Case Studies: Corporate Governance in the Middle East

Case Studies-Corporate Governance in the Middle East

  • Numerous companies in the Middle East improved their governance practices in ways that boosted their performance and growth, highlighting that corporate governance is not a one-size-fits-all concept, but a customized approach.
  • The Nuqul Group case study highlights the role played by corporate governance in the decentralization of power and creation of higher level of accountability among all layers of management.
  • On the other hand, adoption of corporate governance by the Sorouh Group helped improve the credibility of its Sukuk issuance in the eyes of credit rating agencies, thereby resulting in one of the largest and most successful debt issuance in the region.

In part one of our corporate governance article series, we had talked about the meaning of corporate governance and the factors driving the implementing of corporate governance reforms in the Middle East. In the second part, analyzed the progress made on corporate governance implementation by various Middle East nations. And in this third and final part, we share two specific case studies of Middle East-based companies that implemented corporate governance practices to boost business performance and growth.

Case Study 1: Nuqul Group | Jordan   

Founded: 1952 | Conglomerate of over 30 companies                                           

Company Overview: Nuqul Group is a Jordan-based producer of manufactured goods. In 1985, Ghassan Nuqul, the vice chairman of Nuqul Group, took a leading role 33 years after his father founded the company.

Situation: After taking over the leading role, Ghassan Nuqul realized that the firm’s head office had to process all purchase orders, as well as account and audit documents from its four plants. As a result, little accountability existed outside the head office. Also, such a strong concentration of power in one office made the Nuqul Group unattractive to investors. To correct the situation, Ghasan Nuqul took a series of corporate governance steps to institutionalize processes, allocate tasks, and develop accountability mechanisms.  The steps were aimed at increasing accountability at all levels, and also to ensure that all family members understood their roles, responsibilities, and rights within the organization.

Corporate Governance Measures Taken:

  • Over a period of five years, Nuqul headed the firm’s decentralization process. He separated and delegated tasks, created job descriptions, measures of accountability for managers and employees, established key performance indicators (KPIs), balanced performance scorecards and evaluated the company against competitors in the industry.
  • The firm established a strong board composed of both family and non-family members. It now includes board members who are employed by the firm, board members from outside the firm, and board members with relevant specializations.
  • Being a private, non-listed, family-owned company, Nuqul Group is not required by the government to publish financial statements. However, the company publishes an internal annual report voluntarily disclosing information including staff turnover, corporate social responsibility indicators, community service participation, and philanthropy operations in the family foundation.

Impact: Nuqul Group has expanded from four subsidiaries in 1985 to 30 today, and as per vice chairman Ghassan Nuqul, this level of growth would not have been possible without the improved corporate governance practices.

  • As a result of the corporate governance measures taken, Nuqul Group increased accountability among managers, employees, and the family, which ensures the company’s sustainability.
  • By implementing a 10-year business plan, with forecasted budgets for every year, the company was able to create benchmarks and measure itself against global best practices.
  • Since the implementation of these practices, Nuqul Group has continued to grow in terms of size and level of profits.

SOROUH | U.A.E   

Founded: 2003 | Real Estate company                                           

Company Overview: Located in Abu Dhabi, Sorouh Real Estate PJSC is one of the largest real estate developers in the UAE, and currently has over AED 70 billion worth of projects under development.

Situation Faced: From 2006 to H1 2008, Sorouh did not make any major borrowings; however, it wanted to finance its growth. For this, it issued Sukuks to help finance the development of 170 hectares on Al Reem Island and the Saraya development in Abu Dhabi’s central business district. However, as part of this process, Sorouh’s corporate governance practices had to be assessed by external credit agencies responsible for rating the Asset Backed Securities (ABS) transactions that Sorouh used to raise the money.

Corporate Governance Measures Taken: The company’s successful Sukuk issuance is rooted in the improvements it made in its corporate governance framework, in compliance with the UAE Securities and Commodities Authority’s standards. Sorouh had adopted these regulations and implemented all its material requirements in 2007, two years ahead of the compliance deadline.

