By Alissa Amico, Managing Director, GOVERN, Economic and Corporate Governance Center
As a field of research, corporate governance emerged on the stage in the 1990s and has managed to stay in the role of a leading actor for the past 25 years.
Corporate scandals uncovered by the latest financial crisis have undoubtedly helped underpin it as a research field of relevance to corporations and their investors and regulators. While the notion of good governance has different meanings, depending on the legal and regulatory frameworks, ownership structures and the leadership of individual companies, there is universal acceptance that governance is necessary to enhance corporate performance or, at the minimum, to mitigate risks and protect shareholder equity.
In the Arab world, corporate governance standards emerged initially in the banking sector as banks were – and to this day remain – the most important financial sector institutions in the region, while capital markets have been slower to develop. Securities regulators in the region started to pay attention to corporate governance 15 years ago when Oman and Egypt introduced first corporate governance codes aimed at listed companies. Since then, all countries in the first region except Iraq have introduced and revised their corporate governance codes, most of which now apply to listed companies on a comply-or-explain basis.
Revisions and upgrading of existing rules
The regulators’ approach to governance has been dynamic: only in the past year, Kuwait and Oman have both substantially revised their corporate governance codes while Saudi Arabia and Egypt are currently in the process of revising their codes and related regulations. Most corporate governance codes in the region are now broadly in line with international standards, although in a few countries, such as Morocco and Egypt, they still apply on a voluntary basis and progress has been slower to realise than, for example, in Gulf markets.
In parallel, the companies law has also seen significant evolution in Kuwait, Saudi Arabia and the United Arab Emirates in the past three years, positively impacting corporate governance practices in privately held companies. Although this is a step in the right direction, policymakers need to give further consideration to the governance of large family-controlled firms as many of them are effectively ‘too large to fail’ and getting their succession planning right is fundamental to their sustainability. The failure of a large family-controlled conglomerate in the region would have a ripple effect on the domestic banking sector.
Less evident progress has been made with respect to governance of state-owned firms. Unfortunately, in most countries of the region, state-owned enterprises are not subject to company laws with the result that their standards of governance remain generally lower than in listed and private sector firms, except for companies such as SABIC and Etisalat, which have been partially privatised through public equity markets. The transfer of state-owned firms to sovereign funds that has occurred in Bahrain and is currently taking place in Saudi Arabia has proven to improve their efficiency and governance practices.
Governance primarily driven by compliance
And yet, in working with policymakers, regulators, and companies in the region over the past decade, the phrase that constantly emerges in conversations is that corporate governance requirements are essentially viewed by boards and management as a compliance exercise. One of the reasons underpinning this compliance-oriented approach to governance is the low level of institutionalisation of most equity markets
in the region. Our analysis of the ownership structures of MENA-listed companies indicates that private pension funds account for only three per cent of the market capitalisation of MENA equity markets, investment funds for six per cent and alternative investors, such as private equity and hedge funds, for only one per cent.
Another reason is the low levels of interest and capacity of domestic institutional investors to act as stewards of the companies in which they have investments. The levels of investment in equity markets by domestic pension and mutual funds and insurance companies is lower than in OECD countries, and sovereign investors are dominant owners in most equity markets, followed by family offices. While across the region, sovereign investors account for more than 40 per cent of the overall market capitalisation, they generally do not participate in the governance process except by nominating directors in companies where they have block holdings.
A third important reason why advancing good governance practices – whether diversifying boards or providing better disclosure – has been challenging is linked to the fact that Arab companies do not ‘vote’ in the adoption of these requirements. While corporate governance codes and regulations are occasionally subject to a consultative process, this is not always the case and the process of soliciting their views is often unstructured.
Weak involvement of the private sector
Listed companies are clear stakeholders in the regulatory process and hence should be involved in the process of developing standards or recommendations on corporate governance. Investors also have a role in defining standards and need to be engaged, if not for any other reason then to encourage them to consider their own stewardship capacity. And yet, in most Arab countries, corporate governance in listed companies remains in the clear turf of securities regulators.
In the GCC countries which have the largest equity markets in the countries, corporate governance codes were introduced by securities regulators (except in Bahrain, which has a unified regulator) with whom the vast majority of regulatory and enforcement powers are vested. Until recently, exchanges had few roles in defining and enforcing governance requirements – the few notable exceptions are exchanges in Morocco, Egypt and Oman. Only in Morocco the corporate governance code was a result of the work of a commission with public and private stakeholders.
“In the Arab world, corporate governance standards emerged initially in the banking sector, as banks were – and to this day remain – the most important financial sector institutions in the region, while capital markets have been slower to develop”
The consequence of this approach is that the private sector often perceives governance requirements as being arbitrarily imposed, which hence, limits its role to arguing in favour of a ‘light touch’ regulatory approach. For example, in Kuwait, the first corporate governance requirements adopted were made mandatory and companies grappled to adapt to their requirements until more recently the code was changed to a comply-or-explain basis. In Saudi Arabia, the regulator has, over the years, moved to a more consultative decision-making process, making governance codes available online for a public consultation.
