It will be some time yet before a national Gulf company is forced to settle investor’s claims of some $352 million, such as the one related to Shell’s wrongful 2004 energy reserves estimates. This was an unprecedented settlement for a large scale European shareholder dispute, and which also prompted the departure of several top Shell executives, including Chairman Sir Philip Watts. The firm was also fined a record $160 million by both US and UK regulators. And what was the alleged issue? Apparently, the energy giant had shocked investors, when it revealed that it had overbooked its oil and gas reserves by 20 percent. As a further measure, Shell also abolished its twin board structure, which investors complained had lacked clarity and accountability — factors which some had argued had contributed to the reserves scandal.
Financial watchdog regulators have been busy before, and not even the largest names have escaped regulatory fines for alleged financial wrongdoings. Before Shell’s record regulatory fines, Credit Suisse First Boston (CSFB) was fined for around $8 million for breach of market rules, while Citigroup’s fine registered around $28 million. Apparently, Citigroup caused other financial institutions to lose money when it dumped a larger than usual number of euro zone government bonds on the market, forcing prices down in August 2004. The penalty fine smacked of sweet justice — with Citigroup relinquishing around $20 million of the alleged profits it made on the deal, and a further $4 million penalty imposed on top.
The message is clear from hawk-eyed financial regulators — those involved in financial business and public trust, must be committed to maintaining the highest standards of business ethics, and aim to advance best practice leadership in all their business dealings. The financial sector must foster a culture of compliance that is second to none. The reason is obvious — a failure in our favorite supermarket or hotel chain might be a nuisance and a topic of dinner party nostalgic discussion, but a failure in the financial sector is more serious.
The reason is simple — lack of effective regulatory supervision and the consequent failure in financial market participants leads to well-documented panics, the so-called “contagion” effect, with ramifications that go beyond the affected financial institution itself. Investors, depositors, economic confidence and business cycles become interlinked in a vicious downward cycle of lack of confidence.
In Saudi Arabia, the public is well served by the effective banking supervisory role exercised by the Saudi Arabian Monetary Agency (SAMA). There have been no bank failures as such, in the short history of the Saudi financial system, and the few banks which had faced some financial difficulties were either supported through partial government acquisition or merged with other, sounder financial institutions.
As such, while SAMA does not have a formal depositor insurance scheme like that in the US, it is in all respects, a banker of last resort to the Saudi banking system. Furthermore, the Saudi banks are one of the highest capitalized in the world - far in excess of the Basel capital adequacy requirements.
It is in the Saudi capital market arena that there is a need for further financial transparency and market regulation. The continuing malaise of the Saudi stock market seems to be due to a combination of factors — lack of investors training, rumors, herd trading mentality etc. but a certain element is probably due to some public disquiet about the level of transparency of listed companies, and the need for tougher penalties for financial malpractice.
The Capital Market Authority (CMA) has also been doing a commendable job of market regulation and adapting with circumstances as its market experience and supervisory role evolved. Tougher penalties have been imposed on known speculators and market manipulators, and the CMA is not now shy of “naming and shaming” such people. It has insisted on more regular, and meaningful, financial reports and set out clear board of directors’ responsibilities and punishments.
More needs to be done. There should be no upper limit set for fines imposed — these should be based on the severity of individual cases, so that fines are used as a “signaling effect” to other would be transgressors, as highlighted earlier on in this article. It might or might not work, but any would be transgressor might consider twice about the likely fines, if such upper limits are not known beforehand. During 2006, the CMA did fine — but without naming — some substantial market manipulators, but the public’s reaction was skeptical then, with some requesting that the CMA should apply two-part fines like the case of Citigroup — returning back any profits made on such deals, and a further element for a fine.
In the final analysis though, Gulf financial market regulation can only be as good as the technical capability of those supervising such emerging markets. As new products develop, whether conventional or Islamic instruments, Gulf regulators have to be one step ahead in monitoring risks and abuse of investor confidence. They must be able to quickly detect unusual market movements and pricing behavior, and request cross-border regulatory assistance if need be, as the UK and US financial regulatory authorities did in the cases above. The Saudi and other Gulf markets will become more mature over time, and hopefully, more investor rational.
Listed Gulf companies making exaggerated claims about their future earnings and capabilities must be held accountable for any investor losses, as the Shell case above has demonstrated. In the meantime, the regulatory authorities are only to be encouraged to redouble their supervisory efforts to avoid any spread of financial “contagion” disease — bird flu is enough for the time being.
(Dr. Mohamed A. Ramady is visiting associate professor of finance and economics at King Fahd University of Petroleum and Minerals, Dhahran.)