The future of corporate governance in the Gulf

I have just returned from running a workshop in Dubai where we reflected on the governance challenges facing the region. The 15 participants were chairmen, CEOs, CFOs and company secretaries – from eight industrial sectors, and nine countries (including South Africa). They came from a mixture of public, private, State-owned and family-owned backgrounds.

I have visited the region a number of times and, like many, am fascinated by its history and the nature of its economic development. It is worth remembering that, up until about forty years ago, the region operated a subsistence economy of pearl trading, fishing, nomadic animal husbandry, seafaring and subsistence agriculture. The local areas – emirates – were ruled by local tribes, with political tensions managed under the auspices of the British Protectorate. When the British left, in 1971, seven emirates forged a political union and the United Arab Emirates (UAE) was born, with Bahrain and Qatar deciding to remain independent.

ECONOMIC DEVELOPMENT

The discovery of significant oil resources during this period, followed by an explosion in oil prices in 1973, created massive revenues for the region. In Mohamed Shihab’s excellent paper (‘Economic Development in the UAE’), he points out that this enabled the UAE to leap-frog all conventional forms of economic development, and to create a windfall ‘once-and-for-all’ boost to the region’s social and economic infrastructure.

The vision of the founding fathers of the UAE is particularly clear in the buildings and skyline of Dubai.   The Sheikhs’ philosophy could be paraphrased from the Kevin Costner Field of Dreams film – ‘build it, and they will come’. And build it they continue to do. Last week, for example, saw the fifth anniversary of the opening of the Dubai Metro, with plans to construct another 420 kilometres of lines in the next fifteen years.

The path to economic progress hasn’t been totally smooth – the Gulf War in 1990 created difficulties for the region, and there was a property downturn in 2008-9. Otherwise regional growth can only be described as stunning. This year’s World Economic Forum ranking of global competitiveness has seen the UAE jump seven places to 12^th – in 2011, it was 27^th. In the global indices for attracting professional talent, the UAE ranks 3^rd. A new study by the Dubai Economic Council identifies Dubai as the fastest growing city state economy in the world between 1975 and 2008 – while, during this period, the Hong Kong economy grew by a factor of seven, and Singapore by ten, Dubai grew by a factor of eleven.

In 2020, Dubai hosts the World Expo and will rightly become the centre of global attention – remarkable for an entity which will still not even be fifty years old. Dubai is the city state without equal, and the UAE a powerhouse economy (with the exception of China) without parallel.

THE LEGAL, REGULATORY AND GOVERNANCE FRAMEWORK

Can this remarkable growth be sustained, and what are the governance issues which need to be considered? (Although this article deals mainly with the UAE, many of the issues have a wider regional relevance.)

In Dubai, in particular, where it is predicted that there is only another fifteen years of oil production, there is a vision of sustainable wealth creation based on a diversified economy, with a focus on the transition to tourism, services, real estate and construction, trade, entrepôt and financial services. The companies which deliver these products and services are not typical of what we would find in the West. There are few large companies in the region. While institutional investors are present, there is a strong tradition of sovereign wealth involvement, often manifesting itself in dominant and controlling shareholdings. (That said, the recently-proposed partial IPO by Emaar, the Dubai-based real estate company, is a useful reminder of institutional investor interest. Indeed, given the spate of disappointing IPOs in Europe over the last year, some consider that the Gulf may be a better place to do business, with annual growth currently running close to 4%.)

Of particular interest is that 80% of non-oil GDP in the region is estimated to be generated by family firms, although it is calculated that only 15% are creating significant value by the time they reach the third generation.

There is no lack of understanding from the UAE government that capital markets require a proper legal framework –providing security, transparency and accountability – to generate the conditions of market confidence required for foreign direct investment. But there is concern that developments may not be at the speed expected of a region which is becoming a serious player in world capital markets, and a systemically important part of the world economy.

Significant progress has been made. The stock exchanges for the UAE and Dubai – ADX and DFM respectively – are licensed and regulated by the Securities and Commodities Authority (SCA). In 2009, the SCA introduced a new corporate governance regulation (the Corporate Governance Code), which applies to all joint stock companies and institutions whose securities are listed on the two exchanges, with compliance required by 30 April 2010. The Code, largely based on international standards, does not apply to Government owned institutions (at either the Federal or Emirate level), Central Bank regulated entities, or foreign companies.

Separately, the Central Bank has issued binding rules and non-binding guidance in relation to corporate governance within regulated institutions. It issued binding recommendations for corporate governance structures in UAE banks (the Central Bank Rules), and additional non-binding guidance for bank directors was issued in its Corporate Governance Guidelines for Bank Directors (the Central Bank Guidelines).

A much-anticipated UAE Commercial Companies Law is expected shortly, containing – critically – numerous provisions in relation to corporate governance, as well as introducing, for the first time in law, the concept of ‘Social Responsibility’.

The role of the Dubai International Finance Centre (DIFC) has also been critical. It was established to deliver a platform for business and financial institutions to reach into and out of the emerging markets of the region, by providing legal and business infrastructure benchmarked against international standards. DIFC houses two important bodies established to take forward the governance agenda – in 2006, Hawkamah was established to promote corporate governance in the region and, in 2008, Mudara was established as a sister organisation, focused on board effectiveness, and developing director capability and capacity.

