Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Middle EastApril 1 2007

Keys to the kingdom

Saudi Arabia seems to be entering a new golden age, with barriers to the financial sector being lowered and project finance booming. Stephen Timewell reports from Riyadh and Jeddah.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

The world’s largest oil exporter, Saudi Arabia, has created enormous wealth in the past 30 years or more but, despite this, its financial sector has remained largely closed with entry strictly controlled. While briefcase bankers have breezed in from Bahrain, London and New York to grab a slice of the billions of petrodollar action available, the walls have been up, and for the past two decades the financial sector has consisted largely of just 10 banks, albeit including some joint ventures with some of the world’s biggest banks.

But change is afoot. In the middle of yet another oil boom – very different from those of 1973 and 1979 – the financial walls surrounding the kingdom are coming down fast. And on the back of a booming economy, there is a new financial dynamism, which is leading to radical restructuring of existing institutions, the creation of huge new projects and opportunities, and is attracting dozens of new players, including international heavyweights such as Goldman Sachs and Morgan Stanley.

New strategy focus

Described as the ‘Golden Age – Phase II’, the Saudis are now embarking on a very different strategy to that taken during the booms of the 1970s. Rather than investing surpluses abroad, the focus today is on accelerating the pace of economic development in the kingdom, diversifying, developing the private sector and creating much-needed employment.

With oil revenues hitting a record $191bn in 2006, based on an average oil price of $60.50 per barrel, according to Samba chief economist Brad Bourland, the country recorded its eighth consecutive current account surplus in 2006, a record $95.5bn. But, although there is confidence in $50 per barrel oil continuing for the foreseeable future and Saudi Arabia’s oil fundamentals remaining robust, there is keen interest in diversifying the economy away from oil.

Key to this diversification strategy is the $1000bn-worth of foreign investment projects to be completed in the next 15 years. Over the next five years, the kingdom plans to invest $70bn in its oil and gas infrastructure, but it is also planning to put $140bn into infrastructure projects, $92bn into petrochemicals and $88.9bn into electricity and water. In addition, the government has allocated $80bn for the four economic cities – Rabigh, Hail, Madinah and Jizan – heralding a new area of regional development. These development projects are expected to create one million jobs within the next 10 to 20 years. There are plans to launch a fifth economic city in Tabuk soon.

The King Abdullah Economic City (KAEC) in Rabigh, north of Jeddah, which covers an area larger than the size of Paris, will be mainly financed by the private sector and follows a new approach being developed by the Saudi Arabian General Investment Authority (SAGIA) to promote increased foreign investment. Targeting energy and transportation, KAEC is the largest single private sector project in the kingdom and is expected to attract more than $53bn in investments. Leading the project is Dubai-based Emaar Properties. Last August, KAEC raised $680m through a company called Emaar Economic City in a large initial public offering (IPO) for 30% of its equity.

Last May, another major scheme was launched: the King Abdullah Financial District in Riyadh. It is a $4bn development focused on building a specific financial services area in Riyadh, which is designed to accommodate the Capital Markets Authority (CMA), banks, financial institutions and the stock exchange (see below).

It is these economic cities that are leading the government’s diversification effort and it is the need for private sector finance initiatives that is pushing the traditionally conservative government to open up its financial sector.

Barriers come down

In the past year or two, the financial barriers have been lowered, allowing a number of regional banks and some others to establish branches. There are now 22 banks operating in the kingdom, including the Saudi commercial bank, Bank Al Bilad, which opened in May 2005. But the new dynamism and expansion is coming from the long-awaited impact of the 2003 Capital Markets Law, the CMA’s licensing of securities firms, the central bank’s (Saudi Arabian Monetary Agency) licensing of new insurance companies and the government’s decision to create a new megabank to rival the existing leading banks.

New regulations are due to reshape investment banking radically. Under the Capital Markets Law, all commercial banks have to move their investment banking operations into separate institutions and receive individual licences for brokerage, asset management, custodial services, advisory services and securities arranging by July 31. This has led to a surge of activity by local banks as well as new local players and foreign banks. The CMA, as of early March, had listed 45 firms authorised to conduct securities business and many more are expected to follow.

Those 45 firms so far represent a landmark new phase in the country’s financial evolution, bringing both improved sophistication and regulation. “The introduction of these new financial institutions comes at a time of heightened demand for services such as corporate advisory and project finance, as many companies are seeking to raise equity and debt to fund expansion plans. In addition, stock market volatility may encourage more private investors to use professional asset managers. At present, mutual funds account for less than 5% of market capitalisation,” says Samba’s Mr Bourland.

