London: Fitch Ratings says the ratings of Gulf Cooperation Council (GCC) privately-owned corporates are constrained by relatively weaker corporate governance than their developed market peers. This is mainly due to the absence of an effective independent board, weak transparency and limited disclosure practices.
“We believe corporate governance practices are steadily improving in GCC, largely for publicly-listed companies, with both the UAE and Qatar recently having undertaken regulatory reforms to move into emerging market status. Nevertheless, for privately-owned corporates, a move in company culture toward more independency, transparency and disclosure could still take some time, specifically for privately-owned corporates that have yet to adopt these practises on an optional selective basis,” Fitch in a statement said.
“Few regional corporates have independent boards, and of those that do, their effectiveness remains questionable, with few independent directors and “key man” risk from the influence of the dominant CEO or shareholder. Moreover, privately-owned corporates group structure shows a varying degree of complexity and significant related-party transactions. Individual private ownership of a rated entity often results in fewer equity and debt funding options than for listed entities. Fitch considers key man risk to be high among GCC corporates, and it is not unusual for one person to hold more than one key position in the company. Dominant owner/managers can represent key man concentration risk, which makes the role of truly independent directors of central importance to corporate governance analysis.
“Risks also stem from the influence of family shareholders on corporate strategy and operations; related-party transactions; management succession; and dividend policies that may favour family interests over the interests of other stakeholders. Related-party transactions may affect an entity’s rating if they are carried out for the benefit of a related party at the expense of the rated entity. Fitch uses information including IFRS account disclosure, where material, of related-party transactions to assesses the scale of related-party activity and the underlying nature of the transactions, arms-length or otherwise.”
However, Fitch recognises that family ownership can also bring benefits, such as commitment to long-term strategic goals and tapping family wealth to aid business growth. With their own standing and influence, influential owners have created competitive benefits for their companies. Yet issues such as the availability of new equity, either for on-going expansion or during times of distress, are difficult to evaluate for companies in private ownership. The actual wealth of an individual owner or other considerations such as succession, willingness for ownership to be diluted or to commit funds under different circumstances, is also often hard to determine. As a result, Fitch tends not to incorporate the financial strength of an individual or family into its ratings, or to assign “implied” ratings to groups of companies that lack a formal legal relationship with each other.
“Lagging governance standards can discourage international investors from looking for opportunities in GCC as they face closely controlled company ownership and general lack of transparency. GCC companies can improve their access to capital markets and cut the cost of raising debt by strengthening their management and governance practices. For example, in the Fitch-rated universe, UA- based Majid Al Futtaim Holding LLC (BBB/Stable) has an experienced board, exercising effective check and balances, with high quality and timely financial reporting. It is also transparent about its operations and has clear investment strategies and financial policies. These measures have enabled it to tap international capital markets at more favourable rates.
Improved governance practices will not, by themselves, positively affect a credit rating. However, weak governance practices can result in lower ratings than quantitative and qualitative credit factors may otherwise imply. The extent to which ratings are affected depends on the scope and pervasiveness of the governance matters identified, and the relative strength of the issuer’s credit factors within its rating category, balanced against the absolute level of its issuer or debt instruments ratings.”
Fitch evaluates governance matters on two levels: country-specific and issuer-specific. When analysing country-specific governance, Fitch analysts assess the jurisdictional environment of an issuer’s country of incorporation, (or alternatively, where the majority of its debt issuance is placed). In its review of issuer-specific considerations, Fitch focuses on the characteristics shaped by the industry in which the issuer operates, and the relationships between its stakeholders.