In 2009, the Abu Dhabi Center for Corporate Governance was established and, in 2010, we saw the arrival of the Pearl Initiative – a private-sector led, not-for-profit organisation, aimed at improving transparency, accountability and business practices in the Gulf region. In 2011, the S&P/Hawkamah Mena Pan Arab ESG Index – the first of its kind – was established with the support of the International Finance Corporation. The index, covering publically-traded companies in the Middle East and North Africa region, identifies those companies which are environmentally, socially and corporate governance responsible companies. Finally, and significantly, the voluntary ‘The Corporate Governance Code for Small & Medium Enterprises’ was issued in 2011.

THE GOVERNANCE CHALLENGE

While in Dubai, I met the new CEO of Hawkamah, Doctor Ashraf Gamal, former chairman of Egypt Post; and his colleague, Alec Aaltonen, Associate Director of Corporate Governance, who facilitated part of the workshop. Another colleague who facilitated part of the workshop was Claire Alves, a senior Chartered Secretary (ICSA) who has been in the region for ten years and who, in a former role as company secretary of Nasdaq Dubai, has first-hand experience of companies going through the listing process locally. All are clear that the governance wave currently washing through the region will only intensify in the years that lie ahead. Indeed, it is possible that, consistent with the region’s economic performance, the Gulf is potentially on its way towards becoming a centre of governance excellence and global thought leadership.

But the point is that it needs to. The scale of economic development is now so complex, significant and fast – even furious – that the region needs to embrace governance good practice with a heightened sense of urgency and commitment. No-one in the Gulf wants to see repeated the corporate collapses and value destruction which became the hallmark of the western economies during the financial crisis, and which so severely tarnished the reputations of the central banks and sector regulators.

The trick, for Hawkmah, will be to continue to develop a governance model which is culturally attuned to the nature of economic activity in the region, and which makes sense for the region’s market participants. This means finding ways to sell the business benefits of governance to increase the rate of adoption. One of the arguments which the workshop found particularly attractive came from the market data collected by the S&P/Hawkamah Pan Arab ESG index – while correlations between governance performance and share price performance can be tenuous, it is nevertheless difficult to ignore a central message of the analysis, which is that the better-governed companies in the region are out-performing their rivals.

But there remains a concern that the region is still not making sufficient governance progress, particularly among family-owned companies, with the additional risk that the wealth of the region will lead to complacency about governance standards.

In the workshop there were companies only taking the first steps along the governance road, but there were others – not that long in existence – already demonstrating aspects of good practice. As both Claire and Alec reminded the workshop, regulation has been a stimulus for driving standards, but that that is just the beginning of the journey. There are now real imperatives of self-interest and market dynamics to maintain the momentum.

The family-owned companies are looking to professionalise and, at the same time, secure their legacy in a highly competitive world.

For the listed sector, regulators and investors are demanding higher standards based on expectations derived from, and experience gained in, other jurisdictions. (The recent upgrade reclassification of the UAE from “Frontier Market” to “Emerging Market” status – a change which it is estimated could attract between $300million to $4billion of foreign investment – confirms that market momentum is being maintained, but that the governance pressures will merely intensify).

And for the sovereign wealth owners, their reputation and credibility is closely associated with keeping the regions’ state-owned companies performing efficiently and effectively. In a parallel discussion I had with Nick Nadal, a former director of Hawkamah, and now Adviser to the Governance Department of the Executive Council of Dubai, the same governance attention and effort is being focused on state and public sector bodies.

WHAT MORE NEEDS TO BE DONE

The Dubai Financial Services Authority (DFSA), the DIFC’s independent risk-based regulator, recently carried out a corporate governance thematic review of its authorised firms and found a good level of compliance, and that governance structures and arrangements generally reflected the nature, scale and complexity of businesses reviewed. However, it identified areas of concern:

• The practices of many firms reviewed fell short of their own stated policies
• A lack of development and training
• A significant proportion of committees, where these were established, did not minute their meetings nor did they have a charter of terms of reference
• Firms generally did not carry out structured, periodic reviews of the governing bodies and their committees, or their effectiveness.
• Governing bodies were not sufficiently represented by independent members and, therefore, there was a risk that their objectivity might be compromised.

Both Claire and Alec pointed to the way in which cultural issues were potential inhibitors for developing effective governance in the region. Family firms, in particular, needed to arrange the transition from family governance to corporate governance if they were to be able to compete effectively – through addressing the tendency towards privacy and hierarchy, introducing better systems for managing issues of conflict, risk, succession and decision-making, having agreed entry and exit provisions, performance appraisal mechanisms, and processes for the use of third party mediators in internal disputes and, generally, higher standards of management.

Private and public companies needed to embrace the concept of transparency as a mechanism for building confidence among their shareholders and other stakeholders.   As Badr Jafar, founder of the Pearl Initiative, put it, “The Gulf region today is the right place at the right time for good corporate governance. But it is not enough just to change regulations, we need a change of culture”.

The final word goes to Dr Gamal from Hawkamah: “Economic opportunity in the region is enormous, and so potentially also is the potential risk. We need to ensure the governance frameworks and practices are up to the task so that the region can continue to prosper. There is a lot of work to do”.