Best Way to Invest in Saudi Arabia is Trough Funds or Swaps

Interview with Dr. Boutros Klink, CEO of Standard Chartered

Could you give us an overview of the capital market in the Kingdom of Saudi Arabia?

The capital market in Saudi Arabia is quite young relative to other more established markets. The CMA (Capital Markets Authority) started authorising companies in 2005. The Saudi stock market crash in 2006 followed by the credit crisis of 2007/2008 impacted the speed of development of the markets. We were expecting things to develop a lot faster than they did. The number of licensed entities grew exponentially in the first few years, then came off substantially, and we’re currently witnessing growth again.  I do think that over the last few years, significant development and improvement took place accompanied by a lot learning, and we are currently beginning to see the results filter through.

In addition, while in the beginning, many investment companies applied for all the licenses granted by the CMA, many licenses have not been activated and developed, and we are currently witnessing a trend of specialization, with some companies applying for the cancellation of some of the licenses they had initially been awarded.

Many investment companies now understand the environment better, and have developed appreciation for the challenges. Without an edge, it is very difficult to compete and develop a viable and profitable business. The scope of the activities covers many different areas from dealing, to underwriting, advising, arranging, managing investment funds and client portfolios, and custody. Thus, the scope of activities is massive and every single company has its own business profile and strategy regarding which areas it wishes to develop depending on its strengths. Hence, we see a significant diversity of activities from the different companies licensed by the CMA.

Can you tell us why you feel that this is the most important economy and what is your strategy?

As you mentioned, Saudi Arabia is the most important economy in the region; the Middle East excluding the Saudi Arabian economy is like Asia excluding the Chinese or Indian economies. Standard Chartered is focused on the emerging markets of Asia, Africa, and the Middle East. We have existed for around 160 years in places like China and India, and we have been in the Middle East for close to 100 years, with full commercial banking presence in the UAE, Bahrain, Qatar, Oman, Jordan, and Lebanon. We very recently established our commercial banking presence in Iraq. In Saudi Arabia, we operate an investment company licensed by the CMA. Saudi Arabia is a very important to us and we’re very pleased to be on the ground.

Our strategy in the Kingdom is focused on connecting Saudi Arabia with our footprint across Asia, Africa, and the Middle East. This is how we distinguish ourselves relative to the other players. As an example, we assist international investors and issuers in exploring opportunities in the Kingdom as well as helping domestic investors and issuers in exploring opportunities within our footprint.

As you mentioned, Saudi Arabia is the most important economy in the region; the Middle East excluding the Saudi Arabian economy is like Asia excluding the Chinese or Indian economies. Standard Chartered is focused on the emerging markets of Asia, Africa, and the Middle East.

We have a lot of experience working in emerging markets.  We have played a significant role in developing many markets over the past 150 years. We feel that this experience can add a lot of value to the capital markets in Saudi Arabia. Out of our office in Riyadh, we focus on advisory and arranging business activities, related to project finance, mergers & acquisitions, structured finance, financial markets, debt capital markets, and so on. We are continuously looking to expand the range of activities we conduct under the current CMA licenses we hold. Last year we participated in close to half of the volume of all sukuk issuances in Saudi Arabia. It is a market that is developing rapidly, albeit from a relatively low base, and we see a lot of potential. Previously other GCC countries have dominated the space but now Saudi Arabia is playing a significant role and in no time will be the largest issuer of sukuks in the region.

Touching upon sukuks, what is the depth and sophistication of this market?  What is the outlook for sukuks in Saudi Arabia?

Bonds have been issued by the government of Saudi Arabia for many years, although in the recent past, the government has stopped issuing long-term bonds and primarily focused on managing liquidity by issuing instruments with maturities of less than one year. However, in terms of companies and financial institutions issuing securities, I would say that this is again a relatively recent phenomenon. There is definitely a huge demand for such securities given the scarcity. A lot of this is placed very quickly through private placements that are significantly oversubscribed. To date, a very limited number of fixed income instruments is listed and trades on the Tadawul. Given the appetite for such instruments, issuers feel that there is no need to go down this route because the securities they issue in the market are easily absorbed by private investors, banks and other financial institutions. Having said that, Standard Chartered is very keen to assist in developing the secondary trading market in bonds and sukuks in the Kingdom.

How do companies here seek financing? Traditionally it would be with an IPO, yielding of ownership, issuing a bond or taking a loan out from the bank. What is the tradition in Saudi Arabia and do you see it changing?

All of these mechanisms are available. Today, many companies rely on the banking sector, where they obtain bilateral loans at very compelling pricing due to the abundance of liquidity in the Saudi market. There is also a decent syndicated loan business developing. Companies have done IPOs in the past and the number of companies listed on the exchange is quite large relative to other exchanges in the region. We are expecting a couple of significant IPOs this year. Additionally, the volumes of transactions on the exchange are also very large in comparison to other exchanges in the region. Volumes on Saudi Arabia Tadawul account for over 50% of the total trading that takes place in the region.

