In a long anticipated measure, the Saudi Council of Ministers (which is the highest authority in the Kingdom) issued a resolution on 21 July, 2014 authorizing foreign financial institutions to directly buy and sell stocks listed on the Saudi Stock Exchange (Tadawul). The resolution also authorized the Saudi Capital Market Authority (the “CMA”) to set the timing and rules for such participation. On July 22, 2014, the CMA announced that it will publish draft rules for foreign financial institution participation next month, which shall include a 90 day public consultation period. The CMA plans to implement the final rules before the end of 2014, and open the market for foreign financial institution investment during the first half of 2015.
Currently, trading of stocks on Tadawul is restricted to Saudi nationals, GCC nationals and foreign expatriates holding valid resident permits in the Kingdom. At present, foreigner financial institutions may only invest in the Saudi market through total equity return swap agreements with local brokerage firms and mutual funds.
Some key issues resulting from such authorization include:
Classification of Qualified Foreign Investors
Both the Council of Ministers resolution and the CMA announcement refer to the authorization being for “foreign financial institutions” to trade on Tadawul, but it is not yet clear what additional requirements will be set for determining which foreign financial institutions will qualify to directly access the market and on what basis. Presumably, qualification will include evidence that the foreign financial institution is licensed in its home jurisdiction and evidence that the foreign financial institution is otherwise “sophisticated” (which could include a minimum amount of assets under management or minimum length of operating history). Such qualification criteria is expected to be included in the rules which will be published by the CMA.
Maximum Foreign Ownership
Foreign ownership of shares issued by a Saudi listed company may also be subject to certain limitations and ceilings applicable to (i) each foreign financial institution, and (ii) the overall foreign ownership of such shares. In addition, certain shares of Saudi companies might also be excluded from foreign investment (e.g. Saudi real estate companies investing in real estate projects in the two holly cities, Makkah Al Mukkaramah and Al Madinah Al Munawarah).
The Saudi Income Tax Law (Art. 10) states that capital gains realized from disposal of securities listed on Tadawul is exempt from income tax. It is yet to be determined whether the Department of Zakat and Income Tax (DZIT), the regulatory authority responsible for enforcing the Income Tax Law, will extend the said exemption to apply to foreign financial institutions. It is worth noting that at present, capital gains realised by foreign financial institutions through total equity return swap agreements with local brokerage firms are subject to (i) a 20% capital gain tax, and (ii) a 5% withholding tax.
Debt Capital Markets
While still a nascent market, there are a number of publicly listed Islamic debt instruments (sukuk) which trade on Tadawul. Both the Council of Ministers resolution and the CMA announcement only refer to opening of trading “stocks” listed on Tadawul, and do not refer to other securities traded on Tadawul. Therefore, it is anticipated that the rules which will be published by the CMA will be limited to regulating the trading of equities by foreign financial institutions on Tadawul and trading of debt instruments will remain limited to Saudi and GCC nationals, unless separate authorization and guidelines are published.
Mergers & Acquisitions Regulations
The CMA issued the Mergers and & Acquisition Regulations which set forth general merger and acquisition provisions applicable to listed companies. These regulations apply to all mergers and acquisition transactions of companies listed on Tadawul where there is: (a) a restricted purchase of shares; (b) a restricted offer for shares; (c) a takeover offer; or (d) reverse takeover.
It will be interesting to see whether the new CMA rules would enable foreign financial institutions to carry out takeover offers of Saudi listed companies.
Participation in New Subscription of Shares
The Council of Ministers resolution and the CMA announcement are both silent as to whether foreign financial institutions may participate in Saudi initial public offerings (IPOs), whether taking the form of sale of shares or issuances of new shares. At present, only Saudi nationals may participate in IPOs. It will be interesting to see whether the new CMA rules would enable foreign financial institutions to participate in such IPOs.