  • Sorouh developed an Employee Disclosure Policy to ensure that employees are able to “blow the whistle” whenever and wherever they have adequate reasons to believe that ethical conduct has been breached.
  • The company has developed an Insider Share Dealing Policy in order to ensure that directors and employees do not misuse their possession of the company’s stock price-sensitive information.
  • In 2007, the company implemented an enterprise-wide risk management system, which has been initiated to structure and formalize existing risk management practices.

Impact: According to Sorouh’s Chief Corporate Officer, Afshar Monsef, “The actions we took for our corporate governance had a direct impact on the rating we received for our Sukuk and ultimately the interest rate premium, which resulted in paying a lower premium compared with other companies in the region.”

  • Sorouh’s corporate governance practices allowed it to issue more than US$ 1 billion worth of securitized Islamic certificates (or Sukuks), to be used for growth and expansion purpose
  • Moody’s rated the majority of the notes “AA3” while S&P rated them “A”.
  • The high ratings helped Sorouh to gain market acceptance for the Sukuks, resulting in millions in savings for the company.
  • The debt issuance was the first of its kind and size for a Middle East and North Africa (MENA) region corporation.
  • In 2009, Sorouh was ranked 1st in Abu Dhabi and 3rd regionally by the BASIC2 GCC-wide study of corporate governance.

We hope you have enjoyed our coverage on Corporate Governance in the region. Please free to comment and share your views and other relevant examples on this increasingly important issue for businesses in the Middle East.

The article was originally published at: Arab Business Review

To read more thought-leadership stuff by leaders from Arab Region, please visit Arab Business Review

Advertisements

Opening-up of Saudi Stock Exchange to Foreign Investors

Opening-up of Saudi Stock Exchange to Foreign Investors

  • The decision of the Saudi Capital Market Authority (CMA) to open the Saudi stock exchange to foreign investors has induced a lot of excitement and optimism in the market. In this article, we discuss what the change is all about, why it is important, how it is likely to be implemented, and what will be its impact on various stakeholders.

What? Why? How?

So what exactly is going to happen? On July 22, 2014, the Saudi government announced that the Tadawul All Shares Index (TASI) will be open to direct foreign institutional investment from the first half of 2015. This would mark a welcome departure from the current state of affairs, where foreigners can purchase Saudi stocks only via trades conducted through international banks and by making a small number of costly and time-consuming exchange-traded funds (ETFs). As a result of these restrictions, foreign investors currently own less than five percent of the Saudi market, and account for a meagre one percent of the volumes traded on the TASI, which is dominated completely by local retail investors. But once these restrictions are eased in 2015, foreign investors will be able to participate much more freely in the Saudi market, and own and trade stocks of public companies in the kingdom.

Why is the change important? With a capitalization of $530 billion, the Saudi capital market is much bigger than its regional peers (Dubai and Abu Dhabi combined have a market cap of about $235 billion, Qatari listed companies are worth $196 billion and Egypt’s market is about $69 billion), and also boasts of superior liquidity – the daily average turnover at TASI is $2 billion, which is once again much ahead of the trading volume in other Arab nations. And to add to these points is the fact that the Tadawul is home to the some of the largest companies & IPOs in the region, belonging to diverse sectors ranging from petrochemicals to banking to telecommunications to retail and real estate. Therefore, from an investor standpoint, the TASI is one the biggest market which is currently closed to foreign money; therefore, its proposed opening to foreign investors is perhaps the most significant investor-friendly step taken by a Middle East or GCC nation in many years.

However, the Saudi government is not taking this step simply to appease investors. Instead, this move is a part of the kingdom’s long-term strategy to reduce dependence on oil revenues, and strengthen the non-oil sector of the largest economy in the Middle East. The decision also comes close on the heels of Qatar and the UAE getting included in the MSCI emerging market index, and Saudi authorities surely don’t want to be left behind on this front, so an indirect aim would be to get the TASI listed on the MSCI frontier or emerging market index.

The importance attached by the market to this move can be gauged from the fact that the TASI jumped 2.8 percent to a six-year high on the day the announcement was made. Also, the IMF boosted its 2015 GDP growth forecast for KSA from 4.1% to 4.6%, based on expectations of strong private sector performance.

How will the change be implemented? The CMA is yet to come out with a definite plan, but it is obvious that the roll-out to foreign investors will a slow and gradual process to avoid volatility in the market, and also to test waters in a phased-out manner.

