Study on Corporate Governance in the Middle East Finance Essay

Middle East and North Africa (MENA), Region, state-owned enterprises (SOE), Gulf Cooperation Council (GCC) ,International Federation of National Associations for Accountants and lawyers(INSOL

Introduction:

Good corporate governance is essential for modern, well-managed corporations. Many Middle Eastern enterprises have reached a stage in their corporate life where improving transparency, professionalizing board practices, and reinforcing shareholder rights have become crucial to their future growth and competitiveness. Recent interactions in the Middle East clearly revealed the importance of governance, with people recognizing both international governance principles and how such principles fit within their individual cultures. Board functions, board and management relations, and directors' responsibility to act in the best interests of the company they serve (rather than of those who elected them) were all apparent principles. Fundamental to democracy is citizen participation, the freedom to assemble and the freedom to petition the government. A high level of interaction and dialogue between the state and the private sector on issues of concern increases effectiveness. Business organizations and business leaders must be able to share their positions with the government officials who respect their views. When the private sector advocates for legislative reform to improve the business environment and the country's economy, and the government responds positively, governments in the Middle East and elsewhere are recognizing the positive benefit to society as a whole.

Governance is a journey, not a destination. With the participation and voices of the public and private sectors of all countries, in the Middle East and around the world, we all continue to grow together, positively affecting our companies and our countries. Corporate Governance has been practiced for as long as there have been corporate entities. Yet the study of the important crucial subject is less than half a century old. Indeed, the phrase 'corporate governance' was randomly used until the 1980s.The 19th century saw the foundation laid for modern corporation: this was the century of the entrepreneur. The 20th century was the century of management: the phenomenal growth of management theories, management practices, management consultants, management institutions, management teaching, and management gurus, which all simultaneously reflected a pre-occupation with different styles of management. Now the 21st century promises to be the century of thinking on the subject of governance: As the focus swings to the legitimacy and the effectiveness of the wielding of power over corporate entities worldwide. Governance issues arise whenever a corporate entity acquires a life of its own, and the basis of ownership of an enterprise is separated from its management. A much quoted comment by Adam Smith shows that he understood the issue of corporate governance,

" The directors of companies, being managers of the people's money than their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartners frequently watch over their own" (smith 1776).

New concepts of corporate governances:

Overall, corporate governance continues to evolve. The metamorphosis that will determine the bounds and the structure of the subject has yet to occur. Present practice is still rooted in a 19th century legal concept of the corporation that is totally inadequate in the emerging global business environment. Present theory is even less capable of explaining coherently the way that modern corporate organizations are governed and worked. The recent financial crisis prompted by the securitization of sub-prime mortgage loans in the United State, which led to the collapse, takeover and, in some cases, nationalization of banks and other financial institutions around the world raised some fundamental corporate governance issues. There are few questions rise up in my mind: Where were the directors of these failed institutions, particularly the independent directors who were supposed to provide checks on overenthusiastic executives? Did the boards understand their firm's exposure to strategic risk? Will those who designed and encouraged the derivative products and securitization systems be held to account? Did the auditors ensure that their clients' exposure to risk was reported?

Were any of the companies, financial institutions or financial intermediately activities illegal? The global economic and financial crisis is also affecting the MENA region, and threatening its capacity to attain the necessary level of economic growth in order to meet the demands of citizens in search of improved welfare, without destroying natural resources. One of the fundamental lessons to be learned from the global financial crisis is that future strategies cannot be adopted without coordinating public policies at all levels of governance, and without the participation of government, local authorities, legal advisor, civil society and the media at different levels. Around the world, in large and small corporate, in the public and the private sectors, governance has become the focus of attention. The exercise of power over corporate entities, the legitimacy of companies and their directors, the effectiveness of governing bodies, and their accountability in society have become crucial topics. The innovative field of corporate governance is expanding and changing dramatically at very fast pace. Twenty-five years ago the phrase 'corporate governance' was not used in corporate sector but now, it is frequently and prominently being used in corporate world.

Corporate Governance in Middle East region:

For the past few years a corporate governance movement has been sweeping through the Middle East and North Africa (MENA). Practitioners from capital markets, banks, the public and private sectors, and other civil society groups have accepted the need to address corporate governance reform as one of the crucial aspect affecting the international competitiveness, the investment climate and the development of the capital markets of the MENA region. This collaboration is crucial because corporate governance ultimately depends on public-private sector cooperation to achieve the goals of creating a competitive market system and the development of a law & justice based society. Recent research and experience show that certain key corporate governance arrangements are critical to private-sector which has led economic growth, enhanced welfare activities, increased flow of investment, development of capital market, financial market efficiency and corporate sector performance. MENA countries, in their efforts to stimulate growth, employment and investment, increasing acknowledge the talent and has improved corporate governance for the success of the economic reforms.

