I OVERVIEW OF RECENT ACTIVITY
The Saudi Arabian economy, while remaining strong relative to other countries in the region, is currently facing a number of challenges resulting from the severe drop in oil prices recently and the spread of the covid-19 pandemic. Despite being the largest economy in the Middle East, the Saudi Arabian economy grew by a weaker-than-expected 0.3 per cent in 2019 as the oil sector contracted sharply. The 2019 budget for Saudi Arabia, which was announced in December 2019, sets out a slight decrease in government spending of about 0.6 per cent to US$272 billion in 2020 due to the global economic outlook.
While the economy is still driven by abundant oil reserves and related hydrocarbon industries, with oil prices at their lowest in over a decade, the country's leadership has adopted a national transformation plan named 'Vision 2030' to modernise and diversify the economy, and has entrusted a vast amount of assets under the authority of the Public Investment Fund (PIF), which is now one of the world's largest sovereign wealth funds. Vision 2030 focuses on increasing the country's non-oil revenue and employment, particularly in the private sector, in retail, education and healthcare. The government has also announced a broad privatisation programme in many key sectors, which included an initial public offering (IPO) of a 1.5 per cent stake in Saudi Arabian Oil Company (Saudi Aramco), at a valuation of US$1.88 trillion in December 2019. The effects of Vision 2030 have been felt, as non-oil sector private sector growth has substantially increased since the start of 2017.
In response to predicted budget deficits, Saudi Arabia has raised tens of billions of dollars in sovereign issuances in the past four years (after nearly a decade without any public debt issuances) including issuances each month from April 2019 to date with the latest being in June 2020 which was set at 8.495 billion riyals.
In addition to efforts targeted towards attracting increasing local investment in sovereign issuances, as evidenced by the Saudi Arabian Capital Market Authority's (CMA) recent approval of the first Saudi sovereign sukuk fund managed by SAMBA Capital and Investment Management Company and subsequent funds established by Arab National Investment Company, Albilad Capital and Alinma Investment Company, it is also widely speculated that the government will issue an additional sovereign bond and continue to tap into international debt markets to cover the deficit and to avoid further deterioration of its reserves.
The government is also focusing on increasing foreign investment into the country. In a long-awaited and very welcome move, the government opened the Saudi Arabian Stock Exchange (Tadawul) to foreign investment in June 2015, and liberalised the foreign ownership rules in May 2016, August 2016, January 2018 and June 2019. The CMA has also been encouraging many of the country's blue chip and large family operated companies and financial services companies to list, and created a small cap market, the Parallel Market, in February 2017, which saw 10 listings in its first year. Further, Saudi Arabia has introduced a real estate investment trust (REIT) regime, and in November 2016, Riyad REIT was the first REIT to be listed in Saudi Arabia (and only the second REIT to be listed in the Middle East), and was followed by another 14 REITs up to July 2019 with a number of them also increasing their capital to acquire additional assets. More recently, the CMA has published regulations for listed funds, and it is hoped these will spur the development of exchange-traded private equity funds. In general, listings and capital raises in Saudi Arabia have continued to be strong over the past year, while capital markets in other regional and oil-driven economies have dried up.
Over the past three years, the CMA has released numerous regulations covering the establishment of new corporate vehicles, the IPO process and foreign investment in Saudi Arabia, and has promised a complete revamp of existing financial services regulations. Three regulations in particular are pivotal for asset managers looking to raise Saudi Arabia-targeted funds: the rules on the offer of securities and continuing obligations, the investment funds regulations, the real estate investment traded funds instructions and the closed-ended investment traded funds instructions. All these regulations are currently being revamped pursuant to draft amendments that were issued for public consultation by the CMA earlier this year. These regulations provide opportunities to investment banks, private equity firms and asset managers to expand their product offerings and access additional investor bases, particularly with the rules on the offer of securities and continuing obligations, which would potentially allow foreign companies to list their shares on the Tadawul main market.
Saudi Arabia is home to the largest number of investment funds domiciled in the Gulf Cooperation Council (GCC). Funds and asset managers have been gradually diversifying from primarily real estate investments into other parts of the economy, with a particular focus on venture capital and private equity, as these sectors are being supported by the CMA, PIF (through its fund of funds established under the name of Jada), the Saudi Venture Capital Company (a recently created government-owned venture capital investment firm), the Ministry of Commerce, the Ministry of Investment, the Ministry of Labour, Social Development Bank, the Small and Medium Enterprise Authority (SMEA), the Saudi Technology Development and Investment Company (TAQNIA) and other government institutions. Additionally, managers, investors and many government-owned vehicles are being encouraged to reinvest capital and proceeds into Saudi Arabia rather than deploying funds into foreign investments.
The government has empowered forward-thinking regulators that have implemented relatively clear, stable and predictable funds and capital markets regimes. It is encouraging to many investors and commentators to see the Saudi Arabian markets opening up. As a result, it was announced that Saudi Arabia has joined the FTSE and MSCI emerging market indexes, which are moves that will potentially foster more growth and lead to a greater influx of capital into the country's markets.
II GENERAL INTRODUCTION TO THE REGULATORY FRAMEWORK
The CMA and the Saudi Arabian Monetary Authority (SAMA) are the governmental bodies that regulate asset management and financing transactions in Saudi Arabia.