One of the reasons that this change has taken so long to come is that Saudi authorities have been very protective of the companies in the kingdom, and have been averse to foreign investors taking control of key listed companies. Therefore, we can expect the CMA to impose caps on the amount being invested. While official numbers are yet to be announced, the market expects that foreign institutions will not be allowed to own more than 10% of the Saudi market and more than 20% of a Saudi company.

Further, to start with, a limited number of investment licenses are likely to be granted to qualified investors only, in order to avoid a sudden influx of foreign money into the Saudi companies. Such investors likely to be chosen based on the size of their assets under management (AUM) and global investment management experience, with most expectations pointing to an AUM bar of at least $5 billion. Retail investors are unlikely to be given licenses for buying and trading in the first phase of the roll-out.

Finally, most experts believe that the KSA is likely to follow the route adopted by emerging markets like China and Taiwan, where a free and open market is regulated by government officials. Also, oil and gas companies may be kept out of the purview of the initial roll-out to ensure that the Saudi government retains control over firms currently generating majority of the national revenue.

What are the implications of opening-up of the market to foreign investors?

  • On the KSA economy: Saudi Arabia’s economy is likely to get a double boost from this move. First, the influx of foreign capital will boost the overall GDP, and push along the diversification to non-oil revenues that will ensure sustenance of growth. Secondly, a well-diversified and growing economy will help tackle the high level of unemployment, especially among the youth, in the country. As cited earlier, the IMF has already increased its 2015 growth forecast from 4.1% to 4.6%, expecting economic diversification to drive growth.
  • On the Tadawul Index (TASI) and the overall capital market in the kingdom: The index will become the gateway to foreign fund inflow worth ~$50 billion into the country, strengthening its case for inclusion into MSCI’s emerging market index. Even though such an inclusion unlikely to take place before 2016, the TASI will account for three to five percent of the index, when eventually included. The move will also boost trading and IPO activity on the TASI, and will also result in production of higher quality equity research in the region.
  • On Saudi Companies: Most large Saudi companies are cash rich, so obtaining additional funding will not be the biggest gain for them. Instead, such companies will benefit from shareholder activism and improved corporate governance and accounting standards that are likely to be implemented to meet the high standards expected by foreign investors. These companies will also benefit from receiving guidance and expertise from globally experienced investors, on operational as well as strategic issues. For medium-sized companies, influx of foreign capital will lead to lower financing costs and improved valuation. Further, working with global investors will allow companies in the KSA to think global, and will help them execute their international expansion plans (regional or global) in a better manner.
  • On Investors: The move will give investors much awaited access to the largest economy in the GCC and in the Middle East. Huge foreign reserves, a low-risk sovereign credit quality, and an emerging-market like growth potential make the KSA an especially attractive destination for foreign investors.  Additionally, through the TASI, it will give them access to leading firms across industries, such as Samba Bank, Saudi Basic Industries, Saudi Industrial Investment Group, and Yanbu National Petrochemical Company. Not only do these companies have a huge “upside” potential, most Saudi companies also have better corporate governance standards as compared their peers in the Middle East.
  • On Other Asset Classes: The current move is aimed at opening-up of the equity market. However, if the move is successful, it could prompt the government to open even the bond (or Sukuk) market to such investors. Even though such a follow-up move will take a long time before being implemented, the opening-up of the local Sukuk market would give foreign investors access to companies that sold 42 billion riyals ($11.2 billion) through a dozen sales in the past year, according to Bloomberg.

Overall, if implemented well, this move has huge positive implications not just for the KSA, but also for all other countries in the GCC and the Middle East, as discussed above. However, investors are keeping a close eye on the announcement since policymakers in the kingdom have put off such plans in the past. Therefore, it is important that the CMA comes out with a well-defined roll-out plan with actual dates and timelines to alleviate investor concerns, and implement what will be a landmark change in the way capital markets operate in the Arab World.

The article was originally published at: Arab Business Review

To read more thought-leadership stuff by leaders from Arab Region, please visit Arab Business Review

Countries Leading the Second Wave of Corporate Governance in the Middle East

Countries_Second Wave of Corporate Governance

  • Corporate governance (hawkamah in Arabic) in Middle East is no longer a term that requires defining, or has an unclear business case
  • All Middle East countries except Iraq have issued a General Corporate Governance Code, with Egypt, Saudi Arabia and UAE being the front runners.
  • UAE has emerged as one of the least corrupt and most globalised economies in the Middle East, ranking 26th out of 177th in the Transparency International’s 2013 Corruption Perceptions Index.

