Market reforms set Saudi Arabia for international investment

The latest market reforms in Saudi Arabia, which include the introduction of securities lending and covered short-selling, a migration from T+0 to T+2 trade settlement, and eased restrictions around foreign ownership of listed securities, will result in increased international investment in the country.

By Editorial
The latest market reforms in Saudi Arabia, which include the introduction of securities lending and covered short-selling, a migration from T+0 to T+2 trade settlement, and eased restrictions around foreign ownership of listed securities, will result in increased international investment in the country.

The Capital Market Authority (CMA), the Saudi Arabian regulator, issued a statement on May 3, 2016 confirming its latest agenda. The rules will be introduced before the first half of 2017, according to the CMA’s statement. This comes following a previous bout of liberalising measures in June 2015.

“We expect the implementation of covered short-selling and securities lending will attract additional alternative investors in the Kingdom. Even some large sovereign wealth funds (SWFs) are very active in stock lending – primarily as lenders of stock- in developed markets and we expect to see some of them becoming active on that front in Saudi Arabia as well,” said Irfan Hasham, chief operating officer (COO) at HSBC Securities Services, Middle East and North Africa.

While the 2015 liberalising measures were welcomed, they were limited in scope and did not address a number of operational challenges around investing into Saudi Arabia. Rules for foreign investors gaining exposure to listed securities on the Tadawul, the Saudi Arabian stock exchange, were eased last year.

Nonetheless, there were restrictions insofar Qualified Foreign Investors (QFIs) were prohibited from owning more than 20% of shares issued by an individual company, while a single QFI could not own more than 5% of shares in one company. The CMA also stated QFIs could not own more than 10% of Saudi Arabia’s overall stock market value.
This has since been revised with the 20% cap being scrapped, while the threshold for QFI ownership in an individual company has been increased from 5% to 10%. Foreign investors can now own 49% of the total Saudi Arabian stock market value as opposed to 10%. Furthermore, the assets under management (AuM) requirements for foreign investors have also been scaled down from $5 billion to $1 billion, added the CMA. The latter should enable niche and frontier asset managers to add Saudi Arabian listed equities into their portfolios.

The reforms came as international inflows into Saudi Arabia had reportedly disappointed. However, a number of market participants said at the time inflows into recently liberalised markets were often slow to begin with. “The opening of any market is a gradual process. We do not believe there was any expectation of a huge inflow of assets into Saudi Arabia on the day of the market opening. Foreign investors need time to study a new market and get comfortable with the operating environment. The changes announced are a result of feedback from the various foreign investors that have already registered,” added Hasham.

Perhaps the biggest hindrance for foreign investors was Saudi Arabia’s T+0 trade settlement process. This required transactions to be pre-funded, which often exposed foreign investors to counterparty risk at local brokers, a number of whom did not have sufficient balance sheet capital strength. T+0 also makes it very difficult to correct incorrect transactions prior to settlement although it is theoretically possible to back-trade. While custodians had introduced mechanisms by which to work around Saudi Arabia’s T+0 settlement time-frame, some clients erred on the side of caution.

“In the present model – even after the implementation of the independent custody model, foreign investors are exposed to the risk of the executing counterparty. We expect with the introduction of T+2, custodians will have the ability to match client instructions against the broker, and only settle the ones that clients have instructed,” said Hasham.

Other liberalising measures – in part a result of the precipitous oil price fall – have included privatisation of core industries and companies. It is likely that Saudi oil giant ARAMCO will have a partial listing of a 5% stake in what could accrue up to $100 billion. Some of the capital raised is likely to be handed over to a SWF. A number of asset managers are reported to be excited by this development. Furthermore, the Tadawul itself is likely to float around 2018.
The market liberalisation of Saudi Arabia has excited foreign international investors. Saudi Arabia is the largest economy in the Gulf Corporation Council (GCC) and accounts for roughly half of the $1.6 trillion Gulf economy. The Tadawul meanwhile has the largest market capitalisations in the Middle East at £278 billion, according to Thomson Reuters’ data, and it is one of the most liquid and diverse.

In terms of broader market liberalisation in the GCC, efforts are being made. Qatar and the United Arab Emirates (UAE) have introduced rules around asset safety and trade settlement, and were subsequently upgraded from MSCI’s Frontier Market Index to MSCI’s Emerging Market Index. Qatar is also looking to introduce securities lending and margin trading. Nonetheless, progress has been slow and the GCC is mired by a lack of regulatory harmonisation, which can stymie cross-border investment.

There have been calls for MENA economies to improve their market infrastructures and processes. “From a regional perspective, some markets in MENA need to improve the post-trade infrastructure including common settlement procedures for local and international investors, straight through processing (STP) between market intermediaries and the setting up of central counterparty clearing houses (CCPs). We are seeing positive steps being taken by exchanges and regulators in this direction,” said Hasham.

Corporate action processes in MENA are not harmonised and many rely on manual processes. A handful do not issue corporate actions in English, which can lead to errors. However, efforts are being made to address this.
The creation of CCPs is a controversial topic in MENA. There is limited over-the-counter (OTC) derivative trading activity in the region so some question whether building an expensive market infrastructure like a CCP is worthwhile. Others argue that without a CCP, which is line with international standards and regulatory best practices, an OTC market will not flourish in the region.