Corporate Governance The benefits of good practice for private companies in the GCC February 2013
Contents 01 Introduction 02 What is corporate governance? 03 The benefits of good corporate governance for private companies 03 The cornerstone of corporate governance: The board of directors 05 Conflict of interest 06 Formulating a corporate governance policy 10 Conclusion 11 About Pinsent Masons in the Gulf 12 Contacts Details 2
Pinsent Masons Corporate Governance Introduction Since the global financial crisis, much emphasis has been placed on corporate governance both globally, and in the GCC. Although a relatively new concept to the GCC Member States, the role of Corporate Governance in risk management and sustainable growth is being highlighted, as the Member States seek to regain investor confidence and build sustainable economies. However, for many owners and managers of privates companies, corporate governance is an alien concept, and often dismissed as an issue for public companies. While such dismissal could be forgiven due to the legislative emphasis on public companies, it would be a mistake to view corporate governance as having no application in the private sector; good corporate governance practices can lead to significant benefits for privately owned businesses. The origins of Corporate Governance The development of corporate governance into what it is today has taken many years; the first seeds of corporate governance were being sown in both the East and the West as far back as the 18th century. In more recent years, with the collapse of the likes of Enron and WorldCom in the early 2000s, and subsequently the global financial crisis, corporate governance has become a key focus for governments wanting to prevent similar occurrences. A key stage in the development of the corporate governance standards globally, as we know them today, came with the passing of the US Sarbanes-Oxley Act of 2002, which set new or enhanced standards for all U.S. public company boards, management and public accounting firms. More recently, in 2010 the UK Corporate Governance Code came into force as the UK s reaction to the banking crisis. Corporate Governance in the GCC Latterly, standards in corporate governance may have been led by the World s more mature economies, but less mature economies, such as those of the GCC, have recognised that setting robust corporate governance standards, is likely to encourage foreign investment and assist in economic growth. With the exception of Kuwait (which is making moves in the right direction), each GCC Member State has a Corporate Governance Code; Oman led the way in 2002 and latterly Bahrain consolidated its approach in 2010. Predictably, the focus of these codes is public companies, and increasingly financial institutions, as the GCC States seek to grow their respective capital markets and boost confidence in the financial sector. However, there is a growing initiative directed towards private companies. It is fair to say that, perhaps predictably, it is Dubai that has lead the way in relation to Corporate Governance for privately owned companies, with The Corporate Governance Code for Small to Medium Enterprises (The Code), developed by Hawkamah, The Institute for Corporate Governance, and the Dubai Department of Economic Development. The Code is not intended to be prescriptive, in recognition of the various factors to be considered when formulating a corporate governance policy, instead, its purpose is to set a benchmark for best practice in Corporate Governance for private companies. The Code is available in full text from Dubai SME (http://www.sme.ae/en), but set out below is a summary of the recommendations and some practical suggestions as to how to implement them. 1
What is corporate governance? Essentially, the phrase Corporate Governance is the collective term for the systems and procedures pursuant to which a business is operated and managed. The approach to corporate governance globally varies, and is constantly evolving as economies expand and contract, and business practices develop. Similarly, the approach adopted by individual companies will vary depending upon the nature, size and risk profile of the business in question and, as a business grows, so too may its requirement for corporate governance systems that enable the owners and managers to keep track of that growth, and ensure that it is managed in a sustainable way. Key objectives of corporate governance: Accountability Transparency Integrity Risk Management 2
Pinsent Masons Corporate Governance The benefits of good corporate governance for private companies Globally, the application of Corporate Governance to businesses tends to centre on public companies and financial institutions. However, private companies that practice good corporate governance can expect to enjoy real and tangible rewards; a better managed business is likely to lead to improved efficiency, which in turn is likely to affect the bottom line. In addition, the practice of good corporate governance by private companies is likely to result a healthier, more sustainable, economy in the longer term. Key benefits of good corporate governance for private companies A better managed business improved efficiency Less exposure to risk Compliance with anti-corruption legislation A more attractive investment IPO Exit JV Easier sale process on