The CMA regulates Saudi Arabia's capital markets, including securities, sales of assets, equity securities and debt securities (such as sukuk). Its power is granted under the Capital Market Law, which was originally implemented in 2003.
The CMA has issued the implementing regulations governing the management and offerings of securities, including but not limited to the following:
- the Rules on the Offer of Securities and Continuing Obligations, which govern the offering of securities in Saudi Arabia on both a private and public basis;
- the Authorised Persons Regulations, which govern the establishment of asset managers, their conduct of business, systems and controls and handling of client money and assets (which were recently amended and reduced requirements for applicants to obtain a management licence and dramatically reduced the required share capital (in some cases to as little as 5 million riyals);
- the following rules and regulations, which govern the activities, operations and management of companies publicly traded on the Tadawul and the Parallel Market:
- the Listing Rules;
- the Parallel Market Listing Rules;
- the Merger and Acquisition Regulations;
- the Market Conduct Regulations;
- the Instructions of Book Building Process and Allocated Method in Initial Public Offerings;
- the Regulatory Rules and Procedures relating to Listed Joint Stock Companies; and
- the Corporate Governance Regulations;
- the Rules for Special Purpose Entities, which are intended to promote sukuk and the offering of other debt instruments;
- the Rules for Qualified Foreign Financial Institutions Investment in Listed Shares, which govern investment by foreign investors in shares listed on the Tadawul and the Parallel Market;
- the Investment Funds Regulations, which govern private equity funds, hedge funds, money market funds and private real estate funds, significant amendments to which were implemented in November 2016;
- the Real Estate Investment Traded Funds Instructions, which provide for certain public real estate funds to be listed on the Tadawul as real estate investment traded funds, amendments to which were proposed in February 2018;
- the Closed-Ended Investment Traded Funds Instructions, which govern the establishment and listing of certain non-real estate funds (e.g., private equity funds) on the Tadawul;
- the Real Estate Investment Funds Regulations, which govern publicly placed real estate funds;
- the Instructions for the Foreign Strategic Investors' Ownership in Listed Companies;
- the Credit Rating Agencies Regulations, which regulate and monitor the conduct of rating activities; and
- the Securities Business Regulations, the Prudential Rules and the Investment Account Instructions, which govern the operations and actions of asset managers.
In late 2017, the CMA issued the Financial Technology Experimental Permit Instructions, which introduce a 'sandbox' accelerator under which certain financial services companies can apply for licences for products and services in new sectors. In addition, the SAMA announced the launch of the FinTechSaudi initiative in May 2018, which is also aimed at supporting the fintech ecosystem alongside the efforts of the CMA. On 6 February 2019, the CMA announced the issuance of an experimental permit for Falcom Financial Services Company to create an equity crowdfunding platform with six permits that followed with the latest being issued to Wethaq Capital Markets Platform Company in June 2020.
The SAMA acts as the central bank of Saudi Arabia, and is responsible for issuing currency and regulating the insurance industry. It is also responsible for encouraging the development of the Saudi Arabian banking system in both the public and commercial sectors. Additionally, the SAMA is Saudi Arabia's investment authority, and is responsible for managing the country's assets, both inside and outside of the country, although this role is being largely transferred to the PIF.
With few exceptions, individuals who are not citizens of a GCC country and non-GCC corporate entities (including Saudi entities with direct or indirect non-GCC ownership) must register with the Ministry of Investment (MISA) (previously known as the Saudi Arabian General Investment Authority (SAGIA)) prior to owning non-listed shares or real property in Saudi Arabia. The MISA registration process adds expense and time to any transaction. The primary exemptions to MISA registration are ownership in a CMA fund and investment in listed shares (or units in exchange-traded funds or REITs) through the qualified foreign investor (QFI) framework, the CMA-regulated swap regime and potentially pursuant to the Instructions for the Foreign Strategic Investors' Ownership in Listed Companies.
To date, the MISA rules have not governed foreign ownership in a CMA fund. Accordingly, there is no requirement that non-GCC investors in a CMA fund obtain MISA approval. A foreign investor's ownership of units in a CMA fund is only governed by the rules and regulations of the CMA. Moreover, GCC nationals and companies that are majority-owned by GCC nationals (and partly owned by non-GCC nationals) are permitted to invest directly in listed securities in Saudi Arabia. Additionally, financial institutions that register with the CMA as a QFI are permitted to buy and sell shares of publicly listed companies in Saudi Arabia on their own behalf and on behalf of their clients without MISA approval and other foreign corporate investors may own shares under the Instructions for the Foreign Strategic Investors' Ownership in Listed Companies.
As part of the CMA's efforts in revamping the existing financial services regulations, the CMA has introduced a number of proposed amendments to the above-mentioned rules and regulations since the end of 2019, with the most notable being related to the Securities Business Regulations, the Authorised Persons Regulations, the Investment Funds Regulations, the Real Estate Investment Funds Regulations and the Rules on the Offer of Securities and Continuing Obligations.
