Foreign inflows, investor quotas and Saudi Arabiaâs T+0 settlement system were discussed by our panel of asset servicers in Dubai. Chaired by George Mitton.
Stewart Adams (regional head of investors and intermediaries, MENA and Pakistan, Standard Chartered)
Manoj Aidasani (head of direct securities and services, GCC, Deutsche Securities Services, Dubai)
Arindam Das (regional head of Middle East and North Africa, HSBC Securities Services)
Rod Ringrow (managing director, State Street)
Tarek Sherlala (head of asset servicing, Middle East and Africa, BNY Mellon, Dubai)
Mario Tryfonides (managing director, Apex Fund Services Dubai)
Sheldon Woldt (executive director, Middle East region, Northern Trust Saudi Arabia)
Funds Global: The biggest event to happen to the Gulf capital markets in years is expected in the first half of 2015, the opening of the Saudi stock market to direct foreign institutional investment. What does this mean for the region?
Arindam Das, HSBC: It’s transformational. Saudi Arabia, with a market cap of $580 billion, is almost as large as the other GCC countries taken together, and significantly larger than them in terms of trading turnover. It’s one of the last big markets globally to open up to foreign investors, and, from an economic perspective, it is exciting because it is the only country in the region which has both scale and wealth. From a demographic perspective, it’s got a very young population – 60% of the population is less than 30 years of age – and it’s growing very fast – the middle class is expected to double from 20 million to 40 million by 2050.
While it’s not imminent, the estimates of money that could come in if MSCI includes Saudi in its indices range from $9 billion to $50 billion. Even on conservative estimates, it is a phenomenal amount of money, given the size of the regional market. Anything between those two numbers can be a game changer for all of us.
Sheldon Woldt, Northern Trust: I see the Saudi story in terms of opportunities. This is an opportunity for companies across the region to attract new sources of capital, and the whole region will benefit. Then there is the opportunity for global investors to enhance their returns through diversification. We as asset servicing firms have an opportunity too: we will work with asset owners to support them and grow our own businesses.
Rod Ringrow, State Street: It’s the biggest event of the year. The key is how the Saudis bring in the regulations and how they approach the wider market. Are they willing to make the changes required to make it a success? All the hallmarks are there for this to be a great boost to Saudi and to the region in general.
Stewart Adams, Standard Chartered: As a result of the changes, I feel international investors will look more closely at the whole region, and not just focus on Saudi. The other markets will benefit from the regional research and especially Qatar and UAE following the recent MSCI upgrade. Regarding the regulations, we need to see exactly what’s going to be introduced and also if a minimum investment size will be imposed in the market. That could be a significant hurdle to many interested investors.
Mario Tryfonides, Apex Fund Services: I’ve been in the region since 2009 and, from the day I arrived, everyone’s been talking about when Saudi will open up its market. It’s fantastic that we’ve finally got a timeline for it. The potential is there but there are many things that need to be defined and structured before we can assess the impact on the region as a whole.
Manoj Aidasani, Deutsche Bank: I see two positives straight away. Firstly, liquidity will increase, not just for the Saudi market but also for the region. Secondly, with international investor flows coming into the market, there is the chance to create an environment which is more international investor friendly. This will bring about a change in the market infrastructure in Saudi.
Tarek Sherlala, BNY Mellon: This has rightly brought our attention back to Saudi after the announcements of Qatar and UAE being promoted to emerging markets by MSCI. It changes the landscape and brings the focus on to innovation in investment management services. It’s a good opportunity for us all.
Funds Global: What are the challenges service providers face as part of the opening up and how will they be overcome?
Woldt: As a company that opened up a Saudi office in 2013, some practical challenges involve finding enough talent and finding good office space, though the King Abdullah Economic City opening up should help. In terms of the market, we have to understand the rules. When will independent custody be established – the separation of brokerage and custody? Will the investment fund regulations be passed, which say that asset managers have to appoint a separate custodian, other than a related entity? That will define certain aspects of the opportunity for us.
Das: There are two distinct areas. One is the registration process, which is covered in the recently published draft qualified foreign investor (QFI) regulations on which there is a 90-day consultation period. The broad eligibility criteria in the regulations allow institutions with assets under management of $5 billion and a track record of five years to apply for the QFI registration – so evidently the target is to attract large institutional investors with scale and proven expertise. The draft regulations also outline the role to be played by assessing authorised persons (AAPs) in processing the applications and submitting their recommendation to the CMA. The timelines for each leg of the process is quite tight and clearly defined making it a quick and transparent process. The draft regulations also stipulate the ownership ceiling, both by each investor, and collectively by all foreign investors.