Learning curve

The opening up of new firms follows the dramatic correction in the stock market, which ended 2006 on 7933, down a massive 52.5% on the 2005 close of 16,712. This amounted to a stock market capitalisation loss of $500bn, equivalent to more than one-and-a-half times GDP. Although many of the largely retail investor base were badly burned by the so-called market correction, the impact on the banking sector has been relatively muted (see page 93). Many suggest the losses were a necessary part of an important learning curve for the relatively immature retail investors.

This year, the seeds of recovery are being seen with the TASI stock exchange index up to 8683 on March 10, gaining considerable ground in February. Samba Financial Group chief executive Eisa Al-Eisa regards the recent improvement as the market regaining confidence and better trading in better stocks.

Said Al-Shaikh, chief economist at National Commercial Bank in Jeddah, is also positive. “While it will need six months to truly gauge whether the market is maturing, it seems to be on the way. The market may be coming back to recovery, the level of volatility has dropped from 8% to 2%, a quarter of what it was last year, reflecting less panic by investors,” he says.

The new securities firms will not only play an important role in the transition to a more mature, less volatile stock market, but will also bring new structure and expertise in the corporate advisory, project finance and asset management areas. They can also be expected to change the whole dynamic of how, where and by whom banking is done in the kingdom and the Gulf. As one Riyadh banker explains: “Clients want non-suitcase bankers. It is a pride issue, and bigger clients want the big bank resources of large international institutions.” Being on the ground in the kingdom will radically change the way financial services are delivered and the 45 new firms is just the start.

Prominent player

The most prominent of these new players is NCB Capital, the new investment banking offshoot of the kingdom’s largest bank, National Commercial Bank (NCB). In early February, NCB, its subsidiary and the world’s leading investment bank, Goldman Sachs International, signed a memorandum of understanding to pursue strategic co-operation in Saudi Arabia. The tightly worded statement said: “Goldman Sachs and NCB Capital intend to co-operate across a broad range of business areas in or relating to Saudi Arabia, including investment management, securities, investment banking and principal investing. The memorandum also contemplates that Goldman Sachs will make an equity investment in NCB Capital.”

The memorandum, signed by NCB chairman Abdullah Bahamdan and Goldman chairman Lloyd C Blankfein, represents a major strategic development. Mr Bahamdan noted: “The economies of the region, in general, and the kingdom, in particular, are booming and present vast opportunities. The combination of NCB Capital’s presence on the ground with capable management and Goldman Sachs International’s world-class product platform and cutting-edge technology provides the home-grown entity the strongest possible support as it harnesses these opportunities while offering its customers a wide selection of top-notch alternatives.”

For Goldman, which established its first base in the Gulf last year in the Dubai International Financial Centre (DIFC) and has many longstanding relationships in the region, Mr Blankfein said: “The proposed transaction represents an important opportunity for Goldman Sachs and serves to reinforce our commitment to contributing to the further development of the kingdom’s financial markets. We are focused on building a broad business in the region and see this initiative as a key part of our strategy.”

Speaking to The Banker in Jeddah, NCB chief executive Abdulkareem Abu Alnasr, who is also chairman of NCB Capital, which has an initial capital of SR1bn ($267m), said that the second stage of more delicate negotiations on specifics had begun with more details possible in April. “The agreement represents a powerful combination of local know-how along with an international brand name and product access,” he says.

Other heavyweights

Goldman is not the only global heavyweight to grasp the new investment banking opportunities. In January, Morgan Stanley announced its intention to enter into a joint venture agreement with Riyadh-based investment house The Capital Group. The venture will operate under the name of Morgan Stanley Saudi Arabia.

“This joint venture is an important milestone in our growth strategy,” says Morgan Stanley chairman John J Mack. “Morgan Stanley has a strong track record of making long-term commitments to new markets, and establishing a presence in Saudi Arabia through this joint venture is the most recent example. We are looking forward not only to contributing to the growth of the Saudi market, but also to helping develop the substantial Saudi talent base in the kingdom.” The joint venture will focus exclusively on Saudi Arabia and will offer clients a broad range of services, including investment banking, capital markets, sales and trading, asset management and private wealth management.

The presence on the ground in Saudi Arabia of Goldman, Morgan Stanley and many others, including the already active HSBC Saudi Arabia – an investment banking joint venture between HSBC (60%) and local bank SABB (40%), already an HSBC affiliate – will raise the investment banking bar in the kingdom at an opportune time. With huge liquidity available, huge project potential and the government’s huge need to create jobs, the kingdom represents a largely unexplored goldmine for investment banks.

Will all the new firms thrive? The potential is there but Samba’s Mr Al-Eisa says: “All firms struggle to achieve high-quality staffing; this is a case of quality over quantity, and I am sure the list of licences will consolidate.”

