain improvements will be needed to ensure a smooth interaction. He says it has not always been easy to meet the CMA, and that access to officials can on occasion be sporadic.

On the other hand, says the investment manager, in the run-up to the market opening there seemed to be a change in attitude, with CMA officials becoming

Saudi law explainedThe concept of law is synonymous with sharia, which is the basic and primary law of the country, as defined in article 7 of the Basic Law of 1992. No regulation is deemed lawful if it violates a tenet of sharia law. Similarly, if an agreement or individual provision in a contract violates sharia law, it would be unenforceable.

However, Saudi regulations are usually enacted or promulgated as royal decrees or ministerial resolutions, adopted to address specific subjects such as foreign investment, the formation and operation of companies, capital markets and banking activity.

In the judicial system, the King acts as the final court of appeal and as the source of pardons. The Saudi court system consists of three main parts. The largest is the Sharia Courts, which hear most cases in the Saudi legal system. There are several categories: Courts of the First Instance (Summary and General Courts), Courts of Cassation and the Supreme Judicial Council.

Supplementing the Sharia Courts is the Board of Grievances, which hears cases that involve the government. The third part of the Saudi court system consists of various committees within government ministries that address specific disputes, such as labour issues.

Change arrived in 2007, with a royal order approving a new team, including the establishment of a Supreme Court and special commercial, labour and administrative courts. The Supreme Court, in Riyadh, is the highest appellate court in Saudi Arabia.

The Commercial Courts have jurisdiction over the following:• Allcommercialdisputes,whetherprincipalor

consequential, occurring among traders.• Lawsuitsfiledagainstthetraderbecauseoftheprincipalor

consequential acts thereof.• Disputesoccurringamongpartnersinpartnerships.• Alllawsuitsandviolationsrelatingtocommerciallaws

without prejudice to the jurisdiction of the Grievance Board.• Bankruptcylawsuits,interdictionofthebankrupt,orlifting

thereof.• Othercommercialdisputes.

Sources: Norton Rose Fulbright, Saudi Arabian government, Tamimi law firm



more open to phone calls. Increasingly, they will arrange meetings, sometimes at short notice. “We have definitely seen a change in approach and we expect that, going forward, the CMA will take a more open attitude towards dialogue, specifically with international investors,” says the investment manager.

Complaints procedure

Ensuring investor complaints are dealt with properly will be an important consideration. A department at the CMA has been created within the enforcement division dedicated to addressing investor complaints. Based on information obtained through these sources, it obtains intelligence on which to conduct investigations into possible violations and to bring actions before the Committee for the Resolution of Securities Disputes (CRSD). This committee deals with any dispute or disagreement resulting from trading, and it has jurisdiction over the disputes falling under the provisions of the Capital Market Law.

The CRSD’s decision may be appealed before the appeal panel that is formed by a Council of Ministers’ resolution. The appeal panel has the discretion to refuse to review the decisions of the CRSD, to affirm such decisions or to undertake a review of the complaint.

There is no expectation among participants that the CMA will remain remote from the process. The CMA is an active regulator, regularly inspecting AP activities and closely monitoring trading on the Tadawul. As an IMF assessment of the CMA found, the CMA detects and investigates market manipulation, insider trading and non-compliance with its regulatory requirements. There is a full audit trail of order entry and execution for all transactions, which is available to CMA staff.

CMA enforcement

In recent years, the CMA has adopted a stricter approach to enforcement, as illustrated by its call in 2012 to Saudi securities investors to deal only with persons authorised by the CMA to conduct securities business in Saudi Arabia, and by the CMA’s urging such Saudi investors to report any incidence of securities business carried out by persons not authorised to do so.

The new rules grant the CMA stronger powers of oversight over QFIs, enabling them to require QFIs to provide any information, documents and written explanation in respect of the matters giving rise to its consideration. The Saudi regulator has the authority to require the QFI or its representative to answer questions and explain any matter the CMA considers relevant.

It can insist the QFI take steps to verify information, including by communicating with overseas regulatory authorities, and suspend the QFI’s registration or prohibit the QFI from dealing on behalf of one or more of its approved QFI’s clients for such period as the CMA requires. It can also cancel the QFI’s registration, or withdraw the approval of any of its approved QFI clients, and prohibit the QFI from dealing on behalf of one or more of the approved QFI’s clients in listed shares. Under its name-and-shame powers, it can publish the identity of any QFI whose registration has been suspended or revoked or whose approval has been withdrawn.

