Euromoney GCC asset management guide: Regulation in Saudi and Kuwait

This is one of seven articles that made up the Euromoney Guide to Asset Management in the GCC, distributed June 2008 with Euromoney magazine

One reason asset managers are excited about the possibilities in the GCC is because of the changing regulatory environment. Generally, it is getting easier to access to securities, easier to set up businesses, and easier to sell product than ever before in the region.

Partly, this can be seen in the differing approaches of Qatar, Bahrain and Dubai to be seen as regional centres for asset management (see separate article). But at the time of writing, the market receiving the greatest attention from regional and international managers alike was Saudi Arabia.

Saudi Arabia gained a new regulator, the Capital Markets Authority, in June 2003. Until then, the financial services industry had been overseen by the Saudi Arabian Monetary Agency, the country’s central bank. Under SAMA, asset management was handled by the big, full service commercial banks like National Commercial Bank, Saudi British Bank (SABB) and Riyad Bank. They were full service institutions which operated as a single legal entity.

The CMA, which has financial, legal and administrative independence from the government and from SAMA, with a direct reporting line to the prime minister, was given the job of regulating and developing Saudi Arabia’s capital markets. From an asset management perspective, it has taken two particularly significant steps: one, it required all banks to hive off their securities arms into separate entities, which includes the asset management divisions. And two, it started issuing new licences – a lot more licences.

All told, the CMA has awarded financial services to 82 separate institutions for securities business. They’re not all active in asset management (brokerage is particularly crowded), and the 82 includes the securities arms of the original banks, but even so it is a huge increase in the number of market participants.

These include local names, foreign names, and partnerships between western and Saudi interests, and it has been fascinating to see the range of different approaches being taken. Some, like Merrill Lynch and JP Morgan, are going it alone; some, like Goldman Sachs and BNP Paribas, have built joint ventures with the big established banks; some, like HSBC, Calyon and ABN Amro, already had ventures with those banks; some have gone for tie-ups with established families, such as Credit Suisse and Bear Stearns; some have built ventures with a couple of well-established staff, as Morgan Stanley has with the Capital Group; and some have tried a combination, notably Deutsche. See the box “Saudi strategy” elsewhere in this guide for more on these approaches.

This liberalisation of the industry will have an immense effect on asset management in the country. Clearly, it will dramatically increase the amount of choice available for consumers in Saudi Arabia, and the level of competition among asset managers who until recently have had the industry to themselves. It may lead to a period of consolidation, cooperation and closure of new businesses in particular. And in the longer term, it may lead to the beginnings of an open architecture environment in which third party distribution of other managers’ funds takes off for the first time. See the distribution section for more on this.

Still, for all the dynamic change, Saudi Arabia is by no means an open book. For a start, foreigners can’t buy Saudi stocks (although GCC funds, in some circumstances, can, depending on their licensing arrangements). This is precisely the reason Saudi Arabia does not feature in the MSCI Emerging Markets index despite its approximately US$400 billion market capitalisation – and it won’t do until this restriction is eased. A more positive sign came recently when it was clarified that foreigners can buy Saudi Arabian mutual funds, and in practice this is how many regional funds derive their Saudi exposure, by investing in a domestic fund run by one of the bigger Saudi asset managers.

Liberalisation is best observed in the three centres vying to be the hub for asset management in the Middle East: Dubai, Qatar, and Bahrain. They are discussed in a separate chapter. But in fact liberalisation is at work across the region, albeit not at a great pace. In the United Arab Emirates (where the bulk of the domestic funds management industry, and anything in dhirams or for retail, is regulated not through the Dubai International Finance Centre but through the UAE’s central bank in Abu Dhabi) new regulations have been expected on asset management for at least a year, but have yet to make an appearance. When they come, they are expected to add clarity to a sometimes opaque market in which some entrants report uncertainty on what they can and cannot do – a situation that never arises with the fastidious and detailed compliance regime under the Dubai Financial Services Authority governing the DIFC. (Managers report, for example, that the required documentation to lodge a product with DFSA is about three times longer than it is for the central bank.)

Kuwait, which has by most opinions the most sophisticated, mature and liquid stock market in the region, has been puzzlingly slow to accommodate change in its asset management area. To give one example, it does not permit funds to be locally domiciled in Kuwait and denominated in dollars. This is one of the reasons that Kuwait’s mutual fund industry, on official numbers, seems so absurdly small given the size of the market and the wealth there (KD3.265 billion at the end of December, according to the Central Bank of Kuwait): because if anyone wants to make a fund in dollars, they simply domicile it in Bahrain instead. One could argue it represents a lost opportunity for a market that has arguably the most sophisticated and deep stock market in the region.

Joel D’Souza at the Commercial Bank of Kuwait calls the central bank “a sophisticated, tough and stringent regulator that is well respected in the region and globally,” conferring the same praise on the Ministry of Commerce, which also has a regulatory function.  But he adds: “When it comes to the structuring and distribution on non-Kuwaiti dinar denominated mutual funds, it has not been permitted in Kuwait so far.” Also in Kuwait, Shahid Hameed of Global Investment House describes the Kuwaiti regulator as “very conservative. Their concern has been they don’t want to contribute to creating an asset price bubble in the region, and especially in Kuwait.” That has, in fairness, served Kuwait well in the past: when other gulf markets lost half their value in 2006, Kuwait lost 12%. As world markets have tumbled, Kuwait is up this year.

Kuwait did, though, take a welcome step recently when it clarified a long-standing curiosity. Strictly speaking, share trading has long carried capital gains tax in Kuwait. In practice it has never been enforced but its theoretical existence has been blamed for keeping much foreign institutional money out of the country. Now Kuwait has formally stated that the tax has gone. “It has brought phenomenal clarity to the whole situation,” says MR Raghu at Markaz. “Even though foreign investors knew the law was never implemented, they were not sure if it would be implemented at any point in the future so were holding back investments in Kuwait.” Raghu does, though, point out that many stocks have a limit the foreign investment participation in its stocks – his calculations put it at a weighted average of 40% – and thinks that impedes market development. “As long as you have that restriction you won’t be part of a major index,” he says. “You may be part of the MSCI Frontier index, but not necessarily the emerging market index.”

Still, the overall direction of change is to openness, and in particular openness to foreign capital. “All these things, whether on the capital markets or regulatory side, are part of a trend which suggests things are opening up,” says Harshendu Bindal, senior director for CEEMEA at Franklin Templeton Investment Management in Dubai. It’s now up to fund managers, local and international, to take advantage.