In order to encourage foreign ownership to invest in Saudi listed companies, the Capital Market Authority published a draft of its regulations for consultation on 21 August
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2014. The consultation period was continued for 90 days, ended on 20 November 2014 (CMA 2016). The official spokesman for the Capital Market Authority, Abdullah Al- Qahtani, said in that period the commission received more than 500 notes from 33 local and external investors. The internal agencies were from government, legal offices and individual investors while feedback from the foreign entities came from banks, brokerage firms and fund managers (Minshawi 2015).
Unpublished feedback on the draft of Rules for Qualified Foreign Financial Institutions Investment in Listed Securities for consultation in 2014 was provided to the research by an internal source in the Saudi Capital Market Authority. The feedback aimed to assist the researcher to clarify the differences between the first draft and what was published in 2015 and emended in 2016.
For the sake of convenience, the feedback has been divided into three groups based on the type of their opinions and questions which are; sufficient, insufficient, and somewhat sufficient or agree, disagree, and somewhat agree. Also, the feedback was related to the following points:
1. The type of financial institutions
The first group considered that the existing rules including the type of financial institutions were sufficient and would help to achieve the following:
A. Increase an institutional investments in the market;
B. Allow them to take medium to long term investment decisions which would reduce speculation; and
C. They would depend on market research and deep evaluation in the process to take investment decisions.
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On the contrary, the group who disagreed with the draft believed that the types of financial institutions were limited argued that the regulations should allow all types of foreign financial institutions. However, the third group argued that the type of financial institutions should include sovereign wealth funds and central government agencies but not all types of foreign investments. They added that for several reasons working with asset managers would assist in developing corporate governance, reporting and global best practice.
2. The size of the financial institution
The size of the financial institution was a big topic in the feedback. The first group opposed this condition and considered that USD$5bn was too high of foreign financial institution. At the same time, they suggested that decreasing the size of the institution to be USD$5bn would be good at this stage in opening the Saudi stockexchange market. Another group believed that the rules about size were in somewhat sufficient, but that size should not be the criteria for registration. At the same time they argued that opening up the opportunity for less institution could increase the number of applications. They suggested that a size of USD$1- 3bn would comply with other registration rules. Based on their opinion, larger financial institutions would be able to meet the Saudi regulations requirements. Therefore, a downward revision would encourage smaller financial institutions to access the Saudi stock exchange market. It should be added that the Capital Market Authority at its discretion can reduce this entry requirement which would promote more institutional participation with a high quality in the market as well as reduce the impact of retail investors on the market. It is worth noting that no one agreed that the size of financial institutions was sufficient.
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Most of the feedback considered the minimum of five years of investment experience was reasonable for a start. Based on their opinion, this minimum is to insure that they are stable and have enough experience. As the Saudi policymakers aimed to achieve global best practice, global experience would guide them in this regard.
4. QFI and QFI Client conditions
The group who agreed with existing conditions believed that they will add more transparency to QFI investments. The second group partially agreed and argued there should be more details in the rules and regulations to clarify its description. The final group disagreed with the differences between QFI and QFI Client conditions, arguing that the QFIC should have fewer restrictions as long as the QFI is already registered. They pointed out that the majority of pension funds around the world are valued at less than $3 billion. In the meantime, they cannot rely on their investment manager to help them meet the QFIC entry criteria. In other words, the usual strategy of pension funds is to allow a 5-10% weighting for emerging and frontier market investments and they invest in several markets around the world. However, with the current conditions it seems that they would not be able to join the Saudi Stock Exchange.
As part of this discussion, the current rules allow a QFI Client to haveonly one QFI which may limit investor interest in the Saudi stock exchange market. The group who disagreed with this point argued that perhaps the limitation will lead to well diversified investment. In the group that somewhat agree, although it may require more clarification, QFI Clients should be classified as a QFI allowing them to appoint multiple asset managers. The third group who agreed with this argument assumed that this condition may prove to be a major challenge for several large asset owners such as sovereign wealth funds and pension funds who usually prefer their assets being
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managed by multiple asset managers. Thus, there should be no limitation on whether a QFIC employs one or more QFI to manage its funds.