Middle East is making consistent progress in the implementation of corporate governance initiatives. In part 1 of our Corporate Governance article series, we had talked about the meaning of corporate governance and emergence of a second wave of corporate governance reforms in the Middle East. And now, in this second part, we will look at the progress made on actual implementation of corporate governance practices by Middle East nations.

Corporate governance (or hawkamah in Arabic) in the Middle East is no longer a term that requires defining, or has an unclear business case. Even from the perspective of a family-controlled business, the case for better governance requires much lesser justification today as compared to a decade ago, as discussed in our first article. Moreover, over the past few years, regional regulators have been abolishing the voluntary nature of corporate governance standards — The Emirati, Saudi, Jordanian, Omani and the Qatari securities regulators have moved to a mandatory corporate disclosure requirement regarding compliance with local corporate governance codes.

All Middle East countries except Iraq have issued a General Corporate Governance Code, with Egypt, Saudi Arabia and UAE being the front runners. Saudi Arabia and the United Arab Emirates (members of the GCC (Gulf Cooperation Council)) and Egypt were among the first few Middle East nations who developed and issued Corporate Governance Codes and Guidelines for companies in their territory. The Egyptian Institute of Directors was the first in the region to launch a corporate governance code targeted specifically at state-owned entities in 2005, based on OECD Guidelines on Corporate Governance of State-Owned Enterprises. While Saudi Arabia published its Corporate Governance code in 2006, the UAE published corporate governance guidelines in 2007 for joint-stock companies and in 2011 for small and medium enterprises. The table below gives a quick snapshot of the region’s progress so far:

Countries_Second Wave of Corporate Governance1Table 1:  Corporate Governance Codes and Guidelines in Various Middle East Countries

Source: OECD

The UAE has emerged as one of the least corrupt and most globalised economies in the Middle East, ranking 26th out of 177th in the Transparency International’s 2013 Corruption Perceptions Index. Qatar followed at 28th, with Bahrain, Oman and Saudi Arabia not too far behind. If we look at the actual steps taken to control corrupt practices, we find that while corporate governance centers and institutes of directors have been established in most countries of the region, UAE has more than one corporate governance institute i.e. the Hawkamah Institute, the Abu Dhabi Corporate Governance Center, GCC and BDI.

Despite progress made by the countries, corporate governance still leads the list of factors required for improving investor trust and confidence. The importance of corporate governance was highlighted in a recent survey conducted by the CFA Institute to evaluate opinions on key issues currently facing investment markets in the Middle East and North Africa (MENA). The results showed that investment professionals believe political stability and good corporate governance can have the most positive impact on MENA’s economy. Similarly, the majority of respondents (70%) reported that improved corporate governance practices can improve investor trust and confidence across markets in the MENA region. Interestingly, this issue garnered the highest support among all issues in the whole survey.

Question: What do you think would improve investor trust and confidence across markets in the MENA region? Select all that apply. (N=188)

Countries_Second Wave of Corporate Governance2

 

Chart 1: Corporate Governance leads the list of Factors for Improving Investor Trust and Confidence

Source: CFA Institute, MEIC Pre-Conference Survey

We believe that growing awareness at a country level, and increasing investor demand for transparent corporate governance practices will drive adoption among corporates in the region. In the next and final part of our coverage on corporate governance in the region, we will look at case studies of companies in the Middle East that overcame hurdles and improved their governance practices in ways that boosted their performance and growth.

 

The article was originally published at: Arab Business Review

To read more thought-leadership stuff by leaders from Arab Region, please visit Arab Business Review

 

 

Understanding the Second Wave of Corporate Governance in the Middle East

Understanding the Second Wave of Corporate Governance in the Middle East

  • Over the past few years, awareness about- and adoption of- corporate governance has picked up pace worldwide, including the Middle East.
  • The need to attract foreign investors and improve access to capital resulted in the first wave of corporate governance awareness in the region in early 21st century.
  • The second, and the current, wave of corporate governance adoption is being driven by the need for family-owned businesses to diversify their boards to improve strategy and decision making, in wake of increased competition from global organizations entering the Middle East. 