The stage is set for a more transparent and open dialogue between international investors, asset managers and the regulator in Saudi Arabia. The consensus expectation is that the registration and interaction process on the Middle East’s largest market will be a productive one for all sides. ✷

“We can see the Tadawul recently undergoing

significant evolutionary steps towards creating

an independent custody model in the market”

Yazan Abdeen, Sedco Capital


CORPORATE GOVERNANCE

Striving for standardsCorporate governance has long been a priority for the CMA – and this will only intensify with the launch of the QFI system. James Gavin investigates

One of the main benefits of international involvement in the Saudi equity market – and the key motivation highlighted by the Capital Market Authority (CMA) when launching its qualified foreign investor (QFI) system – is the improved standards of oversight of listed firms that will ensue. In Saudi Arabia’s case, these will build on the market regulator’s growing body of work

in the corporate governance sphere, helping investors and analysts to productively navigate what only until recently would have been an unfamiliar, and sometimes foreboding landscape.

The reform will cascade down to board directors, significantly increasing the scope and depth of their responsibilities and duties. With the CMA coming down hard on transgressors, Saudi corporate governance is now being paid far more than lip service.

The CMA has shifted corporate governance to the very top of its in-tray, progressively tightening standards and requirements on listed firms, building on its mandate to boost the quality, transparency and disclosure levels in the securities sector in order to create a suitable investment climate.

Although there is no published single comprehensive code of corporate governance in Saudi Arabia, the CMA issued comprehensive Corporate Governance Regulations (CGR) in November 2006 that

companies must follow.

These regulations predated by almost two years the global financial crisis that did so much to highlight the importance of improving standards of disclosure and transparency – and the perils of getting it wrong. They were issued under a UK-style comply-or-explain approach.

Comply-or-explain

The CMA has gradually mandated a number of provisions related to shareholder rights and disclosure over the years. Today there are 21 mandatory provisions with an amended version of the CGR issued in March 2010.

“The CMA is progressively taking the 21 articles and making them binding,” says Nathalie Potvin, executive director of the GCC Board Directors Institute (BDI), which held a workshop with the CMA in March of this year. “So far

there are three binding articles, which relate to board composition and the need for certain numbers of independent directors.”

In April 2011, the CMA announced the amendment of Article 9 of the CGR to regulate the remuneration and compensation paid to the members of the boards of directors of companies listed on the Saudi Stock Exchange, or Tadawul.

“So far there are three binding articles, which relate to board composition and the need for certain numbers of independent directors” Nathalie Potvin, GCC Board Directors Institute



Others remain under the comply-or-explain approach for now. But the CMA’s gradualist approach is seen as making sense. “It is a smart approach for the Kingdom. It is not a one-size-fits-all methodology,” says Potvin.

From the outset, the CMA has sought to play a strict regulatory role. As far back as 2004, the CMA expanded on the insider trading provisions contained in the Capital Market Law (CML) by issuing a market conduct regulation to define insiders, and prohibit illegal direct and indirect insider trading, as well as market manipulation. The CMA has taken action against insider trading, with the results published on the CMA and Tadawul websites.

Equally important, says Abdullah Saeed A Alkahtani, manager, media and investor awareness at the CMA, are the regulator’s various awareness-raising efforts. “The CMA has organised and participated in several corporate governance awareness raising campaigns, focusing on explaining the CGR and business case for implementing good corporate governance.”

The CMA is proactive in educating board members and arranges workshops to raise awareness of the need to operate in certain ways. The campaigns include a series of conferences and media events, combined with a set of focused seminars and workshops targeting directors and senior managers on issues such as good board practices, risk management and non-financial disclosure.

According to Alkahtani, the CMA continually assesses the implementation of CGR by reviewing companies’ disclosure in their annual board of director reports, attending general assembly meetings and making supervisory visits to the companies. Corporate governance practice has notably improved and the implementation of CGR has strengthened.

The CMA also encourages and supports independent entities such as universities and civil society foundations to assess corporate governance practice in Saudi Arabia.

