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Middle EastNovember 5 2007

Economic cities point to a sea change in thinking

The financial services sector in Saudi Arabia is benefiting from new policies aimed at attracting foreign investors, and creating a more sophisticated market, write Nadine Marroushi and Jon Marks.
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Awash with liquidity, but also going through a phase of opening up to new ideas, the Saudi administration has some ambitious plans that will radically overhaul the financial services sector – and the way in which international banks work with their Saudi counterparts.

Efforts to diversify the economy away from oil have already registered results. Most unusually, Saudi Arabia was among the top 10 reformers in the World Bank’s most recent Doing Business Report, which looks at 178 economies and ranks them by 10 indicators. This saluted moves such as the creation of a commercial credit bureau, which catalogues Saudi companies’ credit exposure. And it will help banks to have a much better picture of local corporate credit and debt.

But there is much to do if the kingdom is to overcome its oil dependency. According to Jeddah-based National Commercial Bank (NCB), Saudi Arabia’s largest public sector bank, the oil sector still represents 48% to 50% of gross domestic product (GDP) in nominal terms and 28% to 30% in real terms.

The modernisation and diversification initiative has been sponsored by King Abdullah bin Abdelaziz al-Saud. It is being pushed ahead with plans to build six huge new ‘economic cities’, along with the new King Abdullah Financial District in Riyadh.

New economic infrastructure

If even half of these plans are achieved, the developments will provide a new economic infrastructure for millions of Saudis to work and live in, and consolidate plans for the entry of many more international banks – which will be encouraged to base themselves in the kingdom, rather than conduct their Saudi business out of smaller, more user-friendly Gulf Cooperation Council (GCC) centres such as Bahrain and Dubai.

These plans form part of the government’s strategy to attract local and foreign private investors into a wide variety of sectors, from heavy and secondary industries to financial services.

In a move to open up the Tadawul All-Share Index to more outside investors and to generate demand for shares, the Capital Market Authority (CMA) has permitted GCC-based investors to buy shares in listed banking and insurance stocks. This was the last major prohibition on GCC investors, who were able to trade in all other stocks, placing them on the same footing as locals.

The Tadawul is still suffering the after-effects of an alarming slump in 2006, but Saudi markets have generally recovered well and, with oil prices at more than $80 per barrel, the Gulf region’s largest economy boasted net foreign assets exceeding SR1000bn ($266.7bn) and a current account surplus that generated SR250bn last year. This year NCB forecasts a current account surplus of SR220bn.

A stream of new international entrants, such as US investment banking giants Merrill Lynch and Bear Stearns, has shown the reciprocal keenness for players to get a slice of the kingdom’s petrodollars. One analyst puts this slant on their entry: “Firms were mainly setting up in Dubai thinking they could cover the market from there. When they realised they weren’t getting the deals, they woke up.”

Law change pays off

The impact of the 2003 Capital Markets Law – which stipulated that all banks must move their investment banking operations into separate institutions, and receive individual licences for brokerage, asset management, custodial services, advisory services and arranging by the end of July – has paid off with the total number of institutions offering securities services reaching 78, up from 45 at the beginning of the year.

This is part of Saudi Arabia’s financial evolution into a more sophisticated market, and comes at a time when the Tadawul All-Share Index, the largest in the Gulf, is still working on lifting itself out of the slump that hit the region early in 2006. On September 26, the exchange closed down 1% since the start of 2007.

The level of volatility, which dropped from 8% to 2% early in the year, persists. Senior NCB economist Dr Said Al-Shaikh told The Banker that share prices have increased from their mid-2006 lows, but the volume of trade has been volatile – and renewing investor confidence has taken a lot longer than expected. “At times, the volume reached SR13bn to SR14bn and we thought that was great, but it was certainly much lower than the average of last year when it was close to SR20bn,” he says.

In recent weeks, the volume has decreased to SR4bn to SR5bn, which is much smaller than in 2006. “It was a hard lesson for many of us in Saudi,” says Mr Al-Shaikh.

