Can Investors Bet on a Broad Emerging Markets Recovery?

Can Investors Bet on a Broad Emerging Markets Recovery

  • Following the 2008 financial crisis, emerging economies rebounded. But since 2011 things have changed.
  • Emerging economies are now richer than ever. And while these countries still have an opportunity to grow in the future, their growth rates are likely to be slower than in the past. 
  • As advanced economies recover and their monetary policies return to more conventional policies, further weakness in emerging markets’ equities and bond markets is expected.

During the global financial crisis the world economy stabilized thanks to vibrant emerging markets. Now, emerging economies are weakened by slower growth, rising financial vulnerabilities, and outflow of capital attracted by higher interest rates in the U.S.

What happened after the financial crisis?
Following the 2008 financial crisis, emerging economies rebounded. But since 2011 things have changed. In 2013 growth was 4.5 percent, compared with 6.5 percent two years earlier. Except for Arica, all emerging market regions were marked by some form of economic slowdown. These were the growth rates of the following areas in 2013 : Russia (1.5%), developing Asia (6.5%), Latin America (2.6%), MENA (2.4%), and Central and Eastern Europe (2.5%).
Emerging economies are now richer than ever. And while these countries still have an opportunity to grow in the future, their growth rates are likely to be slower than in the past. This is normal when a country’s catching-up process succeeds in raising its per capita income and its economy approaches a steady state. For example, Chinese GDP per capita tripled in a decade. At 7.5% in 2013 and 7.3% in 2014, China’s growth is lower than during the past decade, but it remains strong for a country where the GDP per capita is about to reach $10,000 this year.
The problem is that Chinese growth is unbalanced. China’s economy continues to rely on high investment and too much credit. In contrast, consumption is weak; it only represents 35% of the GDP. This low level of consumption reflects the macroeconomic challenges faced by the world’s second largest economy—as it redistributes income in a way that enables sustainable growth—and a larger middle class that benefits the economy by enabling more people to be consumers.
In other emerging and developing countries the problem is reversed. Consumption is too dynamic compared to production capacities, and growth is blocked by supply constraints and a lack of investment. Thus, in places like India, Brazil, Turkey, Indonesia, and South Africa current account deficits have widened to alarming levels .
These external imbalances in emerging countries indicate a contradiction between the aspirations of a growing and educated middle class—looking for more consumption—and production whose development is impeded by the lack of investment and inefficiency of the administration. Lately, these contradictions have resulted in growing political tensions (in Brazil, Turkey, and Ukraine) and increased financial fragility.
Countries with high external deficits are usually vulnerable to unexpected monetary shocks, leading to capital outflows. When the U.S. Federal Reserve hinted at its intention to put an end to its accommodative monetary policy last summer, many emerging markets—particularly those with weak fundamentals—experienced strong reversals of capital inflows as investors reacted to the expected “tempering” by reducing their investments in riskier assets (including the assets of emerging markets).
What to expect?
Renewed troubles and retrenchments of capital flows have certainly not led to a new financial crisis, and none of the emerging countries have defaulted on their debt or called for the IMF’s support (which was often the case in the 1990s).
Whereas this is a strong sign that emerging economies have become stronger, the cost of external financing for these countries increased, their currencies depreciated, and their monetary authorities had to raise interest rates (to contain inflationary pressures). All the same, equities and bond markets dropped.
Fighting inflation and preventing a currency from depreciating require tighter monetary policies. But this hampers domestic demand and weakens growth. Moreover, currency depreciations aggravate public deficits and create the sentiment that emerging countries are less able to service their debts denominated in foreign currencies.
As advanced economies recover and their monetary policies return to more conventional policies, further weakness in emerging markets’ equities and bond markets is expected. Emerging markets will face challenging headwinds this year.

The article is written by Dr. Charbel Cordahi for Arab Business Review

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

Trade the Market like the Pros Do

Trade the Market like the Pros Do

 

  • Day traders, Speculators, and Hobbyists today have access to various Internet and Mobile based trading platforms that can help them trade like professionals.
  • The reality of the market place is that your broker might not necessarily trade on your behalf, but theirs. The pros know how to trade, but we all had to start with the basics and will have to learn how to control your emotions.
  • With the history and basic knowledge it is obvious that no one can explain how the market works or strategies in a couple of paragraphs but to learn how to trade like the pros you have to understand the market. You have to begin with the proper mindset to trade like a market pro and you must practice, practice, and practice. 

