Saudi’s financial revolution

Asiamoney, April 2008

A financial revolution is underway in Saudi Arabia, and it is going to change the country’s financial services industry beyond recognition. But foreign banks differ widely in the approaches they are taking to participating in this new opportunity: some value partnership, others want to go it alone.

This revolution dates back to June 2003 and the foundation of a new regulator, the Capital Markets Authority. Until the CMA came along, the financial services industry had been overseen by the Saudi Arabian Monetary Agency, the country’s central bank, an institution tasked with issuing national currency, managing foreign exchange reserves and conducting monetary policy. With much on its plate, its attitude towards investment banking and asset management, and in particular foreign involvement in those areas, was perhaps best described as ambivalent: rather than outright protectionism, it just didn’t seem to register as a priority.

In 2003, domestic banking was dominated by less than a dozen institutions. Some had foreign minority holdings, but there was no avenue for anyone else to come in and little enthusiasm for innovation or development. And then the CMA came along. Given financial, legal and administrative independence from the government and SAMA, with a direct reporting line to the prime minister, it was tasked with regulating and developing the Saudi capital markets, including the licensing of any businesses active within it.

It would be putting it mildly to say that it has approached its task with gusto. Less than five years after the royal decree was passed to allow for its foundation, and barely three years after it started in earnest, the CMA has licensed 82 separate institutions to conduct securities business. In the last 12 months they’ve started to open. These 82 include the securities arms of the original banks, each of whom have had to hive off those businesses into a separate entity, but even so it represents a seven-fold increase in the number of market participants.

It’s an interesting field and is peppered with foreign names, whether directly in the name of the licensee (Morgan Stanley Saudi Arabia, Ernst & Young Consulting, Merrill Lynch KSA) or within a local venture (such as Credit Suisse in Saudi Swiss Securities). Also in there are Deutsche, JP Morgan and Goldman Sachs, alongside four groups (HSBC, Calyon, ABN Amro and BNP Paribas) who had historical involvement  with Saudi banks. Bear Stearns had been awaiting its own licence, though quite what happens to that now the whole bank has been bought by JP Morgan for the cost of an apartment building remains to be seen.

“You could call it a Big Bang for Saudi Arabia,” says Douglas Hansen-Luke, CEO for the Middle East at Robeco in Bahrain, and until recently the CEO of asset management at Saudi Hollandi, the Riyadh-based bank part owned by ABN Amro. “After being a closed and relatively insulated market for a long time, they are now moving to a very open, very competitive market. You’re moving from 10 or 11 banks with investment capabilities to well over 50 in the space of about 18 months.

“In one go, they’re trying to implement a professional, highly competitive financial sector capable of financing Saudi Arabia’s huge investment plans and needs.”

In understanding what’s happening in Saudi Arabia, it’s useful to have some historical context, because foreign banks have actually been active in the country for the best part of a century – it’s the number and the range of available services that’s new.

Many foreign groups have been operating in Saudi for decades, for pretty much as long as there has been oil there, following companies like Aramco. The British Bank of Iran and the Middle East, which was acquired by HSBC in 1959, opened offices in Jeddah and Al Khobar in 1950, for example; Citibank opened in Jeddah in 1955. Saudi Hollandi Bank, which today is part owned by ABN Amro, goes back even further to 1926, serving workers from the Dutch East Indies.

Things changed in the 1970s when the Saudi Arabian government launched a new program of ‘Saudi-ization’ requiring all foreign banks to sell a majority holding to Saudi nationals. Saudi American Bank, later re-named Samba, was formed to take over Citi’s Jeddah and Riyadh branches and formally opened for business in 1980; Saudi British Bank, later SABB, did the same for HSBC’s branches in 1978.

Citi gradually sold down its stake, formally exiting completely after offloading its remaining 19% stake in Samba to the General Organization of Social Insurance, a key domestic institution, in 2003.  But others stayed the course with minority holdings in these domestic joint ventures: HSBC with SABB, ABN Amro with Saudi Hollandi Bank and Calyon With Banque Saudi Fransi. Saudi Investment Bank, formed in 1976, has long included JP Morgan and Mizuho as shareholders, and has a strategic venture for asset management with BNP Paribas.