The net effect of these efforts has been notably beneficial, says Alkahtani. “Disclosure and transparency have substantially improved in both numbers and quality. Moreover, awareness of the importance of good corporate governance is rising and implementation by companies is improving rapidly.”

QFI expectations

In the context of the market opening to QFIs, the improvement in corporate governance is especially timely. As Abdullatif Al-Othman, governor and chairman of the board at the Saudi Arabian General Investment Authority (SAGIA), said following the BDI workshop in March 2015: “Institutional investors will only invest in those, and only those, with sound corporate governance records.”

Institutional investors, given their sophistication, are more inquisitive and probing than the retail – including very wealthy individuals and families – investors that have hitherto dominated the Saudi market. That in itself will result in a decisive cultural change in the Kingdom.

Foreign investment flows and shareholder confidence are intrinsically linked to robust corporate governance. As Mohammed Aljaadan, chairman of the board of the CMA, says, there is clear link between shareholder confidence and robust corporate governance, which is why the CMA upheld such high governance standards.

“Awareness of the importance of good

corporate governance is rising and

implementation by companies is improving

rabidly” Abdullah Saeed A Alkahtani,

CMA



Liberalisation of the market will have a catalytic impact in improving regulation and governance standards in the Kingdom’s capital markets. “This is to be expected because you will have more sophisticated investors, which will obviously be interested in the market. When you have got some highly performing organisations [involved] it will inevitably change the manner in which companies operate,” says Potvin.

Long-term investment managers have noted the Saudi regulators’ credentials. “If you take a look at the corporate governance manual that is out there, I would say it is one of better ones in the region,” says Salah Shamma, head of investment – Mena equity, at Franklin Templeton Investments ME. “The Saudis adopt the best standards and are quite comprehensive in terms of their requirements.”

From an emerging market point of view, the Saudi rules are regarded as straightforward. Shamma says: “At the board level it is pretty clear, they have defined the frameworks and policies that board members need to operate within, and the oversight committees that monitor the boards and the board members are actually liable for any kind of misappropriation of funds, or any kind of problematic activities. That is important.”

At the disclosure level, there is clear guidance as to what the minimum levels should be and what kind of reporting is required. But there is a need for more of the oversight and enforcement measures in the framework.

Challenges ahead

There is still work to be done, and no-one is yet comparing Saudi corporate governance standards to those generally seen in developed markets.

Enforcement of rules is the biggest requirement. “The rules are out there and you can take a look at them and be satisfied that anything you can see [is similar to rules] in Switzerland,” says Shamma. “Enforcing them is something that has been improving in the past couple of years and the CMA has been more aggressive than others.”

Alissa Amico, manager of the Mena corporate affairs division at the OECD, has noted that the Saudi CMA is the most rigorous in the region in publishing its enforcement actions against listed companies, many of them related to corporate governance breaches, particularly the failure to disclose market-sensitive information.

Listed company requirementsThe CMA requires listed companies to produce quarterly reviewed financial statements – which contain a balance sheet, a profit and loss account, a cash flow statement and notes – as well as audited annual reports. Moreover, the board of directors is required to issue an annual board report containing a description of the issuer and its business, corporate objectives, dividend policies, information regarding board composition and executives of the issuer and their remunerations and indemnification. Furthermore, the report includes a statement by management of current and future developments expected to have a significant effect on the company’s financial position.

The minimum board size is three and the maximum board term is three years renewable. The majority of the members of the board of directors shall be non-executive and independent members should be two or one-third, whichever is greater. The typical board size is eight, with four independent members on average. The CGR defines the board’s functions and responsibilities, prohibits the chairman from acting as executive in the company, as well as defining the roles of the nomination and remuneration committee and the audit committee.

Source: CMA

Custody Advising Corporate Finance Brokerage Asset Management

Contact us on +966 -12- 661- 8200 or visit us at www.aljaziracapital.com.sa to find out how AlJazira Capital can help you.

+966 -12- 661- 8200800 -116 - 9999

IF YOU ARE THINKING ABOUTUNLOCKING THE SAUDI STOCKMARKET THEN TRADE WITH THENUMBER ONE BROKER IN 2014

* According to Tadawul report and in terms of the value of trading.

