Recognizing opportunities created by the growth of the individual investors appetite for international stocks, Saudi banks started international brokerage services by mid 1990’s. In addition, toward diversifying of revenues streams besides increasing customer loyalty, currently all Saudi banks provide international brokerage services to their clients. Obviously, what enabled the Saudi banks to offer brokerage services is the unbundling trend that took place in the 90’s. Parts of the brokerage service offering that used to be bundled by full service houses like Merrill Lynch or Salomon Smith Barney are now available individually or as part of a more customized set of services. This new unbundling phenomena has opened new opportunities for limited experienced Saudi banks in this market, providing execution of trades while aiming to expand their offerings beyond trading and accessing secondary research. Although not directly from Saudi banks but through them, Saudi investors can borrow on margin from the intermediate market maker brokers. However, upper-scale Saudi investors who are interested in the other parts of brokerage services, including financial advisory, primary research and margin trading, are still have to deal directly with major financial brokerage institutions in the US.
All ten commercial banks provide brokerage services to their clients, including the expatriate community in the Kingdom, with a minimum of $50,000 to open an account and rather competitive transaction costs. Out of the 7,622 clients registered with the ten local brokerage services during the second quarter of 2002, Saudi investors represented 90 percent of total clients, while the non-Saudis accounted for the remaining 10 percent. The unbalanced mix could be attributed to the non-Saudis’ familiarity with other alternative avenues of investing in international equities, which includes opening an account on the Internet with a global bank or trading directly through international full service brokerages. Furthermore, local investors of medium and high income groups, have shown an interest in mutual funds, which provide a broader risk diversification and professional management, with total assets in foreign shares reaching SR6.8 billion in the first three months of 2002. Meanwhile, the lack of access to primary economics and financial research by local investors which is essential for actively trading in the global markets, has limited the full potential of brokerage services of local banks.
In times of a global recession, it is the norm for investors to change the structure of their portfolios, reducing their equity holdings and moving into safe heaven assets of bonds, cash and commodities. Given the dismal performance of major equity markets during the last two years, high net worth Saudi investors have reduced their appetite for international stocks, mostly invested in the US equity market. Currently, approximately 98 percent of the total brokerage trades made by local investors are destined to the US market, while only a little over 2 percent of trades are made in the European and Japanese markets. However, the US market is not limited to US stocks, but many European and other international stocks are traded in Wall Street. This huge gap in trades between US and other markets is attributed mainly to the depth of US market, stability of the US dollar as well as the diversity of products. According to the Saudi Arabian Monetary Agency (SAMA), the total value of traded equities through the Saudi banks’ desk of international brokerage services slumped by nearly half to reach SR44.4 billion in 2001 compared to SR85.9 billion the year before. Moreover, the value of traded international equities fell by 17.5 percent to SR19.4 billion in the first half of 2002, against SR23.5 billion over the same period a year earlier.
There are several factors that have led to the increased demand for brokerage services in the Kingdom. First, the investment in the Internet technology and regulatory changes have enabled Saudi banks to offer brokerage services in international equity markets. This, however, allowed less sophisticated investors to access international equity markets directly from their own local banks. Second, the price differential between full-service brokerage in the US and local semi-full brokerage providers is encouraging a shift in demand, whereby those who traditionally used an international full-service brokerage are also now brokering from local banks. Third, the price differential is also allowing those who have not invested in the past, because they did not want to pay the high service fees for the full service brokerage, or because their portfolios were too small, to begin investing their money. Meanwhile, the average traded value per client during the second quarter of 2002 amounted to SR1.1 million (or around SR4.4 million annualized), suggesting that the profiles of such individuals are mostly of high net worth and rather aggressive traders. Given their limited level of expertise and sophistication, local clients tend to invest mostly in international equities, as opposed to trade in other investment products such as options.
