Saudi QFI scheme slowly gets off ground

There have been noticeable capital inflows into Saudi Arabia following the recently enacted Qualified Foreign Investor mechanism although it will take time to reach its full potential, according to HSBC Securities Services.

By Editorial
There have been noticeable capital inflows into Saudi Arabia following the recently enacted Qualified Foreign Investor (QFI) mechanism although it will take time to reach its full potential, according to HSBC Securities Services.

The Capital Market Authority (CMA), the Saudi Arabian regulator, allowed QFIs to access the country’s securities markets in June 2015. QFIs must have at least $5 billion in assets, five years’ experience in the securities industry and be located in a country which meets regulatory equivalence.

There was initial excitement about the opening up of Saudi Arabia, which is the 19th biggest economy in the world and the largest in the region, comprising roughly 50% of the $1.6 trillion Gulf economy. The country’s stock exchange – the Tadawul – is very liquid and diverse, with a market capitalization of approximately $590 billion.

“There was huge optimism that billions of dollars would flow into Saudi Arabia immediately when the market opened up. That did not happen, which disappointed many. But it is their misplaced optimism that is to blame, not the way the market opened,” said Arindam Das, regional head for HSBC Securities Services MENA, speaking in Dubai.

Market participants must be cognizant that when any market opening occurs, it takes time for investors to understand the rules and entry requirements, such as ensuring documentation requirements and applications are submitted correctly. Saudi Arabia is certainly no exception to this rule.

At present, only a handful of large foreign investors have attained QFI status. Ashmore Group and Blackrock, for example, recently became QFIs and used HSBC as local custodian. One factor behind the slow uptake is that foreign institutions can already gain exposure to Saudi Arabia’s securities markets through total return swaps, which has diminished the sense of urgency.

Furthermore, there are restrictions on share ownership by foreign institutions. QFIs cannot own more than 5% of a single issuer’s listed shares while aggregate QFI ownership of a single issuer’s listed securities cannot be more than 20%. QFIs’ exposure to the entire stock market value cannot exceed 10%.

Das, however, said the ownership limits were not that onerous, and barely different from other emerging markets. “The limits become problematic when foreign ownership is nearing the threshold in given securities and a bottleneck emerges. This has not happened in Saudi Arabia yet, and as such, the CMA probably feels no obligation to increase the limits at this point of time,” he said.

Nonetheless, the registration process can be quite laborious. “The documentation to become a CMA registered QFI could be made simpler. However it is reassuring to note that it has already become simpler since the market opening, and the CMA has said that it will assess further requests on a case by case basis,” said Das.

There is speculation Saudi Arabia could be upgraded by MSCI from a Frontier Markets Index to an Emerging Markets Index, which could facilitate huge inflows from passive funds, a point made by Das. Furthermore, Saudi Arabia has made impressive reforms to its custody model meaning investors can now appoint an independent global custodian when transacting in Saudi Arabian securities instead of relying on local brokers, which posed a counterparty risk.

Perhaps the biggest impediment is that Saudi Arabia operates a T+0 trade settlement time-frame meaning transactions in Saudi Arabian securities must be pre-funded. “This is an issue but it is important to note that the Saudi Arabian Riyal is pegged to the US Dollar, meaning that currency fluctuations are not an issue nor are there any capital account controls on convertibility and repatriation,” said Das.

There are also mechanisms by which foreign investors can utilize a Saudi Arabia-based bank to provide credit facilities enabling a longer settlement time-frame and negating the need to pre-fund. In other words, an international broker can obtain a credit line from a Saudi Arabian financial institution and settle in T+0 for a client transaction, and then subsequently settle outside of the market with the client or through a sub-custodian on a T+2 or T+3 settlement cycle, a point made in “Saudi Arabia: The International Opportunity Arrives” – a white paper published by HSBC.

Critics also point out that Saudi Arabia lacks credible market infrastructures. Indeed, there is no central counterparty clearing house (CCP) and the country’s central securities depository (CSD) is under the same ownership structure as the stock exchange.

Das said this was not an issue, particularly around the lack of a CCP. “The Saudi Arabian market is a pre-validated market. There are system checks to ensure the buyer has cash to purchase the securities, while there are checks to ensure the seller possesses the securities to sell. Furthermore, there is no over-the-counter (OTC) securities market,” highlighted Das.

Saudi Arabia is certainly promoting itself on the international stage. Senior executives from listed Saudi Arabian corporates are conducting investor roadshows in major financial centres including London, New York and Singapore.

The opening up of Saudi Arabia comes as other regional players such as the United Arab Emirates (UAE) and Qatar saw their markets upgraded to the Emerging Markets Index from the Frontier Markets Index by the MSCI facilitating huge inflows.

There is also speculation that Iran could see inflows if US and EU sanctions are lifted. It has been reported institutional investors have been surveying the Iranian market although a number of banks have refrained as sanctions remain an issue.