Today’s investor has a wealth of tools at their disposal that were unavailable to previous generations. With the use of the Internet based and mobile trading platforms, “Day Traders” ,”Speculators”, and Hobbyists are better equipped to wage battle on their own terms rather than be at the mercy of the market. A professional is one who has taken the time to perfect as best they can their methods of trading from which they derive their income. However for the average investor out there the waters that enter into are a vast ocean infested with not only delectable and compelling treats but its also filled with dangerous creatures looking for their next prey. We won’t jump into the deep end just yet as there has to be training in the shallows to ensure that you’ll have a fighting chance to survive in the vast ocean known as the marketplace.

We’ve all seen the brokers trading in the “pit” or on the trading floor in an open outcry system bidding and buying and selling all types of contracts. Understand that brokerage firms are not necessarily trading on your behalf, but of course on trading on theirs. In the case of the futures market brokers are not ever cheering for you to have a winning trade unless you are in the same positions as themselves. Just like in a casino the odds are not in your favor. This isn’t meant to scare you off or deter you from trading it is just the reality of the marketplace. There is a “zero sum” game afoot here and just like in the casino when you are winning its probably best not to press your “luck” for too long. Sooner or later the house will recover their losses due to payouts.

The pros know how to trade as we have been doing it for many years, but we all had to start with the basics and although I know many of the major players in this market and honestly like me they put their pants or skirts on one leg at a time and there aren’t too many “experts” only those with years of experience under their belts. So you must understand the basics and you will have to learn how to control your emotions as they will motivate you to act in a way that will usually make you very very sorry you didn’t keep them under control.

With the history and basic knowledge laid out before you it should be obvious that no one can explain how the market works or strategies in a couple of paragraphs but to learn how to trade like the pros you have to understand the market. One of the best authors to learn from is Cornelius Luca. Once you have the basics of the market then you have to learn trading strategies which can be complex. One of the best teachers out there is Raghee Horner. Both authors are quite active and you can find their work quite easily. You have to begin with the proper mindset to trade like a market pro and you must practice, practice, practice. Take it from me

Options trading involve significant risk of loss and may not be suitable for everyone. Options & cash markets are separate and distinct and do not necessarily respond in the same way to similar market stimulus. A movement in the cash market would not necessarily move in tandem with the related options contract being offered.

The article is written by Greg Heath for Arab Business Review

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

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

A Banker’s Primer to Saudi Arabian Family Offices

A Banker’s Primer

 

  • Major global banks have established a presence in the Kingdom, only a few years ago, though with an almost exclusive focus on corporate and private banking.
  • The predominant banking business model involves a partnership between a local bank with an International partner, where critical areas such as risk and asset management are under the purview of International partner.
  • At the apex of the wealthy client pyramid are Family Offices, vehicles established to formally manage the day-to-day investment affairs of the richest families.
  • There are several type of family offices in Saudi Arabia, and they are constantly evolving due to the influence of the Western world.

The Kingdom of Saudi Arabia was never a banking hub for the GCC in the tradition of Bahrain, and later Dubai. That is, foreign banks were never historically established in Riyadh, Jeddah and Dammam with active mandates in servicing the local economy or with the intent to be utilized as a springboard for access to other nations in the GCC. Instead, the commercial linkages between the seat of Islam’s holiest sites and the rest of the world were first based on the general trade in goods, and later—the defining moment in the nation’s history—the discovery of crude oil occurred in the early twentieth century. In the wake of oil’s discovery was the founding of the energy behemoth Saudi Aramco (the Saudi Arabian Oil Company), having begun operations in 1933 as the California-Arabian Standard Oil Company.  With the technological advances and labor-intensive expertise required to extract and manage the world’s most precious tradable commodity came legions of skilled workers from the United States and other nations, critical in establishing what was once considered the consummate American outpost in the Middle East.

The Aramco camps in Eastern province were akin to transplanted Midwestern US cities.  Based on this model in the utilization of crude oil and the reliance on its financial dividends for economic development and later growth, no absolute national consensus was ever formulated on the internationalization and broad-based opening of the Kingdom’s market to foreign banks with the aim of establishing bricks-and-mortar presence.  It is only in the last several years that a few of major global banks established a presence in the Kingdom, with an almost exclusive focus on corporate and private banking.

