Corporate Governance Country Assessment
Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure Authorized62577Report on the Observance ofStandards and Codes (ROSC)Corporate GovernanceCorporate GovernanceCountry AssessmentKingdom of Saudi ArabiaFebruary 2009
Overview of the Corporate Governance ROSC ProgramWHAT IS CORPORATE GOVERNANCE?Corporate governance refers to the structuresand processes for the direction and control of companies. Corporate governance concerns the relationships among the management, Board of Directors,controlling shareholders, minority shareholders andother stakeholders. Good corporate governance contributes to sustainable economic development byenhancing the performance of companies andincreasing their access to outside capital.The OECD Principles of Corporate Governanceprovide the framework for the work of the WorldBank Group in this area, identifying the key practicalissues: the rights and equitable treatment of shareholders and other financial stakeholders, the role ofnon-financial stakeholders, disclosure and transparency, and the responsibilities of the Board ofDirectors.THE CORPORATE GOVERNANCE ROSCASSESSMENTSCorporate governance has been adopted as oneof twelve core best-practice standards by the international financial community. The World Bank is theassessor for the application of the OECD Principles ofCorporate Governance. Its assessments are part ofthe World Bank and International Monetary Fund(IMF) program on Reports on the Observance ofStandards and Codes (ROSC).The goal of the ROSC initiative is to identifyweaknesses that may contribute to a country’s economic and financial vulnerability. Each CorporateGovernance ROSC assessment reviews the legal andregulatory framework, as well as practices and compliance of listed firms, and assesses the frameworkrelative to an internationally accepted benchmark. Corporate governance frameworks are benchmarked against the OECD Principles of CorporateGovernance. Country participation in the assessment process,and the publication of the final report, are voluntary. The assessments focus on the corporate governance of companies listed on stock exchanges. Atthe request of policymakers, the ROSCs can alsoinclude special policy focuses on specific sectors(for example, banks, other financial institutions,or state-owned enterprises). The assessments are standardized and systematic,and include policy recommendations. In response,many countries have initiated legal, regulatoryand institutional corporate governance reforms. Assessments can be updated to measure progressover time.WHY IS CORPORATE GOVERNANCE IMPORTANT?For emerging market countries, improving corporate governance can serve a number of importantpublic policy objectives. Good corporate governancereduces emerging market vulnerability to financialcrises, reinforces property rights, reduces transactioncosts and the cost of capital, and leads to capitalmarket development. Weak corporate governanceframeworks reduce investor confidence, and can discourage outside investment. Also, as pension fundscontinue to invest more in equity markets, good corporate governance is crucial for preserving retirement savings. Over the past several years, the importance of corporate governance has been highlightedby an increasing body of academic research.Studies have shown that good corporate governance practices have led to significant increases ineconomic value added (EVA) of firms, higher productivity, and lower risk of systemic financial failures forcountries.By the end of June 2009, 66 assessments had beencompleted in 55 countries around the world.
REPORT ON THE OBSERVANCE OF STANDARDS AND CODES(ROSC)Corporate governance country assessmentSaudi ArabiaFebruary 2009Executive SummaryGood corporate governance ensures that companies use their resources moreefficiently, protects minority shareholders, leads to better decision making, andimproves relations with workers, creditors, and other stakeholders. It is an importantprerequisite for attracting the patient capital needed for sustained long-termeconomic growth.This report provides an assessment of the Kingdom of Saudi Arabia (KSA)corporate governance policy framework. It highlights recent improvements incorporate governance regulation, makes policy recommendations, and providesinvestors with a benchmark against which to measure corporate governance in KSA.The corporate governance laws, regulations, and institutions that have been put inplace generally reflect international good practice. In the wake of the marketcorrection of 2006, market regulators focused on the need for better corporategovernance via legal and institutional reforms. These included passing a CorporateGovernance Regulation (CGR) for listed companies (2006), and furtherstrengthening the supervisory functions across the financial sector. However, manyof the laws and institutions are still relatively new and untested; awareness of theimportance of good corporate governance is low, and implementation by companiesin its early stages.The report makes a number of recommendations to continue the process of bringingthe corporate governance framework in line with international good practice,including some recommended adjustments to the CGR, additional focusedenforcement efforts, and more steps to turn the “law on the books” into practice.Particular areas of emphasis are the disclosure of ownership information and othernon-financial disclosure. The Capital Markets Authority (CMA) and the SaudiArabian Stock Exchange (Tadawul) should continue to build their credibilitythrough clear and transparent coordination arrangements with other authorities.Perhaps most importantly, CMA and the Saudi Arabian Monetary Authority(SAMA) should work to build awareness of the importance of corporate governanceamong companies, shareholders, and stakeholders, and encourage the developmentof director training programs to build a cadre of qualified directors. Theenhancement of corporate governance practices remains instrumental to betterprotect investors, enhance company oversight, and increase confidence in capitalmarkets.