The second area relates to the settlement and custody model. The challenge there stems from Saudi Arabia’s T+0 settlement system and the rules for custody. Currently, for many of our clients coming through global custodians the broker settles on a T0 basis and then we settle it with the broker on a T2 basis. However, the authorities are planning an independent custody model in which that will change, although the change will not be mandatory. Broking and custody will be differentiated and the custodian will reportedly have full control. However, it will be very difficult for the custodian to have full control in the T+0 cycle because, in a T+0 cycle, by definition, cash and stock will move on T0. If that happens, there is no way a global custodian will be able to instruct us, on T0, to move the cash and stock. So, effectively, there has to be pre-funding of cash, and movement of stock to the trading account prior to execution of trade. There have to be instructions from global custodians that if a trade happens, we settle first, without getting any instructions and matching them, and sort out everything later. That somewhat defeats the purpose of a custodian as the custodian does not have full control over movement of shares and cash based on client instructions.
The current model, in a way, works better, at least for purchases, because it allows for client instructions to be matched with broker allegements, and doesn’t require pre-funding.
Brokers settle in the market. Separately, we as the custodian settle with the broker. On the buy-side it works wonderfully. If I don’t pay, I don’t get the shares. On the sales side, there is a problem because my shares are transferred before I get the money. However, this problem is what the UAE and Qatar lived with for a long time before the current delivery-versus-payment (DVP) process came in. However the current Saudi model also has its own challenges because sub-custodians cannot see or control the shares in the broker’s account, and are not allowed to participate directly in the clearing system.
We are not lobbying for either of these two models because both are imperfect by a long way. We are lobbying for something similar to what happens in the UAE and Qatar, which has its deficiencies but is broadly acceptable to foreign investors.
Sherlala: These are important issues that we will need to find solutions to and we will be having discussions with our partners in the region to get that done.
Tryfonides: From a fund administration perspective, the important thing is to see what’s going to happen and how. Our process includes performing reconciliations so what will happen to p-notes and swaps? We need to see how the systems are working and how information will flow between the investment managers, brokers and custodians. In general, I have a lot of questions that need answers.
Das: The p-notes market will stay because the new rules will not allow everybody to invest in the market. So a lot of the money will have to come into the p-notes because they simply can’t invest directly. Also the draft regulations clearly refer to aggregate foreign ownership using both routes, which makes it clear that both are here to stay.
Aidasani: The important part is the 90 days lead time for consultation. This is where the regulators will discuss with the market participants their views and identify the key points. We need to make sure our systems and processes are in line with international investor requirements as well as regulatory requirements. We need to map them and bring them together.
Funds Global: Do you think more financial services firms will seek to set up operations in Saudi Arabia as a result of the opening up? Or will the process give more of a boost to nearby jurisdictions such as Dubai?
Woldt: Both will benefit. Some regulations require you to do certain things locally. You need to have a licence in Saudi Arabia to do your calling and handle relationships, since that’s been restricted over the last couple of years. But in terms of operations, a lot of what we do requires large manufacturing centres, whether it’s from a custody perspective or an investment management perspective, and those have been outside the country. We are beginning to move some of those processes or functions into Saudi Arabia as our business grows.
We all want to be close to our clients. We will do locally what needs to be done locally, whether it’s in Saudi Arabia or elsewhere in the region. Other jurisdictions will benefit as well, such as Dubai and Abu Dhabi which are both relatively easy to set up in.
Ringrow: The region in general is going to benefit and it depends on whether the Saudis decide to create different levels of market entry, rather than a rigid version. It will also depend on developing talent. The key question is how talent development works in tandem with the expansion of financial services.
For example, the King Abdullah Financial District, at the moment, is restricted to financial services firms. You need to have a wider remit of people in there to build an industry. Take the DIFC [Dubai International Financial Centre]. The infrastructure there is not just financial services firms. It’s all the ancillary elements that are going to make a thriving commercial centre, and that’s what the Saudis need to look at in the programme.
Sherlala: It depends on whether the GCC is going to be harmonised for intraregional investment. The more harmonisation, the more options financial firms will have to set up in Saudi or in Dubai or elsewhere.
Adams: A lot will be dependent on the scope included in the licence issued by the regulator which will cover the services which must be completed in Saudi Arabia and what if anything can be serviced by a remote centre of excellence.
