With Saudi Arabia expected to welcome more foreign investment in its securities market, Nicholas Pratt examines the asset servicing landscape and where changes could be made.
Saudi Arabia’s stock market, the Tadawul, has long been the dominant presence in the Mena investment landscape and there are now signs that it wishes to attract more overseas and institutional investors.
Talk of reform that may end its previous insularity was sparked by a report, Economic Reform in Saudi Arabia, conducted by the King Abdullah Research and Consulting Institute and published in January 2012.
Noting that foreign direct investment (FDI) grew from $475 million annually between 1994 and 2004 to $25 billion between 2005 and 2010, the report concluded that more diversity of investors would improve Saudi Arabia’s global competitiveness.
The study focused on the work of the Saudi Arabian General Investment Authority to develop investment systems and procedures for both domestic and foreign investors. It cited favourable remarks from the World Bank on the safety of its procedures and the ease of local access to Saudi investment.
Nevertheless, the level of FDI in the country is still relatively low. The $25 billion mentioned above represents only 0.9% of net outflows and the processes and systems within Saudi Arabia’s securities market are not up to the technical standards of other Gulf states or Western Europe and North America. Consequently, the Capital Market Authority (CMA), Saudi Arabia’s securities supervisor, is considering what practical steps would be needed to foster more international institutional involvement in the securities market.
The asset servicing industry may well have a large role to play in internationalising capital markets and the Saudi Arabian funds industry, though a lot of questions still remain for global custodians.
Because of the high retail focus, custody is still dominated by domestic providers. If the CMA wants to attract more international and institutional investors, will the bricks and mortar presence of a number of global asset servicing firms be a necessity?
And what kind of fund services will be needed in the Saudi market? Will this vary significantly from other Gulf Co-operation Council states, or will asset servicers already operating in the United Arab Emirates (UAE) or Qatar simply be able to extend their existing offering?
Global involvement
The most prescient issue though, according to Yong Wei, who heads up the Mena equities desk at Emirates NBD, is how quickly any changes will be made and to what extent Saudi supervisors, like the CMA, will be willing to let the market liberalise.
“There has been nothing explicit or overt from the Saudi regulators regarding the opening up of the Saudi stock market, but in their last announcement they stressed that they do not want to do anything that will overly upset the market,” says Wei. He believes greater international institutional involvement would be positive for the Saudi market and could lead to less rather than more volatility.
As is typical with emerging and frontier markets, the majority of liquidity comes from retail investors investing directly into the equity markets. Whereas retail investors tend to make more sentiment-driven trading decisions which can create volatility, institutional investors would be more inclined towards economic fundamentals and this could lead to more accurate pricing. Similarly, the involvement of a limited number of hedge funds or momentum-based traders may actually create more stability by increasing the diversity of participants.
Settlement cycle
“It is always good for a market to have different influences and a diversity in the money supply, but there is a question as to how it is done,” says Wei. “For example, do the regulators impose a blanket level in terms of foreign ownership of stock or do they have a separate limit for each company [as is the case in Qatar and the UAE]? And if it is the latter, who will decide what those limits should be?”
Concentrating on more operational concerns, Wei believes the settlement cycle in Saudi will have to be addressed if global custodians and asset servicers are to be more involved. “The Saudi market is based on T+0, or same-day settlement at the moment, which is not something that all custodians or brokers would go for, so some compromise would have to be made.”
T+0 is used in order to prevent investors making speculative calls with money they do not have, but it also prevents brokers offering investors short-term credit for the duration of the settlement cycle as is the case in the T+2 or T+3 settlement cycles employed in other markets.
Wei says: “I don’t envisage the settlement cycle changing overnight and there have been no official announcements made. But if there are changes, this would mean new arrangements for domestic custodians and brokers with bigger books of business and the introduction of counterparty risk limits but less onerous changes for foreign brokers or custodians.”
Changing the operational processes of Saudi Arabia’s securities market in a way that favours global custodians and brokers at the expense of their local counterparts would be a radical move in any market, but especially so in Saudi Arabia where some people believe that US and UK banks are still unpopular enough for the likes of Saudi American Bank and Saudi British Bank to change their names (to Samba and SABB, respectively).
The asset servicing landscape in Saudi Arabia is very different from its neighbouring Gulf states in that there is far less of an international presence. The largest global custodian in the kingdom is HSBC, which merged its Saudi investment banking business with SABB Securities, the brokerage and custody business unit of the Saudi British Bank in June 2011 to create HSBC Saudi Arabia.
Deutsche Bank is the other global player offering direct custody services into Saudi Arabia’s stock exchange, a decision that was made partly on the strength of the Tadawul’s increased openness back in 2010. For example, the introduction of exchange-traded funds and swap agreements. Meanwhile, BNY Mellon, the world’s largest asset servicing firm, has no operations in Saudi Arabia nor does it have any plans to open any in the near future.
Given that further reforms are expected, one might expect more international custodians to join the likes of HSBC and Deutsche Bank. Citi was previously offering direct custody services through its 20% holding in Saudi American Bank (now known as Samba Financial Group) but sold its stake for $760 million in 2004. At the time, Citi’s decision was motivated by the bank’s strategy of focusing its investments in markets where it has majority control of the banks it owns. Tellingly, though, a 20% share in Samba in 2012 is worth more than $3 billion.
This encapsulates the concerns that global custodians and other international service providers will face when weighing up whether to expend any energy in establishing a Saudi Arabian entity. The regulators are likely to move slowly and cautiously. Making general soundings about the practicalities of reforming the market could still mean that any new rules are a while away yet.
But such is the size of the Saudi market, that the potential rewards on offer could well wipe away any regulatory, administrative or operational concerns.
©2012 funds global