Saudi Arabia: KSA Connections: Legal And Regulatory Developments In The Kingdom Of Saudi Arabia

Welcome to the First Edition of KSA Connections

As a global law firm, we take pride in using local connections to keep clients updated with legal and regulatory developments on the ground. With that in mind, in response to client demand, we are pleased to present the inaugural edition of our new quarterly newsletter, KSA Connections, covering legal and regulatory developments in the Kingdom of Saudi Arabia.  

In this month's edition, we discuss a range of developments, including the new Shariah Governance Rules, the narrowing of the Capital Market Authority's exemptions and algorithmic trading on the stock exchange (Tadawul).  

New Shariah Governance Rules for Financial Institutions: Do You Need a Shariah Committee?

By Ahmed Butt (Partner) and Marwa Al-Siyabi (Associate)

The Saudi Central Bank (SAMA) has issued new Shariah Governance Rules dated May 2021 (the Rules) for financial institutions operating in Saudi Arabia. The Rules apply to financial institutions engaged in one or more of the following finance activities: (i) real estate financing, (ii) asset financing, (iii) small and medium enterprise financing, (iv) lease financing, (v) credit cards, and (vi) consumer financing ("Regulated Activities"). The Rules aim to put in place a governance framework for financial institutions to ensure that Shariah principles are complied with in the context of financing transactions, and to establish clear responsibilities for the management of financial institutions in respect of such transactions. This applies even where the financial institution does not purport to be Shariah compliant and is considered to be a "conventional" finance provider.

Pursuant to the Rules, financial institutions to which the Rules apply must form a Shariah Committee (Committee) to oversee compliance with the Rules. A copy of the policies and procedures of the Committee must be submitted to SAMA, and CVs of the Committee members must be uploaded to the institution's website.

The Rules state that the board of directors is responsible for ensuring that Shariah rules and principles are adhered to in respect of the institution's financing activities, as well as the decisions of the Committee.

The board is also responsible for the implementation of policies setting out the manner in which the main units of the institutions should communicate with the senior management in respect of compliance of financing activities with the Shariah principles in accordance with the Committee's decisions.

Further, the Rules set out provisions relating to the Committee, such as functions and responsibilities, membership requirements and independence and confidentiality. The Committee must comprise a minimum of two members and not exceed five members. The election of the Committee's members is subject to SAMA's approval. Alternatively, the rules expressly permit the outsourcing of the Shariah Committee function to external Shariah consultancies provided that SAMA is notified of such arrangement.

Next Steps For Impacted Financial Institutions

The Rules will come into effect on 1 January 2022. While finance companies operating in Saudi Arabia are generally intended to be Shariah compliant, many such companies do not have a Shariah Committee or specialist Islamic finance lawyers to vet their products. Financial institutions and credit card providers operating in the Regulated Activities are urged to (a) conduct due diligence of all of their products for Shariah compliance; and (b) establish a Shariah Committee, or put in place an outsourcing contract with a Shariah consultancy, to certify their products. Our specialist Islamic finance lawyers maintain longstanding working relationships with eminent Shariah scholars.

Foreign Alert: Removal of Institutions From Securities Advertisement Exemptions

By Ahmed Butt (Partner)

Over the last year, there has been a gradual narrowing of the Capital Market Authority's (CMA) formal Securities Advertisement exemptions, which foreign investment managers had become accustomed to complying with when dealing with Saudi investors. This has led to an increased reliance on the CMA's reverse enquiry principles. We consider the key change, the reverse enquiry principles and how foreign investment managers can mitigate their risk.

• Securities Advertisement to Institutions No Longer Exempt

Previously, any securities advertisement (pre-prepared marketing material) aimed solely at "Institutions" (also interchangeably known as "Investment Companies" and broadly defined as entities that own net assets of SAR10 million or more), certain exempt persons and capital market institutions was an exempt securities advertisement. However, Institutions were removed from the exemption when the Securities Business Regulations were amended in 2020. Consequently, Institutions seeking to invest in foreign investment products will need to adhere to the reverse enquiry principles set out in the CMA's FAQs to receive marketing materials from foreign investment managers.

• Reverse Enquiry Principles Applicable to Institutions

The FAQs provide that investment managers that are licensed by a foreign regulator to perform the relevant regulated activity in any other capital market in countries that apply supervisory and regulatory standards similar to the standards applied by CMA may conduct business with an Institution in the Kingdom provided that:

• Status of the CMA's FAQs

The CMA clearly states that the content of its FAQs shall not prejudice, or be considered as an alternative to, the provisions of its laws and regulations. In the event of any conflict between the FAQs and the provisions of its laws and regulations, those laws and regulations shall prevail.

Considerations for Foreign Investment Managers

Foreign investment managers that had been relying on the formal Securities Advertisements exemption to liaise with Institutions will need to reassess their bespoke pattern of doing business. When relying on reverse enquiries from Institutions, the use of appropriate disclaimers on marketing materials is recommended.

Algorithmic Trading on Tadawul: Permitted or Not?

By Ahmed Butt (Partner)

As algorithmic trading becomes the norm in many capital markets around the globe, it is still a relatively new concept on the Tadawul, which capital market institutions continue to observe with intrigue. Although there has been no formal guidance on algorithmic trading from the Capital Market Authority (CMA) or Tadawul, in recent years, there have been a number of developments that indicate a shift towards an optimal environment where high-frequency trading methods (such as algorithmic trading) could potentially thrive.

Shift Towards an Optimal Environment for High- Frequency Trading

2018: Short Selling Regulations

Short selling is an important component of high-frequency traders' activities. The Short Selling Regulations in 2018 allowed short selling on Tadawul for the first time in 2018. This can be viewed as a pioneering step towards facilitating activities such as algorithmic trading, although the regulations do not refer to high-frequency trading of any type.

2021: Amended Market Conduct Regulations

The Market Conduct Regulations were amended earlier this year to clarify that the prohibition on manipulative and deceptive acts applies when an order is executed by using any means - including "technical tools" to generate and enter orders automatically based on pre-defined instructions or calculations. This clarification implies that the market is preparing for an increase in high-frequency trading such as algorithmic trading.

Tadawul's "G Channel"

The Tadawul's Trading & Membership Procedures refer to a dedicated channel for placing automated orders based on pre-defined calculated instructions - known as "G Channel". However, market participants cite limited use of the channel thus far.

Potential Hurdles: CMA Plan 2021 to 2023

While the CMA Plan 2021 to 2023 states a strategic goal of "facilitation of development of data solutions and financial technology", it also notes the risk associated with "Dangers of Financial Technology Innovations". Although there is no express mention of high-frequency trading, it is a broad concept based on the principle that fast technological advancement may impact supervision and stabilization in the market, which may, in turn, impact the attractiveness of the market and its feasibility.

Vision 2030: Will High-frequency Trading Volume Increase on Tadawul?

In order to thrive, algorithmic trading requires sufficient trading volume driven by institutional investors. The overall volume traded on Tadawul per day in 2021 is at its highest at US$2.7 billion (up from only US$1 billion per day in 2019) - although it is still majority retail driven rather than institutional. One of the stated aims of Vision 2030 is to increase the participation of institutional investors to 44% by 2025. If that is achieved, the environment may gradually become optimal for algorithmic trading.

Considerations for Legal and Compliance Teams

As interest in high-frequency trading grows, legal and compliance teams should conduct appropriate due diligence bespoke to their institution's proposed high-frequency trading activity on Tadawul.

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 Originally published September 2021

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.