Saudi Arabia's mismatched approach to foreign investment has proved problematic for many investors, but the country may be about to embrace a more accessible system, say Hogan Lovells' Imran Mufti and Irfan Butt

Since 2001, the Saudi Arabian Foreign Investment Act has allowed foreign direct investment into the Kingdom. For any non-Gulf Co-operation Council (GCC) shareholder, individual or corporate, the Saudi Arabian General Investment Authority (SAGIA) is the regulator that issues an investment licence to either incorporate a company or register an establishment to do business in Saudi Arabia.

This May, Abdullatif A Al-Othman, a former high-ranking official at energy company Saudi Aramco, was named as the new governor of SAGIA. His appointment brought a sense of optimism that the efficient working practices and processes at Saudi Aramco would, over time, work their way into SAGIA, making it a more streamlined and accessible operation for existing and new foreign investors.

Surprisingly, one of the first decisions made by SAGIA following the appointment of the new governor was the suspension of all service sector licence applications and the increase, albeit unofficially, of the minimum capitalisation requirement for a manufacturing licence to SAR50m (£8.4m).

Both those decisions were reversed within a month of being introduced, with service sector licence applications reopening and the capitalisation requirement for a manufacturing licence reverting down to the previous minimum of SAR1m (£168,000).

The historical development of the policies of SAGIA and how it has taken shape over the past decade may go some way in explaining its reasons for introducing, and then reversing, these new policies.

Non-GCC entities and individuals were initially allowed to apply for an investment licence to SAGIA in the service and manufacturing sectors, and since 2008 entities have been permitted to apply for consultancy and 'trading' (any form of retail or wholesale buying and selling of goods).

A negative list of activities (ie not open to foreign investment) includes, among others, land transportation and investment in the holy cities of Mecca and Medina.
The negative list is subject to periodic review and has been considerably reduced since 2001 with the last major change taking place in 2008, when consultancy services (albeit with stringent requirements) and trading were permitted for the first time.

Application hurdles
An application to SAGIA is made on a designated application form and is submitted with a long list of documents that vary according to the type of application being made.

For example, for a non-specialist service licence, a bank certificate for the full value of the proposed capital of each shareholder is required – there is no such requirement for specialist service licence applications.

Common elements of all applications include the constitutional documents of the proposed shareholders, a power of attorney authorising a representative – normally a lawyer – to make the application, and a shareholder's resolution authorising the application on behalf of the applicant.

One notable difference in policy since 2001 has been the reluctance of SAGIA to accept applications for individuals looking to set up establishments. These have generally been phased out in recent years and in practice, most licences issued are now for joint ventures between companies, either wholly foreign owned or 'mixed liability' companies where one of the joint venture partners is Saudi.

Applications in certain sectors require mandatory capital investment of a Saudi partner. For trading activities, such as retail or wholesale trade, SAGIA will only license a mixed limited liability company with a minimum capital investment of SAR26.7m (£4.5m), with 25% of the capital invested by a Saudi investor.

Similarly, for project management licences, where the activity is mainly related to the management of the construction of buildings, 25% of the capital must be invested by a Saudi individual or company that must also now hold a professional licence from the Saudi Council of Engineers.

Practically, the most important part of the application to SAGIA is, first, to convince SAGIA that the applicant has good enough credentials and, second, that the wording of the proposed activity being applied for is not prohibited either because of a policy decision, or because it is too close to an activity on the negative list.

In 2001, the focus of SAGIA was on making sure that the activity applied for was not on the negative list and that the applicant had successfully deposited the full capital amount into a local bank account. The result was a huge influx of foreign direct investment (FDI), making the Saudi economy one of the largest recipients of FDI in the Arab world.

With SAGIA on a steep learning curve on the type of applicants it was licensing, and investors expecting the liberty to do business, the result was often a mismatch of expectations which ultimately led to SAGIA adopting a hit-and-miss approach.
The activity that is licensed by SAGIA is also now subject to intense scrutiny.

Typically, an applicant must demonstrate that either the same activity exists in the objects clause of the constitutional documents of the shareholding applicant, or that it has a proven track record in the industry – and preferably both.

The activity that is approved or licensed by SAGIA will be the only activity that will be permitted by the newly established Saudi entity. This limits the scope of business that the foreign investor is able to carry out, and means that any subsequent business opportunity outside the scope of the licence may be missed unless an additional application to SAGIA, post-incorporation, is made to either amend the existing licence or issue an additional one.

Such heavy regulation and the limiting nature of SAGIA invariably inhibits investors, many of whom are used to a more laissez-faire approach to doing business.

The activity granted by SAGIA is the key to a successful application. The restricting nature of the licence means there is a very limited concept of setting up a dormant SAGIA-licensed entity with a view to doing business at a later date.

Opening multiple entities with different joint venture partners at the same time is also not common, with SAGIA preferring a foreign investor to demonstrate performance in the form of accounts and tax certificates for at least a year before it considers granting additional licences with different activities with new or the same partners.

Accordingly, foreign investors should appreciate the regulatory nature of SAGIA even after an applicant has successfully incorporated in Saudi Arabia.

Quality over quantity
SAGIA today has developed its policy, from the early years of a very liberal policy on licensing to a more measured procedure based on the quality of applicant and not just the size of capital being invested.

The main considerations for SAGIA now are the value-add in terms of expertise or the know-how that a foreign investor will bring to the Saudi economy. An applicant who offers a programme of training of specialist skills will almost always be looked upon favourably by SAGIA.

SAGIA has matured in its approach to what it wants from a foreign investor. Unfortunately, this has not always translated into making the investment rules, or more importantly the policy decisions involved to implement them, easy to understand for foreign investors.

SAGIA is currently reviewing the entire investment application procedure and it is likely there will be further changes at some point. The suspensions in May were never formally announced or communicated, which is common in Saudi Arabia, so it may mean that any rule or policy changes made in the review are communicated to applicants in the next few months.

In the future, it is hoped that the whole SAGIA process will continue with its professional development programme with an increased focus on consistency, transparency and efficiency.

Consistent with the Saudi government's objectives of developing an economy based on knowledge-based capital, a key objective of SAGIA is to secure qualitative foreign investment which brings with it expertise in a given field as well as a competitive edge commercially.

This is not a problem for the right investor. The size and opportunity of the Saudi economy is a major attraction for foreign investors.

SAGIA has a great opportunity to finish the detailed review currently being carried out and introduce long-lasting changes that will make it easier for foreigners to invest. Hopefully, this will yield the financial results and achieve the policy objectives that the Kingdom seeks while balancing the commercial imperatives of the foreign investor.

Imran Mufti is a partner and Irfan Butt is an associate at Hogan Lovells. Both are on secondment at Al-Yaqoub Attorneys & Legal Advisers in association with Hogan Lovells International in Saudi Arabia.