*

An Investor should be kindly aware of securities risk that can fluctuate in price or value or income may fall and the investor may get back less than the amount invested and that some securities may be difficult to convert them to cash immediately, and there is no guarantee that the investor can recover the original amount of his investment nor on its revenues. The investor should be aware of the change in a foreign currency, that changes in currency rates may have an adverse effect on the value, price or income of the security. This advertisement may not be suitable for all recipients, if they have any doubts, they should seek advice from their investment adviser. The investor should be aware of deductions for charges and expenses are made at the time of the initial investment or on the sale of the investment.

Al Jazira Capital company – CR # 1010351313 – CMA license # 07076-37 P.O. Box 20438 Riyadh 11455 - Kingdom of Saudi Arabia.



As the regulator, the CMA has the legal power to pursue market participations and listed companies as well as enforce penalties, whether monetary or even in the form of prison sentences.

Proof of this has come with an accounting scandal at the mobile telecoms firm Mobily, which in February 2015 was forced to revise its 2014 earnings to show a loss of $243m, in replacing a previously-announced profit. The CMA’s launch of a probe investigating the possibility of insider trading of Mobily shares, served to reinforce its credentials as a tough regulator. It has now referred the suspected insider trading to the public prosecutor.

The CMA is active at policing the companies listed on Tadawul, publishing the companies that have failed to make such disclosures under a name-and-shame approach.

Adoption of standards

All this activity has had the effect of galvanising action from listed Saudi entities, with firms reportedly taking more care when preparing earnings statements. The Saudi Cable Company announced in March this year that it was delaying the release of its 2014 earnings statement, because it was still compiling information required by an external auditor. That was seen as symbolic of the increasing pressure on Saudi companies to provide more detailed financial reporting.

This evolution reflects a greater focus by Saudi companies since the 2007-08 financial crisis, which proved something of a wake-up call for the region.

“We have seen the improvements,” says Potvin. “We now have a level of companies that reaches out to us at the BDI. They want their board’s performance reviewed or [for board members] to undertake

a workshop, because they realise that some key topics that pertain to governance are misunderstood or not known.”

The BDI says the attendance rate at its workshops has been significantly higher in the past three years, compared with when it started holding them in 2007.

The change in mind-set is evident. Back then, a lot of companies would refuse to meet international investors and refuse to disclose any kind of information. A lot of financials were in Arabic only and they did not provide English documentation. There was absolutely no segmentation, no forecasts and no guidance.

Since then a lot of companies have adopted a very robust investor relations function, with dedicated personnel who understand the requirements and needs of international investors.

Shamma says: “We are now getting quarterly disclosure, we are getting guidance and we are getting segmentation, whether in revenue or in earnings. We are getting access to management. I am not sure if this shift has been pushed by the regulator, but the fact is we are seeing the benefits of being able to interact with international investors and what that brings to performance and share prices.”

One aspect that is expected to see a strong improvement in line with the market opening is the analysis of company financials. The Saudi market is well covered by most bulge bracket banks as well as Saudi ones, and research capabilities are seen as strong, with analysts enjoying fairly strong access to management. There is, however, patchier reporting on the small and mid-cap firms, which

“The Saudis adopt the best standards out there and are quite comprehensive in terms of their requirements” Salah Shamma, Franklin Templeton



only report their financials in Arabic language, and where there is a generally less developed level of disclosure.

Intermediaries though are providing better visibility on the smaller cap space, says Shamma. “Some companies are not up to speed but intermediaries have been quite active covering them and these guys offer international investors a good option to gain some information in English, and they have a good platform to provide insights into that segment,” he says. “Not all companies are going to tick every box, but that is the same for all markets.”

The CMA has not yet implemented bilingual disclosure requirements, so this is an area in which institutional investors are expecting to see an improvement.

One area where progress is needed is regulation related to conflicts of interest and minority shareholder representation, as well as respect of the rights of minority shareholders. Potvin says: “If you have shareholder representatives, you need to ensure that the directors do not [just]… protect their interests but are there to serve the company on whose board they serve. But these are challenges for every jurisdiction.”

Standards are a moving feast. The CMA will be urged to be more prescriptive in terms of board evaluations, perhaps by introducing mandatory performance reviews. “There is a risk that could be a box ticking exercise, where firms say they have done it without any real intention behind it. But this could trigger improvements in the way that boards are assessed and managed,” says Potvin.

