Notes from a leader.

Stu­art An­der­son, man­ag­ing di­rec­tor and re­gional head for the Mid­dle East at S&P Global Rat­ings, dis­cusses the ways in which mean­ing­ful longterm change can be made to cor­po­rate gov­er­nance in the Gulf

Gulf Business - - CONTENTS -

Re­gional ini­tia­tives to el­e­vate cor­po­rate gov­er­nance standards

The cor­po­rate gov­er­nance standards of GCC cor­po­rates still lag be­hind their in­ter­na­tional coun­ter­parts, de­spite sig­nif­i­cant leg­isla­tive and cul­tural progress.

In or­der to se­cure cheaper and longer term fund­ing and to di­ver­sify their fund­ing base, Gulf com­pa­nies should place higher im­por­tance on gov­er­nance prac­tices.

The Mid­dle East of­fers a strong growth pro­file, which has, over the past decade, led pol­i­cy­mak­ers to tar­get cap­i­tal mar­ket re­form to at­tract more in­vest­ment and en­able deep and liq­uid mar­kets. Re­gional de­vel­op­ments in gov­er­nance have been steady but grad­ual, in­clud­ing the es­tab­lish­ment of cor­po­rate gov­er­nance re­quire­ments, in­sti­tu­tion­al­is­ing se­cu­ri­ties reg­u­la­tors, re­vi­sions to com­pany law, list­ing re­quire­ments and en­force­ment of cor­po­rate gov­er­nance rules – al­beit to vary­ing de­grees across the re­gion. The UAE, for ex­am­ple has adopted a new stan­dard in in­vestor re­la­tions, man­dat­ing all com­pa­nies to have a ded­i­cated in­vestor re­la­tions func­tion. These de­vel­op­ments are strongly pos­i­tive, but im­ple­men­ta­tion and mon­i­tor­ing have been in­con­sis­tent.

High pro­file re­gional cases such as Al Go­saibi, IPIC, Arabtec and Mo­bily, have put the spot­light on cor­po­rate gov­er­nance standards, clearly demon­strat­ing more can be done to im­prove gov­er­nance at listed com­pa­nies.

S&P views gov­er­nance as more than just the make-up and ef­fec­tive­ness of the board of di­rec­tors, which forms just a part of the com­pre­hen­sive an­a­lyt­i­cal frame­work used to as­sess a com­pany’s credit risk.

Strate­gic po­si­tion­ing, con­sis­tency of strat­egy and man­age­ment’s abil­ity to ex­e­cute its plans, mar­ket con­di­tions, risk man­age­ment and op­er­a­tional per­for­mance all con­trib­ute to a com­pany’s credit out­look.

In ad­di­tion, S&P as­sesses a com­pany’s in­ter­nal con­trol, au­dit, or­gan­i­sa­tional ef­fec­tive­ness, the breadth, depth and ex­pe­ri­ence of man­age­ment and – of course – gov­er­nance.

The ways in which mes­sages are com­mu­ni­cated from the or­gan­i­sa­tion to mul­ti­ple stake­holder groups and a com­pany’s fi­nan­cial re­port­ing and trans­parency also play a part in S&P’s broader an­a­lyt­i­cal process.

Al­though rat­ings are typ­i­cally fo­cused on credit risk, we also see equity in­vestors tak­ing stock of S&P Global Rat­ings’ man­age­ment and gov­er­nance (M&G) scores as an im­por­tant com­fort fac­tor. S&P Global Rat­ings’ (M&G) scores are among the fac­tors used to de­ter­mine a com­pany’s credit rat­ing.

De­spite the re­form de­vel­op­ments we have seen, just 6 per cent of the GCC com­pa­nies rated by S&P Global Rat­ings have strong M&G scores. Out of the 33 GCC-based cor­po­rates un­der S&P Global Rat­ings’ coverage, only two – Ma­jid Al Fut­taim Hold­ing LLC (MAF) and Saudi Ba­sic In­dus­tries Corp. (SABIC) – are rated with strong M&G scores. This com­pares with 9 per cent in Europe, the Mid­dle East and Africa as a whole. Glob­ally, there is a strong cor­re­la­tion be­tween rat­ings lev­els and man­age­ment and gov­er­nance standards.

Own­er­ship struc­ture per­me­ates strongly when as­sess­ing credit risk in the Gulf. As fam­ily groups grapple with the tran­si­tion from an in­for­mal com­bined set of com­pa­nies to a for­mal hold­ing com­pany group struc­ture, we see sub­op­ti­mal in­vestor com­mu­ni­ca­tion. While some, such as MAF, saw the

need and ben­e­fit of be­ing trans­par­ent and op­er­at­ing with strong cor­po­rate gov­er­nance pro­cesses, oth­ers still op­er­ate un­der a veil of se­crecy and se­lec­tive dis­clo­sure.

Own­er­ship was a key topic in a re­cent re­port by GOV­ERN, the MENA re­gion’s cen­tre for eco­nomic and cor­po­rate gov­er­nance, which was pre­sented at a re­cent S&P and GOV­ERN we­b­cast.