MENA countries in co-operation with the OECD working group and other multilateral or bilateral association is also working on governance in order to highlight priorities and possible suggestions and recommendations for reform to improve corporate governance frameworks, promote legal changes and progress with reforms of the corporate governance of state-owned enterprises (SOE). In Middle East region, businesses are classified as having: Concentrated ownership, with strong family ownership of both private and listed, companies with state ownership. Dominant family oversight and control, with leadership from the head of the family, entrepreneurial decision making, opaque communications, and relationship base trading. Debt financing in which bank financing is often more than shareholders' equity. Banking sector equity investment, with banks holding significant shares in companies. The states are typically grouped together as the Middle East and North Africa (MENA). The MENA region includes: Table: A

The MENA states

Algeria Jordan Iraq Morocco Syria Bahrain Kuwait Iran Sultanate of Oman U.A.E. Egypt Lebanon Israel Qatar Tunisia Djibouti Libya Malta Saudi Arabia West Bank and Gaza

Sources: https://go.worldbank.org/ Broadly, some of these countries have relatively low GDPs and slow industrial growth. In recent years the oil producing countries, benefiting from rising oil prices, have generated large surpluses, which have been invested abroad. Banking reforms have attempted to channel some of these saving into local growth, but domestic financial markets were not so emergent. States also appreciate the need to attract foreign direct investment (FDI) and, therefore, recognize the importance of sound corporate governance. Since the capital markets are not so emergent characterized as small size therefore facing liquidity. Consequently the market does not offer opportunities to investors. Of course there are exceptions to such aforesaid general observations, like Dubai & Abu Dhabi (UAE) are making massive investment in tourism and property, whilst attempting to become an international financial centre. Recent evidence shows in UAE, ' Burj Khalifa' is not a just a building, it is a global icon. As the tallest free-standing man-made structure in the world, the gleaming tower reaching to 828 meters in the sky is an example of courage and man's ability to realize the dreams.

The MENA region is an economically diverse region that includes countries with a common heritage and significant distinctions in levels of per capita income. Mostly is single-commodity (oil) economy dependent, despite the continuous and tremendous efforts done to diverse the economies. The countries' region can be categorized in three distinct economic statutes. The first are the early reformers such as Egypt, Jordan, Morocco and Tunisia which embarked on economic reform programs since mid-1980s opening up their economies to foreign investments, privatizing state-owned enterprises, reducing budget deficit and inflation and liberalized their trade. Securities markets in these countries were established and revitalized5 to be the main vehicle for implementing the privatization program. The second are the oil exporting states mainly the Gulf Cooperation Council (GCC) in which their economies heavily dependent on producing and exporting oil. They achieved relatively macroeconomic stability mainly for the continuous increase in oil prices and despite of the recent Iraqi war. Despite the strong fundamentals of these economies, securities markets role, in most of GCC countries, yet minimal in growth. The third category are countries still hasn't achieved economic stability yet either due to political instability such as in West Bank & Gaza and in Iraq, or they are in their early stages of reforms such as Lebanon, Syria, Algeria, Sudan, Libya and Yemen. Securities markets in these countries are either relatively small or doesn't exist.

The MENA region GDP, in terms of current U.S. dollars, is near US$ 600 billion, about 2% on average of the World's GDP in 2001 and 20027. Due to the substantial increase in oil prices, national savings -especially in the oil producing countries- exceeded investments resulting in substantial accumulation of financial assets abroad. Saudi Arabia and Kuwait constituted 3.3% and 2.4% respectively of total global export of capital flows in year 2001, while in 2002, Saudi Arabia share declined to 2.2% and for Kuwait was below 1%9, which might explains the outstanding performance of both markets recently. Market capitalization of MENA region markets amounts for US$ 209 billion in 2002, about 1% of world market capitalization10 and about 35% of MENA's GDP. Saudi Arabia is the largest in terms of capitalization with 36% of total market capitalization of MENA markets in 2002, followed by Kuwait and Egypt with share 17% and 12% respectively. The most active during year 2002 was Kuwait Securities Market with 61% turnover ratio11 followed by Saudi Arabia and Egypt with 41% and 24%, respectively. Six of the eighteen MENA countries (Algeria, Egypt, Jordan, Morocco, Tunisia and the United Arab of Emirates) undergone the exercise of Report on the Observance of Standards and Codes (ROSC) of the World Bank and International Monetary Fund (IMF). The exercises covered four main areas out of ten. Egypt, Jordan and Morocco are represented in the S&P/IFC indices and in the MSCI EMF indices. Saudi Arabia and Bahrain are represented only in the S&P/IFC indices. With exception of Egypt, Jordan and Morocco which opened their markets to foreign participation since they embarked on economic reform programs, still some shared a main characteristic of restricting foreign participation and ownership, mostly in GCC countries. In GCC countries, access to their capital markets was restricted to GCC nationals and residents only.