Aside from these long-standing local cooperations, the only other example of foreign partnership with one of Saudi Arabia’s major banks came in February 2007, when National Commercial Bank, the biggest lender in the kingdom, confirmed a tie-up with Goldman Sachs. At this stage, as part of the new CMA requirements, NCB was forming a new company, NCB Capital, to separate its investment banking and asset management activities from the commercial banking operation; the Goldman deal not only committed the two banks to worth together in this venture, but (in the words of the memorandum) “contemplates” an equity stake by Goldman in the venture, though the precise quantum involved has never been made public.

So that brings us to the state of play as the new licensing regime comes into effect: the existing banks, some of them with foreign participation, others not; and then a huge clutch of new entrants.

What’s interesting is the different approaches each have taken to the Saudi opportunity. At one extreme are the names that are going it completely alone. Merrill Lynch is an example here: it has the widest ranging licence available under the CMA, covering global markets, investment banking, wealth management, M&A advisory, structured finance and equity and debt capital markets solutions, but it does not appear to involve partnership with any local venture.

Another is JP Morgan, which received one of the first new banking licences in Saudi Arabia back in 2004 and opened in Riyadh in 2006; the firm has been busy, poaching Mohammad Al-Tuwaijri from SABB/HSBC as chief country officer last May, and has underwritten landmark debt deals including a $500 million inaugural Eurobond for Riyad Bank and arranging a $4 billion revolving credit facility for Aramco. But, notwithstanding its longstanding history in the country, its licence suggests it is in Saudi on its own.

Others have hunted for suitable local partners. Among them is Moran Stanley, which in January 2007 struck a joint venture with The Capital Group, which it calls “a leading local investment bank in Saudi Arabia.” That grand description is perhaps a little strong: The Capital Group has only existed since 2001, and is chiefly of interest because of the two very well-connected individuals who run the place. Fahad Almubarak, who founded it, had previously run the Rana Investment Company; in 2006 he brought in Basel Algadhib, who had been head of Middle East investment banking for JP Morgan, as Capital’s chief executive officer. Much like its recent tie-up with Gateway Securities in Vietnam, this gives Morgan an entity with approved licences (in investment advisory, investment banking, asset management and trading services), good people and a short history that brings no legacy issues to deal with. The venture runs under the name Morgan Stanley Saudi Arabia and is headquartered in Riyadh.

Another group who took the partnership approach was Credit Suisse, which holds a stake (believed to be a minority stake) in Saudi Swiss Securities, a financial services company which was formally launched in May 2007 as a full service equity brokerage.

Credit Suisse picked some big-name partners. One is the Olayan group, a private global investor which is among other things a major shareholder in both Credit Suisse and Merrill Lynch; other partners include prominent Saudi families and another private investment group, ABQ Investments.

In June, Bear Stearns announced a similar approach, though what happens to it now is not at all clear. Its announcement at the time said that it had signed a letter of intent to form Bear Stearns Arabia Asset Management with a consortium of Saudi business leaders including a prince, Mishaal Al-Saud, who is also the chief executive of a private investment firm called Zad Investment Company which manages the Mishaal family’s assets. Bear Stearns was to have a 50% stake in the business and planned to offer a range of asset management services to institutions and high net worth investors. At the time of writing the venture did not appear on the CMA’s list of authorised persons for securities business.

Perhaps the most interesting of the foreign groups is Deutsche Bank, which appears to have gone in twice. Back in 2005, it signed a joint proposal to establish an investment banking joint venture, to provide equities brokerage and other investment banking services, with Al Azizia Commercial Investment Company.

This was a big deal: the chairman of ACIC is Price Alwaleed bin Talal bin Abdulaziz Al Saud, frequently cited as one of the world’s richest men (“The Arabian Warren Buffett” is a common tag) and the man behind the large stakes taken in Citibank in recent years. ACIC features a host of other prominent Saudi business groups on its ownership roster, among them Olayan and the Saudi Bin Ladin Group.