Historically, the predominant banking business model in Saudi Arabia has been for local banks to include a non-Saudi partner institution, typically with a stake of 40 percent. Critical areas of bank management, including, heads of finance, risk management, asset management—just to name a few—were within the purview of the banking partner by contract. Over time, wealthy Saudi clients have become accustomed to dealing with their local banks for corporate loans and regional brokerage and investment services. When it comes to sophisticated investments, packaged as funds for example, the reliance continues to be on US and European private banks—many of which have been reliant on the “briefcase banker” approach. This entails flying bankers to the Kingdom for a few days of marathon one-on-one client meetings to introduce a product and collect a tidy sum of money—with the hope that the fees generated from client investments will ultimately cover the banker’s costs.

At the apex of the wealthy client pyramid are Family Offices, vehicles established to formally manage the day-to-day investment affairs of the richest families. In Saudi Arabia there are several types of these entities and it is worth our while to outline them.

The Mega Family Office:

The minute a foreign banker lands at an airport in the Kingdom, these family offices are the first few stops to make as they represent the wealthiest fifty families in the Kingdom. By their very nature, they were established decades ago and have highly sophisticated departmental structures, for example splitting managerial investment functions among Equity, Fixed Income and Private Equity teams. There is a formal investment committee process in which new proposals are discussed on voted on and IT expenditure to support detailed reports and investment analysis are standard. In a few cases, these billionaire families have offices in Dubai, Europe (primarily London and Geneva) and the US to complement their Saudi presence. The logic behind this is approach is to remain closer to their investments abroad while vetting ideas from the source. But also from a practical standpoint, many senior investment staff members are precluded from leaving their families due to personal obligations in their home countries.

Multi-Generational Office:

This structure supports various owners from many branches of the family. In the Kingdom Due to the participants in this office structure, the internal challenge is to accommodate various points of view regarding investments (type, time horizon and risk). These types of offices at times allow other families, generally maternal relatives, to participate while functioning as a multi-family office to increase the purchasing power of the owning family group. In effect, multi-generational offices reflect the current state of Saudi Arabian family businesses with young sons and daughters, typically freshly minted university graduates, being brought into the family business in the hope of an inter-generational succession proceeding smoothly one day.

The Corporate Group:

This type of entity supports the shareholders of operating business. The primary role is to maintain business control through effective wealth transfer, providing strategies for internal stock transactions among shareholders or leverage as needed to generate liquidity for owners. The office also supports owners’ financial needs for income, diversification of assets, and risk management.   A head of finance for these groups will typically handle both the company’s day-to-day affairs as well as individual investment management for the Chairman and associated family members.

The Single Provider Office:

In the last few years, some families have decided to stop granting bankers calling for an appointment to hold sales meetings, as a matter of policy. Instead, they have relied on an internal staff member to vet various product providers and settle on a single institution to manage the office’s affairs. It then becomes the mandate of the bank advisory professional handling the relationship to suggest investments from third party banks or investment houses. This “gatekeeper” approach has a major benefit for the families involved as there is a simplification of the process and reporting is handled by the hired bank, an ostensible cost savings.

Philanthropy/Foundation Office:

The Kingdom has an immense number of philanthropic institutions that families have established apart for their corporate alms-giving that is compulsory in Islam. Many of these offices are distinct from the family’s investment arm and, as would be expected, their investment universe is typically more limited. When it comes to the plethora of foundations which dot the Arabian landscape, the majority that bankers deal with are affiliated with religious or university funds. Bankers visiting Saudi Arabia are frequently surprised by the risk-return profile of these investors, with many delving into products that are far more esoteric than one would expect. Of course Sharia-compliance remains of paramount importance.

The Royal Family Office:

The trend today within these offices is launching new businesses and offering value-added projects for the benefit of Saudi society. Most of the initiatives undertaken by these investors will target a particular rate of return on a project or a feeder fund to a project, instead of seeking an income-generating fund investment—for example. The due diligence on the banker at the beginning of an introductory meeting is critical and being asked for a return visit is not assured. Knowledge of local market deal flow is key in these relationships.

The evolution of the family office unit, much like business itself, relies on constant change. There are trends in Europe and the US that are having an impact both on the vision and operational aspects of establishing, managing and growing a family office. Despite the influence of corporate practices and financial institutions on the most sophisticated investors in the Kingdom, most of them continue to hold sacred one slogan: “Made in Saudi Arabia.”

 

[1] (Source:  https://www.familyoffice.com/understanding-family-office/types-family-offices)

 

The article is written by Ragheed Moghrabi for Arab Business Review

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

Step into green logistics

Step into green logistics

 

  • Defective supply chains are costing companies billions every year in lost revenue and create significant negative environmental impact.
  • Warehouses can play an important role in mitigating the environmental impacts of logistics activities through green initiatives.
  • Logistics centres being an integral part of manufacturing, the concept of green warehousing is going to be an operational norm, and should attract investment from both MNC’s and SME’s.
  • MNCs having aggressive targets of reducing carbon emissions from both mobile infrastructure and immobile infrastructure in the entire supply chain, are likely to be the prime investors in this segment.

