Euromoney: Saudi after five years of CMA licensing

Euromoney, May 2011

One of the many initiatives that would follow the establishment of the CMA was a requirement that all Saudi financial institutions hive off their asset management, brokerage and investment banking units into separate entities, and in the wake of that it set about issuing new licences both for established players and new ones who wanted to set up these investment units. It swiftly became clear that it was going to issue plenty of them. From eight authorised persons – the formal title for licensed bodies – at the end of 2005, there were 45 by the end of 2006, 80 by 2007 and 110 by the end of 2008. A peak was hit that year – 12 more were issued in 2009, but 12 more revoked, leaving the final number the same – and while the CMA does continue to issue new licences, such as to Lazard Saudi Arabia last June and QInvest in January, today the AP list runs to a more modest 92 and is expected to come down from there.

So far this year, far more CMA announcements have been about cancellation of licences than issuing of new ones. Financial Transaction House, which grew out of the corporate finance arm of Anderson Worldwide and was one of the very first to be licensed in June 2005, had its authorization as an arranger and advisor on securities cancelled in April; Assets Financial House Company, another early licensee back in 2006, went the same way in March; and Arab Experts Capital and Kuwait’s The National Investor had their licences cancelled in February. In each case, the CMA said this was at the company’s own request. Elsewhere there is consolidation, such as the merger of CAAM Saudi Fransi and Calyon Saudi Fransi into Fransi Tadawul, which was then re-named Saudi Fransi Capital. The whole thing is affiliated with Banque Saudi Fransi, which in turn is 31.1% owned by Credit Agricole. Others are amending their licences, such as GIB Capital, which in April had its Dealing as an Agent licence replaced with a Dealing as a Principal and Underwriter licence.

Further consolidation is seen as inevitable. “There are way too many players at this point,” says Jawdat Al-Halabi, CEO of NCB Capital. “The market is big enough to manage a good number of players, but the issue is that from my perspective everybody wants to do everything. That is not sustainable and I believe we will see consolidation and a rationalization of services.”

“When the split between the commercial banks and investment banks took place, it was followed immediately by the crash,” he adds. “So most companies, still in start-up mode, faced an extremely difficult time.” If, as some expect, the minimum capital levels are increased for the investment banking industry – they’re already high by international standards on the commercial banking side – then that is likely to thin the field further. “It will remain to be seen if every player is willing to commit additional capital, because that’s going to require a return,” says David Dew, CEO of SABB.

Five years on from the beginning of the new licensing process, Euromoney asked three CEOs of investment banking businesses spun off from established heavyweights how the market had changed for them, and where the opportunities lie today. In some sense these are the groups that had it easiest: they had established businesses to start with, and they could continue to use the branch networks of their affiliated commercial banks as a way to source customers.

NCB Capital, for example, came out of National Commercial Bank, and was the first investment banking arm of a local institution to be approved by the CMA in 2007. Among other things, this group was behind the Al Ahli mutual fund range, which remains the biggest in asset terms in Saudi Arabia and the region as a whole; all told NCB Capital now has over a million clients and US$15 billion under management. Al-Halabi likes to believe that “we do not rely on what we had from our parent,” and points to new funds and a discretionary portfolio management business that have been built since separation, but acknowledges “NCB were the pioneers of this business.”

Correspondingly, wealth management is the biggest growth area for NCB Capital, including asset management and wealth advisory. “We are the Kingdom’s largest manager of wealth and this is where our greatest opportunity is today,” Al-Halabi says. He also sees potential for growth in brokerage, and in underwriting sukuk issues. “It’s still a nascent market but the need to issue sukuk to finance projects and companies is growing, and there aren’t that many players focusing on that.”

Al Rajhi Capital came out of Al Rajhi, the largest Islamic bank in the world by assets. Its CEO, Gaurav Shah, tries to develop his asset management, brokerage and investment banking businesses in tandem. “The challenge for me as CEO is to ensure that we have the right business mix: enough stable annuity income from asset management and brokerage, with a healthy business pipeline within investment banking side, which is more deal-focused,” he says.

Another house with a long-established asset management business – he puts the group’s market share in Saudi Arabian mutual funds at 9.2%, with a near doubling of assets in the last two years – Shah also sees this as one of the key areas for growth. “Diversifying the client base is very important, and there are emerging new clients,” says Gaurav Shah, CEO of Al Rajhi Capital. “If you look at the west, insurance is the backbone of the asset management industry; it’s still an emerging sector in Saudi Arabia. I’m very positive about the contribution of this sector to the growth of the local asset management industry.” Al Rajhi has made a point of trying to bring international appetite into Saudi Arabia too, and launched a Saudi equities fund in Luxembourg recently on the Credit Suisse platform.

