How is the Middle East’s landscape for corporate governance evolving?
As technology continues to be embedded in how businesses activities are conducted, regulations constantly need to be fine-tuned to cater to new risks and vulnerabilities. Financial policies, regulations and structures are being implemented within the Middle East (ME) such as the Basel III and the International Financial Reporting Standards (IFRS) 9, to name a few. However, sustainability of these policies is heavily dependent on practising the spirit of corporate governance – beyond just mere compliance with the rules. This includes establishing a framework and being consistently accountable when managing risk.
What is corporate governance?
‘Corporate Governance’, as defined by the BusinessDictionary.com, is “the framework of rules and practices by which a board of directors ensures accountability, fairness, and transparency in a company’s relationship with its all stakeholders.”
The three main pillars of corporate governance are risk, compliance and audit which contribute to the value of a good reputable organisation. Governance structures need to adhere to the laws and regulations of the country in conducting business locally and globally.
What is the currently implemented in the ME?
- Basel III and IV
UAE’s banking sector is prepared to fully comply with the Basel III requirements by the end of 2019. Basel III is a regulation that has been updated with a new set of rules that significantly impacts banks. For example, banks will be required to maintain capital and liquidity levels in the UAE with the introduction of this regulation.
The new standards are expected to impact banks’ risk-weighted assets (RWAs), and off-balance-sheet exposures weighted according to risk. RWAs are an estimate of risk that determines the minimum level of regulatory capital a bank must maintain to deal with unexpected losses.
While the Basel III is set for compliance by the end of 2019, the implementation of the Basel IV framework has already begun.
Under the Basel IV, the focus is on the calculation of the credit, market and operational risks. This will be achieved through the use of either standardised or internal model-based approaches.
- IFRS 9
IFRS 9 is an International Financial Reporting Standard (IFRS) published by the International Accounting Standards Board (IASB). It addresses the accounting for financial instruments. The adoption of the IFRS 9 is likely to significantly impact banks’ balance sheets, accounting systems and processes. Although the IFRS 9 went into effect on January 1, 2018, there are a total of three phases of financial instruments projects, which are classification and measurement, impairment and hedge accounting. These are still being conducted through various tests to help banks navigate the enhanced reporting standards.
According to Moody’s Analytics, IFRS 9 introduces changes across three areas:
- The classification and measurement of financial assets
- The introduction of a new expected-loss impairment framework
- The overhaul of hedge accounting models to better align the accounting treatment with risk management activities
IFRS 9 is a genuine paradigm shift for banks, not just in the UAE but worldwide. This is not a change that affects only the finance or risk function. Under IFRS 9, product mixes and business models will also need to be evaluated. On the operational side – systems, processes and other infrastructure will also need to change. Since significant judgment and estimates are required, banks would have to set up an appropriate governance mechanism. With IFRS, banks will be able to follow a set of guidelines that can assist them in managing this new mechanism.
- Financial Action Task Force (FATF) Evaluation
Dubai has built a reputation as the pre-eminent business hub in the ME, with an open economy that welcomes companies and individuals from around the world. However, the nation needs to take into account the growing threats that open economies are also vulnerable to such as money laundering.
In a move to reduce money laundering, the FATF evaluation 2019 has launched a host of regulatory initiatives and supervisory actions in the region. This includes an assessment and review of anti-money laundering (AML) and implementing sanctions combating the financing of terrorism (CFT).
- Know Your Customer (KYC) with Blockchain
Automated KYC is currently a pressing concern for banks and financial institutions in ME. Procedures often tend to be performed using traditional and outdated checklists with low quality data – albeit using centralised systems which are in fact fast and effective platforms.
To address these inefficiencies, banks are considering using blockchain technology to perform KYCs. The Dubai International Financial Centre (DIFC), Mashreq Bank and Norbloc have announced a blockchain data-sharing KYC consortium due to launch in the first quarter of 2020. The creation of a consortium agreement will govern KYC efforts among future participating banks, government bodies, financial institutions as well as other licensing authorities to subscribe to the platform.
How should the financial sector sustain itself?
Keeping up with these initiatives would be essential to ensure that sustainable financial goals are achieved. Regulatory Technologies (RegTech) will also be a key trend that is up-and-coming in the field of corporate governance in the ME region. However, this is also dependent on the outlook of talent that is available in the market to support RegTech. In ME, a potential solution could be incorporating efficient risk management to curb emerging threats in the financial market.
Incorporating Risk Management
Risk management has primarily focused on compliance with laws and regulations. However, a narrow focus on regulation often fails to understand or address emerging threats within a continuously evolving risk landscape. Instituting a strong corporate governance framework, including an engaged board and effective internal controls, will help companies assess risk more effectively and respond quickly to changes in the business.
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