AcknowledgementsThis assessment of corporate governance in KSA was conducted in 2008 byPasquale Di Benedetta and Alexander Berg with the support of SebastianMolineus, from the Corporate Governance Group, part of the Global CapitalMarkets Development Department of the World Bank, as part of the Reports onObservance of Standards and Codes (ROSC) Program. The report was based on atemplate/questionnaire completed by the law firm Talal Abu-Ghazeleh. Theassessment reflects technical discussions with a number of private and publicsector institutions, as well as other relevant stakeholders, whom the World Bankwould like to thank. The interlocutors include: Saudi Capital Market Authority(CMA), Saudi Stock Exchange (Tadawul), Saudi Arabian Monetary Authority(SAMA), Saudi Organization for Certified Public Accountants (SOCPA), SaudiArabian General Investment Authority (SAGIA), Saudi Arabian Ministry ofCommerce and Industry, legal and accounting experts, and representatives ofcompanies, banks, and market participants.Joseph Saba, Director (MNATD), Jamal Al-Kibbi, Country Manager(MNASA), Philippe de Meneval, PSD Specialist, and Saad El Gueddari,(MNSED), Martin Steindl, Program Manager, and Christopher Razook, OperationOfficer (IFC, CMEPF) provided advice and comments.
Table of ContentsMarket profile. 1Key findings. 3Investor protection. 3Disclosure . 4Company oversight and the board. 5Enforcement. 6Recommendations . 6Summary of Observance of OECD Corporate Governance Principles. 11Corporate Governance Landscape . 13Ownership Framework and Capital Markets. 13Legal and Regulatory Framework. 14Principle - By - Principle Review of Corporate Governance. 16Section I: Ensuring The Basis For An Effective Corporate Governance Framework . 16Section II: The Rights of Shareholders and Key Ownership Functions . 18Section III: The Equitable treatment of Shareholders. 24Section IV: The Role of Stakeholders in Corporate Governance . 26Section V: Disclosure and Transparency. 27Section VI: The Responsibilities of the Board . 31
Corporate Governance AssessmentSaudi ArabiaCountry assessment: Saudi ArabiaThis Report on the Observance of Standards and Codes (ROSC) assessment ofcorporate governance in the Kingdom of Saudi Arabia (KSA) benchmarks lawand practice against the OECD Principles of Corporate Governance, and focuseson listed companies. Good corporate governance ensures that companies use theirresources more efficiently and leads to better relations with workers, creditors,and other stakeholders. It is an important prerequisite for attracting the patientcapital needed for sustained long-term economic growth. The challenge topolicymakers is to implement reforms without raising the costs of remaininglisted, or increasing the incentives of companies to leave the public market.An awareness of the importance of good corporate governance is beginning toemerge in KSA. In the wake of the market correction of 2006, authorities andmarket regulators pushed for better corporate governance and legal andinstitutional reforms. These included a Corporate Governance Regulation (CGR)for listed companies (2006), guidelines on corporate governance best practices forbanks (in the process of being finalized), and further strengthening of thesupervisory functions across the financial sector. Although the regulatory andinstitutional improvements are steps in the right direction, additional reformefforts are required to bring corporate governance practices in line with theinternational standards.Market profileThe KSA equity marketis relatively large.The KSA equity market is by far the largest in the Arab world with a marketcapitalization of USD 519 billion at the end of 2007, well ahead of United ArabEmirates (USD 224 billion), and Qatar and Kuwait (USD 95 billion each). Morecompanies are coming to market: eight new securities were listed in 2008 and 25in 2007, for a total of 119 as of May 2008. More IPOs are expected in 2008. and is recoveringfrom the severedownturn of 2006 and2008Share prices have traditionally been strongly correlated with international oilprices, and the market index (TASI) reached its historical peak in February 2006,over 800% above its level at the beginning of 2003. Several factors in the firstquarter of 2006 led to a 60% market correction. Since August 2006, marketcapitalization has rebounded by 62%. The rebound does include the additional57% market correction experienced in 2008.The shares ofprivatized companiesare among the mostactively