HSBC: Saudi market opening up

HSBC: Saudi market opening up

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Can you summarise the current Qualified Foreign Investors regime (QFI) in Saudi Arabia (KSA) and any impending changes?

Madhur: Since last summer, the KSA has introduced – or announced – a number of capital market reforms designed to improve institutional participation, and thereby facilitate both foreign and domestic flows into the domestic stock market.

The biggest shift came in June 2015, when the KSA regulator the Capital Markets Authority (CMA) introduced the new QFI regime. Investors from outside the GCC had for some time enjoyed the economic benefits of access to KSA companies through synthetic products. But from June 2015, for the first time, the QFI regime has provided qualifying foreign investors full legal ownership of KSA stocks on the Tadawul, the KSA stock exchange.

The rules initially covered banks, broker-dealers, fund management companies and insurance companies with AuM of $5bn or more, which could show professional securities management experience of at least five years and were from a qualifying jurisdiction. Once they had been granted a QFI license, subject to ownership limits, they enjoyed the same legal ownership and voting rights as domestic investors.

Since then, the QFI regime has been expanded and the new Rules For Qualified Foreign Financial Institutions Investment in Listed Shares (the Rules) were introduced for public consultation, which ended in July 2016. The Rules have now been finalised and published and will be in force from 4 September 2016.

KSA market access has been made easier by relaxing the eligibility criteria, with greater access to more categories of investors and with enhanced ownership limits etc.

The AuM eligibility criteria of $5bn has been reduced to $1bn. Investment funds can now access the Saudi market directly as QFIs, as opposed to QFI clients in the earlier Rules. Having been limited to holding no more than 5% of any listed stock, a foreign investor may now own up to 10%. The overall limit of QFI ownership in a particular stock, which was 20%, has been removed, thereby providing foreign investors significant headroom within the overall foreign ownership cap – which is retained at 49% though some companies may have a different limit

Also, the CMA recently announced that QFIs will also be permitted to participate in IPOs of KSA companies for the first time. Further evidence of the regulators’ policy of proactive engagement with investors has been the issuance of FAQ releases clarifying the Rules.

Given KSA’s shifting economic model, what is the context for these reforms?

Kapil: It’s important to note that these rule changes affecting capital markets are not happening in a vacuum. They are part of a wider set of market changes that form a new vision for the development of capital markets in KSA.

Although many of the reforms pre-date the thinking contained in it, the wider strategy of the changes is contained in the KSA’s Vision 2030, first detailed in April. This describes the proposed shift of the KSA’s economic model away from oil, which will fuel new foreign investment and place it on a trajectory towards real economic diversification by 2030. For capital markets this vision includes the desire to shift the investor mix from the current heavy reliance on retail investors to one more weighted towards institutions.

The government appreciates that progress towards better corporate governance is important to appeal to institutional investors.

Changes have included measures to combat conflicts of interest among company board members and requirements covering the duration auditors can serve. Recently, the CMA mandated that the IFRS reporting framework be adopted for all KSA-listed companies from 2017. Local authorised persons, meanwhile, are now required to publish financial statements on their websites.

Furthermore, steps are being taken around increasing the investible universe. Vision 2030 talks of increasing the IPO pipeline with more state privatisations, in part by bringing a greater number of government companies to market. The most visible example is the public article in January 2016 of a possible listing of Saudi Aramco. Also notable are the plans announced by the Tadawul to list in 2018.

What associated changes are occurring to the KSA’s market infrastructure?

Madhur: Critically, recent announcements have tabled fundamental changes in the KSA’s market infrastructure, notably around custody and settlement.

A proposed shift from the current T+0 settlement cycle to T+2 is one of the most notable examples. This introduces considerable relaxation of pre-funding and the associated costs of T+0 cycle. It is likely that the shift will go live in the first half of 2017. Given the size of the retail market, this is a considerable undertaking and it signals the commitment the regulator has towards client risk protection and facilitating greater alignment with institutional flows.

The second key shift in market infrastructure happened in 2015 around the introduction of an independent custody model (ICM), involving the segregation of investor assets from the brokers’, allowing institutional investors to appoint a custodian independent from the broker and also trade with multiple brokers while keeping a single custodian. For the vast majority of local providers, brokerage and custody were considered the front and back end of the same model, so customers could not effectively segregate the custody of their assets from the firms they employed as broker-dealers.

HSBC SA has been providing independent custody to domestic and regional institutional participants for some time. Under the new ICM, similar formal adoption of segregation should become more prevalent.

As well as greater protection, a key benefit of segregation is flexibility. Firms will be able to use any licensed custodian purely as a custodian, for example, with no commitment to employ that entity as an executing broker.

How popular do you anticipate segregated custody will be?

Madhur: It is already popular with certain segments of domestic and regional institutional investors. With the entrance of QFIs, the increase in foreign investor participation is likely to further increase the uptake of segregated custody. In the case of KSA public funds, it is now mandatory to have independent custody arrangements. In the case of family offices and other institutional investors, we expect to see the increased need for a custodian. There are growth opportunities for custody and the wider securities services platform.

New rules governing investment funds provide a further pillar enshrining independent custody. Local public mutual fund managers, licensed by the CMA, must now appoint independent custodians for their existing and upcoming funds. Adopting international best practice introduces an additional layer of governance over the fund in addition to that exercised by the fund manager.

Phased implementation means that all existing funds must appoint an independent custodian by April 2018. The new amended Investment Funds Regulations will be in force from 6 November 2016 and our expectation is that all new investment funds launched after this will be required to appoint an independent custodian.

Together, these changes evidence the regulator’s willingness to listen to market participants and implement best practices. The growing interest of foreign investors in KSA, partly due to these changes, is reflected in our business pipeline with the number of clients actively reviewing to join via QFI at multiples of the number that have been approved already.

What is HSBC’s role in widening of capital market access and how have your clients responded to the recent rule changes?

Kapil: Our role in this process is twofold. On the one hand, we funnel the views and sentiment of our investors around the world back to the KSA. On the other, we showcase the KSA story around our international network so that investors learn about the developments and are in a position to take advantage of them.

In both capacities, we have participated in the process of regulatory reform, helping realise the potential that these changes provide to our investors and contributing to the expansion of KSA capital markets.

HSBC Group’s (HSBC) global presence in custody and clearing and HSBC SA’s linkages with the wider group means we are in a good position to share our learning with the CMA. For our client network, we can disseminate the message quickly and clearly. HSBC’s strong relationships with global custodians mean that we are in a position to educate them and their clients. We have also participated in several roadshows in various locations to educate clients about developments.

The related benefit for investors considering taking part in the KSA is the extent of the services we provide locally through HSBC SA. HSBC SA has the full suite of licenses from the CMA and is able to provide equity capital markets, equity trading and sales, research and custody. All of these separate businesses are subjected to our high standards of segregation and Chinese walls, but translating to an integrated and end-to-end solution for those who need it.

Our strength on the ground in the KSA has allowed us to move very quickly when changes have resonated with our clients. Our integrated efforts meant that HSBC Global Markets, in its own capacity, was one of the first to get a QFI license and trade on the opening day in June 2015. Another fund manager, a sizeable emerging market player, was also able to go live with its investments as a QFI shortly thereafter.

This two-pronged approach – relaying investors’ sentiment to regulators and vice versa – is part of our best practice model when it comes to working in – and with – jurisdictions where similar capital markets expansion happening. It is similar to the role we played in markets including China in recent years and contributed to providing benefits to the local market as well for clients connecting to market opportunities.

 

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