Another theme is diversification by asset class and product. “To achieve greater diversification and predictability of returns, you need a developed fixed income or sukuk marketplace combined with a multi-asset class approach to investors. It is essential for product providers such as us to offer investors this choice and a more diversified offering,” Shah says. He sees the biggest challenge in asset management not so much as other competitors, but the nature of investors themselves. “When 10 to 12 companies account for 60 to 65% of market cap, a lot of investors feel they can invest on their own. Building a managed investment culture, which asset management provides, takes time.”

To Shah, investment banking has some distance to go, though he feels advisory is a growing trend. And he believes opportunities are growing in institutional brokerage rather than just the retail area that has been the focus to date.

And what of Islamic? Al Rajhi is one of several purely Islamic banks in Saudi Arabia, and is often considered to be among the most strict Islamic institutions in the world in terms of compliance. It’s clearly a point of difference but Shah is keen to avoid that being the only selling point. “We compete with conventional and Islamic banks based on our products, people, processes and the risk-adjusted returns we aim to generate on a long-term basis,” he says. “Competition is always fierce and the product selection is always based after benchmarking with the entire industry – Islamic and conventional.”

Nevertheless, the momentum of Islamic finance in Saudi Arabia is overwhelming, particularly on the retail side (HSBC estimates 80 to 90% of retail banking product is now Islamic); with every passing year it becomes a more dominant force in the mutual fund industry. And providers say it is becoming an institutional story too.

HSBC Saudi Arabia was in the first round of newly licensed entities under the CMA, spun out of SABB, which was formerly known as Saudi British Bank. HSBC owns 40% of SABB; SABB in turn earns 40% of HSBC Saudi Arabia, and HSBC the other 60%. Walid Khoury, the chief executive of that business and formerly SABB’s treasurer, is building the business on the foundation that HSBC is both a global institution and one with a long-standing historical attachment to Saudi. “The mission as we view it is to bring international expertise to Saudi Arabia, and bring international connectivity to Saudi customers through our network.”

Khoury believes that “the deal flow does not justify that very large number” of APs in Saudi Arabia, and expects M&A among them. He notes that “the premise from which a lot of APs started – being everything to everybody – is not tenable in the long term.”

For institutions like these, it will be interesting to see how the internationalisation of the Saudi capital markets continues in years to come. It has already opened some distance: until recently foreigners could only get access to the Saudi stock market through mutual funds, and even then were restricted. Now a swap arrangement allows for synthetic exposure to Saudi securities. “In coming years there probably will be an opening,” says Khoury. “Right now foreigners can have access to the Saudi stock market through swap products, but a lot of fund managers cannot use these instruments because they are deemed as derivatives. They have to have direct access, and we believe over the next few years that will happen – with some rules, of course, like in some other markets around the world.” When it happens, Khoury says, “it will bring new institutional money, and more stability, as this money will be sticky if it is coming from long-only managers.” From that would follow entry into world stock market indices, a corresponding weight of capital, and a great deal more business for the brokerage operations of all these competing operations in Saudi.

Al-Halabi says “the opening of the market is a great thing and will expand the opportunity here,” but adds: “doing it gradually is in my view very prudent. You don’t want to create chaos in the market. We know the CMA is heading towards more openness, but you will not see it all in one go.”

At the same time, domestic institutions are becoming increasingly savvy. The Saudi Arabian Monetary Agency, the country’s central bank, fulfils some of the roles of a sovereign wealth fund but is generally conservative and fixed income-dominated in its allocations. But newer state investment entities, such as the endowment fund of the King Abdullah University of Science and Technology, are already becoming known for a sophisticated approach to questions of asset allocation and investment technique. Much of this capital will flow overseas – indeed, the whole business model of many of the foreign businesses licensed by the CMA is to assist it in doing so – but the increasing savvy of local capital ought also to support the sustainability of the industry.

For the long-standing commercial banks, less has changed. “The pace of change in commercial banking is slower than in the investment banking arena,” says Dew. There are some relatively new players – Bank Al Bilad and Alinma Bank being the main ones – while some subsidiaries of foreign banks are attempting to enter wholesale banking and develop corporate and treasury businesses, catering for the biggest companies in the country. “So there’s some level of increased competition for sure, but not as extensive as on the investment banking side.”

Here, too, the sense of growing openness is a prompt for growth. Dew is on a second stint in Saudi having been chief operating officer from 2001 to 2004. “There is no question from an economic perspective Saudi is now more open,” he says. “Trade and investment flows in both directions are significantly stronger and the core economic strategy of the country does make a huge amount of sense.” That is, at its core, an oil and gas story, with an increasing downstream element in petrochemicals, but increasingly mining and minerals are being developed along with financial, shipping and other supportive sectors. “The economy is playing to its strengths and engaging with the rest of the world on its own terms,” he says.