According to some analysts, stock market volatility should encourage more people to use asset managers. According to Timothy Gray, HSBC Saudi Arabia chief executive: “During the heady days of 2005 and early 2006, we saw a huge run up in funds under management, not only for mutual funds on the retail side, but also among the larger and more sophisticated investors, in the form of funds placed for discretionary management.”

The decline in funds under management came not only from the falling value of the underlying shares but also from the huge amounts of redemptions. At the time, many people did not understand the function of mutual funds. Funds under management decreased precipitously after the stock market crash in 2006 and most of the top fund managers were affected quite significantly.

Since the market has settled, all fund managers now have a core set of investors, and the number of investors and the value of funds under management are expected to start to rise again. Another boom and bust is not expected but the hard-learned lesson has prompted banks to diversify their funds.

“The trade-off in the market has given us an opportunity to launch more international equity funds, and to move the market away from investing purely in domestic equity funds,” says Mr Gray.

HSBC has launched a China-India fund – Chindia – and is launching an emerging markets fund and other global funds, most of which are sharia-compliant. “What we really need is more institutional investors and, in the absence of there being a real institutional market in Saudi, we need the market to open up to foreign fund managers. This would provide greater stability to the market,” says Mr Gray.

Market movement

The recent move to open up insurance and bank stocks to GCC investors means that the Saudi market is moving in this direction. Analysts say that it is inevitable that the market will open up to other foreign investors and when that happens, it will be important to have broking execution and knowledge of the companies and on-the-ground research. That is why many financial institutions are building research teams to cater to what is expected to be a growing institutional market.

This expectation explains why international investment banks are eager to move quickly into the Saudi market. Following on from Goldman Sachs, which has established a joint venture with NCB, the latest entrants include Merrill Lynch and Bear Stearns, the latter in a venture to be called Bear Stearns Asset Management Arabia (BSAMA). A spokeswoman at Bear Stearns says that the bank is still waiting for licensing approvals.

In June, it was announced that a consortium of Saudi business leaders headed by Prince Mishaal Al-Saud, CEO of Zad Investments, had signed a deal with Bear Stearns to form a 50/50 joint venture asset management company with headquarters in Riyadh. Prince Mishaal said at the time: “BSAMA will serve institutions and high net worth individuals across the kingdom.”

BSAMA will develop and distribute sharia-compliant and traditional equity and fixed income, hedge fund and private equity fund products. Prince Mishaal will be chairman, and Bear Stearns International CEO Michel Peretie and New York-based Bear Stearns Asset Management’s international head Christian Yates will sit on the board of directors.

“The joint venture will combine world-class asset management expertise with a deep knowledge of the investment needs and references of large investors across the kingdom and the rest of the world,” Prince Mishaal was quoted as saying.

Richard Martin, BSAMA chairman and CEO of Bear Stearns Asset Management, says the goal is “to be the leading independent asset manager in the kingdom and a worldwide leader in sharia-compliant investment products”. BSAMA plans to eventually expand into trading, brokerage and advisory services.

Zad Investment Company is a privately controlled investment firm that manages the investments of the Mishaal family.

Project finance booms

As international banks recover from a US subprime crisis, Saudi banks are being urged to step in as lenders to the kingdom’s major project developers. Others have put aside fears and are still keen to have a slice of the more than $365bn-worth of projects that have so far been announced in Saudi Arabia.

According to Saudi British Bank, institutions from the kingdom accounted for almost 60% of Gulf acquisitions, worth $37bn in the first eight months of this year.

State-owned Saudi Basic Industries Corporation (SABIC), established in 1976 to produce chemicals, polymers and fertilizers, recently signed a $6.1bn loan agreement with the Arab Bank Group. The money will be used to finance the acquisition of the US General Electric’s General Electric Plastic Company.

Key to securing financing is the kingdom’s appetite for debt that complies with Islamic law. Among recent deals, state-owned Riyad Bank has organised a SR900m sharia-compliant credit facility for The National Shipping Company of Saudi Arabia, which operates crude oil and chemical tankers.