tradedTrading is concentrated in a few major shares. Most actively traded shares on theSaudi Stock Exchange (Tadawul) originated as public offerings of minority stakesin state-owned companies. Private-sector offerings have increased since theCapital Markets Authority (CMA) was established in 2003.Ownership and controlare concentratedamong foundingfamilies and the StateWhile data on the ownership of Saudi listed companies are limited, ownership ofSaudi listed companies appears to be highly concentrated. Roughly one-third ofthe market's total capital is owned by the government (including public pensionfunds), and another one-third is tied up in strategic holdings (founding families). 1Most of the remaining shares (required free float is set at 30%) are in the hands ofSaudi retail investors, who are responsible for 93% of the trading activities andinclude many first-time investors drawn to the market by a succession ofprofitable and oversubscribed IPOs.1Source: Economist Intelligence UnitFebruary 2009Page 1
Corporate Governance AssessmentSaudi ArabiaForeign portfolioinvestment is partiallyrestricted, anddomestic institutionalinvestors are only nowbeginning to emergeTraditionally, the market has been closed to foreigners. However, following the2006 market correction, the authorities decided to increase demand for shares byfurther opening the market. Financial institutions and institutional investors fromother Gulf Cooperation Council (GCC) countries and foreign legal residents arenow allowed to invest directly in Saudi shares, and other foreigners can also do sovia Saudi investment funds. The impact of these measures remains limited, withforeign trading representing less than 2% of the total. There is an on-going debateover whether the market should be further opened to investment from nonresidents.The future growth inlistings may bechecked by abundantliquidity andownershipconcentrationSome of the largest 20 companies in Saudi Arabia are not listed and do not plan todo so in the near future2. The abundant liquidity in the market reduces the need togo public, as banks are well capitalized (their capital adequacy ratio is well abovethe minimum required by Basel) and ready to provide financing, and ownership isconcentrated in the hands of the government and founding funding families, bothof which appear to be unwilling to dilute their holdings.The financial sector isexpanding and beingslowly liberalizedThere are now 22 banks licensed to operate in the Kingdom, as the sector wasliberalized in 2005, when the country joined the WTO. Until liberalization, therehad been only 11 banks for the best part of two decades. In the last two years, 11branches of foreign banks have begun operations under licenses recently grantedby the Saudi Arabian Monetary Authority (SAMA), and more are expected. Thecouncil of ministers has approved licenses for over 20 new insurance companies,which fall under the surveillance of SAMA. The CMA has also licensed a widerrange of specialized financial institutions since 2006. Asset-management andbrokerage firms as well as a small number of investment banks have entered themarket since 2006.The financialregulatory structurehas changed andenforcement capacityis being made moreefficientPublic companies are under the supervision of the CMA. The Tadawul is thecountry’s stock exchange, and the SAMA is the regulator for banks. As a result ofthe increased number of market participants, CMA and SAMA are expandingtheir supervisory capacity. In particular the CMA, established in 2003 by RoyalDecree No. N/30 dated 31 July, 2003, is in the process of strengthening itsenforcement functions. Also, the Tadawul (currently a state-owned joint stockcompany) may eventually sell part of its shares in an initial public offering, andseparate the Securities Depositary Center (SDC), currently a department ofTadawul.KSA legal frameworkis based on Sharia lawThe fundamental source of law in Saudi Arabia is Islamic Law (the Sharia).Several other sources of law elaborate on the Sharia, and are issued through RoyalDecrees. Regulations, often issued by government agencies, elaborate on theselaws and provide more specific requirements. The legal framework governingcompanies is the CL by Royal Decree M/6, the Capital Market Law (CML) byRoyal Decree M/30, the Listing Rules (LRs) of the CMA by decision No. 3-112004, and the Merger and Acquisition Regulations (MAR) issued by the Board ofthe CMA, Decision No. 1-50-2007. However, it should be noted that both the LRsand MAR apply to listed companies only.The CGR is animportant step towardawareness raising andreformThe most significant recent legal development in the area of corporate governancewas the issuance of the CGR by the CMA in 2006. Listed companies are requiredto disclose their adherence to the CGR on a ‘comply or explain’ basis. Authoritieshave reported relatively low compliance with the regulation in its first year of2 ‘Source: Ownership Structures in MENA Countries: Listed Companies, State-Owned, Family Enterprises and some Policy Implications’, OECD 2006,page 3 ebruary 2009Page 2
