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Political unrest has wracked the Middle East andNorth Africa in early 2011 – but has corporategovernance reform kept pace with social change?
Nasser Saidi, Ph.D., Executive Director, Hawkamah Institute for Corporate Governance and Chief Economist, Dubai International Financial Centre Authority
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The Middle East and North Africa(MENA) region is an emerging marketin which corporate governance is seenas a relatively new concept. Indeedit is only in the last ten years that an Arabic word for corporate governance,
Hawkamah
, has emerged. Despiteits infancy in the region, corporategovernance has been makingsignificant headway. Although it isdifficult to predict the outcome of thecurrent turmoil – the ‘Arab Spring’ orthe ‘Arab Firestorm’– it has highlightedsome pressing demographic, political,governance and socioeconomicchallenges, which, if properlyaddressed, should lead to furthercorporate governance reform.
Overview of recent corporategovernance developments
The Hawkamah Institute for CorporateGovernance was set up in 2006 to helpbridge the corporate governance gapin the region. The Institute was foundedin partnership with internationalorganisations including the OECD, theIFC, and the World Bank GCGF, andregional organisations including theUnion of Arab Banks and the DubaiInternational Financial Centre (DIFC) Authority. Hawkamah resulted fromthe recognition of a growing need fora regional organisation working on theground, for regional institution-building,in order for corporate governance toachieve buy-in of stakeholders. Sincethen Hawkamah has been at theforefront of the corporate governancedebate in the region.Hawkamah’s primary goal is to establishcorporate governance as a topic onthe agendas of MENA policymakersby providing the region’s companiesand regulators with practical tools onhow to improve corporate governance. The Institute’s work involves engaginggovernments and industry, conductingsurveys and studies, and creatingregional benchmarks which often act ascatalysts for reform.In the initial years, Hawkamah’s callsfor corporate governance reform werevery much like voices in the desert. Although the need for better corporategovernance was recognised, theprevailing opinion was that the regionwas not ready for reform. Illustrative of the then state of corporate governanceis the finding of the 2007 benchmarkHawkamah-IFC study that only 3%f listed companies and banks inthe MENA followed good corporateovernance practices, with noneomplying with internationalbest practices.Much has changed since then.ubsequent Hawkamah researchnd surveys have indicated that therehave been significant improvementsin corporate governance in the MENAregion in just a few short years. Although implementation is still patchy,the concept and principles of corporateovernance are now well accepted.Regulators and companies have takenubstantial steps, albeit from a lowbase, to improve their practices. Themajority of MENA countries has nowissued corporate governance codesnd guidelines or is in the processf doing so. Similarly, an increasingnumber of MENA companies havebegun investing in better governancend addressing their corporateovernance shortcomings.
Drivers of corporate governance inthe MENA
orporate governance reform inthe MENA, to date, has not beeninvestor-driven. Much of this stemsfrom a combination of facts suchs the ownership structures of MENA companies (mainly family ortate-owned), the ready availabilityf liquidity and financing fromregional banks, and the relativelyunderdeveloped capital markets thatre dominated by retail investors. The region is also generally overlookedby global long-term investors largelybecause of the region’s poor trackrecord in transparency, disclosure andreporting. Regional asset managersuch as the sovereign wealth fundshave not exhibited governance vigourin their local investment processesnd have mainly invested outside theregion in order to diversify away fromlocal risk. Consequently, the benefits of ood corporate governance have beentypically seen by companies in termsf better strategic decision-makingand regulatory compliance ratherthan being associated with better andcheaper access to credit and capital orimproved valuation of companies.
S&P/Hawkamah ESG Pan-Arab Index
To address these gaps, Hawkamahin partnership with Standard & Poor’sand the IFC have created the first-everEnvironmental, Social and Governance(ESG) Index for the MENA. It ranks andtracks the transparency and disclosureof regional listed companies on ESGissues. The constituents of this Indexare derived from 11 Arab equitymarkets. The purpose of this Index isto identify the MENA companies thatgo the extra mile in ESG reportingand policy implementation. TheHawkamah-S&P Index is a tool forinternational and regional investorswho may not have the expertise in theMENA companies or in incorporatingcorporate governance in theirinvestment processes. The Index is not only a tool forinvestors, but also for companies.Inclusion in the Index provides publicrecognition for a local company of its ESG practices, but the Index ismore than just a badge of honour. Asthe socially responsible investmentmovement spreads to the region,capital will start flowing towardscompanies with better ESG reporting,thereby improving their access toexternal capital.
