Riyadh tightens capital market regulation

Saudi Arabia’s stock market regulator is stepping up efforts to stamp out irregular trading and poor disclosure to broaden the bourse’s appeal to investors. Published in MEED, 3 July 2013

Stock markets around the world are always at risk of manipulation by investors looking to make a quick and easy profit, whether through insider dealing, the pumping and dumping of stocks or other underhand strategies.

Just how much of it goes on is all but impossible to judge. By definition, those who get away with it are not discovered. Trying to limit it as much as possible is critical to the credibility of any stock market. If investors feel that they are being taken for a ride then they are likely to simply put their money elsewhere and, without enough investors on hand, companies will not want to list their shares.

Market manipulation

For the Saudi Stock Exchange (Tadawul), the largest bourse in the region and where most of the trading is carried out by retail investors, it is a critical subject, although views on the scale of the problem vary.

“We don’t have credible data to assert whether there is a lot of insider trading or not, but the nagging doubt in many minds is that, in common with many countries at the early stages of development of a stock market and the regulatory environment around it, you should assume there is a measure of insider trading,” says one Riyadh-based executive. “Just how much goes on is much more difficult to say, but it happens everywhere. Even advanced markets suffer from it. It happens in London and in New York.”

The issue of market manipulation has come to the fore this year with a very public spat between US business magazine Forbes and Prince Alwaleed bin Talal al-Saud, the chairman of the local Kingdom Holding and perhaps the most high profile businessmen in the region. At its heart are questions about the credibility of Tadawul.

When Forbes published its annual list of the world’s richest men in March, Prince Alwaleed was ranked in 26th place with a net worth of $20bn, the same level as US leveraged buyout specialist Carl Ichan and Hong Kong property tycoons Thomas and Raymond Kwok. The figure for Prince Alwaleed would have been more, but Forbes said it had discounted the value of his stake in Kingdom Holding because of what it saw as unusual patterns of trading in the company’s shares on the Tadawul.

Kingdom Holding has disputed the ranking and the methodology that it is based on. In a statement released on 8 March, Shadi Sanbar, chief financial officer of Kingdom Holding, said “the Tadawul is a fully regulated bourse with credibility in the financial community and whose valuations have been used by banks for reporting and compliance purposes for many years”. He went on to add that a suggestion in the Forbes article that stock manipulation was a “national sport” in Saudi Arabia was “insulting to the regulating bodies that oversee the Tadawul”.

The argument may yet end up being settled in a London court room and finance industry executives in Riyadh remain tight-lipped about it. But regardless of which side is ultimately proved right or wrong in that dispute, there is a widespread acknowledgement that market manipulation almost certainly happens in some corners of the Tadawul.

“It is a place that will be influenced by the international markets, by local considerations and also by fundamentals and we hear about speculation and the manipulation of stocks,” says a senior executive at one local bank. “It is probably happening.”

“There has been talk about this for several years,” says an investment banker in the city.

“As in any market, some people get away with insider trading. I’m not sure you can have it fool-proof, but the key is to make it the exception rather than the rule through aggressive enforcement that sets the standard for what is acceptable behaviour and what is not. You want to maintain the credibility and integrity of the market.”

The job of enforcing the rules falls to the Capital Market Authority (CMA), which regulates the stock market. So far this year, it has announced SR530,000 ($140,000) worth of fines on companies traded on the Tadawul, most of which were levied for failing to provide important information in a timely manner to the CMA or the wider market.

For example, on 30 April, Saudi Kayan Petrochemical Company was fined SR50,000 for failing to disclose the expected financial impact from halting production at some of its units for maintenance. The following month, the CMA levied a SR100,000 fine on the United Cooperative Assurance Company for not disclosing its financial results for the previous year within the 40-day time limit required.

Irregular trading

In April, the CMA also said that it had noticed “irregular trading activity” in the shares of three companies listed on the market, which it suspected could be a violation of its rules and regulations. The three firms were Tihama Advertising & Public Relations Company, Tourism Enterprise Company and Saudi Indian Company for Cooperative Insurance. It said at the time that it was investigating the situation although, to date, no further action has been announced against any of the three.

It is not just companies that have been fined. There have also been at least nine instances this year of individuals being fined by the CMA for dealing in securities without the proper authorisation from the regulator. The fines came to a total of SR950,000, with individual penalties ranging from SR50,000 to SR200,000. According to some, not all the fines and penalties imposed by the authorities are made public. “Some enforcement action is not necessarily announced,” says the investment banker. “Some actions are done in the form of a settlement that are not public.”

‘Name and shame’

“In the West, ‘name and shame’ is part and parcel of the penalty,” says Tim Plews, managing partner of the Saudi practice of international law firm Clifford Chance. “Here, some sanctions are never put to a name. For some other rule breaches, the company will be named and shamed and given a small fine, generally around accounting regulations or the late filing of audited financial statements. It is not about who knows who, it’s about what rules have been broken. Some of it is anonymous, some of it isn’t.”

Part of the problem for the Saudi market is the preponderance of retail investors. Around 85-90 per cent of trades on the Tadawul are carried out on behalf of retail investors. Local investment banks have long hoped that more Saudis will start to invest in professionally-run mutual funds, but there seems little appetite for that at the moment. Instead, most locals prefer to trade more directly through brokers.

That in turn can create volatility and patterns of investment, driven by sentiment rather than fundamentals. “There are a lot of unusual movements, but I wouldn’t necessarily attribute it to insider trading,” says an economist at one local investment bank, who instead points to retail investors acting according to their own understanding of what is important. “In December, the country announced a fifth record high budget and the market was in the red. A few days later, on the last day of December, the US announced a partial agreement on the fiscal cliff and the market went in the green.”

If and when the Tadawul opens up to international investors that situation might start to change and volatility could decrease. The appointment of Mohammed al-Sheikh as chairman of the CMA’s board of governors earlier this year may move the process along. The well regarded former lawyer was brought back from Washington DC, where he had been an executive director of the World Bank, to take over from Abdulrahman al-Tuwaijri on 5 February. Since then, local media have quoted Al-Sheikh as saying that the CMA is looking at how to open up the market to foreign buyers.

Market opening

“Opening up the market to qualified foreign investors is always an area for discussion,” says another senior banker in Riyadh. “I think it will be positive for the market. Nobody knows when it will happen, but we’re hopeful it will be sooner rather than later. The Saudi market is retail based and having more stable, institutional money in the market will be good.”

The size of Saudi Arabia’s economy and the wealth generated by its oil industry means that, in terms of capital, the Tadawul does not necessarily need to attract a lot of foreign investment. However, it would provide an endorsement that the market is well run in the eyes of the wider world and it could also help to put the Riyadh bourse back on a level footing with some other Gulf markets. In mid-June, both Qatar and the UAE were upgraded from frontier market to emerging market status by international financial indices firm MSCI. Saudi Arabia, however, is still classified as a frontier market, not least because of the restrictions on foreign investors.

Reducing volatility could help to indirectly reduce the room for market manipulation. A continual strengthening of the resources available to the CMA, along with greater transparency around the detection and punishment of any illicit dealings might also help.