Thirty years ago, the Kingdom of Saudi Arabia (KSA) was known primarily for two things: oil and the Muslim pilgrimage know as Hajj. While its oil wealth and religious significance have not waned, the kingdom has undergone a transformation amid a boom in population that has pushed other sectors such as infrastructure, banking, capital markets and even alternative energy into the spotlight.
On the economic front, Saudi Arabia has much to offer in terms of growth. The kingdom boasted gross domestic product of 6.6 percent last year, fuelled by soaring oil prices and heavy government spending. That is especially impressive when considering that the GDP among the old guard of economic powers, such as the United States, was half that of the kingdom.
“We had a record breaking year last year in terms of growth and towards the end of last year, confidence edged up pretty consistently,” says Jarmo Kotilaine, chief economist at National Commercial Bank. “We are seeing some positive momentum in the capital markets and in bank lending, which is particularly impressive as we went through quite a period of bad loans and provisions. If we are looking at the fundamentals of the economy, everything looks pretty good.”
In December, the Ministry of Finance projected that the government is likely to spend 690 billion riyals ($184 billion) in 2012 – a figure Fitch Ratings deemed conservative and likely to be exceeded. Much of that expenditure is expected to take place in the construction and infrastructure sectors, creating vast opportunities for businesses and legal advisers alike to cash in on the bounty.
Infrastructure boom
Saudi Arabia is estimated to have projects worth $623 billion currently underway, according to the economic weekly MEED, making it by far the largest projects market in the region, worth almost as much as the other five GCC states combined. A report by MEED Insights also estimates that the kingdom has more than $300 billion worth of projects planned and yet to be awarded.
Kotilaine says infrastructure will continue to be the big story for years to come, with the country’s rising population requiring more housing, water desalination and power generation facilities among other key needs. For lawyers, the infrastructure boom in the kingdom is a gold mine.
“The projects market in Saudi is a hot area for growth,” says Harj Rai, senior associate at Latham & Watkins, based in Riyadh and Dubai. “There is a tremendous need to finance projects that are planned by the government. We’re seeing increased interest in power projects as the demands for electricity grow. There is a need for Saudi Arabia to diversify from just oil, so we are also seeing increased interest in renewable energy and petrochemicals.”
Saudi Arabia, which sits on the world's biggest oil reserves, is struggling to keep pace with rising power demand. It plans to diversify its energy mix, including nuclear and solar energy, away from depending on oil alone.
In February, Saudi Arabia's Royal Commission for Jubail and Yanbu approved new petrochemical projects worth $5.65 billion. Saudi Arabia is expected to invest $100 billion in the petrochemicals sector over the next five years, a board member of state-run oil titan Saudi Aramco said at an industry conference in Qatar last year.
Lawyers say that helping to finance these initiatives has become the law firms’ daily bread and butter. To that end, debt capital markets work has grown sharply with Saudi Arabia taking the lead in Islamic bond, or sukuk, issuances in the first quarter of the year.
“Traditionally, you would see the UAE in the lead in terms of regional sukuk issuances,” says Bilal Kahlon, partner at Baker & McKenzie in Bahrain. “Saudi Arabia had never fully developed in this area, but that is changing very fast. Saudi Arabia was always a sleeping giant from the perspective of debt capital markets. Clearly being the biggest economy in the region, when the market finally matures, it will overshadow others in the region.”
Sukuk issuances for the Gulf region totalled $6.9 billion in the first quarter, led by a $4 billion ten-year sukuk by the kingdom’s General Authority for Civil Aviation (GACA), which will be used to help fund the $7.2 billion development of King Abdulaziz International Airport. Saudi Arabia’s Al-Jadaan & Partners joined global law firm Clifford Chance in advising GACA on the deal. Allen & Overy, in association with Abdulaziz AlGasim Law Firm advised the lender HSBC Saudi Arabia on the deal.
The second quarter is also shaping up to be strong for sukuk issuances, especially coming out of Saudi Arabia. In April, Banque Saudi Fransi established a $2 billion Islamic bond while Saudi Electricity Co priced a $1.75 billion Islamic bond in March to great demand. Almarai Co raised $266.6 million through a sukuk offering in March, as well. Baker & McKenzie and Maples and Calder advised Banque Saudi Fransi on its deal while Allen & Overy served as adviser on Saudi Electricity’s offering. “The sukuk market is definitely the flavour of the month,” says Rai.
Funds fervour
While debt capital markets and infrastructure have taken the spotlight in recent months, lawyers say the real estate sector is a hidden gem in Saudi Arabia – a surprising pocket of strength given the thrashing global real estate markets took in the wake of the financial crisis.