A superior logistics system is a ‘proprietary asset’ of any organization that cannot be easily duplicated. Logistics have a pivotal role to play in making the whole supply chain experience seamless. Many organizations have begun to view business logistics as an effective competitive weapon. Although winds of change are sweeping across supply chain business the industry is becoming more complex with increased globalization and has become the centre stage of discussion.

Industry Challenge

Defective supply chains are costing companies billions every year in lost revenue. At this point there is a need for optimization, automation, risk mitigation and innovation. According to reports, around 75 per cent of a company’s carbon footprint comes from transportation and logistics alone. In such a scenario, warehouses can play an important role in mitigating the environmental impacts of logistics activities through green initiatives.

The demand for quality Logistics infrastructure is being strongly felt across all industries owing to growth in the emerging economies, the future of the warehousing sector seems bright. The driving force behind the green movement is the continuous rise in fuel costs. Moreover, growing demands from global players for green supply chain processes and the need to cut down on external and wasteful costs that leave carbon footprints in environment are other major factors driving companies to go green.

Potential investors

Logistics centres being an integral part of manufacturing, the concept of green warehousing is going to be an operational norm, as the concept will provide the much desired qualification to engage in business with the MNC’s and SMEs. MNCs in general are going to be the prime investors in this segment and have aggressive targets of reducing carbon emissions from both mobile infrastructure and immobile infrastructure in the entire supply chain. This situation demands companies to adopt green measures. This also helps in bringing long-term benefits to these companies

Where to Start?

To facilitate the Green supply chain process, a comprehensive review of operations across the supply chain and the value proposition for implementing an advanced supply chain planning and logistics solution is required. The scope of this effort includes all supply chain processes across the following functional areas:

  • Prioritize potential business capability improvements
  • Outlined technology solutions required to support these improvements
  • Implementation of a series of program and infrastructure upgrades
  • Optimization of resources,
  • Adaption of technology in different areas of warehousing,
  • Automation of order to cash processes, and outsourcing
  • Integration of warehousing with efficient transport & Distribution network systems.
  • Waste disposals & recycles

Create a Value proposition

The environmental initiative builds the value proposition of a logistics company and sets it apart from the competitors as it reflects its commitment to the environment. The benefits of undertaking green logistics and environmental initiatives include

  1. Brand building for being projected as an Eco-friendly company holding corporate social responsibility
  2. Cost management from energy savings by reducing fuel consumption and CO2 emissions resulting in efficient and sustainable supply chain infrastructure, which creates an opportunity to earn carbon credits.
  3. Human well-being index results in increased productivity of employees.

Material compliance & Automation

Implementation of Green supply chain is a challenge as it involves both automation and material compliance meeting the carbon reduction. Logistics automation has virtually made inventory paperless and the use of information technology is bringing warehouse operation towards the greener side. In addition, using construction materials that possess good strength and durability proves to be of utmost importance like the precast as it reduce the CO2 emissions. It plays an important role as the warehouse structures are expected to exist and perform over long periods of time, and hence the construction materials used should be compliant to sustainable standards to bear the long-term wear & tear and reduce the cost of replacement to a large extent. For e.g the roof structures facilitating use of solar PV, usage of skylight concepts will drive reduction in costs of alternative fuels on a year-on-year basis, insulated steel panels will ensure lower consumption through the grid and eventually play a crucial role in the green technology.

Seven steps to Green implementation

  1. Building a road map based on corporate social responsibility
  2. customer acceptance and good business sense
  3. Looking for customer competitive advantage and USP s
  4. Evaluating green initiatives in terms of cost, timescale and business case
  5. Measuring and bench marking
  6. Adopting the right green practices for Eco-friendly
  7. Design energy-efficient construction and operations in warehouses

Operational Excellence

Today, the manufacturing industry is facing a volatile economy, intense competition and rising energy / material costs. Improving operational efficiency has become an imperative not just for margin purposes, but also for long term success. Cost reduction, quality and productivity improvement have now become key levers for gaining competitive advantage. Operational Excellence is the pursuit of conducting business in a manner that continuously improves the quality of goods and services, reduces cost, and enhances speed and flexibility to achieve competitive superiority. Green Optimization of the supply chain can significantly improve company profitability and support in achieving Operational Excellence.

 

The article is written by Raghu Menon for 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