Regional investors and banks
Regional investors, as noted above,have not formally incorporatedcorporate governance criteria intheir investment decision-makingprocess. The index is being used toraise awareness among the region’ssovereign wealth funds on the impactgood corporate governance can haveon the bottom line and the index hasoutperformed the market benchmarkby a significant margin. One of theregion’s sovereign wealth funds hasinvested in the Index and hopefullyothers will follow.Given their size – MENA SWFsmanage some $2 trillion in assets –and growing importance, encouraging
MENA
ICGN YEARBOOK 2011
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Nasser Saidi, Ph.D., Executive Director, Hawkamah Institute for Corporate Governance and Chief Economist, Dubai International Financial Centre Authority
sovereign wealth funds to adopt amore active role in promoting goodcorporate governance would not onlybe a welcome step for the developmentof the MENA capital markets, but alsoacross the world in the markets andcompanies they invest in.But in a region which is dominatedby non-listed, family-ownedenterprises and/or small and mediumsized companies that typically lookto banks to finance their expansionthrough loans, it is the banks that arein the prime seat to drive governancereform. Indeed bank intermediatedfinance represents some 60% of theoverall financial structure in MENA,while debt finance is underdevelopedat 10% of the total. Hawkamah, inpartnership with the OECD and theUAB, have issued a Policy Brief onimproving the corporate governance of banks in MENA. Although thePolicy Brief is primarily focusedon addressing the governancechallenges faced by the sector andthe regulators/central banks, one of its recommendations is for banks toincorporate corporate governancecriteria into their lending criteria.
The regulators
As mentioned above, corporategovernance codes are now largely inplace in the MENA. The issue nowis implementation. Given the marketdynamics, in which there is an absenceof institutional investors scrutinisingthe governance arrangements of companies, the burden of ensuringimplementation falls on the regulators.Some countries have started takingsignificant steps in this regard: in 2010,both the Saudi and Omani CapitalMarket Authorities set up corporategovernance units to ensure properimplementation and compliance withtheir governance codes. But the focusof implementation should not solely beon enforcement, but on facilitation of better corporate governance practicesby capacity building initiatives as one of the barriers to better governance, oftencited by companies, is the lack of know-how and experts. In other words, therehave been significant improvementsin the MENA within the realm of listedcompanies, but the next challengesare even greater: the governance of state-owned enterprises and instilling aculture of governance to family-ownedenterprises as well as the small andmedium sized enterprises (SMEs).
The Arab Firestorm
The turmoil in the Arab world thatbegan with the self-immolation in Tunisia of Mohamed Bouazizi in mid-December of last year now signalschanges in the political, social andeconomic geography of the region. The recent events have uncovered anumber of vulnerabilities, chief of whichis the demographic picture. Some60% of the Arab population is nowyounger than 29 years of age, andyouth unemployment averages 25%,with the young female rate reportedlyat 30%. These young and unemployedare restless and despairing, notleast because sclerotic educationalsystems have made so many of themunemployable. Young women feelparticularly dejected because their oftenhigh educational attainment rates areschizophrenically linked to low labourforce participation and their exclusionfrom economic and political life. This sense of vulnerability is politicalbecause it not only reflects youngpeople’s lack of participation andrepresentation but also frustration withwidespread corruption, the state’s lackof accountability and inadequate publicservices. Mounting dissatisfaction withthe governance of many Arab statesis fuelled by a sense that often naturalresources have been captured byspecial interests, and that state controlof the media has stifled the ‘voices’ of society. Political repression of this sorthas not surprisingly led to widespreadcalls for the restoration of ‘Karama’,human dignity and for change andreform, as expressed by the ‘Kifayah’(enough) movement in Egypt.
The Arab Firestorm andcorporate governance
The two themes that come out of the Arab firestorm are job-creation &employment and accountability, whichdirectly relate to the need for privatesector growth and reform of the state-owned enterprises.
Private sector growth and corporate governance
Private companies and family-ownedenterprises constitute the backboneof the corporate sector and accountfor a large fraction of employment. Itis this sector that needs to grow if theregion is to tackle the unemploymentcrisis and create jobs. Just for Egypt,Jordan, Lebanon, Morocco, Syria, Tunisia, some 18 million new jobs arerequired by 2020!For the private sector to grow, amechanism must be set up to facilitatethe process through which companiescould tap into the equity markets. Theregional capital markets are tailoredfor large companies, whereas a stockexchange should be created to meetthe needs and the ambitions of theprivate companies. A second tierequity market for young and growthcompanies might become a keydriver in the development of a liquidcapital market, the diversificationof economic activities and providelong-term capital for the growth of the dynamic entrepreneurial segmentof the economies of the region. Itwould also facilitate the introductionof corporate governance into thisimportant segment of the economy,and thereby become a key driver of corporate governance.Private equity (PE) has also emergedas a potential source of corporate
“Initial calls for corporategovernance reform werelike voices in the desert.”
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