Corporate Governance AssessmentSaudi Arabiaadoption. SAMA is also in the process of drafting a corporate governance manualfor banks, which is in the process of being finalized. Bank directors will beexpected to follow this Manual and implement its guidelines.Key findingsThe following sections highlight the principle-by-principle assessment of KSA’scompliance with the OECD Principles of Corporate Governance.Investor protectionBasic shareholderrights are protectedBasic shareholder rights are in place in KSA. Registration is secure anddematerialized through the SDC. Shareholders can demand a variety ofinformation from the company and have a clear right to participate in the generalshareholder meetings (GSM) either in person or via proxy, add items to the GSMagenda, call for a GSM, and have a clear right to nominate, vote for, and removeboard members. Cumulative voting has also been recently introduced by the CGRas a means to nominate directors. Changes to the company’s articles ofassociation, increasing authorized capital, and large transactions all require extraordinary assembly (EGM) approval, with a constituting quorum of 50% of thecapital and approving quorum of 75%. Shareholders have pre-emptive rights tonew share issues (although these can be waived by the government in the case ofcompanies with state ownership, and the company’s articles of association).The regime governingthe review, approval,and disclosure ofrelated partytransactions isunderdevelopedA potentially greater problem is posed by the approval and disclosure of relatedparty transactions (RPTs). The LRs require companies to disclose promptly to theCMA any transaction between the company and a connected person, and toinclude in the board report information related to any contract between thecompany and the chief executive officer (CEO), chief financial officer (CFO) andany director. There is no mention of RPTs in the CGRs, no other requirements topublically disclose RPTs before they are carried out, or rules for approvals ofsignificant RPTs by the board or by shareholders.Market participantsperceive insidertrading and marketmanipulation to bewidespread, however,the CMA is working toresolve these practices.Many investors are concerned that brokers and other industry insiders engage inimproper conduct and abuse their position. This includes trading on insideinformation, improper trading with shares in investor accountants, and marketmanipulation. In 2004, the CMA expanded on the insider trading provisionscontained in the CML by issuing a Market Conduct Regulation to define“insiders”, and prohibit illegal direct and indirect insider trading, as well asmarket manipulation. Moreover, the CMA has taken action against insidertrading, and results have been published on its website.Funds arerecommended todisclose voting orvoting policy, in linewith good practiceRecent growth in equity markets has increased the importance of a new class offinancial intermediaries: fund managers, investment bankers, and researchanalysts. These intermediaries are currently regulated by the Authorized PersonsRegulations (APR), which appears to capture most of the core principles of theIOSCO Statement of Principles for Addressing Sell-side Securities AnalystConflicts of Interest, 2003. However, the core measures of principles of theIOSCO Statement of Principles for Addressing Sell-side Securities AnalystConflicts of Interest, 2003 do not need to be addressed by the legal frameworknecessarily. Of note is that the CGR encourages fund managers to disclose theirvoting, or voting policy, in the GSM for companies in which they invest. Havingand disclosing a voting policy can make funds more effective advocates for goodcorporate governance.February 2009Page 3
