It has been over five years since the collapse of Lehman Brothers, but the financial crisis continues to cast a long shadow over the global economy. In a stubbornly weak global economic environment, the development of Capital Markets in the GCC remains vital for catalysing future growth. In turn, more robust corporate governance in the region holds the key to unlocking the development of Capital Markets. So in effect, it is lagging corporate governance that is holding back economic growth.
Many believe that Capital Markets can create a virtuous circle of sustainable economic growth. Deeper and more liquid Capital Markets with regular bond issuances and benchmark sovereign yield curves facilitate capital market access for corporate borrowers and enable corporates to confidently access the bond and Sukuk markets, diversifying their funding sources and attracting foreign investment. In addition, the bond markets increasingly satisfy corporate funding requirements, enabling banks to target new business opportunities and reopen conventional funding channels, financing enhanced corporate growth as a result.
The Asian Financial Crisis of the late 1990s precipitated the strengthening of local Asian bond markets, leading to more resilient and more stable financial sectors across South East Asia. The strengthening of corporate governance was a central pillar in this strategy, providing foreign investors with enhanced transparency, thereby improving access to capital markets and cutting the cost of raising debt. This model has not been followed in the GCC however, despite the severity of the global economic crisis. Instead, the continuing relative weakness of corporate governance in the GCC — combined with the traditional reliance on uncommitted short term funding — remains a significant drag on the development of Capital Markets in the region and, in turn, continues to slow economic growth.
Lagging corporate governance standards often deter international investors looking for opportunities in the GCC. This has been exacerbated by the greater public, political and regulatory scrutiny of international investors — and how they manage their capital — since the onset of the global financial crisis. Potential international investors in the GCC face a number of challenges in the region in relation to corporate governance, including closed company ownership structures, the lack of independence on company boards and weak transparency and disclosure. These factors can leave institutions open to the risk of weak management and, in extreme cases, fraud. In addition, excess liquidity has previously led some GCC corporations to invest opportunistically in promising projects and investments, sometimes without adequately recognising the risks involved.
Of the listed governance challenges that investors have most often raised, weak transparency and disclosure in particular can be readily addressed. The preparation of financial statements in accordance with international financial reporting standards would be a positive step, as would fully audited accounts and quarterly financial statements being freely accessible and available. Equally, enhancing governance disclosure by providing detail on how company boards and executives interact and how internal decision making processes are agreed and handled would be extremely beneficial for potential investors, as would enhance disclosure regarding direct and indirect ownership. In addition, implementing stricter risk management policies and procedures; drafting comprehensive investment strategies and financial policies and the adoption of comprehensive sets of governance standards are steps that companies can readily take — and indeed have already been taken by select institutions in the GCC.
Corporates in the region are now recognizing that strengthening their corporate governance practices in such ways will be vital for their future growth and development, will improve their access to the international capital markets, diversify their funding sources and will potentially cut the cost of raising longer-tenor debt. Developments in legislation are taking place in the region and corporates are increasingly making that gradual cultural shift towards greater transparency, whilst looking to build capacity and expertise around corporate governance. Improvements are being made, and the overall trend is positive, as more progressive practices are adopted, coupled with the increasing international investor pressures for change. However, this will take time.
Five years after Lehman Brothers and there is evidence of gradual improvements in corporate governance standards across the region. But the GCC is competing for foreign investment in an increasingly interconnected, competitive global marketplace, with the cost of capital and investor risk aversion remaining high. In this current economic environment, more radical reform of corporate governance policies will need to be implemented by companies across the region in order for them to effectively compete. Ever since the Asian Financial Crisis, capital market development has been viewed as the key to unlocking economic development. It is now increasingly clear that corporate governance holds the key to unlocking capital markets.
The writer is Managing Director and Regional Head of the Middle East at Standard & Poor’s