March 2018

Flow highlights recent initiatives that have made the Gulf Cooperation markets attractive destinations for foreign investors

In the past few years, Gulf Cooperation Council (GCC) markets have embarked on a journey to transform their oil-dependent economies into  ones that are more diversified, stable, long term and self-sufficient.

Saudi Arabia is one such market to take note of. The authority’s response to reforms has been to implement a bold policy of economic diversification. The reforms are being enabled through the government’s Vision 2030 programme, an initiative that puts privatisation of state-owned enterprises such as ARAMCO, the government oil conglomerate, and market liberalisation at its core. 

While a lot has been written about the partial floatation of ARAMCO, several other domestic large-cap quoted companies are also likely to go public, initiate dual listings or participate in depository receipt programmes over the next few years. The return potential for foreign investors in Saudi Arabia is strong, said Charles Cohen, director, head of securities services, global securities services, global transaction banking at Deutsche Bank in Saudi Arabia.

“The Tadawul has a market capitalisation of more than $450 billion excluding ARAMCO. Domestic equities are overwhelmingly state-owned, state-invested or state seeded, and only 43% of the TASI (Tadawul All Share Index) is free-floating. However, a number of domestic stakeholders want to divest in order to reduce their localised portfolio concentrations and chase global opportunities elsewhere, opening the market up for foreign investors,” commented Cohen.

The Investors Trickle In

Despite having the largest stock market capitalisation in the GCC, Saudi Arabia – until recently – has been an economy which foreign institutional investors struggled to penetrate - in marked contrast to its neighbours in the United Arab Emirates (UAE). Traditionally, foreign investor access to Saudi Arabian equities was only available indirectly through swap transactions with Capital Market Authority (CMA) authorised entities.

This insular approach to foreign investment is changing as a consequence of the challenging macroeconomic headwinds. “Saudi Arabia’s CMA first permitted qualified foreign investors (QFIs) to enter the market back in June 2015, and since then there have been two revisions to the rules making it significantly easier for institutions to gain exposure to domestic equities,” said Manoj Aidasani, head of GCC, Securities Services at Deutsche Bank.  The CMA’s decision to initially limit QFI admission to financial institutions with a minimum of $5 billion in assets also restricted flows. Market entry criteria was subsequently relaxed and made available to $1 billion + firms in 2016, although this was further reduced to $500 million in January 2018. Equally, the CMA’s previous insistence that QFIs have at least five years investment experience has been scrapped too. Cohen said he was confident that further liberalisation of the QFI rules would materialise over the course of 2018 and 2019.

QFI authorisation processes have been simplified. Previously, the Authorised Accessing Person (AAP), namely the custodian, assisted clients with the QFI application process and submitted the relevant documents to the CMA for authorisation. In January 2018, it was confirmed that AAPs – rather than the CMA - would become solely responsible for assessing whether an applicant qualifies for QFI status. Furthermore, the CMA said AAPs could place greater reliance on client KYC performed by third parties such as global custodians.  Both of these decisions will expedite QFI authorisations.

“Since 2015, approximately 120 QFI accounts have been created with around $2 billion invested. The flows have not met expectations and are trickling in quite slowly, but the initial entry requirements adopted by Saudi Arabia were very high. The easing of ownership limits and minimum asset thresholds and enablement of the streamlined approval process will help generate more foreign investor interest over the next couple of months,” explained Aidasani.

The early-mover investors have so far been quite mixed, comprising active and passive managers; sovereign wealth funds (SWFs); and prime brokers, said Cohen. “After historic false-starts, would-be investors no longer appear to be in denial about the direction that the Saudi market is taking and the smarter investors are now making their market entry arrangements. Among the investors who understand the challenges around Saudi market access, there is now a feeling of urgency and purpose in regards to ensuring arrangements are in place pre-ARAMCO listing and pre-MSCI Emerging Markets inclusion,” added Cohen.

Implementing new infrastructure

Saudi Arabia and the UAE are making decent progress and have implemented a number of reforms to their regulations and market infrastructure designed implicitly to draw in international investors. A T+2 settlement timeframe in both regions nullifies the requirement for counterparties to pre-fund their transactions and mitigates the risk of error trades. DVP (delivery versus payment), was also introduced, thereby helping to relieve some of the credit risk incurred on trades.

“Saudi Arabia has created an independent custody model, something which did not exist before. These rule-changes will help drive regulated mutual funds such as UCITS or 40 Act funds into the market. The CMA also announced last year that it would introduce additional safeguards to the independent custody model by allowing custodian providers to reject the settlement of unconfirmed trades,” commented Aidasani.

Efforts to automate post-trade flows are underway in both markets. Saudi Arabia, for example, is introducing SWIFT communication tools and integrating ISO 20022 compliant software into its systems in order to deliver maximum efficiency, a project due to complete in the second half of 2019. Again, this is a constructive market development endorsed by end investors.

Saudi Arabia and UAE are keen to assemble their market infrastructure to an international standard. “The UAE is expected to create a fully separate CSD (central securities depository) to its exchange while Saudi Arabia has launched EDAA (Securities Depository Centre Company) under the Tadawul’s umbrella, but operations are segregated,” said Aidasani.


“From a maturity perspective, the UAE has been in the Emerging Market Index for three years, so it is probably ready to launch a CCP. Saudi Arabia too is in the early stages of introducing a CCP. Saudi Arabia is an ideal CCP candidate because of its sheer market size, liquidity and trading volumes. Given the Tadawul’s market capitalisation, there is no real need for the country to wait to build a CCP,” said Aidasani.

The Rewards

A major objective of Saudi Arabia’s newfound liberalisation policies and infrastructure reforms is to secure inclusion in the MSCI Emerging Markets Index, a feat achieved by the UAE back in 2014. While the UAE historically adopted a fairly unrestrictive approach to external investment, its MSCI upgrade came off the back of a series of market infrastructure reforms, which brought the country into line with international best practices.

Following its upgrade, the UAE experienced strong passive and active inflows and Saudi Arabia is hoping to replicate this. Experts believe an announcement on Saudi Arabia’s MSCI inclusion will be made later this year, meaning it could take effect at some point in 2019 resulting in more than $50 billion of foreign capital flows entering the country.

“In the short-term the recent capital market reforms and the current reform agenda should be sufficient to see Saudi Arabia included in the MSCI Emerging Markets Index in 2019. This will be a windfall for any Saudi quoted company included in the index,” said Cohen.

“Deutsche Bank is present in the Saudi and UAE markets for over 8 years and is ready to support Clients as the market opens up further, we have repeatedly demonstrated that entry and transitions in the GCC markets are doable and are managed efficiently with the assistance of our team on the ground, we have ensured we are here when our Clients need us,” said Aidasani.

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