Stock exchanges gaining more responsibilities
Although historically exchanges in the region had few self-regulatory powers, including in the area of governance, this is changing as a number of them are currently privatising and demutualising. The Kuwait Stock Exchange is the first exchange in the region to have transitioned from state to private ownership earlier this year and the Bourse de Casablanca is close to completing its demutualisation. The Saudi Stock Exchange and Beirut Stock Exchange have announced plans to privatise; Oman and Jordan are considering corporatisation.
It may appear paradoxical that exchanges in the region are inheriting regulatory responsibilities and moving towards the self-regulatory status at a time when they are transitioning to private ownership and management. Globally, exchanges’ transition to private ownership has often been accompanied by a reduction of regulatory authority, in particular with reference to their own listing. Self-listing is so far rare in the Arab world, with only the Dubai Financial Market being traded on its own platform.
For the evolution of governance in the region, the fact that Arab exchanges are gaining some regulatory authority is likely positive, especially considering that they will continue to operate with a public good perspective and hence will be unlikely to engage in any regulatory ‘race to the bottom’. An important reason for this is that stock exchanges in the region are closer to the private sector than securities regulators, as many of them have brokers and other private sector participants on their boards.
How to improve investor engagement
The private sector should be involved in the standard-setting process and doing so would result in its ownership of the devised governance rules. Indeed, a recent report by the French securities regulator (Autorité des Marchés Financiers), which examined corporate governance codes in 10 developed European markets found that only in Spain had the corporate governance code been developed by the regulator in a group of private and public experts. The other nine jurisdictions had various models, ranging from codes being developed by an issuer association (in France) to a corporate governance committee (in Italy) to a dedicated governance watchdog (in the United Kingdom).
In the OECD member countries, codes were developed by regulators in less than half of the countries. Countries such as Germany and Korea have deferred this responsibility to the ministry in charge of the company law. In Hong Kong, a country whose financial sector the GCC countries regard highly, the role of public regulators is limited to monitoring disclosure or breaches of the securities law, as corporate governance rules are mostly supervised and enforced privately.
Giving exchanges more authority over corporate governance opens the door to private sector engagement in corporate governance. Additional private sector engagement in the corporate governance debate in the region could be stimulated in a multitude of ways, drawing on experts from leading corporations, NGOs, institutional investors and family groups. National corporate governance commissions established in the Netherlands, Italy and other countries have so far only been adopted in Morocco, and in recent years it has been inactive.
Chambers of Commerce are often powerful bodies in the region, especially in the GCC countries, and have the capacity to represent the views of the private sector in the public debate on governance. Institutes of directors and corporate governance centres, which now exist in most countries in the region could also contribute to this process. Last but not least, capital markets and investor associations – to the extent they exist in various countries of the region – could also be usefully drawn in the corporate governance debate.
Developing investor and asset management associations, such as the Investment Management Association in the UK or the French Asset Management Association (Association Française de la Gestion Financière), is an important priority for the region in its own right to set and promote self-regulatory standards for the sector. Their engagement in the corporate governance debate can help create a demand for good governance so it is not perceived by the listed companies as a purely regulatory requirement.
What is the benefit for the private sector?
Investors and issuers alike need to realise that by being involved in the regulatory process, they stand to gain by, for instance, arguing for a level-playing field in governance between state-owned and private companies. They also need to realise that raising governance standards is a precondition for attracting foreign investment. They should see their involvement as an opportunity to contribute to this objective. If local institutional investors do not voice their views on the governance of their investee companies, further opening of GCC markets to foreign investors might result in the latter importing engagement tactics.
“If local institutional investors do not voice their views on the governance of their investee companies, further opening of GCC markets to foreign investors might result in them importing foreign engagement tactics”
Ultimately, if the engagement of the private sector leads to a weakening of the requirements in such as way that is unacceptable to the regulators, they always have the upper hand to bring back the regulatory pendulum in their favour. However, as highlighted by the European experience cited above, the risk of this appears to be low. The upside of better private sector involvement in the standard-setting process is significant insofar as it can help regulators better gauge obstacles in the implementation of rules and support real ownership of the governance agenda by private sector leaders.
Corporate governance is fundamentally linked to ownership structures and yet the MENA region is still in the process of discovering its owners. So far, the majority stakeholders in the corporate governance agenda have been the securities regulators and this has helped expedite the rule-making process. In a world where stock exchanges were state-owned and where the largest institutional investors were sovereign, this model was arguably efficient and effective. As markets in the region are undergoing a seachange, inviting issuers and investors to the table where regulatory decisions are taken is an approach that should help further align the quality of corporate governance practices with the aspirations of Arab capital markets for the next decade.
About the Author: Alissa Amico is the Managing Director of GOVERN which works alongside public and corporate leaders in advancing on corporate and economic governance in the Middle East and North Africa and other emerging markets. Until 2015, Alissa was responsible for overseeing OECD’s work on financial markets and corporate governance in the Middle East and North Africa. Alissa joined the OECD in 2005 to establish a regional programme on private sector development in the MENA region with the relevant Ministers in the region.