As the Saudi market opens its doors to QFIs, the CMA’s Aljaadan will doubtless be pushing hard to give his regulator more resources to ensure it remains proactive and ensures standards are the best they can possibly be. ✷

“Institutional investors will only invest in

those, and only those, with sound corporate

governance records” Abdullatif Al-Othman, SAGIA


KiNG ABduLLAH FiNANCiAL diSTRiCT

The company behind the King Abdullah Financial District (KAFD) project – Al Ra’idah Investment Company, the investment arm of the Saudi Public Pension Agency – describes it as the first of its kind in the Middle East in terms of size, organisation and technical specifications. Its backers say the 1.6 million square metre development, which will house the headquarters of the Saudi

Capital Market Authority and the Saudi Stock Exchange, will compete with the global financial centres.

A report from the Riyadh Chamber of Commerce and Industry states that when the centre is finished, Saudi Arabia “will upgrade its position as a financial capital for the Middle East, given that the Kingdom has made great strides in its self-contained, carefully-planned programme to modernise, develop and advance its financial sector”.

Not everyone is impressed by the rate of progress, though. It is 12 years since the project was first announced and Nigel Sillitoe, CEO Insight Discovery, is concerned that KAFD has been left behind by other regional centres with similar aspirations.

“Given the size of the Saudi economy it is understandable why the Kingdom would establish a new financial centre. My concern is that while Saudi Arabia, like a number of other financial centres in the GCC, will have a first class business plan which maps out how its financial resources will attract hundreds of international companies – it may have left it too late. There is already far too much competition from more established financial centres in Dubai, Doha and Manama.”

John Sfakianakis, GCC regional director for Ashmore, suggests that KAFD should be viewed more as a project to consolidate financial service providers in Riyadh – rather than having them scattered around a city of nearly 7 million people – and less as a financial centre to compete with others in the region.

In terms of leading regional financial centres, Sillitoe describes the Dubai International Financial Centre as the clear winner at the moment, largely because it is a hub for travelling around the region and a place where international professionals want to live.

“In the short term I am sure the Kingdom will attract investment banks and law firms, which will be attracted by the number of IPOs. Persuading insurance companies and asset managers to set up shop will be much harder, especially when most have already established a presence in one of the many existing financial centres in the GCC.”

Taking stockFor all the fanfare surrounding its development, the King Abdullah Financial District faces considerable regional competition. Paul Golden reports

“KAFD makes a good business case even if

international financial institutions don’t

relocate here, given the large number of local financial institutions within Saudi Arabia”

Vijay Harpalani, Al Mal Capital



KiNG ABduLLAH FiNANCiAL diSTRiCT

Others are more optimistic about KAFD’s prospects. Setting-up a dedicated financial centre will support the country’s ambition to diversify its economy away from oil according to Vijay Harpalani, fund manager at Al Mal Capital, who reckons it is premature to say at this stage that it will have to compete for business with DIFC and other regional centres.

“It can actually complement other regional financial centres. KAFD makes a good business case even if international financial institutions don’t relocate here, given the large number of local financial institutions within Saudi Arabia,” he says.

Zak Hydari, chief executive at EIIB-Rasmala, is another who believes that KAFD has the potential to become a significant centre for financial services, at least within the Middle East.

“Saudi Arabia is one of the largest economies in the Middle East, which historically has been largely dependent on oil. In order to drive its economic diversification agenda the Saudi government is investing in financial infrastructure to ensure local regulators implement a clear, stable and predictable

fund management and capital markets regime which should help facilitate investment and job creation. It is a common assumption that there isn’t enough room for more than one financial centre in the GCC, but we believe the GCC economy is large enough to sustain multiple centres.”

Wassim Moukahal, senior vice-president at Samena Capital, also suggests that the size of the Saudi economy supports his view that KAFD is a sustainable venture: “Saudi Arabia has a nominal GDP of $664bn, constituting approximately 45% of the total GDP for the GCC and around 20% of total GDP for the Middle East and north Africa. Its stock market is one of the most active with 177 listed stocks, a total market capitalisation of $594bn and advanced capital markets regulation mirroring global standards when it comes to share issuance and disclosures.