However under the pressure to diversify their economies and the attempt to be immune from volatile oil prices, regional markets commenced on allowing gradually foreign investment in their market. Bahrain was one of the earliest GCC countries that opened up its market to foreigners. According to an Amiri decree, non-GCC residences have been allowed to own up to 49% of capital. Also, Bahrain Stock Exchange was the first to list non-GCC Company. Oman opened its market to foreigners since 1998 with the issuance of Royal decree number 80. As for the Kuwaiti market, currently foreigners are allowed to participate in the securities markets. Under the new Foreign Direct Investment Law issued in April 2001 foreigners are allowed to own up to 100% of Kuwaiti companies subject to some conditions. As for portfolio investments, Portfolio Foreign Investment Law issued in September 2000 allowing foreigners to own and trade shares of joint-stock companies listed on the Kuwaiti Stock Exchange condition on neither an individual nor group of foreigners may own more than 5% of capital of a Kuwaiti bank unless approved by Central Bank of Kuwait. Saudi Arabia allows foreign investors to participate in the securities market through investing in open-end mutual funds. In 1997, the first special purpose vehicle (SPV) was established to facilitate foreign portfolio investment in equities. Qatar, recently, allowed GCC citizens and expatriates to invest in the Doha Securities Market as an initial phase to introduce new law that will allow foreign investments.

Dubai Declaration on Corporate Governance:

The Dubai Declaration by Hawkamah's first MENA conference in Dubai formulates a road map and key corporate governance initiatives for the region, writes Bhaskar Raj "Good corporate governance is a vital key factor in sustaining economic growth and development in the Gulf region. Policy makers are taking the lead and committing to secure significantly higher standards of corporate governance in the member countries of the GCC". Policy makers, regulators, representatives from regional and international organisations, and business leaders from across the Middle East and North Africa, representing countries of Bahrain, Egypt, Iraq, Jordan, Kuwait, Lebanon, Morocco, Oman, Qatar, Saudi Arabia and the UAE, gathered in Dubai to jointly issue the Dubai Declaration on Corporate Governance.

This was a landmark event for the region, and they agreed upon following initiatives for reforms in governance: The criteria of two taskforces: one focusing on the corporate governance of banks; and a second focusing on the corporate governance of State-Owned Enterprises. The issuance of two policy briefs: one for banks; and a second for SOEs; both to be approved by the relevant taskforces. The consideration of issues relating to the corporate governance of Shariah compliant banks and financial institutions and the importance of ensuring that regional corporate governance frameworks and standards are in line with international codes and the key standards, whilst at the same time remaining consistent with Shariah rules. The preparation of a corporate governance survey of SOEs, to be developed on a consultative basis with the cooperation of key organizations and governments. The recognition of a need to tackle issues surrounding insolvency and corporate restructuring.

The Hawkamah

Hawkamah, the Institute for Corporate Governance, is a regional entity whose mission is to assist countries and companies of the wider MENA region in developing sound and globally well-integrated corporate governance frameworks, policy and practices. It supports regional and international initiatives to develop open and transparent markets and sound corporate governance regimes. The OECD and Hawkamah works with INSOL and the World Bank and invite ministries, financial institutions, the judiciary, representatives of OECD countries and other regional and international bodies, to meet and to discuss these issues during the first half of 2007. Executive Director of Hawkamah Nasser Saidi outlined "Whilst there is still a need for raising awareness and capacity building in this field, we have made significant headway in terms of taskforces, policy briefs, addressing corporate governance in Islamic banking and finance, corporate restructuring and insolvency, family-owned enterprises and small & medium enterprises. We now move towards concrete actions and direction resulting from these principles, facilitating the design of a comprehensive roadmap for corporate governance in our region. This will enable us to achieve our ultimate goals of encouraging investment, project finance, job creation and the development of sound financial markets."