Even bigger deals are in the pipeline, and not just for petrochemicals and energy projects. Financiers are being sought to arrange $5bn for a bid on a 1100-kilometre railway crossing the Saudi desert. Bidding for the Saudi land-bridge project was due to close on November 5 with the outcome expected early next year. The Bin Laden family heads a group, which includes Deutsche Bank and other major international developers, bidding for this. Also in the running are Al-Rajhi’s investment arm, heading a group with Samba Financial Group; while Kuwait’s Agility heads a group with National Bank of Kuwait and Riyad Bank.

Banks that have traditionally competed in the project financing market are HSBC, Deutsche Bank, Standard Chartered, NCB, Al-Rajhi Bank, Samba Financial Group, HSBC affiliate Saudi British Bank and Riyad Bank.

Riyad Bank announced in September that it planned to raise SR13bn in a rights issue before the end of 2007 to more than double its paid up capital of SR15bn. The move came ahead of the government’s creation of a rival, Al-Inma Bank, which is also expected to be capitalised at SR15bn, although the initial public offering (IPO) has been delayed since 2006.

Economic cities

All these institutions are looking keenly at the economic cities plan. An essential goal to be achieved by the six cities is job creation for Saudi Arabia’s unemployed youth, which government figures place at 9.6% although others estimate a much higher figure.

The economic cities have been strategically placed in underdeveloped areas as regeneration projects to spread wealth across the kingdom. Abdullah Wahid Al-Humaid, planning and development officer at the Labour Ministry, says that the six cities in Tabuk, Hail, the Eastern Province, Madina, Rabigh and Jizan will create 2.1 million jobs between 2010 and 2020.

What makes these cities different to ones built at Jubail and Yanbu in the last economic boom of the 1970s is their focus on attracting services industries, which are labour-intensive, instead of capital-intensive manufacturing industries. The cities will have four industrial core sectors, including aluminium, steel, fertilizer and petrochemicals.

According to the Saudi Arabian General Investment Authority, a key promoter of the developments, the six cities will contribute $150bn to GDP by 2020 and increase per capita GDP from $13,000 to $33,500.

NCB’s Mr Al-Shaikh says that the cities’ impact on the economy will be gradual. “The cities will start to affect the economy once they are built, populated and have attracted the industries they were meant for. Their current impact is in the demand of building materials they have generated for the infrastructure, and this will be accounted for in the GDP. But the real impact will be felt in four to five years, once they start producing goods and services,” he says.

Another difference of these economic cities is that they are being developed through public-private partnerships, in contrast to those of the 1970s, which were financed solely by the government.

The Jazan Economic City, in the south-west of the kingdom, is being developed by the Malaysia Mining Corporation (MMC) and Saudi Bin Laden Group (SBG). Its main attraction is its low costs. The Aluminum Corporation of China (Chalco) recently signed a deal with MMC and SBG to develop a $3bn aluminium smelter. Jazan offers Chalco lower electricity costs than those in its home country: energy costs $20 per megawatt-hour in the Middle East, compared with $40 in China.

The SR100bn King Abdullah Economic City, located in Rabigh, near Jeddah, is the largest city. It is being developed by Emaar the Economic City, a company formed by the Dubai government’s real estate vehicle, Emaar properties, alongside Saudi investors. Construction began in December 2005 and phase one is expected to be complete in 2008. Its components include a port, an industrial district, a financial centre and residential complexes. The industrial and residential areas are now open to investors.

Rakisa Holdings, lead developer in the Prince Abdul Aziz Bin Musaed Economic City in Hail, north-west of Riyadh, is planning an IPO of 30% of its shares; although, this has been delayed for some time, due to “market conditions”. Rakisa estimates the value of investments in the project to be $8bn, including funds for the construction of a new airport, and industrial and residential areas.

The $7bn Knowledge Economic City, which is being developed in Madina, is planned as an information city to include universities, Islamic research centres and other amenities. A fifth economic city will be established in the northern city of Tabuk, and a sixth (SR100bn) city in the Eastern Province.

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