Wealth redistribution

New securities firms are not the only financial initiatives taking place. King Abdullah is understood to be concerned about the redistribution of wealth to ordinary Saudis and, despite the stock market debacle last year, is keen to see the IPO process used to that end. The bulk of the 16 IPOs offered since 2003 are well above their offer price (including the eight IPOs of 2006) and, following this strategy, the government plans to establish a new megabank in which 30% will be offered in an IPO, open as usual only to Saudi individuals.

Speaking to The Banker, Saudi finance minister Ibrahim Al-Assaf explained: “There is a need for banking services and in particular Islamic banking services; and the establishment of a new full-service commercial bank, called AlInma Bank, has been approved by the government.” The new bank will be born big with a paid-up capital of SR15bn, owned 70% by three government entities and the 30% IPO taking place later this year with Samba acting as the sole adviser.

Details of AlInma Bank are sparse. Some bankers are questioning how such a huge bank can be effectively set up and staffed when the latest newcomer, the much smaller Bank Al Bilad, is seen to be struggling. Others, such as Riyad Bank chief executive Talal Al-Qudaibi, say: “Project finance requirements in the kingdom are big; banks have adjusted well to competition and have become better. This move is good for the market.”

Mr Al-Assaf expects AlInma to start operations at the end of this year or early in 2008. However, although there is likely to be considerable appetite for such an AlInma IPO, creating a commercial bank to compete with the kingdom’s biggest banks represents a significant challenge.

Mr Al-Assaf sees huge opportunities for banks in the new package of laws on mortgage finance, which are due to be enacted in the second half of 2007, opening up the important housing market. This is likely to provide a major boost for retail banks because there is huge demand for home finance, which has been largely unmet due to the unclear legal structure for banks, particularly in regard to repossession.

“Mortgages are the best thing that can happen to the country,” says Mr Al-Eisa, who is optimistic about the prospects for housing finance once the new laws are in place. The finance minister also sees huge growth potential in insurance as deregulation in the sector continues. The Saudi Arabian Monetary Agency (SAMA, the central bank) granted licences to 13 insurance companies in October 2006, and a further 18 companies are reported to be in the pipeline. Most of the new players are joint ventures with foreign partners, which is expected to boost service and competition significantly.

Important year

While many of the financial reforms have been in process for years in the traditional Saudi style, this year, following the stock market collapse last year, is the one in which many reforms come to fruition. With the economy booming and likely to continue to do so – apart from exceptional regional political turmoil – the surge in investment banking capability available through new firms and foreign partners opens up a new financial era.

Backed by a new megabank, new insurance companies, new mortgage laws, and the new economic cities and plethora of new projects, Saudi Arabia is at last putting a comprehensive financial infrastructure in place at home to match its oil revenue muscle.

While the financial outposts in the Gulf that have serviced the Saudi market in the past will no doubt try to take advantage of a growing Saudi financial pie, a new financial era is opening up in the kingdom itself, where Saudi operations on the ground service Saudi clients. The era of the briefcase bankers is ending.

KING ABDULLAH FINANCIAL DISTRICT

The ambitious, new King Abdullah Financial District (KAFD) in Riyadh is perhaps the clearest reflection yet of the government’s strategy to develop the private sector, enhance the financial sector and create new jobs. Due to open late in 2008, the 160-hectare site in a prime location will be the headquarters of the Capital Market Authority (CMA), the stock exchange (Tadawul) and the commodity market, and for financial institutions and other service providers such as accountants, auditors, lawyers, analysts, rating agencies, consultants and IT providers.

With first excavations scheduled for this month, the SR4.3bn ($1bn) infrastructure project will essentially bring Riyadh’s major financial institutions under one roof rather than spread across the sprawling city. Described by Samba chief executive Eisa Al-Eisa as “the Canary Wharf of the desert”, referring to London’s new financial district, the KAFD will be a lot more than a collection of financial institutions.

In addition to world-class office space and housing, the district will have a financial academy, recreational facilities, skywalks and its own monorail. It will offer a fully integrated development, including offices, hotels, a conference centre, shops and sports arenas for football, volleyball and basketball. Key to the KAFD design is quality of life and a pollution-free environment. Built around the modernised concept of a wadi, or central waterway, a major feature of KAFD will be quiet open spaces and parks with cars restricted to the 40,000 parking spaces on the perimeter.

Owned by the pension fund, the development has attracted high demand, with 13 banks already signed up, including Samba and Riyad Bank among others. Finance minister Ibrahim Al-Assaf says that KAFD is designed to become an international financial centre equal in scale as well as in quality to some of the world’s leading capital markets. “No other centre in the region offers a comparable partnership with the world’s financial institutions in order to finance and develop one of the largest and most diversified programmes of projects,” he says. KAFD is expected to create 43,000 jobs.

Was this article helpful?

Thank you for your feedback!