The re­port found sov­er­eign in­vestors and fam­ily of­fices were the most dom­i­nant cat­e­gories of (in­sti­tu­tional) in­vestors in the re­gion re­spec­tively own­ing 41 per cent and 26 per cent of the 600 largest listed com­pa­nies in the MENA re­gion, re­plac­ing pen­sion and mu­tual funds and in­sur­ance com­pa­nies, which are the main own­ers of pub­licly listed equity in de­vel­oped mar­kets. In ad­di­tion, re­tail in­vestors are es­ti­mated to ac­count for 39 per cent of eq­ui­ties own­er­ship across the re­gion, with their trad­ing par­tic­i­pa­tion even higher.

This is a con­se­quence of sev­eral fac­tors, no­tably the con­cen­tra­tion of wealth in the hands of rel­a­tively few high net worth in­di­vid­u­als, the slow de­vel­op­ment of the do­mes­tic in­sti­tu­tional in­vest­ment in­dus­try, and the rel­a­tively weak in­ter­est in MENA mar­kets by large for­eign in­sti­tu­tional in­vestors.

Reg­u­la­tion and scale also limit in­flow of for­eign in­sti­tu­tional cap­i­tal to our re­gion’s equity mar­kets. While poli­cies to at­tract more in­sti­tu­tional in­vestors have been ex­plored, their im­pact has been lim­ited with the sov­er­eign linked in­vestors, banks, and fam­ily of­fices for­mu­lat­ing the largest sources of in­sti­tu­tional cap­i­tal.

In­sti­tu­tional in­vest­ment is crit­i­cal to the de­vel­op­ment of cap­i­tal mar­kets in the re­gion as they at­tract cor­po­ra­tions to equity mar­kets and de­crease mar­ket volatil­ity linked to the short­term ap­proach of re­tail in­vestors. In­sti­tu­tional in­vest­ment is also cru­cial in the push for more trans­parency and bet­ter gov­er­nance so, in a catch 22 sit­u­a­tion, the en­try of active in­sti­tu­tional cap­i­tal in to the Gulf is be­ing im­peded by low qual­ity trans­parency and dis­clo­sure.

GOV­ERN, Mid­dle East In­vestor Re­la­tions As­so­ci­a­tion, GCC Board

REG­U­LA­TORY STANDARDS NEED TO BE RAISED FUR­THER AND EN­FORCED MORE SYS­TEM­AT­I­CALLY IN OR­DER FOR COM­PA­NIES TO TAKE COR­PO­RATE GOV­ER­NANCE MORE SE­RI­OUSLY.

Di­rec­tor’s In­sti­tute, Pearl Ini­tia­tive and Hawkamah con­sis­tently raise the pro­file of good cor­po­rate gov­er­nance and strong in­vestor re­la­tions in the Gulf; but in­trin­sic cul­tural and struc­tural dif­fer­ences re­main.

For ex­am­ple, a ten­dency to keep in­for­ma­tion pri­vate, gen­eral man­age­ment style and in­stances of one per­son hold­ing the CEO and chair­man role and other deeply em­bed­ded prac­tices, will take time to in­ter­na­tion­alise. This is sub­stan­tially borne out of a long pe­riod of am­ple bank liq­uid­ity to the ex­tent where risk has typ­i­cally been un­der-priced, creat­ing a com­pla­cent environment.

We also see those com­pa­nies that have less ex­po­sure to the in­ter­na­tional in­vest­ment com­mu­nity evolv­ing more slowly than those that are en­gag­ing with in­ter­na­tional best prac­tice. Ul­ti­mately, those com­pa­nies listed on global stock ex­changes are re­quired to in­ter­act with in­ter­na­tional in­vestors, fur­ther el­e­vat­ing their standards, while lo­cally listed com­pa­nies need to work harder to gain the at­ten­tion of the global cap­i­tal mar­kets, widen­ing the al­ready ex­ist­ing gap.

Weak dis­clo­sure and trans­parency, cou­pled with a lack of board in­de­pen­dence and in­suf­fi­cient over­sight are the main con­trib­u­tors to the Gulf ’s low M&G scores.

So what will move the dial? Firstly, reg­u­la­tory standards need to be raised fur­ther and en­forced more sys­tem­i­cally in or­der for com­pa­nies to take cor­po­rate gov­er­nance more se­ri­ously. There is also a strong case for a pool of pro­fes­sional in­de­pen­dent non-ex­ec­u­tive di­rec­tors and a greater obli­ga­tion on boards to ful­fil func­tions in­clud­ing strat­egy set­ting, risk man­age­ment and group in­ter­nal con­trol.

These ini­tia­tives – com­bined with con­tin­ued pressure from in­vestors – are cru­cial to bring­ing about a mean­ing­ful long-term change and an im­prove­ment in cor­po­rate gov­er­nance standards in the Gulf.

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