Currently, with more access to market information than ever before, Saudi investors increasingly look to non-Saudi companies to diversify their investment portfolios. International equity trading value through local banks surged by 34 percent to reach SR85.9 billion in 2000, largely attributed to the significant performance of the US equity market during that period. Between 1998 and December 1999, the Dow Jones increased by 25 percent compared to negative 7.3 percent for all shares index of Saudi stocks. Moreover, growth in the US was fueled by the triple-digit increase in the volatile technology, media and telecommunication sectors. However, following the turmoil in the US equity market, particularly in the volatile stocks, Saudi investors seem to have adjusted their investment interest from the US stocks into local stock market, real estate and cash. In turn, the value of traded shares of the Saudi stock market increased significantly by 28 percent to reach SR83.6 billion in 2001 from SR65.3 billion the year before, while the value of international brokerage services through local banks dropped sharply by nearly 48.3 percent to reach SR44.38 billion in 2001 from SR83.7 billion in 2000.
Reflecting the better performance of the Saudi stock market, which surged by 13 percent in the first half of 2002, the value of locally traded shares rose significantly by 86 percent to reach SR77.4 billion during the same period. Meanwhile, total value of international brokerage services by Saudi banks declined by 7.5 percent in the first half of 2002, partially suggesting a switch from international equity to local stocks. Saudi investors are increasingly becoming vigilant about the benefits of diversifying their portfolios with non-Saudi stocks. Given the recent negative correlation between US stocks and Saudi equity market, a diversified global portfolio obviously will function to hedge market risks thereby reducing the impacts of volatility in local stocks driven by changes in oil prices. Although, not evident at first glance, but relative stock markets performance is a leading indicator of cross-boarder capital flows. The 1999 and 2000 period in which the US stock market outperformed Saudi stocks resulted in capital outflows from Saudi Arabia. However, during 2001, in which the Saudi stock market outperformed the US stocks, this resulted in capital inflows into Saudi Arabia, with total portfolio investment coming to around $2.8 billion in the same year.
Unlike full-service brokerage companies such as Merrill Lynch or Morgan Stanley brokerage services operated by Saudi banks do not provide an advisory services as well as not offer facilities for margin trading from their own resources, while they can offer similar facilities on local equities. Accordingly, local brokerage services generate income mainly from commission, thereby focusing on aggressive traders to achieve economies of scale. Moreover, local brokerage services exercise a trade through major brokerage houses in the US before it hits the stock exchange, thereby part of the commission obviously is shared with the international brokerage institution. While the Saudi market is currently not very competitive and customers complain of rather high prices, commissions between Saudi banks are very comparable, however, banks differentiate themselves based on service. The following service issues are important consideration for Saudi clients when selecting a broker, which include the availability of research, low wait times when exercising trade, and availability of a dealing room. In the US, there are dozens of brokerage firms, but in Saudi there are only 10 at present. The Saudi banks own the existing brokerages and for the most part, these banks do not consider discount brokerage to be a priority service. They provide these services simply because their banking customers demand them. The price differential between Saudi Arabia and the United states is significant. In Saudi Arabia, the lowest prices for trades are around $100 per transaction of first 1000 shares and thereafter of 8 to 10 cents per share exceeding 1000 shares. On average, there is $15 to $20 difference between Saudi prices and the US prices for a comparable service.
The Saudi British Bank was the largest in terms of traded value accounting for 25 percent of the total market in the Kingdom, followed by the Saudi Fransi Bank with 21 percent share while NCB captured 15 percent of international equity trading, during the first half of 2002. However, the market shares of international brokerage services through Saudi banks have fluctuated since 1999, with the top five providers portraying very strong competition. Meanwhile, the Saudi American Bank commanded 37 percent of the total international equity traded in 1999 while the Saudi Investment Bank was second with 18.5 percent. Nonetheless, to achieve a competitive advantage in the local brokerage services, Saudi banks need to provide distinguished services, timely economic and financial information and expert advice to their investors, as well as to reduce the transaction cost of trading international equities.
Brokerage services through Saudi banks should try to keep up with their international peers to improve products and services of equity trading. Inevitably foreign investment banks will enter the Saudi market and intensify the competition. Therefore, local banks should form strategic alliances with global investment banks, with the former providing the branch network and customer base, while the latter providing advanced technology transactions, expert advice and access to reputed research and analysis by professional traders.
(Dr. Said Al-Shaikh is chief economist at National Commercial Bank, Jeddah)
Arab News Business 25 November 2002