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GUEST ARTICLE: Moving fast In Saudi Arabia

Emad Mostaque, December 7, 2017


Some events can obscure the investment opportunities that Saudi Arabia offers, but this country pays serious attention, the author of this article says.

For various reasons, investors might be wary of putting money to work in Saudi Arabia, an oil-rich jurisdiction with a number of geo-political challenges. In this article, Emad Mostaque, co-chief investment officer of Capricorn Fund Managers, argues why wealth managers and clients should consider the country. As always with guest contributions, the editors of this publication don’t necessarily endorse all views that are published, but do value contributions to debate. Readers who want to comment can contact tom.burroughes@wealthbriefing.com

The sudden corruption crackdown in Saudi Arabia has hit the headlines primarily due to some high profile arrests, ranging from media owners to prominent financiers to some of the Crown Prince’s own aides. This has raised concern over the feasibility of ambitious reform and diversification plans as it seems like this may scare off foreign investors. However, the opposite may be true.

Since the death of King Abdulaziz ibn Abdul Rahman ibn Faisal ibn Turki ibn Abdullah ibn Muhammad Al Saud in 1953, his forty-five sons established a consensus-based system for rule where power did not go from father to son necessarily, but from one branch of the family to the other, with a spread of power across the rule of provinces, key industries and the three main branches of the security forces.

This has all now changed as King Salman and his son, Mohammad bin Salman, have swept away the traditional power structures and consolidated leadership of the branches of government, security forces and state owned enterprises.

The previous system suffered from a classical social contract of the state effectively guaranteeing public sector jobs, where 90 per cent of Saudi nationals were employed, which, combined with competing power blocs and special interests, led to a huge amount of inertia and bureaucracy to do the simplest of things in a very conservative country, with certain individuals accumulating wealth well above their pay grade.

In a way this led to great stability, with steady reforms under King Abdullah, for example in the banking sector where in the wake of a potential $20 billion loss in the Saad / Al Gosaibi saga, banks moved away from lending on the basis of family name to building huge capital buffers and more stringent lending criteria. The market has also steadily opened to foreigners, but there was continued frustration at the slow pace by investors outside of the Gulf.

In a country where two thirds of the population are under the age of 35, needing to create over 600,000 new jobs yearly, this reached breaking point in recent years, where there was real concern over the stability of the economy and long-term health of the country as oil prices collapsed to $28 a barrel last year. 

The new leadership of the country recognised this and have embarked on a dramatic plan of reform and that a few years ago no observer of the Kingdom would have countenanced, looking to modernise the country and open it to the world to provide the impetus to provide a sustainable future for its citizens. 

Part of this push has been to provide an environment that can attract foreign direct investment of all types. This ranges from stock investment that would accelerate after an Aramco IPO in 2018 and potential inclusion in the MSCI indices in 2019, which would increase foreign ownership of local stocks from current levels of under 1 per cent to over 30 per cent in line with other Emerging Markets, to large scale investments in new mega projects such as NEOM designed to diversify the economy.

Saudi listed corporates have improved dramatically in their communication and transparency in the last decade and the CMA and Tadawul exchange have been increasing support for engaging them with a potential new investor base through roadshows, conferences and more investor-friendly regulations. In some ways they have actually had to move backwards to international standards, for example moving stock settlement from same day to 2 days. 

Aramco has been held up by the Crown Prince as the cornerstone of this strategy as a superbly-run company employing some of the brightest local talent in conjunction with foreign expertise that may well be the largest stock listing ever. In the wake of this weekend’s events the call by US President Donald Trump for it to list on the New York Stock Exchange should not be underestimated, which would necessitate a further improvement in transparency and information rights for investors.

Transparency is important as it allows for increased confidence to reduce the perceived level of risk for investors. Corruption is antithetical to transparency, but is endemic worldwide, even if it is dressed up as legal no tender contracts and similar in developed markets. There can be a thin line between government-supported companies and corrupt ones in many countries, as fortunes can turn depending on who is in power. A key element for long-term returns on listed stocks is adherence to a predictable rule of law and either a fair playing field for private companies, or a clear, centralised, government strategy for state-owned enterprises that is aligned with minority investors.

Given the scale of reform that would have been unimaginable a few short years ago, it is difficult to judge what the “rule of law” should be as the law itself is changing. Saudi Arabia has clearly indicated that it wants to catch up with international norms and so there will be careful scrutiny to see if this situation is handled in a way that is “fair”, although the recent crackdown has been mild in comparison to those we have seen in other emerging markets, such as Turkey recently after the failed coup last year. The opening of corruption proceedings creates an opportunity to establish new laws against conflicts of interests and an independent judiciary to adjudicate cases like this, structures that have not been in place to date.

The scale of the opportunity to participate in the reform and opening of a market that has been trapped by its own structural bureaucracy and conservatism is something that will naturally attract significant interest in the coming years. 

The temptation for a young, ambitious government can be to follow the Facebook motto of “move fast and break things”, but the key to success will be to make sure that they create a path that is as predictable and transparent as possible to gather the necessary support to make their vision a success.

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