“Although there is a drive towards opening up the economy, of which allowing foreign investors access to the stock exchange is symptomatic, the Saudi economy and its capital markets are defined by local characteristics and norms, and are less integrated with the international markets. Hence a

local financial centre will provide better access to the wealth of local economic activity.”

Hydari suggests that a local presence is necessary given the size and complexity of the Saudi economy and that international investors cannot be active in a meaningful way without being physically present.

Harpalani agrees that local presence is an advantage in the asset management/investment banking business, although he also warns that it is not clear at this stage if the centre will have a separate regulatory structure and easier visa policies, which are both important considerations when deciding whether or not to relocate.

Most financial services firms in the DIFC and other regional financial hubs conduct a significant amount of their business in Saudi already, notes Moukahal. “With the presence of a world class infrastructure and laws to start and operate businesses with foreign ownership, I believe KAFD will attract a large number of financial institutions eager to tap into the opportunities of the Saudi market,” he adds. ✷

“My concern is that Saudi Arabia may have left it too late – there is already far too much competition from more established financial centres in Dubai, Doha and Manama” Nigel Sillitoe, Insight Discovery


iPOs

Last year was the strongest year for initial public offering (IPO) activity in Saudi Arabia since 2014, dominated by the $6bn raised by the Kingdom’s largest lender, National Commercial Bank in November. Investment in Saudi

IPOs has been profitable and low risk, proving a compelling proposition for many local investors. With the Saudi Stock Market, Tadawul, opening its doors to direct investment qualified foreign investors (QFIs) from June, there is now a chance for international institutions to grab a slice of a healthy pipeline of equity issuance, although there remain obstacles to be overcome in the Kingdom.

Overall the fundamentals for the IPO market are good, but against the backdrop of oil price fluctuations around the turn of 2014-15, the IPO market is expected to remain cautious, according to specialists who advise clients seeking to float on the Saudi bourse. While the market appears to have stabilised, long lead times for IPOs means that it is yet to flow through to a renewed wave of issuance.

“Several IPOs are planned in Q2 2015 and include companies from the Saudi market,” says Mayur Pau, Mena IPO leader at EY. “One factor driving the trend is that the fluctuations in the region’s stock market has settled down recently.”

Access all areasWhile foreign investors will not be allowed direct access to IPOs, they can gain exposure via a proliferating number of IPO funds, writes James Gavin

“There is a pretty good pipeline of IPO opportunities from Saudi, which we expect to be reflected in the second half of 2015” Mayur Pau, EY


iPOs • Co-Financial Advisor and Co-Lead Manager to National Commercial Bank on its SAR 22.5 billion IPO, the largest public offering in MENA to date and the second-largest globally in 2014

• Exclusive Financial Advisor to General Lighting Company on the sale of a 51% stake to Royal Philips for US$ 235 million in 2014

• Co-Underwriter and Co-Lead Manager to Saudi Arabian Mining Company (Ma'aden) on its SAR 5.6 billion rights issue in 2014

• Joint Lead Manager and Joint Bookrunner on National Commercial Bank's US$ 1.3 billion Basel III Compliant Subordinated Tier 2 Sukuk in 2014

• Joint Lead Manager and Joint Bookrunner for 3 consecutive years on US$ 4.25 billion of bond issuances for the Kingdom of Bahrain in 2012, 2013 and 2014

At the forefront of Saudi capital markets for more than a decade with over US$11 billion in public offerings since 2003, we continue to excel among our peers and persevere during challenging market conditions. Our clients include family offices, corporations, financial institutions, sovereign entities and individuals. Our pedigree and the prestige it carries compel us to exceed expectations. We take pride in our history as we build towards future successes.

GIB Capital LLC is regulated by the Capital Market Authority of the Kingdom of Saudi Arabia with license number 07078-37GIB Capital is a fully owned subsidiary of Gulf International Bank BSC | Gulf International Bank BSC is licensed by the Central Bank of Bahrain as a commercial wholesale bank

YOU’RESEEING

THE TIP

ONLY

www.gibcapital.com

In the three years to end-2014, the Saudi primary market witnessed 18 corporate listings, raising SAR32.5bn ($8.7bn) in IPOs. That volume looks set to continue at a steady pace, says Pau. “There is a pretty good pipeline of IPO opportunities from Saudi, which we expect to be reflected in the second half of 2015.”