Across the board, there is pressure on headcount. One person who used to work at an executive level in Saudi Arabian banking considers this the biggest problem the industry faces. “The banking system remains shambolic,” he says. “There are poor levels of human capital, very high staff turnover, and high levels of absenteeism and lack of engagement, driven by Saudization [a national policy to increase local Saudi employment in the private sector], generous pensions and CMA requirements for qualified staff.” This last, he says, “should be good, but it has ignited a bidding war for the very small pool of talent. And the Arab Spring is likely to further deter new talent arriving without further pay rises.”

While bankers on the ground today agree that competition for talent is still intense, many feel that it was at its worst when the new licences were being awarded en masse between 2006 and 2008, not now. There is also widespread agreement that the talent pool is better than people think. “In Saudi there is a huge focus on education,” says Shah, “with very, very bright local Saudi talent. You have to compete to retain people, but that’s not special to Saudi: you have to create the right work culture, training opportunities and sophistication of product so you are where everybody wants to work.” Khoury at HSBC says “there is very strong competition and a strong bid for Saudi talent”, but says firms like his have developed programs to grow the available pool, hiring graduates fresh from universities and training people “to make the leaders of tomorrow. Salaries and packages have evolved normally; they’re not that different from what we might see elsewhere.” David Dew on the commercial banking side at SABB says “we continue to get a reasonably good supply of Saudi graduates: the quality is good and probably getting better every year. We do see that as talent emerges it has more and more opportunity; people can move up fairly quickly and can begin to command pretty attractive packages. The starting point hasn’t changed a great deal, but competition for talent and the leaders of tomorrow is quite intense.”

Al-Halabi agrees. “The key issue is to have the right environment for our people, their development and training, and the right compensation for the team,” he says. “New entrants with deep pockets can buy anybody. But if we, as an industry, want the financial sector to grow and be successful, everyone should be willing to invest in developing local talent.”

BOX: Saudi and regional unrest

As soon as it became clear that the protests in Tunisia and Egypt were spreading around the Middle East, investors started casting a nervous glance towards Saudi Arabia.

“The biggest risk to the market is the possibility of political unrest reaching Saudi Arabia,” says Joe Kawkabani, chief investment officer for MENA equity at Franklin Templeton Investments in Dubai. But his fears – from the perspective of investor stability – haven’t been realised. Pro-democracy campaigners announced intentions to protest on Facebook, attracting thousands of followers, but fewer turned up for protests on the ground. Subsequent attempts have attracted fewer and fewer people. The government tightened security, and – crucially – religious scholars issued statements outlawing protests in the country as unIslamic. “It’s important to note the big role the army and clergy play in the country,” Kawkabani says. “When the government, army and clergy are aligned, it’s very hard to implement change.” Behind the scenes, King Abdullah also held meetings with tribal chiefs, many of whom subsequently pledged allegiance.

To cement all this, on March 18 the King announced a series of measures designed to head off any dissatisfaction before it got going. He set a new minimum wage of R3,000 (US$800) for all Saudis – a 38% increase; announced a bonus of two months wages to all government employees and students; new unemployment benefits; 60,000 new jobs in the military; and funds to construct 500,000 new social housing units. In total, it has been reported that these measures involved some $93 billion of spending. And this all followed $37 billion of handouts the previous month. “The reaction on the streets was overwhelmingly positive,” says Kawkabani. “The next day was a public holiday and people were driving around waving pictures of the king.”

None of this is the democratic reform that has been called for in other Middle Eastern states, but it appears to have been enough to keep the population content for the moment, and does have broader economic knock-on effects. “It’s beneficial to the economy and will promote consumption and bank lending,” says Kawkabani. “The only downside we can see is wage inflation across the country.”

With a soaring oil price and foreign exchange reserves of over $400 billion, it’s not hard for Saudi to spend its way out of trouble. And few on the ground feel any sense of political change. “What’s happened in the region in the last three months does impact investor sentiment, but we strongly believe the fundamental outlook and trend over the next four to five years in Saudi Arabia remains solid and has not changed,” says Shah.

Al-Halabi agrees. “With all these things that have been happening around us, I was worried we would see flight of capital,” he says. “On the contrary, we have seen little of that.” And Dew at SABB speaks of “a mood of cautious optimism and stability. There are headwinds but there are more reasons for a positive than a negative outlook, and the sense is that is mirrored by our customers.”