The proposed amendments to the Securities Business Regulations and the Authorised Persons Regulations introduce certain amendments to the defined scope of securities activities, the types of licences and the minimum capital required to carry out these activities. They also introduce new classifications for the types of clients for CMA-regulated entities whereby clients are 'retail clients', 'qualified clients' or 'institutional clients'. In addition, the exemptions for securities advertisements in the Kingdom have been amended under the proposed amendments to the Securities Business Regulations, and a number of additional requirements have been introduced with respect to dealing with conflicts of interest.
In June 2020, the CMA also announced draft proposed amendments to Investment Funds Regulations and Real Estate Investment Funds Regulations. The proposed amendments aim to codify a number of CMA practices and also introduce a number of significant changes. In terms of private funds, the proposed amendments introduce a number of amendments concerning investor eligibility and corporate governance and also aim to resolve certain ambiguities in the market regarding the permissibility of capital commitment structures by clearly permitting them under the proposed amendments. With regard to public funds, the proposed amendments touch on a number of areas including investment restrictions and governance. Pursuant to the draft amendments, REITs and certain non-real estate funds that are currently able to list on the Tadawul are also given the right to list on the Parallel Market.
III COMMON ASSET MANAGEMENT STRUCTURES
For tax and other regulatory reasons, the majority of structures used in Saudi Arabia are domestically based. The primary structures for asset management in Saudi Arabia are managed accounts and investment funds regulated by the CMA. As opposed to other Saudi Arabian vehicles, a CMA fund is relatively inexpensive to establish and maintain and allows for significant structuring flexibility. Further, a manager can structure the fund so that investors are truly passive, unlike many other vehicles where investors actually have statutory veto rights and other substantial minority protections.
A CMA fund is a contractual entity formed between the fund manager and its investors upon execution of the terms and conditions of the fund. Under CMA regulations (and from the perspective of other governmental authorities and ministries), a CMA fund is not considered to be a legal entity separate from the fund manager. Accordingly, the Saudi Arabian Ministry of Commerce (MOC) will not issue a commercial registration to a CMA fund. Therefore, all actions of a CMA fund, including ownership of real property, assets and shares in Saudi companies, must be performed by a CMA-licensed fund manager or a CMA-licensed custodian on the CMA fund's behalf. The CMA issued a circular in August 2015 requiring that independent CMA-licensed custodians must mandatorily hold the assets of all real estate funds, and in November 2016 adopted amendments to the funds regulations requiring all funds to have independent custodians. These amendments to the funds regulations codify many of the unwritten practices and procedures of the CMA that have been adopted over the past decade.
The Saudi CMA fund is arguably the most efficient vehicle for structuring investments into Saudi Arabia. If properly structured, they create the ability to minimise restrictions from MISA and can also provide certain tax efficiencies not available with other structures.
Before the rise in popularity of CMA funds, most collective investment vehicles in Saudi Arabia took the form of limited liability companies. However, they are relatively inflexible vehicles that statutorily provide substantial rights to their shareholders, which makes it hard for managers to enforce any default provisions or even to exit investments or wind down a fund. For example, structuring and enforcing a capital commitment structure in a Saudi limited liability company is very complex. The government enacted new companies regulations in May 2016, which permit single-shareholder companies and give other clarifications to corporate formations and structures. However, it is unlikely that any corporate structures will surpass the popularity of CMA funds, although the SMEA, MOC and the CMA are jointly collaborating to explore the legal and regulatory framework for companies necessary to nurture start-ups and small businesses.
There has been a recent upsurge in the utilisation of asset management and investment structures in the Abu Dhabi Global Market (ADGM) in relation to assets in Saudi Arabia. The ADGM is a financial free zone based in the Emirate of Abu Dhabi, United Arab Emirates, which has a legal regime based on English law. Companies domiciled in the ADGM can be deemed 'GCC' when conducting business in Saudi Arabia and potentially would not need to be registered with MISA. Under certain circumstances ADGM companies can also elect to be treated as Saudi tax residents with the tax authorities. As such, due to various tax, regulatory, legal and practical considerations, managers and investors have increasingly explored using ADGM for Saudi business and investment ventures.
IV MAIN SOURCES OF INVESTMENT
With over 500 domestic funds currently in operation, Saudi Arabia has the largest number of funds domiciled in the Middle East by a large margin. Historically, investment funds in Saudi Arabia were offered to retail clients and invested in traditional asset classes such as listed equities, money market instruments and corporate and sovereign debt. More recently, the private funds market has thrived. Private funds have tended to invest in real estate, which has been the asset of choice for high net worth and institutional Saudi investors and is easier to structure in order to be shariah-compliant than many alternative assets. More recently, there has been a surge in private equity and venture capital funds due to the encouragement of the CMA, SMEA and other government authorities and various incentive programmes. In early 2018 the government introduced a framework for credit funds, and it is expected that several private credit funds will eventually launch in this sector.
While the vast majority of investors in Saudi Arabian funds are Saudi nationals, Saudi-domiciled institutions and family offices, and government-backed entities and organisations, there is also a significant level of investment from GCC nationals and institutions in such funds. Traditionally, most funds in Saudi Arabia had been publicly offered and had targeted retail investors, but there has been a significant shift toward privately placed funds due to the relative ease of their establishment both in terms of timing and regulatory scrutiny. Since the primary sources of capital for Saudi Arabian funds are family offices and the government, it is expected that most investors will easily be able to meet the basic qualifying criteria under the Investment Funds Regulations, namely investing at least 1 million riyals or qualifying as a sophisticated investor. In the current proposed amendments to the Investment Funds Regulations, investors must be qualified clients or institutional clients or investors investing a maximum amount equal to 200,000 riyals.
