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

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.