“There is a real estate boom happening here and this is one area we are seeing tremendous focus on given the young, growing population,” says Nabil Issa, partner at King & Spalding in Dubai. “We’re also seeing a new focus on higher end commercial real estate.”
Financing for such initiatives has historically been obtained through a mixture of government funds and syndicated loans from international banks. But international banks are struggling with mounting global economic fears as well as their own balance sheet woes, thus making lending less attractive.
To counter this setback, Issa says locally domiciled funds have emerged to help finance such real estate projects. Changes in Saudi legislation are helping to facilitate these funds. In the past, rules surrounding the development of a fund were unclear and approval processes plagued with ambiguity. As a result, Saudi parties would set up funds in the Cayman Islands and use it to invest internationally. But when those same funds would attempt to invest in their home country of Saudi Arabia, they would be hit with taxes reserved for foreign investment.
The Capital Markets Authority passed laws a few years ago, allowing for locally domiciled funds to raise money from Saudi parties to invest in Saudi Arabia without negative tax consequences. This reform has brought in a new wave of business, Issa says. UAE-based Shuaa Capital launched the Saudi Hospitality Fund in 2008. King & Spalding advised on the creation of the sharia-compliant realty fund.
“I would say in the last three and a half years, we have seen big growth in these locally domiciled funds,” he says. “Personally, it is 55 to 70 percent of the business I am doing in Saudi.”
The legal work is not just limited to fund formation. The growth in locally domiciled funds in Saudi has led to increased work in private equity and lending in the kingdom.
A challenging endeavour
But opportunity does not come without challenges. On the surface, there is no doubt that Saudi Arabia is an attractive investment destination. In practice, however, the kingdom remains a difficult market to navigate for outsiders. The country’s legislative environment, while in the process of reforming, remains a mystery to many interested investors.
“Under the foreign investment law in Saudi Arabia, which is coming up to almost 10 years of being in place, there are sectors in which there can be 100 percent foreign ownership while other sectors still require a local sponsor,” says Latham & Watkins’ Rai. “But it is a moving target where things can change rapidly. We may have clients that want to invest in a particular sector, usually a regulated sector like healthcare or media, and we have to tell them to wait so that we can check the list of approved sectors for any unexpected changes.”
That kind of ambiguity, lawyers say, can slow down or even stifle eager investors who may be forced to pay large legal fees in order to get their heads around the way business is done in Saudi Arabia.
Law firms are not immune to the struggles. Setting up shop in Saudi Arabia can be a daunting task for the legal community. The kingdom does not allow foreign law firms to practice without a local sponsor. In addition, only a citizen of a Gulf Cooperation Council member country is allowed to register a law firm in Saudi Arabia.
“Striking the right balance in your relationship with local partners is one of the most critical aspects of doing business in Saudi,” said King & Spalding’s Issa. “These relationships take a lot of time and work to get to know the local parties. If the local partner feels that the relationship is no longer beneficial, they will push to terminate that relationship.”
That has been a problem for many international law firms looking to crack this market. Earlier this year, Trowers & Hamlins ended its exclusive alliance with the Saudi Arabian Feras Alshawaf Law Firm, following the departure of its last lawyer in Riyadh. The news came less than a year after the firm shut down its Jeddah office, just months after opening in the city.
“It is not easy to retain people in Saudi and we are holding discussions on how to recruit the right people and deploy them effectively,” the firm said in a statement, adding that it has not abandoned the market in the kingdom and will continue to work with clients interested in signing deals within Saudi Arabia.
That, however, is easier said than done from afar, lawyers say. “It is not an easy sell to attract foreign lawyers because the incentives to live and work here aren’t so sufficiently higher than in places like Dubai that people think it is a better deal to come to Saudi,” says Rai. “So much depends on face time and good personal relationships here. There is a definite advantage to being on the ground. But the concern for international law firms is that when you do have the right people in place, they become targets for other law firms wanting to establish a presence. The clients here tend to be loyal and follow the lawyers rather than the name of the law firm.”
Despite the challenges, international law firms are still eagerly trying to break into the Saudi market. Global law firm Jones Day opened three offices in the kingdom in 2011 in association with Alsulaim Alawaji & Partners Law Firm. Partners of the firm man the offices – a smart move, lawyers say.
A Riyadh-based lawyer who asked not to be named says that many foreign law firms come in with little to no understanding of the Saudi culture and way of doing business. Some firms opt to staff a Saudi office with a more junior lawyer, rather than a partner, he says, which can lead to misunderstandings.
“Some local clients think it is a matter of disrespect that they are only dealing with an associate, rather than a partner, given the fees they are paying. If these associates are very good, they leave to take partnerships at other firms. When they are not so good and do not have the significant international experience needed, clients and sponsors walk away,” he says.
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