V KEY TRENDS
i Equity capital markets
The government is encouraging significant investment into the economy from both local and foreign investors. There were many IPOs in 2014, including the IPO of the National Commercial Bank (NCB), which was the largest ever regional IPO, and the second-largest globally in 2014. While Saudi Arabia only witnessed six IPOs in 2015, raising approximately US$1.4 billion, such trend was reflected in most of the GCC region, which only witnessed two other IPOs (one in the UAE and one in Oman). Saudi Arabia witnessed four IPOs in 2016, including the offering of L'azurde Company for Jewellery, which was backed by regional private equity heavyweights including Investcorp, and the listing of Riyad REIT, the first Saudi Arabian-listed REIT. In 2017, there were 16 IPOs in Saudi Arabia, although all but one (Zahrat Al Waha for Trading Co) were REITs and small-cap listings on the Nomu.2 It has been speculated that a number of prominent Saudi companies, including ACWA Power, units of Saudi Arabian Airlines, Bateel International, Dar Al-Arkan Properties are preparing for listing in the near future on the main market of the Tadawul.
In June 2015, foreign investors were permitted to directly own shares listed on the Tadawul through the QFI framework. The foreign ownership rules were twice liberalised in 2016, with further amendments becoming effective in January 2018. Only foreign institutions that have a minimum of US$500 million in assets under management and five years of experience will be permitted to register with the CMA as a QFI. Once registered, a QFI can purchase or arrange for its clients to purchase shares of companies listed on the Tadawul (except for six companies that have substantial real estate holdings in Mecca and Medina, where ownership of real property is limited to Saudi Arabian nationals). Holdings in a single company by a QFI or its clients will be limited to 10 per cent, and holdings in a single company by QFIs in the aggregate will be limited to 49 per cent.
Prior to June 2015, foreign investors could participate in listed companies through swap arrangements only, which allowed investors to participate in the profits of the companies but did not provide for voting rights. It is expected that, as a result of the QFI framework, foreign investment in the Saudi Arabian stock market will grow from US$7 billion to nearly US$35 billion in the future. In addition to the QFI framework, the CMA more recently on 26 June 2019 announced the introduction of the Instructions for the Foreign Strategic Investors' Ownership in Listed Companies, which were widely welcomed as they pave the way for relaxing the regulatory framework for foreign investment in Saudi listed companies. Prior to the introduction of these instructions, foreign participation in the Tadawul was limited to investment through swap arrangements or under the QFI regime and subject to a maximum limit of 49 per cent of the share capital of a single company for all foreign investors. However, the newly introduced instructions allow non-financial entities to invest in Saudi listed companies and it is hoped that foreign strategic shareholders will be permitted to own shares in excess of 49 per cent of a company's share capital without being subject to overly restrictive lock-up periods.
In February 2017, the CMA and Tadawul created the Parallel Market to allow for alternative and small-cap listings. This move was widely anticipated and well received, improves SMEs' access to capital and encourages better corporate governance. As of July 2020, more than 10 companies are listed on the Parallel Market, with the latest being Somu Real Estate Company whose approval for listing on the Parallel Market was announced by the CMA on 28 April 2020.
In October 2016, the CMA's Real Estate Investment Traded Funds Instructions (REIT Regulations) were introduced, which allow managers to list certain public real estate funds on the Tadawul. As of the end of June 2020, the Tadawul is host to 17 listed REITs and it is widely expected that the REIT Regulations will further spur the real estate market in Saudi Arabia.
In October 2018, the CMA issued the Closed-Ended Investment Traded Funds Instructions, which govern the establishment and listing of certain non-real estate funds on the Tadawul. Following the introduction of the REIT Regulations, it is anticipated that listing of private equity funds under these instructions will gain traction as retail investors are given exposure to privately held companies with minimal investment.
During the first half of 2019, the CMA announced the approval of four IPOs of Maharah Human Resources Company, Nayifat Finance Company, Ataa Educational Company and Arabian Centres Company, the latter being the largest IPO in the Kingdom during the last five years and the first offering in the Kingdom under Rule 144a, which allows the sale of securities to qualified institutional investors in the United States. More recently, during the second half of 2019 to date, we witnessed a number of IPOs approved by the CMA including the IPO of Saudi Aramco, Dr Sulaiman Al Habib Medical Services, Amlak International for Real Estate Finance Company and BinDawood Holding Company. In addition, the market has recently started to witness signs of consolidation among various sectors, in particular the banking sector, which already saw the successful merger between the Saudi British Bank and Alawwal Bank earlier in 2019 in addition to a more recent announced merger between National Commercial Bank and SAMBA Bank that has been announced to create a combined group with more than US$200 billion in assets. In line with the consolidations in the banking sector, it is also expected that consolidations will follow in the insurance sector as the market expects that the minimum capital requirement for SAMA licensed insurance companies is due to increase from 100 million riyals to 500 million riyals.
ii Debt capital markets
Historically, the majority of debt issues from Saudi Arabia have been in the form of sukuk. While it is expected this trend will continue in the long term, the government has recently launched several large conventional bond programs.