QFI access to IPOs

Participation in IPOs directly remains off-limits for non-Saudis, in spite of the new rules that offer direct access to the market to QFIs. However, the Capital Market Authority (CMA) has made it abundantly clear that it wants to raise the proportion of shares allocated to institutional investors in IPOs, as part of its mandate to promote stability and reduce market manipulation.

As a CMA statement issued on May 25 2015 noted, increasing institutional investors’ strategic ownership in listed companies “supports governance practices and increases transparency, a target that is hard to achieve amid the dominance of retail investors in the market.”

In recent IPOs, the CMA has allocated 60% of shares to institutional investors and 40% to retail investors – an increased weighting to institutions compared with the previous trend, which was a 50:50 allocation. And with many Saudi retail investors representing larger entities, such as family offices, the distinction between institutional and retail investors is often more blurred than in other markets.

Within the institutional allocation, there is a strong bias towards mutual funds, with 90% of IPOs’ institutional tranche allocation reserved for such funds. The overriding aim of the CMA is to encourage retail investors to participate in IPOs, through specialised channels run by professionals with a greater appreciation of risk.

The rules do not explicitly state whether QFIs will be able to get involved in the book-building process, but the expectation is that they will not be allowed to.

“The way the authorities look at IPOs is part of a wealth redistribution mandate. It is a way of giving something back to the public, and they will not be opening that to the large foreign institutions,” says Alhassan

Ghoussous, chief operating officer of Saudi-based Albilad Capital.

Saudi shares tend to be offered at a substantial discount to normal valuations. After an IPO, market prices would increase significantly, providing a big incentive for retail investors to play the market.

The CMA’s changes to the IPO regulatory framework, first introduced in 2006, limited daily price movements to 10%, excluding the first day of trading following an IPO. The second reform took effect in 2013, to extend the 10% price oscillation cap to the first day of trading after an IPO. These changes have changed the dynamics of IPO returns, notes Aljazira Capital in a research note released last year. Returns take longer to peak compared with previous IPOs, as well as eliminating so-called moonshots.

CMA involvement

The CMA is likely to remain a key player in the Saudi IPO process. For years, the Saudi market regulator was heavily involved in arriving at the public price of securities, while the book-building exercise was for the most part undertaken as a guidance for the issuing company – the investment bank arranging

“The larger IPO funds are emerging from authorised persons for companies that have a foreign connection” Alhassan Ghoussous, Albilad Capital

• Co-Financial Advisor and Co-Lead Manager to National Commercial Bank on its SAR 22.5 billion IPO, the largest public offering in MENA to date and the second-largest globally in 2014

• Exclusive Financial Advisor to General Lighting Company on the sale of a 51% stake to Royal Philips for US$ 235 million in 2014

• Co-Underwriter and Co-Lead Manager to Saudi Arabian Mining Company (Ma'aden) on its SAR 5.6 billion rights issue in 2014

• Joint Lead Manager and Joint Bookrunner on National Commercial Bank's US$ 1.3 billion Basel III Compliant Subordinated Tier 2 Sukuk in 2014

• Joint Lead Manager and Joint Bookrunner for 3 consecutive years on US$ 4.25 billion of bond issuances for the Kingdom of Bahrain in 2012, 2013 and 2014

At the forefront of Saudi capital markets for more than a decade with over US$11 billion in public offerings since 2003, we continue to excel among our peers and persevere during challenging market conditions. Our clients include family offices, corporations, financial institutions, sovereign entities and individuals. Our pedigree and the prestige it carries compel us to exceed expectations. We take pride in our history as we build towards future successes.

GIB Capital LLC is regulated by the Capital Market Authority of the Kingdom of Saudi Arabia with license number 07078-37GIB Capital is a fully owned subsidiary of Gulf International Bank BSC | Gulf International Bank BSC is licensed by the Central Bank of Bahrain as a commercial wholesale bank

YOU’RESEEING

THE TIP

ONLY

www.gibcapital.com


iPOs

the IPO and the CMA. At the end of the day, the CMA retained a large say in the price of a stock.