Corporate Governance AssessmentTender offers are onlyrequired upon CMAapprovalSaudi ArabiaRegulations issued by the CMA govern takeovers. Any shareholder who acquiresmore than 50% of shares may be required to make a tender offer for alloutstanding shares, if the CMA decides so. Tender offers are an importantshareholder protection mechanism and the MAR has been issued to provide legalprotection to shareholders, in particular minority shareholders. The regulationgrants a discretionary power to the CMA to call for tender offers; however, thismay also create a legitimate cause of concern for minority shareholders and addsa degree of market insecurity.DisclosureListed companies issuequarterly, semiannual, and auditedannual financialstatementsListed companies in KSA are required to produce quarterly and semi-annualfinancial statements, which contain a balance sheet, a profit and loss account, acash flow statement, and notes, as well as audited annual reports. Annual reportsmust also contain a description of the issuer and its business, informationregarding the board, officers, and staff of the issuer, and a statement bymanagement of current and future developments expected to have a significanteffect on the company's financial position. A number of company websites alsohave this and additional information.Compliance with nonfinancial disclosurerequirements appearsweakThe LRs rules are fairly complete and require significant disclosure. However,compliance with certain existing non-financial disclosure requirements isconsidered to be weak by market participants in particular with respect tocorporate governance-related information. Although companies are required todisclose in the board report their corporate objectives, their dividend policies, andthe board composition, disclosure in other areas remains haphazard, in particularthe disclosure of information related to beneficial ownership, board memberqualifications, and nomination procedures.Public disclosure ofbeneficial ownershipremains a key concern,however, the Tadawulhas undertaken aninitiative to publishownership data online,in-line with goodpracticeThe current corporate governance framework requires the disclosure of theultimate (“beneficial”) owners, however, disclosure is to be made to the CMA,and not public. Any shareholder crossing the 5% threshold (includingshareholders acting in concert) must notify the company and the CMA, however,it is left to the CMA on whether to disseminate this information to the public. TheTadawul has recently begun to publish ownership data of shareholders whoexceed or fall below the 5% ownership threshold—a noteworthy initiative muchin-line with good practice. The annual report (board report) must also describesignificant shareholders.Progress has beenmade in improvingNational Accountingand AuditingStandards, butconvergence with IFRSis not currentlyplannedFinancial statements are to be prepared according to local National AccountingStandards and audited with National Standards on Auditing. According to theSaudi Organization for Certified Public Accountants (SOCPA), Saudi Arabiadoes not intend to converge its own accounting standards with InternationalFinancial Reporting Standards (IFRS). Compliance with the national standards isreportedly high, however, there is a strong case to be made to converge withinternationally acceptable accounting and auditing standards to improve uponfinancial reporting and further assure investors.The legal basis forsetting Accounting andAuditing Standards isexplicitSOCPA is the accounting and auditing standard setter, their authority is generallyrespected and there is an explicit legal basis for SOCPA to set accounting andauditing standards via sub-committees (SOCPA has nine in total).February 2009Page 4
Corporate Governance AssessmentQuality reviews ofaudits is consideredinefficientSaudi ArabiaSOCPA conducts cross-examinations and verifies audit quality through a peerreview process. This peer review process, however, lacks the resources to beefficient and effective.Company oversight and the boardBasic requirements forthe board of directorsare in placeBoards of directors do appear to play a central and strategic role in manycompanies. The minimum board size is two and maximum board term is threeyears renewable. The typical board size is eight, in-line with good practice;boards tend to be larger in more capitalized companies. According to a recentreport issued by the International Finance Corporation (IFC) and the HawkamahInstitute for Corporate Governance (Hawkamah), founding families appear tohave relatively few family members