Saudi Capital Market Authority consults on how firms serve Saudi clients abroad

The consultation proposes improvements to the regulation of dealings in financial markets outside the Kingdom and aims to increase supervision of activity in foreign stock and debt markets.

The proposals (2 pages / 261 KB PDF) were published by Saudi Arabia’s Capital Market Authority (CMA) on 27 September.

The CMA is proposing a much more prescriptive approach to margin trading by Saudi CMA regulated institutions when giving clients access to overseas markets. The consultation outlines that where a client trades on margin, the CMA regulated firm will have to collect margin of at least half the value of the trade before it goes ahead. After that, the firm will have to keep the client’s margin at a quarter or more of what the position is currently in and check it daily. Some margin trades will be banned outright.

What this means in practice is that before a client can enter into a margin trade, they must provide at least 50% of the value of the transaction from their own funds.  The regulated CMA firm can finance the remainder, up to 50%. After the trade has been executed, the firm must monitor the position every day. The client's equity in the position must remain at no less than 25% of the current market value of the investment. If market movements cause the client's equity to fall below 25%, the firm would need to take steps to restore the margin position in accordance with its margin procedures.

Under the terms of the consultation, regulated CMA firms will also not be able to offer margin on leveraged funds or any other highly leveraged instruments, whose accumulated losses have reached half or more of their capital. They will also have to check that the dealing is suitable for the client before they start trading for them on foreign markets. The concern from the regulator appears to be that these products already contain leverage or heightened volatility. Allowing a client to borrow money to acquire them would create so-called ‘double leverage’ and significantly increase risk.

Firms will not be able to profit from a client’s assets or orders, or arrange for anyone else to profit from them, including any broker that they use abroad, unless they inform the client and the client agrees in writing, separately from anything else they sign. This covers money made from lending out a client’s securities, and payment for order flow.

The consultation follows separate proposals put forward by the CMA earlier this year to lower the minimum capital requirement for securities businesses to SAR 20 million ($5.33 million) and establish a minimum capital requirement for arranging activities which involve holding client funds in securities-based crowdfunding.

Marie Chowdhry, a financial regulatory expert with Pinsent Masons in the region, said the proposed framework signalled the CMA’s ongoing commitment to setting the terms on which CMA regulated institutions can operate and take advantage of Saudi investors’ growing appetite for international markets. “The margin requirements mean a client can borrow no more than they put up themselves, and margin trading is prohibited altogether on leveraged exchange-traded funds,” said Chowdhry. “The proposals also indicate that leveraged traded securities and securities linked to commodities, metals and volatility indices will also be prohibited, so firms whose international offering is built on those will have to rethink it.”

Chowdhry said the proposals would be particularly relevant for capital market institutions in the Kingdom that offer clients access to international markets, as well as their compliance and operations teams. She said regional banks with Saudi brokerage arms and external brokers and custodians in the execution chain should also review the CMA’s proposals carefully and respond to the consultation.

Jessa White, a financial services expert with Pinsent Masons in the region, said the draft provision that is mostly likely to be overlooked is the one on benefits taken from client business. “A firm will not be able to profit from lending a client's securities or from payment for order flow unless it discloses the arrangement fully and obtains explicit consent, in writing,” she said. “That reaches the economics of relationships with external brokers.”

The consultation window is open for just 30 days, until 27 October. The CMA said it intends to finalise the draft provisions and bring them into force on 1 November.