Since the credit crises, we have seen a relatively diminished number of IPOs coming to the market but we do expect this to increase over the next few years. We are seeing many companies prepare themselves for IPOs. Generally, companies just IPO a small portion of the company. There is a lot of support and encouragement from the regulator to go down that route to help develop the capital market in Saudi Arabia and to encourage people to participate in the development of the market and the growth of those companies. It is an activity that I am sure will grow.

In terms of sukuks, it has been a similar phenomenon. The large companies have been dealing with the banks for quite some time. Some of the larger companies have issued bonds a few years back; but many of the bonds that were issued around 2006 and 2007 have been retired. We are now seeing this market beginning to develop with increased volumes of issuances. Many smaller companies are also exploring this form of funding. Nevertheless, the development is taking place in a robust manner.

Therefore, is the bulk of the sukuk market happening in the public sector and not in the private sector?

It is happening in both. In general though, it tends to be government related entities that are the large issuers of sukuks and the sizes of their issuances dominate the market. The largest issuance was by the General Authority of Civil Aviation (GACA) that took place last year, with an issuance of around 15.2 billion Riyals, which dominates any scene due to its massive size. The previous year also saw an issuance by GACA of similar magnitude. The issuances were very well absorbed by the investors given the explicit guarantee by the government and the reliability of the securities.  By and large, it remains the bigger players who are tapping this market to support their massive investment plans.

You mentioned that these sukuks are oversubscribed, what do you think is behind the appetite for sukuks?

Right now, the companies are very robust and there is very little supply of such instruments. There is great demand for any issuance by companies related to the government of Saudi Arabia. For other sukuks, it really depends on the companies. A lot of interest comes from banks, pension funds and so on. They have specific requirements in terms of the quality of the paper that they can invest in as defined by their investment strategies. The supply is very limited. With the growth of the economy and the growth of the balance sheets of financial institutions, there is tremendous demand that overwhelms the limited supply. I believe that this kind of structural setting or environment will remain for the next few years and is very supportive for the development of the sukuk market in the Kingdom.

Do you think the valuations of companies on the capital markets are reasonable, under-priced or overvalued?

While I refrain from commenting on valuations, the Saudi environment is very robust. A lot of the investment spending is now filtering through into the economy. Companies are doing very well given the massive opportunities. If we look at CDS rates for Saudi Arabia, we will see that they are the tightest in the region. Furthermore, international investors are keen to gain exposure to the Saudi market. Thus, should the market open up to international investors at some point, that would lend increased support to the capital markets in Saudi Arabia.

Right now, what is the easiest way for foreigners to invest in Saudi Arabia?

Right now, the options are either through funds or through swaps. Foreigners would prefer direct ownership of securities and this has been an ongoing debate for quite some time. There have been many expectations around the opening up the market to qualified foreign investors but there is still no specific timeline set. How this evolves remains to be seen. Many of our foreign clients are keen to get involved.

We have talked about you being a kind of cross-border entity that aims to connect the Middle East, Asia and Africa. It seems a balance of power is now shifting towards the east and so this region is very important in the world. Can you connect your role as a cross-border transaction entity with the outlook for the economy of Saudi Arabia as a whole?

In my opinion, the economy in Saudi Arabia is quite robust. Many initiatives have taken place and are ongoing to diversify away from the oil sector and to build up the non-oil component of the economy. Massive investment in infrastructure is underway. Many efforts exist to develop downstream industries. There is a lot of interest in developing the SME space in order to tackle the issue of youth unemployment, which is a big challenge. I think that we will see a lot of progress in that direction over the coming few years.

The massive investment spending in infrastructure and the size and scope of the projects is attracting the attention of numerous multinational companies. Growth in the economy will continue to be solid over the coming few years. Given that the Saudi economy remains heavily dependent on the oil sector, there are challenges depending on how the shale story plays out. However, for the time being, the demand for Saudi Arabian oil remains solid.

Growth in the economy will continue to be solid over the coming few years. Given that the Saudi economy remains heavily dependent on the oil sector, there are challenges depending on how the shale story plays out. However, for the time being, the demand for Saudi Arabian oil remains solid.

One thing that is important to note is that there is an increase in energy demand domestically, fueled by the growth in the Kingdom’s population, which is growing at a relatively fast rate in comparison to other developed countries. There are many initiatives taking place to address the increasing domestic power needs and to develop the alternative energy industry. This space will be very exciting in the coming years.

Is there anything that you would like to add?

Right now, with the boom in the Saudi economy, we find that many Saudi companies are primarily domestically focused. However, we are beginning to see companies look a little bit further beyond this region. Africa is of key interest to many Saudi companies, which we feel will provide tremendous opportunities over the coming years. Furthermore, the opportunities in Asia remain huge. Standard Chartered is very well positioned as Saudi companies look beyond the Kingdom and explore opportunities in our footprint. We are very excited about our future in the Kingdom and delighted to be able to add value to Saudi companies and contribute to the development of the Saudi Arabian financial markets.