who directly sit on boards, and insteadappoint representatives from outside the family, again in-line with good practice.Fiduciary duties ofcare and loyalty arebeginning to emergeAs various supervisory institutions are raising awareness of corporate governance,directors are beginning to understand their duties and obligations, and aredeveloping an awareness and understanding of their duties to the company and allshareholders, as prescribed by the CGR but not the CL. On the other hand, thereare almost no suits filed against directors, and it appears that directors do notusually purchase liability insurance.The CGR providesgood-practiceguidance to boards,board committees, anddirectorsThe CGR defines the board’s functions and responsibilities, prohibits thechairman from acting as CEO, and defines the role of the nomination, theremuneration, and the audit committees. The CGR also recommends paymentforms for board remuneration, and generically defines the roles of stakeholder andshareholder in the governance of the company.The definition ofindependence isreasonably complete,however the assignedroles of anindependent directorshould be specifiedThe CGR defines an “independent board member”. Accordingly, directors whoare controlling shareholders; senior executives (or directors who were seniorexecutives over the past two years); first-degree relatives of a board member orsenior executive; board members of a company within the holding or groupstructure; employees of an affiliate of the company (or affiliate within the holdingor group structure) are not considered to be independent. The CGR recommends aminimum of two board members or at least one-third of the board (whichever isgreater in number) to be independent. Other board commitments are limited tofive. However, the CGR does not assign specific responsibilities or boardcommittee memberships to the independent directors, and ultimately leaves it upto the company articles of association to define how independent directors willcontribute to the effective roll out and completion of board tasks.Succession planningand formalperformanceevaluation proceduresare not widespreadAudit committees tend to be present in most of the banks and some listedcompanies; however, their role is not fully defined and/or well understood.Nomination and remuneration committees are recommended by the CGRhowever their scope is not fully defined. Few companies are thought to have suchcommittees. Succession planning and performance evaluation frameworks forboard members and executive do not appear to be present and/or widespreadamong listed companies.Cumulative voting isencouraged by theCGR, yet remains to beimplementedThere are several specific measures that allow minority shareholder participationin the board election process, including cumulative voting. The CGR is still in theprocess of being implemented, so it is difficult to test the effectiveness ofcumulative voting at this stage. There appear to be no requirements for thedisclosure of board nomination policies.February 2009Page 5
Corporate Governance AssessmentSaudi ArabiaEnforcementSeveral enforcementactions are at disposalof the CMA and CRSDand several cases havebeen investigatedThe CMA has the power to investigate and take enforcement action. In 2006, 83cases were brought to the CMA’s attention, some through referral reports byshareholders. Most of these cases were related to market manipulation and delaysin disclosure. Daily suspension of trading activities, warnings, fines, and ceaseand desist orders are the remedies at the CMA’s disposal.Violators are also prosecuted before the Committee for the Resolution forSecurities Disputes (CRSD), an independent committee created to complementthe Saudi judiciary on securities’ disputes falling under the provisions of theCML, and the regulations issued by the CMA and the Tadawul. The CRSD iscomprised of legal advisors specialized in commercial and financial issues, andsecurities transactions.The CMA has the authority to levy administrative fines. For more severepenalties (e.g. imprisonment) the CMA has to present its case to the CRSD.Pecuniary fines vary from approximately USD 2,600 to USD 26,000. The firstcase
Capital Markets Authority (CMA) was established in 2003. Ownership and control are concentrated among founding families and the State. While data on the ownership of Saudi listed companies are limited, ownership of Saudi listed companie
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