Sukuk and bond issuances are regulated by the CMA. It is expected that the CMA will issue regulations in the near future governing the process to list and trade sukuk and bonds on the Tadawul.
It is reported that the Kingdom issued US$5 billion of debt, taking advantage of low borrowing costs globally. It is understood that the Kingdom is seeking to cover part of its growing budget deficit by selling about US$32 billion of local currency and international debt over the course of the year 2020 and investors placed more than $23 billion of orders for the debt.
The current population demographics of Saudi Arabia are significant in supporting strong growth in the domestic consumer market. It is estimated that approximately 80 per cent of Saudi Arabia's population is under the age of 35, providing the potential for a greater demand for property mortgages, automobile loans and general personal borrowing. It is expected that retail lenders will inevitably need to tap the international capital markets to meet the potential increased demand for retail borrowing. The growth of the domestic market should also encourage the expansion of business interests that may require access to debt capital markets to help finance them. A number of Saudi Arabian banks are considering sukuk to meet required capital adequacy requirements, and there have been sukuk of over 1 billion riyals issued in recent years by NCB, Riyad Bank, Saudi British Bank and AlJazira Bank, which are among the country's largest lenders.
iii Investment funds
The CMA has increasingly scrutinised blind-pool investment funds and real estate development funds. Owing to this heightened scrutiny and the relative ease with which managers can establish private CMA funds, there has been a significant shift toward single asset funds, particularly single asset real estate funds with very limited numbers of investors. However, an exception to this has been the rise in venture capital and private equity funds that are supported by the government through Jada or Saudi Venture Capital Company, which support and encourage blind pool funds as they are pushing for the development and growth of the asset management industry in Saudi Arabia.
The local turbulence within Saudi Arabia has led many investors to look outside of Saudi Arabia (and the wider MENA region) towards the more established markets of Europe and the United States, which, despite the geopolitical events in those jurisdictions, are widely seen as significantly more stable than Saudi Arabia. This sentiment has not gone unnoticed by foreign asset managers, who are increasingly approaching high net worth individuals, families, sovereigns and institutions and marketing their foreign funds as being better alternative investments vehicles to those available in Saudi Arabia (which has experienced a turbulent past year). Noticing this trend, Saudi-based asset managers are increasingly setting up investment funds whose investment strategy is focused on investing mainly in the United States and Europe, with a particular focus on the real estate sector, and foreign asset managers are becoming increasingly interested in offering their funds to Saudi investors.
Foreign funds may only be offered in Saudi Arabia as a private placement to sophisticated investors or to no more than 100 offerees (excluding sophisticated investors), and the minimum amount payable per offeree is not less than one 1 million riyals or an equivalent amount. In addition, the CMA has mentioned on its website that reverse solicitation is a tolerated practice.
VI SECTORAL REGULATION
The SAMA regulates the insurance industry in Saudi Arabia. In particular, insurance companies are governed by the Law on Supervision of Co-operative Insurance Companies and its Implementing Regulations, and the Investment Regulations issued by the SAMA.
Every insurance company must adopt an investment policy approved by the SAMA. Any material changes to the investment policy must also be approved by the SAMA.
If the SAMA does not approve an insurance company's investment policy, or an insurance company does not have any investment policy, then the insurance company must adhere to the investment standards set out in Table 1 of the Implementing Regulations (see below), provided that investments outside Saudi Arabia will not exceed 20 per cent of the total investments and are in accordance with Article 59(2) of the Implementing Regulations. Article 59(2) provides that the insurance company must invest 50 per cent of its total invested assets in riyals. The SAMA's written approval is required if the insurance company wishes to reduce this percentage.
The Regulations are silent on what constitutes investments outside Saudi Arabia.
|The Implementing Regulations|
|Investment type||per cent for general insurance||per cent for protection and savings insurance|
|Saudi authorised banks||20 maximum||10 maximum|
|Saudi government bonds||20 maximum||10 maximum|
|Saudi riyal-denominated investment funds||10 maximum||15 maximum|
|Foreign currency-denominated investment funds||10 maximum||10 maximum|
|Foreign government bonds||5 maximum||5 maximum|
|Bonds issued by domestic companies||5 maximum||5 maximum|
|Bonds issued by foreign companies||5 maximum||5 maximum|
|Equities||15 maximum||15 maximum|
|Real estate in Saudi Arabia||zero maximum||5 maximum|
|Loans secured by real estate mortgages||zero||5 maximum|
|Loans secured by policies issued by the insurer||zero||5 maximum|
|Other investments||15 maximum||15 maximum|
Insurance companies must take into account the investment concentration risks. Concentration in an investment instrument must not exceed 50 per cent in any one of the investment instruments mentioned in the table above.
Insurance companies are prohibited from investing in derivatives, option contracts, hedge funds, deposits with foreign banks, private equity investments and any off-balance sheet instrument, and these should also not form part of the insurance company's asset allocation unless specifically approved by the SAMA, and must be based on efficient portfolio management justification. An insurance company can, with the approval of the SAMA, invest in derivatives subject to the following conditions:
- such derivatives must be listed on a stock exchange, capable of being readily closed out and based on underlying admissible assets, and must have a prescribed pricing basis;
- the insurance company must set aside assets that can be used to settle any obligations under these derivatives, and set out adequate provisions for any adverse changes to the derivatives and their coverage; and
- the counterparty must be reputable and in an acceptable financial condition.