5. QFI Registration Procedures
The feedback on registration procedures has considered the reasonableness of information and documents required. The first group believed that the requested documents and information were reasonable as the Saudi authorities intended to provide comprehensive information. The procedures may reflect the transparency of the Saudi market as well as increase protection of local investors. The somewhat reasonable group indicated that these procedures seem to be sufficient, but were onerous and some clients could not meet all the requirements. Therefore, they suggested that the Capital Market Authority should require the documents based on the type of entity or nature of business, particularly the trust clients like endowments. The final group believed that these procedures were excessive based on comparing registration procedures for their investments in most other markets. For instance, providing information on affiliates and beneficial ownership of funds was considered to be challenging.
In terms of identifying the most difficult information and documents that must be obtained by the applicant, details of legal or regulatory sanctions and details of the identity and ownership of each controller were in the top of these challenges. This was particularly so in the latter case when applying for QFIC, because domicile investment funds in some countries such as Luxemburg or Switzerland rely on secrecy laws. In instances such as this, providing details of the ultimate controllers or who is behind the nominee owners is nearly impossible.
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In some feedback it was expected that the procedure should be quite easy, although, the rules did not provide much details about opening an account with the depositary centre. It is noteworthy that most of the feedback considered the procedure to open an account with a depository centre and itsdocumentation requirements were very easy.
Generally speaking, it could be said that most feedback noted that the SAMA requirements to open such accounts were compatible with the minimum regulatory framework that is usually required for bank accounts. The procedures are required to apply for both local investments and foreign investments. In some feedback, the SAMA’s procedures for opening an investment account for foreign investments institutionsneed in some instances more time to complete. As an example, most of the documents that got approval from the CMA were required again from SAMA to open investment cash accounts for financial institutions. Thus, getting approval from the CMA should be sufficient in order to avoid time consuming paperwork. It should be noted that some of the information and documents required by SAMA are in some cases difficult to obtain. The feedback provided an example of such nearly impossible requirements: as point number 5 in circular 400-4 of SAMA rules requires identification of the actual beneficiaries and final controllers with a minimum natural owner who holds 5%. The reasonable reason behind the difficulty is that investment funds in several developed markets do not permit the disclosure of owner information. In addition, many of funds are open ended funds in which the shareholders register changes every day.
7. Investment limitations
The group that generally agreed with the limitations believed that they are warranted, but suggested that the Capital Market Authority can add more flexibility to QFI’s by
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increasing the single limit for QFI and related clients (5%) to reach (10%). The limitation of more than one QFI and approved QFI clients is set at 20% whereas for all QFI and Swaps together is set at 49%. As a result of that limitation, foreign investors would prefer to invest through the swap route. Another group believed that the single and total ownership percentage of QFI and approved QFI clients are the greatest obstacle to the success of the current regulations. They anticipated that all current limitations would be detrimental to the Saudi equity market as it is not able to include the MSCI. Moreover, the maximum proportion of QFIs and approved QFI clients to be 10% by market value including any interests under swaps is not necessarily a limitation as it renders the size of Saudi Stock Exchange market less relevant compared to other stock exchange markets. Based on these estimates, if the Saudi regulators waive those limitations this could potentially lead to flow of foreign investment in the near future.
8. The settlement cycle
In regard to knowing if the settlement cycle might impact on foreign investors applying to become QFIs and QFI Clients, most of the groups agreed that it would affect the influence. They suggested that the settlement cycle should be changed from T+0 to at least T+1 or T+2 for the QFI and their clients. The T+0 market effects the ability of investors and asset manager to manage cash and that investors may miss an investment opportunity because they do not have enough sufficient in the cash account.
It could be summarized that the most obstacles in the rules related to the size of financial institutions and investment limitations. Although these constraints were mentioned by some foreign investors, they had not initially been addressed. Therefore, the final rules in 2015 were almost similar to the rules draft that issued in August 2014. However, during 2016 the Capital Market Authority amended its regulations. The most
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important changes are outlined in the next section. The feedback discussed above was addressed by the Capital Market Authority in the amended rules 2016.