Das: It’s also a question of what financial services you’re talking about. GCC asset managers are already allowed to invest in Saudi Arabia. If you are servicing just a GCC asset manager, you won’t need to bolster your capacity in any way. This development really affects foreign investors and service providers to foreign investors. Given that the foreign investors are based overseas and so are the global custodians, there should not be any major impact there in terms of them setting up offices in Saudi Arabia.
It’s the sub-custody space where new firms may be tempted to come in, but the size of the opportunity depends on how much the market opens up. Given the draft QFI regulations, which suggest that a QFI and all its clients would need to appoint one AAP, and given the $5 billion and five-year track record eligibility criteria, I don’t see the need or scope for too many additional players. In terms of broking, there are already a large number of brokers in Saudi, including international names.
Funds Global: Which fund admin functions are required on the ground in Saudi Arabia?
Das: Transfer agency. That apparently needs to be done in-country but this notion needs to be revalidated. In other respects, the Saudi authorities are open to offshoring but the registered provider has to be a local entity and has to have final responsibility for the offshored process.
They have the concept of an AP, authorised person, which has to be a Saudi institution. The AP can carry out multiple activities, from asset management to investment banking to broking to custody.
However, we would prefer it to be a bit more specific in terms of outlining the roles of these various categories, because they cover very different activities. The independent custody model proposed by the Tadawul attempts to bring out the distinction between brokers and custodians but that model brings in its own set of unintended consequences. This will become important when we look at the implementation of the new QFI regulations, because it does not clearly specify who at the AP (the broker or the custodian arm) can play the role of the AAP.
This may have significant implications because a QFI or QFI client can have only one AAP, and typically most investors like to use multiple brokers.
Funds Global: What is the status of discussions about harmonising the GCC markets, and the potential introduction of fund passporting?
Woldt: This is an important question because, ideally, financial firms would like to set up in one jurisdiction in the GCC and then be able to do business throughout the region. That’s difficult to do because every country wants to protect their own interests. They each want to grow their own industry, whether it’s financial services, legal, consulting or tax firms. Harmonisation would help drive down costs for the end investor. Europe did it. It’s possible. The question is how far we are in the evolution of the relationships within the GCC.
Das: I’ve seen no signs of it happening and no discussions except for forums like this which, unfortunately, do not significantly influence regulatory decision making. Actually, some Gulf states are moving in the opposite direction. The regulators are coming up with distribution fees for funds domiciled in other jurisdictions but being distributed in their country.
Aidasani: It will probably happen in Asia first. Asia has bigger and more mature markets. They have still not been able to do it, though. I would give the GCC some time to go through that process. It will benefit the investors, as well as the asset managers and intermediaries like us. But it will take time.
Das: I agree it’s likely to happen first in the western world, then Asia, then here, but that’s the wrong way to approach it. Asia doesn’t have this problem to the extent we have it in the Middle East. Many Asian countries have scale within the country.
Passporting is beneficial there but not essential. Except for Saudi and Egypt, we don’t have scale in the other countries. As we can see in Qatar and UAE, they have taken significant steps to grow the funds industry for several years, but with limited success.
Funds Global: Looking at the GCC more broadly, what are the main regulatory issues that you hope to see resolved?
Aidasani: Regulation is an evolving topic. It keeps on changing. One good thing is that the regulators here in the region are receptive. You can go and meet them, they listen to your points and there is progress. Interestingly, there were some enhancements released in Saudi Arabia in the first quarter, for example, limiting speculation in loss making companies, under certain situations they can settle on T+2. There are changes happening which don’t always get a lot of coverage in the news.
Das: The UAE fund regulation is done and dusted. I haven’t seen any huge upsurge in the number of funds registered in the UAE because of these regulations. Qatar’s regulation is currently in draft form and doing its rounds. We’ll see what comes out of it but, fundamentally, I feel that the funds industry as it is doesn’t have scale. Regulators should look beyond the pure funds industry and look at asset management as an industry. There’s a huge amount of asset management that happens in this part of the world, through discretionary portfolio management, where there is no independent custody, no independent administration, and the investors are as susceptible to the same risks as an investor investing through a mutual fund.
There’s no reason why you should look at these two pools differently. There is scale in the overall asset management industry, but not in the mutual fund industry, and I believe there should be similar standards governing both.
