The Middle East and North Africa (MENA) region has been one of those emerging markets in which corporate governance is seen as a relatively new concept; indeed it is only in the last ten years that an Arabic word, “hawkamah” for ‘corporate governance' has emerged. But despite its infancy in the region, corporate governance has been making significant headways.
Hawkamah Institute for Corporate Governance is an international association dedicated to the advancement of good corporate governance across MENA. Hawkamah has been at the forefront of corporate governance debates through conducting studies on the state of governance in the Middle East, identifying gaps, outlining areas for reform, providing advice and assistance, and working with companies and regulators to bridge the corporate governance gap.
According to a 2008 joint study by Hawkamah and the International Finance Corporation (IFC) only three percent of listed companies and banks in the MENA followed good corporate governance practices, with none complying with international best practices. Much of this stems from a combination of facts such as the ownership structures of MENA companies (mainly family or state-owned), the ready availability of liquidity and financing from regional banks, and the relatively underdeveloped capital markets. Consequently, the benefits of good corporate governance have been typically seen by companies in terms of better strategic decision-making and regulatory compliance rather than being associated with better and cheaper access to credit and capital.
This mindset has traditionally had a direct bearing on the level of regional transparency and disclosure practices which seriously lag behind international best practices. Similarly, the compositions and practices of the region's boards leave much to be desired. Most of the boards have been dominated by majority shareholders or their representatives, and according to the 2008 study, 57 percent of listed companies in the MENA had a single or no independent directors on their boards. The same study also indicated that boards needed to do better in terms of overseeing risk management and control. In fact, less than half of the surveyed companies had a risk management function in place.
Comprehensive corporate governance improvements do not happen overnight but there is evidence that there have been substantial improvements in the past two years. Although the region as a whole has yet to internalise that good corporate governance is a competitive advantage to be exploited, an increasing number of MENA companies have began investing in better governance and addressing their corporate governance shortcomings.
Hawkamah, in cooperation with The National Investor, assessed all Gulf-listed companies measuring their “investor friendliness” and transparency practices on an annual basis since 2008. Their 2009 study indicated that two-thirds of the companies showed year-on-year improvement and 26 companies increased their score by 100 percent. This trend is encouraging, although it should be noted that the improvements stem from a low base and that the gap between international best practice and regional practices remains substantial.
Reforming the framework
Traditionally, the MENA region has looked for change and reform to be signaled and enforced from the top, with government and regulators taking the lead. And governments and regulators across MENA recognise the role governance malpractices and failures played in the lead up to the financial crisis as well as in some regional corporate scandals.
A number of MENA countries have been active over recent years in developing corporate governance codes. Oman has been ahead of the curve with the Omani Capital Market Authority announcing corporate governance standards for listed companies as early as 2002. Both Qatar and Morocco issued governance codes in 2008, Bahrain has put draft corporate governance codes for public consultation, a code is also forthcoming in Lebanon while in the UAE, the corporate governance guidelines introduced by the Emirates Securities and Commodities Authority in 2007 will become mandatory for listed companies in 2010. The central bank of the UAE has also recently issued draft corporate governance guidelines for bank directors in the Emirates, while in Saudi Arabia, the Capital Markets Authority has started a gradual process of making some corporate governance regulations compulsory.
Better corporate governance
These mark important milestones in the development of corporate governance in the region. However, it is noteworthy that many of these initiatives pre-date the crisis, and the region would benefit from revisiting some of these guidelines in the light of recent international developments, especially in relation to risk management.
Important as it is to have such guidelines in place, challenges remain. It is one thing to have regulations issued, it is quite another to have them implemented. The financial crisis stemmed from markets where the corporate governance codes were the most advanced, but evidently not followed. The challenge across MENA is to create a culture of enforcement and compliance.
Hawkamah encourages regulators, whether bank regulators or capital market authorities, to set up specialist corporate governance departments to monitor the implementation of corporate governance in the entities they are supervising. The objective is not to shackle corporations but rather to balance the promotion of enterprise with greater accountability. Regulators must also be careful not to turn corporate governance into a box-ticking exercise. The objective is not governance for the sake of governance. Enforcement of compliance, in particular, is called for in three key areas: transparency and disclosure, risk management and board practices.
For this to be effective, regulators themselves need to ensure that they are both transparent and accountable, that their responsibilities are well-defined and not conflicted, that they are not subject to political intervention or ‘regulatory capture' and that they are staffed with competent and experienced personnel.
Financial institutions
Regulators should particularly focus on the region's banks and financial institutions. Hawkamah and the MENA-OECD CG Working Group with the Union of Arab Banks have recently issued a policy brief on corporate governance of banks in the MENA region, designed to address governance challenges of a variety of banks, whether listed or private, family-owned or state-owned, Shari'a compliant or conventional. The brief recommends, among others, that more detailed codes be introduced at the national level and that each bank regulator develops its own corporate governance expertise and issues specific guidance against which banks could be assessed. Hawkamah also advocates that bank regulators introduce guidelines requiring banks to introduce corporate governance criteria in their lending and investment decisions, aiming to extend good corporate governance from banks to their corporate clients.
State-owned enterprises
The region's regulators also need to address corporate governance standards in State-Owned Enterprises (SOEs) which are a major and pervasive part of the economic system. Improving the corporate governance of SOEs will lead to mutually reinforcing multiple rewards of significant efficiency gains, improvement in the quality of public services, increased foreign investment and ultimately improved growth prospects. In many instances, better performing SOEs can have positive fiscal implications, insofar as government budgets are all too often called to the rescue of large SOEs. Many argue that a level playing field with the private sector, reinforced SOE ownership function, improved transparency, empowered SOE boards and improved accountability is needed.
State audit institutions who act as guardians and protectors of the state and public interests can and should adopt corporate governance principles in their review of and assessment of SOEs, their performance effectiveness. Adopting the OECD SOE Corporate Governance principles would be a natural extension of the role and mandate of State Audit Institutions, beyond the strict and traditional boundaries of financial audit and recognition of the fact that better corporate governance results in improved financial and risk management and results.
But it should also be remembered that although corporate governance codes form an important part of the overall governance framework, legislative reform in related areas is also needed to make the region more investor-friendly. There is a clear link between insolvency practices, the protection of creditor rights, corporate governance, foreign investment and access to credit and capital.
Currently, in the MENA region, insolvency systems function less effectively than they do in many other regions across the globe, yielding extremely low stakeholder returns. Throughout MENA, it takes 3.5 years for a company to go through insolvency, which is double the OECD average of 1.7 years. On average, one might expect to recover about 29.9 cents on the dollar (OECD about 68.6), at a cost of 14.1 percent of the estate, while in Bahrain (the highest) you would expect to recover 63 cents on the dollar.
It has been said that the region requires effective debtor-creditor regimes and modern insolvency regimes to address the weaknesses that have been uncovered by the crisis. To this end, Hawkamah has launched – with the World Bank, IFC, OECD and INSOL International – a Regional Forum on Insolvency Reform in MENA (FIRM). FIRM aims to engage, educate, and inform stakeholders about the reform process, serve as a platform for sharing international and regional best practices and provide technical assistance for countries wanting to reform.
The MENA region has been striving to improve governance standards and much has been achieved in a relatively short period. However, there clearly is no room for complacency. The region's regulators need to build on this momentum for corporate governance to take root, especially in the areas of transparency and disclosure, board practices and risk management, whether in the realm of listed companies, banks or state-owned enterprises. This will require that the region's regulators themselves embrace highest governance standards – accountability and transparency. This, of course, is something that not just the MENA regulators should aspire to.