As Zeyad Khoshaim, a Riyadh-based partner in association with the law firm of Allen & Overy, notes, for petrochemical companies the initial offer price would be set to allow IPO investors to benefit from the allocation of gas feedstock that was cheap compared with that available in other world markets. “This was the Ministry of Petroleum’s and CMA’s way of ensuring that the Kingdom’s energy abundance is widely shared and not just concentrated in the founders of those companies. And that impetus is unlikely to shift in the near term,” he says.

Initially, at least, there will be extreme caution about opening up the book-building process to non-Saudis, says James Stull, a senior partner in the Dubai office of law firm King & Spalding. This reflects the CMA’s concern that foreign money could come in and flow out equally as quickly. “That is why they are having every foreign investor vetted by a CMA-authorised person, requiring only that the very largest established institutions, managing a minimum SAR5bn, will be allowed entry,” he says.

IPO funds

The concern about massive volatility, or fluctuations, in pricing has led the CMA to redouble its efforts to encourage investment in dedicated IPO funds, of which there has been a proliferation in the past 12

months. These open-ended funds are operated by CMA-regulated firms, and include non-Saudi entities such as Bank Muscat of Oman and Blominvest, a Lebanese firm.

Ghoussous says: “At the beginning of 2014 there were four funds in Saudi Arabia dedicated to investing in IPOs, with assets under management (AuM) in the region of SAR400m to SAR500m. Fast forward to 2015 and there are now 13, with AuM of more than SAR2bn.”

Of the 13 IPO funds in the Kingdom, 10 have been established in the past year. They have proved to be strong performers. According to Bank Muscat, the average performance of Saudi IPO funds in the past three years has been 37% per annum. In each year between 2012 and 2014, Saudi IPO funds outperformed Saudi equity funds.

Investing in IPO funds offers foreign investors a way of circumventing the restrictions on investing directly in Saudi IPOs. By investing in the funds,

they are treated effectively as local investors. And already there are signs that foreigners see these instruments as a convenient means of capturing Saudi growth opportunities.

Ghoussous adds: “If you look at the plans that are in existence now, the larger funds are emerging from authorised persons for companies that have a foreign connection. For example, Kuwait Finance House has launched a Saudi IPO fund that has got SAR280m, while Audi Capital of Lebanon has SAR330m in its fund.”

Saudi investors can get direct exposure to the IPO rather than being forced into the fund structure. That means that for those asset managers whose target investors are local Saudis, IPO funds will not be the biggest priority, and most have existing funds that can already invest in IPOs as and when they come out.

According to EY’s Pau, foreign QFIs – subject to certain caps and limits – should get an opportunity to invest in the Saudi secondary market. “They will have the opportunity to allocate a larger proportion

“[A low issue price] was the Ministry of Petroleum’s and CMA’s way of ensuring that the Kingdom’s energy abundance is widely shared” Zeyad Khoshaim, Allen & Overy


iPOS

of their assets towards Saudi, which currently is somewhat limited and therefore the activity levels would be expected to increase in future.”

Institutional involvement

Above all, the CMA committed to bolstering the allocation to institutional investors. As George Hanna, the Riyadh-based head of asset management at Blominvest Saudi Arabia notes, the balance between the institutional and retail tranches, which used to be equal, will tilt increasingly to the former at the expense of allocation to the latter.

“Before, the institutional tranche would do the book building, the bidding and valuations, and they would come up with a certain price for the IPO. That has never been less than the highest price in the range,” says Hanna, whose firm has recently launched a Saudi IPO fund. “Retail would then take the price and claw back 50% of that from the institutional shares. But that is gradually being reduced.”

For recent IPOs, the retail component has been 40% rather than 50%, and the next ones are most likely to be lower still at 30%. This will whittle further until retail does not participate in the bidding process and will then invest in IPOs only through mutual funds or dedicated IPO funds.

The Saudi Arabia’s IPO pipeline outlook remains positive, with formidable inducements for companies to float their shares on the local market. Muscat Capital has identified 21 companies that are expected to launch an IPO in the next two years. These companies are also the ones that display the nascent dynamism of the Middle East’s largest market, and will doubtless attract the interest of foreign investors.

With large Saudi projects and privatisations in prospect, many foreign QFIs will be looking to the burgeoning stream of IPO funds to gain exposure to this important market. Further ahead, there may even be other avenues to secure involvement. But for now, the dedicated funds look set to play the key role. ✷

Documents

Saudi Arabia Capital Markets Guide PDF