exit at higher price Reputation Employees Clients Customers Suppliers Bankers and financial backers Wider community and those likely to be affected by Company activities The cornerstone of corporate governance: The board of directors With responsibility for the day-to-day management of a company, the Board of Directors is arguably the cornerstone of a company s Corporate Governance policy. It will be the Directors that prevent the practice of good corporate governance becoming a tick-box exercise. The composition of the Board of Directors will depend upon the nature and size of the company in question, but could include both executive directors, and non-executive directors. The role of an Executive Director The role of an executive director is one of leadership and hands-on management. Some companies have just one executive director, who will often have the title of Chief Executive Officer. Bigger companies may have a team of executive directors, with clearly defined roles and responsibilities. Role of an Executive Director: Design, develop and implement strategic and business plans Day-to-day operation of the organization Managing committees and staff Reporting to the board on a regular basis Motivate and mentor staff 3
The role of the Non-Executive Director (NED) In contrast, an NED is not part of the executive management team, and will not be an employee of the company, or otherwise affiliated with it. NEDs are the custodians of the governance process. They are not involved in the day-to-day running of the business, but monitor the activity of the executives and contribute to the development of strategy. Role of a NED: Scrutinise performance of management Assist in determining appropriate levels of remuneration of Executive Directors Take a key role in appointment and removal of senior management Monitor reporting of performance Be satisfied with financial controls and information Risk management (the third line of defence) Succession planning Develop understanding of views of main stakeholders Constructively challenge the board Develop proposals on strategy Building the Board The composition of the Board will be influenced by a number of factors, and creating the right Board will involve an analysis of the nature and type of business, the long term strategy for growth, and key risk areas. For example, a small, family run business operating in a low risk jurisdiction is unlikely to require an executive director to fulfill each management function of the business. In contrast, a larger business operating in several jurisdictions, with an ultimate objective of a listing on an exchange, for example, may benefit from a team of executive directors, each with responsibility for a different element of the business. Furthermore, in these latter circumstances, the company may benefit from the input of one or more NEDs. Key features of an effective board The knowledge and skills of board members, individually and collectively Their personal dynamics and teamwork A culture of open and constructive challenge A strong chairman ensuring engagement by all directors The integrity and quality of the board s information 4
Pinsent Masons Corporate Governance Conflicts of interest A key component of any corporate governance policy will be the approach taken to conflict of interests. A conflict of interest will generally arise in the context of a director when that director has competing interests. Smaller, owner managed companies are less likely to be concerned with conflict of interest because the directors are likely to be the owners of the company. However, as a company grows, taking a robust approach to conflict of interest will become more important. When dealing with conflicts of interest, transparency is essential; in all cases, where a director has, or may have, a conflict of interest, he or she should disclose it to the Board. In some cases, a director with an actual or potential conflict of interest may still vote on the matter, in other cases the director will not be permitted to vote; much will depend on the nature of the company in question. Types of conflicts of interest Broadly speaking, there are two types of potential conflicts of interest: Transactional conflicts of interest A transaction with the company in which a director has an interest (whether directly or indirectly) Situational conflicts of interest A situation, as opposed to a specific transaction, that could produce a conflict of interest (whether directly or indirectly) A director is also a supplier to, or customer of, the company A director s relative stands to benefit from a contract with the company A director is also a director of another company that stands to benefit from entering into a contract with the first company A director having an interest in a commercial opportunity that could also be exploited by the company A director sitting on two boards where the duties to each may conflict 5