Need for successful corporate governance:

The values of corporate governance: transparency, accountability, and responsibility offer the key for the modernization of the countries of the Middle East and North Africa. The private sector business community can play a leading role in economic, political, and social reforms in the region. In fact, reforms led by the private sector provide the greatest promise for meeting the challenges caused by the region's tepid economic growth and surging youth demographic. Sound corporate governance practices will attract new, much needed investment to the Middle East and North Africa because they improve their management of firms and reduce risk. National institutions, laws, regulations, and practices based on international norms and standards would enable the countries of the region to modernize their corporate sectors, enabling them to attract technology and foreign investment and become internationally competitive. Furthermore, political and sovereign risk would be reduced and economic performance and outcomes would be de-linked from ruling political regimes and a dependence on oil and gas resources. Perhaps more importantly, the process of designing and implementing the basics of corporate governance-transparency and regular reporting, independent auditing, removal of conflicts of interest, ethics, protection of minority shareholders' rights-provides a foundation for meaningful reform in the economic sector and elsewhere in society. It is clear that there is no one ideal structure for corporate governance. Many alternative structures can work well in the appropriate context.

In fact, despite all the commentary on governance structure-unitary and two-tier board, the proportion of INEDs, the separation of chairman and CEO, board committees and the rest, the issue of effective governance is not really about structure but about process. As we have seen some of the different ways countries and cultures apply in the corporate governance, we can now identify the few thrust areas that are needed to support successful governance. These include: Accounting and legal professions that are internationally respected, able to discipline their members, and ensure compliance with accounting standards, and legal requirement. A company's registry that facilities comprehensive disclosure, with high levels of transparency. Always vigilance regulatory authorities including securities and future market regulators. A stock market with sufficient degree of liquidity, standing on international norms and foreign and institutional investors. Auditing firms that are professionally managed, reliable, and independent of their clients. A reliable legal system including an independent judiciary, courts that are bias and corruption free, and judgments those are enforceable, free of state or other political pressures. Accountability fix for financial institutions, including brokers, sponsor for new issues, and financial advisors. Professional organizations such as director and company secretary qualifying and disciplining bodies. Accountability also given to educational institutions to develop education standard and train for relevant qualifications require for corporate governance. Consulting agencies able to advice companies and its directors.

With the support of private and public organization, seminars, workshop to be conducted or organized on different platforms, and conclusion report to be sent to competent authority for taking decisions. Research institution making research on different aspects of corporate governance according to the need of region. Research publications, international conferences and professional journals play a significant contribution to the convergence of corporate governance thinking and practice. Formulate corporate governance codes of good practices. Just implementing Western rules and standards will not improve corporate governance and accounting quality in MENA region. Standards alone do not help. There need to be more disclosure on key government variables and related party transactions. They are more important than accounting. Other important changes include building the right market infrastructures and systems for companies to operate, as well as leveling the playing filed between government-owned and privately-owned firms.

Conclusion:

The paper attempted to provide an overview on corporate governance in the MENA region's markets.. It is evident that MENA markets in the recent decade undergone number of reforms and restructuring on legislative and infrastructure fronts. However, cautious should be taken while adopting and implementing measures of reform. Moving towards a self-regulatory organization (SRO) model without matured institutions is dangerous. Limited institutional capacity, overlapping regulatory functions among authorities and lack of fast track dispute settlement are impediments for SROs. Maturity is not only in terms of laws and regulations but also in terms of practice and enforcement. Thus, adopting self-regulatory organizations (SRO) model remains a future challenge to regional markets. Market discipline, with its various tools, still not yet developed to an extent that improves corporate governance practices; markets are either inefficient or utmost weakly efficient. Thus proper valuation and realized premiums are not really reflective to the soundness corporate governance practice. Thus, market discipline is an element that will not be observed until markets efficiency improves and investors' culture develops. Market discipline is both a result and supplementary of massive reforms towards better governance which is only observed in matured efficient markets.

Thus, reformers should work on allowing appropriate and even environment for both systems. Which of either system are best for regional markets? Is a question imposes itself. Fundamentally, traditions and cultures should be allowed implicitly to choose their acquaintance with one of the two systems and not vice versa. Using the opposite direction might result in institutional failure, market crises and the collapse of the investors' wealth. Previous emerging market crises were good evidence. The key issue is that sound corporate governance practices are reached when trust and confidence is observed. Policy makers and reformers should realize that better corporate governance practices is function of the soundness of the total system and that this parameter is significant and influential given the characteristics of the regional markets.

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