Ringrow: The other thing governments could do is give a boost to workplace savings plans. That, in itself, would drive money into institutional markets and spur the development of the GCC markets. There has been talk of developing such schemes in Dubai and Bahrain but it’s not happened yet. There are significant unfunded end-of-service-benefits across the region which, if you could mobilise them, would be a great boost to the industry.
Adams: Assets under management, held in mutual funds, are not significant across the region compared to what we see in other more developed markets in Europe, Asia and the US, therefore, any changes to help boost the assets would be well received. It’s unfortunate that Bahrain experienced political troubles recently as they probably had the most developed funds regulation set-up in the region and rather than continuing to grow assets or fund businesses this has been stable or reducing in the past years.
That said, Bahrain is looking at new limited partnership structures being introduced and if Bahrain can pick up again and drive the fund industry, that could boost the whole region.
Das: That’s where these protectionist tendencies become a challenge. Distribution costs levied on non-locally domiciled funds just end up increasing costs for investors, without necessarily offering additional protection.
Woldt: It’s worth touching on another category of regulations: those that make investors and index providers comfortable with investing in the market. It would be good if Saudi Arabia is classified as an emerging market, to get more assets flowing. That requires acceptable foreign ownership limits, rights of foreign investors and good governance laws around the corporations. We want good transparency of information from these companies. They should not be able to operate like quasi-private companies. They need to provide information that makes us comfortable that this is a good, viable investment for clients.
Tryfonides: We also need to clarify the role of the fund administrator. There are still a lot of managers in the region who cut their own NAV [net asset value]. If you’re going to attract more institutional money into the region, one of the boxes that needs to be ticked is whether an independent administrator has been appointed by a fund. By making this mandatory, it will aid our continued efforts for best practice and potentially attract more money into the region and into regionally managed funds
Funds Global: How can relationships with institutional clients be more profitable?
Ringrow: We’ve seen an increasing demand from clients to have more risk management services from third party providers. We did some research among the official sector recently, and managing risk was one of the big issues they were facing.
That was a combination of risk from investing in emerging markets to new risk systems internally, for example.With large, sophisticated global investors, it is a question of getting your value proposition further up the chain. The events of the last few years have resulted in a number of funds in this part of the world looking at third parties to provide them with additional services.
Sherlala: I’ll take that same angle. There is a demand for risk management from investors, particularly those who continue to allocate funding to alternatives, and in the context of the changing regulatory environment. It also becomes an issue of scale. There’s an active discussion about how much these investors should outsource and engage other providers to help them. There is no question that data management is at the centre of risk governance. Your risk management is only as good as your data.
Aidasani: When you have demanding clients always trying to ask for something more than what you can offer, such services do differentiate and create opportunities. As a bank, we are always looking at how we can embed them into our current systems and, of course, we have to weigh the cost impact versus what we get out of it.
Woldt: Fees have been pushed down some time ago, but we’ve all recognised that it’s about the depth and breadth of the relationship. As we’ve developed our capabilities, we’re able to do more things. Where you have in-house investment management in some of these large investors, they might want to outsource their middle office. That’s something we can do that transforms the nature of the relationship, so it becomes more of a partnership.
Tryfonides: At Apex, we’ve spent a lot of money upgrading our software and systems, we have established a middle office outsourcing team, and hired experienced teams and staff across all our product lines for the simple fact that there is now a lot more awareness of risk management by businesses here. Even if we look at the private equity investment that’s happening regionally, you need specialist software to be able to provide enhanced reporting and performance analytics to investors and managers. It is about providing a good service and, we want to give a complete package to all our clients whatever asset class they are in.
Das: I’d like to make a slightly different point about the profitability of relationships with the sovereigns. While they are certainly significant revenue generators in absolute terms I’m not sure whether this has been measured against the risks that service providers take. The way the documentation and the legal agreements of sovereign wealth funds are structured, they take almost zero risk. This has become an industry norm with every provider accepting it for competitive reasons. Luckily, nothing has gone wrong yet.
Ringrow: It’s a good point, the take-it-or-leave-it approach when it comes to documentation is becoming more of the norm.
Adams: It also depends on what your bank can offer. What can we give them, from an end to end perspective? Following Chinese walls, information on deals will not be shared with other departments including securities services. It’s about managing relationships at the C-suite level to make sure our entire banking solution is visible to the clients senior management. It’s important to get cross-fertilisation of ideas because only by deepening the relationship can you have a true understanding of the clients requirements and offer alternative solutions.
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