By Steve Drake
Capital markets expert Steve Drake on the key role of regulators in improving corporate governance in the GCC.
Fairly robust requirements have been introduced in the UAE and Saudi Arabia relating to corporate governance. These requirements cover matters such as board composition, independent directors, audit committees and other subcommittees such as nomination and remuneration committees.
However, these regimes are in the early stages of implementation and many companies are only now complying with the new requirements for the first time.
Both the Securities and Commodities Authority (SCA) in the UAE and the Capital Markets Authority (CMA) in Saudi Arabia have been active in educating listed companies and investors with respect to their respective corporate governance requirements.
The crucial next step will be in the outcome of ongoing monitoring of compliance by regulators as listed companies start to publish annual compliance statements.
The regulators have a key role to play in terms of enforcing compliance with regulatory requirements whether through education or remedial action.
Regulatory action needs to be taken (and seen to be taken) in the event of non-compliance in order to ensure that lessons can be learnt by all listed companies and examples of good and bad governance are reinforced. Investors also have an important role to play in holding boards to account for poor governance.
We have all seen in the recent case of Damas, that the lack of a proper corporate governance framework, that is operating effectively, can have a catastrophic effect on how a company is run and therefore ultimately on its value.
With Damas we saw the Dubai Financial Services Authority (DFSA) take regulatory action as a result of the failures highlighted in their report, however this case still raises questions as to whether more should be done on the regulatory side, to monitor companies on an ongoing basis or ensure a compliant governance framework is actually operating at the point of listing.
With new listings, both lead advisors and regulators have a role to play to ensure that at the point of listing, new entrants to the market are fully compliant with governance requirements and ready to meet the challenges that being a public company brings – systems need to be up and running and boards and board sub-committees need to be in place and fully functioning.
Good corporate governance is about being a well run company. Investors like well run companies as they tend to have a lower risk and fewer surprises.
We find that companies in the region still tend to view corporate governance as a compliance exercise, something that they have to demonstrate in order to meet a regulatory requirement – rather than consider the benefits that good governance can bring to the business more broadly.
Companies actually have to “live the system” and put everything into practice for a corporate governance system to be truly effective. It's not enough to just have the right documentation, controls and processes in place - they must be operated by suitably experienced people, who are incentivised in the right way and are supported by – and themselves supporting – a strong governance culture.
Board directors need to be engaged in the process, independent non-executive directors of the right caliber and experience, with adequate time to devote to the company, need to bring constructive challenge to the executive management team and board subcommittees need to live up to their mandate and responsibilities.
In practice an effective board controls the business but delegates day to day responsibility to the executive management.
The UK Combined Code on Corporate Governance quite neatly explains the board’s responsibility for leading a company: “Every company should be headed by an effective board which is collectively responsible for the long-term success of the company. The board’s role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed.
"The board should set the company’s strategic aims, ensure that the necessary financial and human resources are in place for the company to meet its objectives and review management performance. The board should set the company’s values and standards and ensure that its obligations to its shareholders and others are understood and met.”
There are many facets that contribute to an effective board. To be truly effective the board must meet regularly to consider both long term strategic issues and shorter term performance issues.
Agenda items need to be accompanied by supporting papers that are sufficiently detailed to be informative and need to be received in sufficient time to be considered. High attendance by all board members should be expected for an effective meeting to be held. The chairman has a key role in facilitating effective contributions from non-executive directors and keeping the discussions focused.
One of the key areas for the board is in managing risk effectively which includes strategic, operational, compliance and financial risk. Successful companies manage the risks that threaten the achievement of their objectives and so risk management is embedded in the board’s decision making process. An effective board performs a proactive role in monitoring, identifying and reacting to the ever changing risks that the company faces.
To help the board in its many responsibilities it is important that the board has subcommittees in place. Whilst overall responsibility still rests with the board, it is appropriate to delegate tasks to an audit committee or other board committees with the results of those committees being reported back to and considered by the board.
The activities associated with oversight of financial reporting and controls are extensive and therefore it’s essential that an audit committee has the necessary time, financial, business and governance expertise to fulfill its remit effectively and relieve pressure on the board.
Generally, companies with good governance tend to perform better than companies without. With the relevant regulatory framework in place, companies and their boards need to recognize the value that being a well run company brings and embrace “living the system” - embedding governance within their organizations and moving away from a box ticking approach.
There is clear evidence that the corporate governance culture in the Middle East is moving in the right direction and regulators are establishing compliance systems that will help governance to continually evolve and ultimately improve.
However, key to ensuring that governance will be embedded across organisations is recognition that regulators have an enforcement role to play and that each and every organization has its own role to play.
A move from viewing corporate governance as a compliance exercise to a culture of embracing corporate governance for the tangible benefits it can bring to a business will be an important pre-requisite change in mindset for regional businesses and boards to consider and adapt to.
As this change process gains momentum and we see boards embracing the change culture we believe they will begin to reap the benefits of an effective governance system, some of the key components of which, we have highlighted in this article.
Steven Drake is head of the Middle East Capital Markets Group, PricewaterhouseCoopers.
How long will it take before the bad habits are changed? 2 to 3 years?Is it right that making changes at the top of the corporations will not translate with immediate changes in the day to day business? Or am I missing something?