But little has been heard about this venture since, and in July 2007 Deutsche announced it had received a brokerage licence, in the name Deutsche Securities Saudi Arabia, to go in on its own. This company, which will be a subsidiary of Deutsche Bank, is authorised for the full range of securities trading, custody, underwriting, arranging, advising, and asset management. The announcement of this business referred only to the fact that Deutsche had previously opened a branch in Riyadh, and made no reference to Prince Alwaleed. The bank still clearly values the merits of contribution to national endeavour, though: in January this year it announced it would sponsor the Saudi Arabian General Investment Authority’s National Competitive Center, which has been formed to boost competitiveness and a pro-business environment in Saudi Arabia.

So, everyone’s here (bar Citi, which, despite one the longest traditions in the country, no longer has a formal presence; UBS also lacks a local licence). But why are they here? And is there enough for them all to do?

With oil at over US$100 a barrel, Saudi Arabia is clearly in a powerful position right now, particularly in comparison to a troubled global economy. But it’s about more than oil. Brad Bourland, chief economist at Jadwa Investments, one of a number of newly-licensed groups in the asset management area, forecasts the non-oil sector to grow at between 7 and 8% through 2010. “The boom continues to build and spread to the private sector,” he says. “From what it originated as – an oil price driven boom, which means government revenues and mega projects – it is now spreading to more non-oil, with private sector enthusiasm across the board. The outlook’s very bright.”

“Everybody sees the huge opportunity,” says Hansen-Luke. “Even before oil prices flirted with $100  a barrel, you had immense public spending plans, and investment plans for infrastructure; all that requires financing and investment.”

And how. To give one example, the Saudi Arabian government has announced the development of four different economic cities. The King Abdullah Economic City will be a hub for energy, finance and transport; the Prince Abdulaziz Economic City will serve logistics, mining, and petrochemicals; the Knowledge Economic City will serve knowledge-based industries; and the Jazan Economic City is yet to receive a clear focus. The King Abdullah project alone is said to envisage SAR100 billion of investment, with the creation of one million jobs and a two million population, according to a recent presentation by Credit Suisse.

On top of that, there’s the allure of offering banking services to some of the world’s richest people, as well as the sovereign wealth theme. Saudi Arabia does not have a single formal sovereign wealth fund like the Kuwait Investment Authority or the Abu Dhabi Investment Authority, but it does have several institutions which collectively are thought to have about US$300 billion in assets, among them SAMA and GOSI.

So the opportunity is clearly there. But there’s a challenge too. “At the same time, when you move from a cozy environment of 10 or 11 to over 50, it’s also a period of uncertainty and frenzied competition,” says Hansen-Luke. “It’s probably going to take another year or two before the winners and losers emerge. For some I think it’s a period of insecurity and for everyone it’s challenging.” [The different numbers referred to by people – 50, 60, 82 – depends on exactly what type of business one is referring to; there are 82 licences but not all cover the same areas.]

One of the keenest areas in which this challenge will be felt is human resources. “Even for the most aggressive professional international newcomer, they have to recruit in what is a pretty small pool of potential employees,” Hansen-Luke says. “A market which before had 11 compliance officers now needs more than 60. It’s good that every single company has to obey international norms, but there is a quintupling of demand for experienced, senior people, and something like that can’t be filled overnight.” Unsurprisingly, salaries are on the rise: Asiamoney spoke to one person who had changed jobs three times in 18 months and put his salary up by 50% each time.

Another reason new entrants will face a challenge is because of the way Saudi Arabian private and institutional wealth behaves. It is no surprise to anyone that there are some fabulously rich people in Saudi Arabia. But those people have been served by international private bankers for years without them needing a physical presence on the ground. Many of the ultra-rich have little need for onshore service, so in that sense, the competition for new banks is not just rivals on the ground but people on the end of the flights to Geneva and Zurich. “The immediate success will hinge on persuading both the richest portions of the population, who’ve got 60% of their money offshore, and the biggest government and corporate institutions, to do business with entities in Riyadh rather than continuing their offshore relationships,” says one private banker in the region. “People have been investing this way since the first oil crisis in the 70s. And it’s not just a habit, people prefer the anonymity of operating offshore.”

Clearly, some will thrive in this new environment, and others will flounder; consolidation is expected in due course. It makes for a quite dramatic market, and not really what Saudi Arabia is used to.  “People in Saudi are often criticised for doing things too slowly,” says Hansen-Luke. “It would be ironic if we were to criticise them for doing it too quickly.”