Investment in sukuk is allowed provided they are equivalent to bonds and the percentage allocation in them does not conflict with those outlined in the table above. The maximum limit of allocating sukuk that are issued by local companies in which the government has a significant ownership is 20 per cent, and the solvency margin is equivalent to the government's participation in the capital.
There are two large governmental institutions in Saudi Arabia focused on pensions and payments of employee benefits: the Public Pension Agency (PPA) and the General Organisation for Social Insurance (GOSI). Additionally, Saudi Aramco Investment Management Company (SAIMCO), which invests the capital for the Saudi Aramco pension and retirement plans, is a big player. Otherwise, private pension plans are not particularly active players in asset management in Saudi Arabia.
Government employees in Saudi Arabia are entitled to pensions of up to 80 per cent of their final salary. The PPA, which is a division of the Saudi Arabian Ministry of Finance, manages all retirement programmes for civil and military pensioners.
The PPA primarily invests in shares of Saudi Arabian companies listed on the Tadawul, and it is believed that its local stock market holdings are worth more than 40 billion riyals. However, the PPA also has substantial investments in real estate and fixed income products.
All employers in Saudi Arabia are obligated to register with the GOSI, and to enrol all Saudi and non-Saudi employees in the GOSI. The payment obligations to the GOSI are as follows:
- Saudi employees are required to be registered under the Annuities Branch of the GOSI subject to the payment of 18 per cent of the employee's wage. The employer shall pay 9 per cent of the subscription amount, and the remaining 9 per cent must be deducted from the employee's salary on a monthly basis; and
- Saudi and non-Saudi employees are required to be registered under the Occupational Hazards Branch of the GOSI. The employer shall pay the subscription amount of 2 per cent of the employee's wage for Saudi and non-Saudi employees.
Over 6 million individuals and corporate bodies are covered by this regime. GOSI investments are distributed among a number of major investment fields such as cash investments, bonds, loans, shares and real estate investments, but the GOSI is primarily focused on international private equity investments. The GOSI follows a long-term investment management strategy that aims to avoid risks, seeks large revenues that enable it to meet its liabilities towards its contributors and beneficiaries, and concentrates on profitable local investments. Although the direct objective of GOSI investments is to maintain fund sustainability to cover contributors' insurance benefits, they also indirectly support development projects in Saudi Arabia. These investments are usually directed to developmental projects that play an important role in containing labour force and developing human and material resources.
It is estimated that the GOSI has US$116 billion in assets under management, invested primarily in Saudi Arabian listed equities with additional investments in other securities and financial instruments and real estate.
Another active player is Saudi Aramco, the government-owned oil and gas company. Saudi Aramco is quite different from the government entities described above, as it is primarily an industrial operating company, and less frequently associated with the financial services and asset management industries. However, with annual revenues of over US$300 billion, Saudi Aramco is an active investor in technology, energy and venture capital investments both in Saudi Arabia and worldwide. Through its investment management division, SAIMCO, Saudi Aramco invests a substantial portion of its revenues for the benefit of its retirement and pension plans. Saudi Aramco's energy investments division, Saudi Aramco Energy Ventures, is also an active investor both in Saudi Arabia and abroad. More recently, Saudi Aramco announced its acquisition of a 70 per cent stake in Saudi Arabian Basic Industries Corporation (SABIC) from the PIF for a total purchase price of 259.125 billion riyals.
iii Real property
The Real Estate Finance Regulations were passed in July 2012 and provide a provisional framework for secured and structured finance transactions pertaining to real estate assets. This is a positive development for the potential growth of an asset-backed securitisation market in Saudi Arabia.
Public real estate funds are governed by the Real Estate Investment Funds Regulations implemented by the CMA. Public real estate funds that also comply with the REIT Regulations can be listed on the Tadawul and potentially the Parallel Market as suggested under the proposed amendments to the Real Estate Investment Funds Regulations. All privately placed real estate funds are governed by the private placement rules in the Investment Funds Regulations, which are significantly more comprehensive and provide managers with much greater flexibility. The vast majority of private funds in Saudi Arabia are real estate-focused.
In July 2012, Saudi Arabia released the long-anticipated Real Estate Registered Mortgage Regulations (Mortgage Regulations). The Mortgage Regulations provide the foundation for the creation of all mortgages in Saudi Arabia. The legislation represents a significant milestone in the registration, prioritisation and enforcement of security rights within Saudi Arabia. Many asset managers believe this will increase liquidity for potential home buyers in Saudi Arabia, and as a result are keen to acquire and develop properties. Most banking transactions have not yet complied with the Mortgage Regulations; however, the SAMA has recently issued circulars requiring banks to start registering mortgages under the Mortgage Regulations, and has issued various incentives for mortgage holders.
iv Hedge funds
Hedge funds are regulated by the Investment Funds Regulations, which provide specific requirements regarding the diversification parameters and amount of leverage a fund can incur. Further, the regulations require that all open-ended funds allow for sales and redemptions at least twice a week. These subscription and redemption requirements apply unless formally waived by the CMA. However, the CMA has taken the position that such requirements do not apply to private placed funds.
v Private equity
Saudi Arabia witnessed a considerable decrease in private equity deal value and volume in 2018 and 2019 (compared to prior years) driven by consistently low oil prices (which began to rebound later during this period), uncertainty regarding the impact of regulatory, legal and fiscal reform (which included a major anti-corruption campaign in November 2017) and the occurrence of several geopolitical events in the region. A number of investors have commented that this makes forecasting potential investees' future results more difficult, resulting in a lower level of deals in Saudi Arabia.