Over the past few years, awareness about- and adoption of- corporate governance has picked up pace worldwide, including the Middle East. In this first article of a two part series, we will talk about the meaning of corporate governance and the reasons driving the implementing of corporate governance reforms in the Middle East. In the second article, we will look at the progress made on actual implementation of corporate governance practices by the Middle East companies.

Before we analyze the factors driving corporate governance in the Middle East, let’s understand what the term really means. The Cadbury Report in 1992 offered the simplest and most concise definition of the term: “Corporate governance is the system by which companies are directed and controlled”. It essentially means balancing the interests of all stakeholders in an organization – shareholders, management, customers, suppliers, financiers, government and the community.

Now, let’s understand the business conditions in the Middle East that have created the need for improved corporate governance in the region.

The need to attract foreign investors and improve access to capital resulted in the first wave of corporate governance awareness in the region in early 21st century. Middle East was faced difficulty in attracting foreign investors due to a perceived lack of transparency and accountability among businesses in the region, which hampered FDI inflow and corporate partnerships from investors and corporates in the US and the UK. In fact, the first wave of corporate governance awareness occurred in the Middle East about a decade ago (early 21st century), primarily fuelled by the drive to garner foreign funds particularly by countries having no petrochemical resources and requiring substantial funds for developing their infrastructure. The fact that businesses which lacked corporate governance practices had to face higher funding costs and enjoyed a limited access to capital markets compelled the local companies to adopt corporate governance reforms.

However, Transparency International’s 2013 Corruption Perceptions Index, that ranks 177 countries and territories on a scale from 0 (highly corrupt) to 100 (very clean) based on how corrupt their public sector seems to be, lists five Arab countries in the bottom ten of the list. Also, according to PwC’s 2014 Global Economic Crime Survey, 21% of Middle East companies have been the victims of some form of economic crime.  Therefore, corporate governance reforms are far from complete and there is still a lot that needs to be done to improve the attractiveness of the region for foreign investors.

Understanding the Second Wave of Corporate Governance in the Middle East 1

Transparency International’s Corruption Perceptions Index 2013 

Source: Transparency International

The second, and the current, wave of corporate governance adoption is being driven by the need for family-owned businesses to diversify their boards to improve strategy and decision making, in wake of increased competition from global organizations entering the Middle East.

The presence of a large number of state-owned and family businesses in the region, especially in the Gulf Cooperation Countries (GCC), is characterized by extreme ownership concentrations. With 90% of Middle East companies being family-owned, they tend to be run by a single person or group of persons (appointed by the family). Even majority of the non-listed companies (also SMEs) are controlled by family business founders or their descendants. However, while the family-owned structure results in greater control, it creates challenges as the business passes from one generation to another, and faces hurdles in the form of increased competition from big multinationals entering the region.

As per S&P, “Government-related entities tend to make decisions that serve the interest of state policies rather than minority shareholders or creditors. Similarly, in the case of family-owned businesses, one person often holds both the chairman and CEO position, which combined with a strong appetite for investments, risks creating diversified companies ‘that are based more on opportunism than a clearly articulated strategy’”

Understanding the Second Wave of Corporate Governance in the Middle East 2

Family-owned Businesses & the Need for Corporate Governance in the Middle East 

Source: EY Family Business Yearbook 2014

As a result, governance challenges have multiplied, and leaders have come under public pressure to professionalize their boards and management. The above factors have created a compelling case for companies in the Middle East to restructure their boards and adopt advanced corporate governance principles. According to research conducted by the Pearl Initiative (GCC-based organization into corporate governance) and PwC in 2013, there is growing appreciation amongst family-owned companies in the region about the importance of a strong well-functioning independent Board. About 55% of the surveyed GCC-based family firms had Board members from outside the family, and 42% of firms had at least one non-family non-executive director on the Board.

Visionary companies across the region have adopted corporate governance practices as a strategic advantage in their search for growth and profitability. We will look at the progress made by the region’s countries as well as companies in the next part of our article. Watch this space!

The article was originally published at: Arab Business Review

 To read more thought-leadership stuff by leaders from Arab Region, please visit Arab Business Review