Saudi Arabia leads in stock lending as short selling grows

September 25, 2024, 3:54 AM

Saudi stock lending. Short selling relies on stock prices falling for the seller to make a profit, but the lender makes money from fees regardless — Short selling relies on stock prices falling for the seller to make a profit, but the lender makes money from fees regardless

Short selling requires stock lending
Lending fee revenue rising
Saudi companies dominate

Saudi Arabia is the Middle East’s most active market for stock lending – an important part of the process of short selling – and demand from borrowers is likely to increase as more sophisticated investors start trading, new research suggests.

In stock lending, an entity – usually a broker or financial institution – pays a fee to borrow shares in a company from an investor in that company. The borrower uses the shares for short selling or other hedging strategies.

The lender, typically a tracking fund or other passive investor, retains ownership of the stock and still benefits from share price movements and receives dividends; as such, stock lending can boost returns for long-term shareholders at relatively little risk.

“The Saudi investment services market has really changed over the past three years,” Jalal Faruki, head of custodial and securities services at Riyadh’s SNB Capital, told a webinar. “You now have a lot of international asset managers coming in and setting up offices in the kingdom.”

Some are traditional long-only asset managers, while some are long-short, he said.

Long-only investors buy stocks aiming to profit from stock price rises, as well as dividend payments. Long-short investors buy what they believe are undervalued stocks and sell – or short – stocks they perceive as overvalued, with the aim of benefitting from both rising and falling prices.

To short stocks, one must typically first borrow them from other investors.

“You have a lot more types of investment strategies than simply long-only mutual funds,” said Faruki. “We see those long-short managers as also one of the key drivers for demand to borrow.”

Saudi Arabia represented 58 percent of total assets in Middle East and North African securities lending pools as of September 2024, up from 13 percent a year earlier, according to S&P Global data that covers Saudi Arabia, the United Arab Emirates, Egypt, Qatar and Kuwait.

Mena daily securities lending revenue peaked at nearly $50,000 in early May, with most of this generated through Saudi stocks. Daily revenue then fell following the completion of Saudi Aramco’s $12.4 billion secondary share sale in June and is currently at around $30,000 per day, S&P found.

“Transactions like the one from Aramco create a huge amount of demand for investors to borrow those shares with the expectation they would (then) cover (this) through the secondary offering,” said Faruki.

In Aramco’s case, short sellers bet that the company’s stock price would fall as a result of the increase in its supply of available shares once its secondary offering was complete. Such investors would borrow and immediately sell those shares before buying them back at a lower price later.

“The biggest pocket of demand we've been focusing on is the mid-cap and small-cap (stocks) that are not benchmark names where a lot of investors historically, even through OTC (over the counter) derivatives, weren't able to get exposure on the short side. That's where we've seen the most growth and the longest tenor of securities on loan.”

Shareholders in Saudi Aramco generated $2.08 million from lending the stock this year to September 5, S&P data shows. Acwa Power was second with $990,000 and Savola Group was third with $390,000. The top 10 were all listed Saudi companies.

The average fee lending has soared to 405 basis points (bps) this year from 124 bps in 2023.

“These fees are very enticing,” Shaan Jivan, a specialist in securities finance at S&P Global Market Intelligence, told the webinar.

Average fees in the broader Europe, Middle East and Africa region are just 60 bps this year, he said.

Stock lending is a common revenue-generating strategy for the Gulf’s sovereign funds – at least from their investments in developed market equities.

“Some of the largest, most experienced, longest tenured beneficial owners that engage in securities lending are in the Middle East,” said Simon Lee, head of regional business development at eSecLending, which lends equities, bonds and ETF securities in about 40 markets.

Saudi rules

Saudi Arabia allows almost all investors to participate as either a lender or borrower, said Faruki: “If you're a qualified investor, you can generally enter into a transaction with any other party, but if you're a retail investor you have to have a lending agent in the middle.”

Various Saudi bourse initiatives such as market-making, derivatives and the enablement of short selling are “drivers to demand for securities lending”, said Faruki.

“If you look at the number of securities on loan a year ago compared to the number on loan now it's grown significantly and the same for the value securities on loan but… there's still room for that to expand a lot further,” said Faruki.

Despite the introduction of more sophisticated regulation, there remains “a lot of practical challenges to entering securities lending or borrowing trades in Saudi”, said Faruki.

Making securities lending sharia-compliant is a central factor for prospective lenders, he said.

SNB Capital has received regulatory approval for its own securities lending procedures and “we look to take that live”, said Faruki.

“Once that starts becoming a market standard, you will have a lot more people coming into the supply side and providing inventory for securities on loan.”