As previously mentioned, the proposed amendments to the Investment Funds Regulations were issued in June 2020, allowing Saudi-domiciled funds to implement many of the terms utilised by managers based in more developed markets that are prevalent in private equity funds in traditional funds jurisdictions.
While we continue to see an increase in the use of single asset funds for private equity deals, there has also been a slight increase in government-backed blind pool private equity and venture capital funds in the Kingdom. Privately placed CMA funds offer a means to pool Saudi, GCC and foreign investors in a vehicle to acquire an asset, while avoiding the challenges involved in partly foreign-owned limited liability companies making private equity investments in Saudi Arabia.
The SMEA, the PIF fund of funds and Saudi Venture Capital Company are spearheading a review of the private and equity and venture capital environment in Saudi Arabia in an effort to make it easier for entrepreneurs to establish small businesses and for investors to comfortably provide capital to Saudi-domiciled companies.
vi Other sectors
Most investment in Saudi Arabian funds and other vehicles comes from two investor classes: family offices and investment companies, and government entities.
Family groups such as SEDCO, Olayan, Al Fozan, Muhaideb, Bin Saedan, Al Rajhi and MASIC are major players in the asset management field in Saudi Arabia. Many of these groups are now CMA-licensed themselves or substantial shareholders in CMA-licensed entities, and are moving from their traditional roles of investing family money to a new role of raising and managing third-party funds.
While Saudi Arabian government investment vehicles historically have not been as prominent as some of the sovereign wealth funds elsewhere in the GCC (such as the Abu Dhabi Investment Authority, the Qatar Investment Authority and the Kuwait Investment Authority), the government is a major player in the asset management and investment arenas, particularly with the astronomical growth of the PIF over the past three years. The SAMA, the GOSI, the PPA, the PIF and other government-owned organisations are estimated to have over US$1 trillion under management (not including Saudi Aramco, which is majority-owned by the PIF and which is estimated to have a value of approximately US$2 trillion). The majority of that sum is deployed in non-Saudi investments, although there has been a strong push for these organisations to increase the amounts of their investments in Saudi Arabia. The PIF in particular is expected to dramatically grow in size in the foreseeable future, as the government intends to convert it into Saudi Arabia's primary sovereign wealth fund and has moved its stake in Saudi Aramco to the fund. Additionally, the PIF made waves in June 2016 when it closed on a US$3.5 billion investment in Uber, in October 2016 when it announced it would be investing up to US$45 billion in SoftBank Vision Fund and, again in October 2017, when it committed US$20 billion to a Blackstone infrastructure fund. More recently, the PIF also made investments in Lucid Motors, Boeing, Facebook, Citigroup, Disney and Bank of America with the most recent investment made in Jio Platforms, a subsidiary of Reliance Industries Limited.
The growth of the PIF comes on the heels of the government recently establishing two sovereign wealth funds: Sanabil Al-Saudia in 2008 and Hassana Investment Company in 2009. Sanabil and Hassana were established to manage the assets and investments of the PIF and the GOSI, respectively. The intention of these organisations is to diversify the existing investments of the PIF and the GOSI within the various industries of Saudi Arabia, and also to provide training and expertise to Saudi nationals. Additionally, it has been announced that Saudi Arabia will establish another sovereign wealth fund, and it is expected that the National Reserve Fund will be officially launched in the near future.
The Islamic Development Bank (IDB) is a multilateral development financing institution owned and funded by 56 primarily Islamic countries spread across the globe and headquartered in Jeddah, Saudi Arabia. IDB has long invested in infrastructure projects and educational programmes, but is also becoming a more active investor in both regional and international shariah-compliant private equity funds, real estate funds and other alternative investments. Further, IDB, as a highly rated supranational body, has become an important issuer of sukuk, in addition to being an increasingly important and active investor in funds.
While endowments of universities and colleges are not major institutional investors generally in Saudi Arabia, King Abdullah University for Sciences and Technology (KAUST) is a powerful exception. KAUST, which opened in 2009, is an international, graduate-level research university in Saudi Arabia dedicated to inspiring a new age of scientific achievement in Saudi Arabia. With an endowment of approximately US$20 billion, KAUST is a respected, and frequently approached, institutional investor. Its focus is on the advancement of science and technology to improve the lives of people in Saudi Arabia and the world, but it invests across asset classes both inside and outside Saudi Arabia.
