Matthew Robinson: Why have the Saudi Capital Market Authority and Tadawul been seeking the greater participation of foreign investors in its capital markets?

Robert Eastwood: In response to the various concerns raised regarding the success of the regime for foreign financial institutions (QFIs) to date, the Saudi Capital Market Authority (the CMA) and the Saudi Stock Exchange (Tadawul) have been at pains to remind stakeholders that the introduction of foreign investors through the QFI regime was a focused initiative aimed at enhancing sophistication and accelerating development in the market whilst improving stability through reducing volatility; rather than simply adding liquidity or increasing capital flow. Specifically, the CMA anticipates that the participation of experienced foreign institutions in the Saudi market will result in knowledge transfer, enhanced shareholder activism, a demand for better governance and improved research coverage, amongst other benefits.

The CMA has equally stressed that joining global indices was a key objective and that the CMA would do all that is necessary to ensure that the Saudi market was well positioned for index membership. In this light, the recent revisions to the Rules for Qualified Foreign Financial Institutions Investment in Listed Shares (the QFI Rules) (on 4 September this year) which further ease foreign access to Saudi Arabia's capital markets are seen as a significant step towards this objective by improving the Saudi market's eligibility for admission to global indices.

MR: Why are the most recent updates significant?

RE: The revised QFI Rules significantly relax the criteria for the registration of foreign institutions and the various investment restrictions that they were subject to under the first iteration of the rules and signal a clear willingness on the part of the CMA to respond to the various concerns voiced by the investment community that the threshold criteria for approval and the extent of the investment restrictions were too severe.

Key revisions include the following:

1. Securities vs Shares

QFIs are now permitted to invest in "securities" providing much broader market access beyond just listed shares. This will enable QFIs to invest in the full range of products listed on Tadawul, such as exchange traded funds (ETFs), bonds and mutual funds, and possibly real estate investment trusts (REITs) once these are listed on Tadawul.

2. Eligibility Criteria for QFIs

The criteria regarding minimum "size of the financial institution" has been reduced from assets under management (AUM) of or equivalent to SAR 18.75 billion (around USD 5 billion) to SAR 3.75 billion (around USD 1 billion). AUM includes both assets held by the QFI applicant or its group as well as assets managed by the applicant/its group for the account of another person or persons but in the case of fund managers also includes assets owned by the external portfolio manager or it's group, for the account of another person or persons.

The list of institutions eligible to qualify as QFIs now also includes governments and related entities and the CMA has specifically reserved a discretion to approve any other financial institution which it "considers eligible" which signals the CMA's flexibility.

The regime also now permits investment funds to be registered directly as QFIs whilst allowing fund managers to continue in their role without the need to obtain a formal authorization from the CMA to carry on securities business in Saudi when engaging with QFI registered investment funds. Fund managers need only qualify as "foreign portfolio managers" under the QFI Rules, meaning that the relevant manager needs to be incorporated in a jurisdiction with regulatory standards equivalent to those of Saudi Arabia with at least 5 years' experience. Portfolio managers may also apply directly to be registered as QFIs in their own right.

3. Relaxation of Investment Limits

The CMA has significantly liberalized the investment limits for QFIs so that, apart from existing legislative and regulatory restrictions on the foreign ownership of certain listed entities (such as banks and telecommunications companies), the only applicable limits are as follows:

i.Each QFI may not own 10% or more of the shares of any issuer whose shares are listed (an increase from the previous limit of 5% which was calculated on the aggregate holding of the QFI and its affiliates).

ii.The maximum proportion of the shares of any issuer whose shares are listed that may be owned by all foreign investors (in all categories, whether residents or non-residents) in aggregate is 49%.

The previous restrictions which limited the total ownership of QFIs in any particular Saudi listed company to 20% and imposed an overall cap of 10% by market value on the holding by QFIs of all Tadawul listed issuers, have been removed.

4. AAP as Custodian or Broker

The New QFI Rules provide that CMA-licensed entities (each, an Authorized Person) wishing to operate as assessing Authorized Persons (each an AAP) must have custody license or a dealing license. Previously, the rules stipulated that AAPs required a dealing license only.

This clarifies that either a custodian or broker may occupy the role of the AAP under the independent custody model implemented by Tadawul.

5. Removal of Certain Ongoing Requirements

The requirement for annual submissions by QFIs of annual reports and consolidated accounts together with certain material information and annual assessments by AAPs has been removed and the timeframe for the notification of notifiable events has been clarified as being within 5 business days of the relevant event occurring.

MR: How might the revisions benefit local IPOs / new issuers?

RE: On 18 August 2016 the CMA confirmed in its announcement of the publication of the new Instructions of Book Building Process and Allocation that QFIs will be permitted to participate in IPOs via the book building process from 1 January 2017.

Whilst this means that issuers will now be able to approach an expanded the pool of institutions as part of the bookbuilding process, there may be several other potential benefits for Saudi issuers beyond access to foreign pools of capital.

QFIs with industry specific experience relevant to the issuer may provide valuable assistance in the price discovery process by virtue of their knowledge of similar entities in other jurisdictions, particularly where the issuer is in a sector without a significant number of listed peers.

Securing a well known foreign institution with established market credibility as an investor (particularly if it subscribes for the maximum allowable 10%) may also be perceived as a measure of "quality assurance" in the market which could have a positive effect on the valuation and attract the interest of other institutions.

QFI participation in Saudi IPOs will likely be conditional on the extent to which investment committees of the QFIs are able to get comfortable with the nature of the governance framework and systems for reporting and disclosure implemented by the issuer.

In addition, significant QFI participation would likely only commence following the Saudi Exchange's admission to one or more of the global indices.

MR: What future developments are in the pipeline?

RE: The Saudi market is currently experiencing an unprecedented phase of growth with several developments on the horizon.

Recent developments include a confirmation from the CMA and Tadawul that the Saudi market will migrate to a T+2 settlement cycle, which is expected to occur in mid-2017.

In addition, a draft framework for the offering of REITs as a new product on the market has been published for consultation, significant revisions to the current M&A Regulations (which regulate public takeovers) are expected to be published later this year and a separate market for small- and medium-sized enterprises (SMEs) is expected to commence operation early in 2017.

All in all, these further developments amongst others are likely to result in Saudi Arabia being characterised as an increasingly mature, dynamic and responsive market with legitimate claims for a place amongst the world's recognised investment markets.

To hear more updates about the Saudi rules for qualified foreign financial institutions, consider attending the Saudi M&A and Private Equity Forum on 16 November in Riyadh. Visit the website to find out more and how to book your place.

Matthew Robinson Event Director Acuris

Matthew is responsible for the content, production, marketing and operations team for custom events and conferences.