Formulating a corporate governance policy The process of formulating a corporate governance policy can be a very useful exercise in itself, as it forces an analysis of the company s key aspirations and potential barriers to success. However, irrespective of whether you are starting from scratch, or reviewing an existing policy, it may be difficult to know where to begin. Before you begin 3 key points to bear in mind at the commencement of the process: A corporate governance policy is only as good as the commitment to the implementation, and continued application, of it Avoid the temptation to cut and paste to be meaningful, the policy should be specific to the company in question Accept that the policy will be an evolving document build in the flexibility for future growth. Development Stage There will be several key factors to take into account when formulating a corporate governance policy. The table below sets out some of the more common factors, but there may be factors specific to the company in question. Key factors in formulating a Corporate Governance Policy Aspirations of the company growth/expansion/listing on an exchange/exit through sale or succession Size Nature of the business industry sector, services/goods, customer base Geographical spread Stakeholders Specific risks associated with the business The Corporate Governance Policy As illustrated above, the actual content of the policy will depend upon several factors. However, as a starting the point, The Code (The Corporate Governance Code for Small to Medium Enterprises, developed by Hawkamah, The Institute for Corporate Governance, and the Dubai Department of Economic Development) reflects key principles and themes of corporate governance practices adopted in more mature jurisdictions, and is therefore a good starting point in the formulation of a corporate governance policy. The Code comprises 9 Pillars, covering key principles of corporate governance. The 9 Pillars of The Code 1. Formal governance framework 2. Succession Planning 3. Transparency 4. Board of Directors 5. Mandate for Board of Directors 6. Books of accounts and audit 7. Internal control 8. Needs of the stakeholders 9. Family Businesses 6
Pinsent Masons Corporate Governance The 9 Pillars of Corporate Governance as suggested by the Code Pillar 1 Formal Framework Adopt a formal corporate governance framework outlining the roles of key bodies such as partners, shareholders, board of directors and management (Pillar 1, The Code). The policy should take into account: Type of company Nature of business Aspirations Record the policy in writing and communicate it to key stakeholders Pillar 2 Succession Planning Conduct a succession planning process (Pillar 2, The Code) Identify the key personnel whose departure would really impact the business? Consider what steps you will take in this eventuality to: Protect the business Appoint a replacement Can you identify a successor? What steps do you need to take to develop that potential successor? Consider the ultimate exit strategy (sale, IPO etc) and think about what shape the business needs to be in to realise this strategy Pillar 3 Transparency Establish a timely, open and transparent flow of information with shareholders (Pillar 3, The Code) Establish a reporting protocol Frequency? Method of communication? Content of reports? Understand the requirements of the legal framework in which you are operating Ask the shareholders what information they want to receive. Is this reasonable? 7
Pillar 4 Board of Directors Endeavour to set up a formal board of directors to accompany the growth of the company (Pillar 4, The Code) Understand what is required by law in terms of the management of the company Consider the following questions: If a board is appropriate, how many directors do you need? Who? Would NEDs add value to your business? Develop an induction program for new directors Pillar 5 Operation of the Board of Directors Develop a clear mandate for its Board of Directors to oversee the operational performance of the business as well as evaluating and improving business strategies. (Pillar 5, The Code) Prepare a Board Charter to include: Extent and scope of the board s powers Frequency of Board meetings Location of Board meetings Conduct of Board meetings How meetings are called Review and evaluate the performance of the Board annually Pillar 6 Accounts & Audit Maintain credible books of accounts, which are annually audited by an external auditor (Pillar 6, The Code) Identify the accounting standards that will be applied Appoint credible and reputable auditors Where a potential exit (through sale or IPO) is envisaged, consider using an international firm of accountants Evaluate the performance of the auditors Consider implementing a policy that requires the auditors to be replaced every few years or so to preserve independence 8
Pinsent Masons Corporate Governance Pillar 7 Internal Control Set up an internal control framework and conduct regular review of risk (Pillar 7, The Code) Identify key risk areas, using a broad definition of risk: Internal risks risk arising from events taking place within the business Loss of key personnel Loss of business data Failure of policies (reporting systems, limits on authority, record keeping etc) External risks risk arising from events taking place outside the business Security risk in key operating locations Loss of key clients or suppliers Cost of raw materials Establish a formal review process for monitoring these risks Pillar 8 Needs of the Stakeholders Recognise the needs of the stakeholders (Pillar 8, The Code) Identify the key stakeholders in your business: Employees Clients Customers Suppliers Bankers and financial backers Wider community and those likely to be affected by Company s activities Develop written policies in connection with