VII TAX LAW
Taxation in Saudi Arabia is administered by the Saudi Arabian General Authority for Zakat and Taxation (GAZT). The main taxes levied on businesses in Saudi Arabia are income tax on business profits and zakat (i.e., mandatory Islamic charitable giving).
i Zakat and income tax
The tax exposure of wholly Saudi-owned and GCC-owned entities formed in Saudi Arabia is limited to zakat and, for entities formed in other GCC jurisdictions, a withholding tax on dividends and capital gains. A Saudi Arabian corporate vehicle will only be subject to zakat at 2.5 per cent on the higher of its net worth or its profits so long as it is wholly owned by Saudi or GCC shareholders, or both.
To the extent that a portion of a Saudi-domiciled corporate entity is owned by non-GCC foreigners, a corresponding portion of the entity's profits will be subject to tax at a rate of 20 per cent on such profits. The portion of the entity's profits corresponding to the ownership by Saudi and GCC shareholders will continue to be subject to zakat at a rate of 2.5 per cent.
The Saudi Arabian tax and zakat regulations provide for the look through of ownership shareholdings in a Saudi Arabian company from a GCC state to determine whether such shareholding should be subject to income tax. This means that if any of the corporate shareholders in a Saudi-domiciled corporate structure that targets Saudi investments has any non-GCC foreign shareholders, the Saudi-domiciled company will be liable to pay income tax to the extent that its ultimate owners are non-GCC foreigners.
Additionally, in June 2016, the Cabinet approved the introduction of a tax on undeveloped real estate. While the implementing regulations for the tax are still being introduced, the government intends to impose a 2.5 per cent annual tax on the value of undeveloped urban land.
ii Withholding tax
A withholding tax is payable on payments for income derived from Saudi Arabia made to non-Saudi nationals and companies. Withholding tax will not apply to non-Saudis who are resident in Saudi Arabia or have a permanent establishment in Saudi Arabia.
If a Saudi company or individual makes a payment that is from a source in Saudi Arabia to a non-Saudi, then such payment is subject to withholding tax at various rates depending on the nature of the payment. The withholding tax will not apply to payments made on contracts for goods, but will apply to payments made for services and on interest payments under loan agreements.
A dividend paid by a Saudi Arabian company to a non-Saudi resident shareholder results in withholding tax at a rate of 5 per cent. This tax will apply to dividends attributable to non-Saudi GCC shareholders and non-GCC foreign shareholders.
Capital gains on the sale of shares in an unlisted company in Saudi Arabia by a non-resident shareholder results in withholding tax at a rate of 20 per cent on the amount of the gain. This tax will apply to non-Saudi GCC shareholders and non-GCC foreign shareholders.
iii Value added tax
In January 2018, value added tax (VAT) of 5 per cent became effective in Saudi Arabia on most transactions. This is currently only assessed on transactions between Saudi parties. As such, a foreign manager or adviser would not be assessed for VAT on fees charged to Saudi clients. However, fees payable to a Saudi manager or adviser by a Saudi client would be subject to VAT. Effective as of 1 July 2020, VAT was increased to 15 per cent to help counter the unprecedented economic fallout caused by the ongoing covid-19 pandemic.
iv Effect of Saudi tax issues on structuring
To avail itself of the least tax exposure, any corporate vehicle organised in, or conducting business within, Saudi Arabia should be structured so that it is Saudi-domiciled and wholly owned by Saudi or GCC nationals, or both (i.e., foreign investment should not be sought at the Saudi or GCC level) to avoid exposure to income tax at a rate of 20 per cent (on the portion of profits relating to its foreign shareholders); and the exit of the shares in the target company in Saudi Arabia from the investment should be done by a holding entity in Saudi Arabia.
A 100 per cent Saudi or other GCC-owned entity incorporated outside the GCC (e.g., in the Cayman Islands) will be treated as a foreign entity for the purposes of the regulations in Saudi Arabia.
Saudi funds are extremely tax-efficient vehicles. To date, the GAZT has not assessed any taxes on Saudi funds, their investments or unitholders in a Saudi fund; however, it has reserved the right to tax funds in the future and on a retroactive basis, and in fact the Shura Council, an influential advisory body to the government, has recommended that closed-ended investment funds be subject to tax. Therefore, it is recommended that parties closely consult with tax advisers in Saudi Arabia and take into consideration the fact that a tax may be applied retroactively.
Saudi Arabia has the largest economy in the Middle East. Following the significant slump in the price of oil, the government is maintaining aggressive plans to grow, modernise and diversify its economy. Accordingly, this is an exciting time for the asset management industry, particularly with the opening of the Tadawul to foreign investors and the introduction of new regulations intended to spur foreign investment and new products in the country. Additionally, the funds industry in Saudi Arabia has been a success story compared with the rest of the region, and locally domiciled funds have flourished. The CMA and other regulators have encouraged this growth and stability, and have been revolutionising the structuring of private equity and real estate deals in Saudi Arabia. Finally, the extensive activity of the PIF and other government bodies has created many opportunities for those operating in the asset management industry and other investment sectors. As such, it is expected that Saudi Arabian markets will continue to expand in the coming year.
1 Nabil A Issa and James R Stull are partners, Macky O'Sullivan is a senior associate and Sayf Shuqair is an associate at King & Spalding LLP.
2 A parallel equity market with lighter listing requirements that serves as an alternative platform for companies to go public. Investment in this market is restricted to qualified investors.