the company s dealing with its stakeholders what are the key messages that the company wants to give to those stakeholders? Set targets for the management of stakeholders and review whether those targets are met Consider how to encourage the meeting of those targets Pillar 9 Family Business Formulate a framework setting out the family s relationship to the business (Pillar 9, The Code) Understand the family s vision for the business What are the family s expectations as to: Growth and direction of the company Information sharing Employment by the company of family members Where the company employs family members: implement an induction process to help that member understand the separation between the company and the family implement clear lines of authority and decision making With a large family, consider creating a family committee to represent the family in dealings with the company 9
Conclusion With much still to do in the context of corporate governance for publicly listed companies and financial institutions, it is hardly surprising that, with the exception of initiatives such as that of Hawkamah and the Dubai Department of Economic Development, the focus of governments and regulators in the GCC has not been on private companies. It therefore falls upon the owners and managers of private companies to take the initiative. In the absence of being forced to adopt a specified standard of corporate governance, private companies can seize this initiative and implement a corporate governance policy that has the potential to really add value to the business as a whole, by contributing to the overall goals of the company; whether those goals include continued growth, an exit through a sale or otherwise. 10
Pinsent Masons Corporate Governance About Pinsent Masons in the Gulf With its strategic location as a bridge between east and west, the Gulf region is one of the fastest growing markets in the world. Pinsent Masons has been established in the Gulf since 2004, and working in the region for the last 30 years. From our offices in the UAE and Qatar, we offer the full range of legal services to meet the needs of this exciting market. Our core areas of expertise in the Gulf include: Banking & Finance Commercial Contracts & Transactions Commercial Dispute Resolution Company Establishments & Corporate Support Construction Advisory & Disputes Corporate Transactions Employment Projects & Infrastructure Real Estate Shariah Compliance Technology Media & Telecoms Wealth Management. Combining this legal expertise with our global sector expertise in Energy & Natural Resources, Infrastructure, Financial Services, Advanced Manufacturing & Technology Services and certain core industries and markets (such as Retail, Sports, Hotels, Real Estate, Life Sciences, Education), our legal services are delivered in a way that makes dealing with legal matters more straightforward for our clients. We, like the local business community, operate in English, but our teams include fluent speakers of Arabic, Mandarin, German, French, Dutch, Spanish, Urdu, Hindi and Punjabi, to name a few. Our lawyers are commercially minded and have strong relationships with key government agencies and regulatory bodies. Our approach to the demands of international operations means we put local conditions into context to match our client s strategies and aspirations. Our cross-border service is enhanced by the skills and resources of over 1,500 lawyers operating across Europe and Asia Pacific. We work with an alliance network with local law firms in neighboring countries in the GCC and wider MENA Region. Our relationships with these firms mean we offer efficient and coordinated legal services across the Gulf and wider MENA region. Whether a public or private company, government or financial institution, our commitment to you is to listen and understand your needs. 11
Contact Details Alison Hubbard Partner Corporate Dubai T: +971 4 373 9693 M: +971 50 450 2856 E: alison.hubbard@pinsentmasons.com Alan Wood Partner Corporate Dubai T: +971 4 373 9610 M: +971 50 557 7167 E: alan.wood@pinsentmasons.com 12
Combining the experience, resources and international reach of McGrigors and Pinsent Masons Pinsent Masons LLP is a limited liability partnership registered in England & Wales (registered number: OC333653) authorised and regulated by the Solicitors Regulation Authority and the appropriate regulatory body in the other jurisdictions in which it operates. The word partner, used in relation to the LLP, refers to a member of the LLP or an employee or consultant of the LLP or any affiliated firm of equivalent standing. A list of the members of the LLP, and of those non-members who are designated as partners, is displayed at the LLP s registered office: 30 Crown Place, London EC2A 4ES, United Kingdom. We use Pinsent Masons to refer to Pinsent Masons LLP and affiliated entities that practise under the name Pinsent Masons or a name that incorporates those words. Reference to Pinsent Masons is to Pinsent Masons LLP and/or one or more of those affiliated entities as the context requires. Pinsent Masons LLP operates in Qatar as Pinsent Masons LLP, QFC Branch which is licensed and regulated by the QFCA with licence number 154. Pinsent Masons LLP 2013. For a full list of our locations around the globe please visit our websites: w w w.pinsentmasons.com/gulf w w w.out-law.com