Context

The global economic crisis has once again highlighted the need for effective risk management and corporate governance structures with suitable checks and balances. Bahrain has taken steps to update corporate governance for listed companies and in March 2010 issued a new Corporate Governance Code (the Code) for Bahrain’s public companies which mirrors many of the standards found in other markets such as director independence and training and the formation of audit, nomination and remuneration committees.

The Code, which was developed by the National Steering Committee on Corporate Governance in cooperation with the Ministry of Industry and Commerce (the MOIC) and the Central Bank of Bahrain (the CBB) following a consultation period of more than a year and review of more than 25 national and company governance codes from other countries, becomes effective on 1 January 2011. All Joint Stock companies which are incorporated under the Bahrain Commercial Companies Law must adhere to the Code by the end of 2011 or explain to their shareholders why they are not doing so. The Code states that initially it will apply only to public companies but is intended to be used as a model by all other companies to the extent that it applies in their circumstances. That said, public statements from the CBB have stated that the Code will also apply to all CBB licensees that are incorporated as companies.

The Code, which establishes a minimum standard of best-practice corporate governance principles, supplements the principles of corporate governance which already exist within Bahrain’s legislative framework, such as rules on fiduciary duties, board and shareholder meetings and dealing with company shares.

Principle based code

The Code consists of nine principles:

  1. The company shall be headed by an effective, collegial and informed board;
  2. The directors and officers shall have full loyalty to the company;
  3. The board shall have rigorous controls for financial audit, internal control and compliance with the law;
  4. The company shall have rigorous procedures for appointment, training and evaluation of the board;
  5. The company shall remunerate directors and officers fairly and responsibly;
  6. The board shall establish a clear and efficient management structure;
  7. The board shall communicate with shareholders and encourage their participation;
  8. The company shall disclose its corporate governance; and
  9. Companies which refer to themselves as “Islamic” must follow the principles of Islamic Shari’a.

These principles are each followed by one or more broad directives for applying the principle. The Code states that the principles and directives should be complied with. The directives are supplemented by a number of recommendations. While compliance with the recommendations is not mandatory, if a company decides not to comply with a specific recommendation (or other aspects of the Code), it must explain its non-compliance in a “comply or explain” report disclosed under principle 8 of the Code.

Features of the Code

The Code contains a number of interesting features.

Directors’ independence

Directive 1.3 states that, “No individual or group of directors should dominate the board’s decision making” and includes a recommendation that “the board should review the independence of each director at least annually.” Further, the Code recommends that the Chairman of the board and the CEO should not be the same person, and that at least 50% of the board of directors be non-executive directors.

This aspect of the Code contrasts with the situation in many unlisted family owned companies. The issue of family influence is particularly relevant for unlisted CBB regulated companies that may, given references in the Code to expected revisions of the Code applying to other types of companies, fall within the ambit of the Code in the future. Clear separation between the board, the management and the shareholders is an important aspect of corporate governance and this feature of the Code will further enhance the CBB’s reputation for regulation in this sector to improve transparency within the management of companies.

Loyalty to the company

Directive 2.1 addresses accountability and makes it clear that every director and officer should understand that they are personally accountable to the company and its shareholders and can be sued if they breach their duty of loyalty owed to the company. This duty of loyalty places the following obligations on each director and officer:

  • not to use company property as though it was his own property;
  • not to disclose confidential information of the company or use it for his personal profit;
  • not to take business opportunities of the company for himself;
  • not to compete in business with the company; and
  • to serve the company’s interests in any transaction in which he is considered to have a “personal interest” (as defined in the Code)

Induction and training of directors

Directive 4.5 provides that each new director shall receive a formal and tailored induction. The induction shall include meetings with senior management, visits to company facilities, presentations regarding strategic plans, significant financial, accounting and risk management issues, and compliance programs. The directive also highlights the importance of directors obtaining continuous education throughout their term on the board.

This measure seeks to ensure that directors have a full understanding of the company to be in a position to make informed board decisions that will ultimately benefit the shareholders. It is also intended to help combat the situation where a board is made up of directors who are inexperienced in a particular industry sector.

Directors’ remuneration

The issue of directors’ pay continues to be widely discussed in relation to board members who have received substantial remuneration packages that may not be adequately linked to performance. Directive 5.1 of the Code seeks to address this issue by requiring the establishment of a remuneration committee which shall:

  • make recommendations and obtain shareholder approval for the board of directors and senior management remuneration policies; and
  • remunerate board members based on performance and attendance.

A remuneration committee must exercise judgment free from personal interests. In recognition of this fact one of the recommendations that accompanies this principle is that the remuneration committee should be made up solely of independent directors (i.e. a director as defined in Appendix A of the Code whom the board determines has no material relationship which could affect his independence of judgment) or non-executive directors of whom a majority are independent directors and the chairman is an independent director.

Corporate Governance Guidelines

Principle 8 of the Code requires the board of each company to adopt written corporate governance guidelines and states that the board shall report on the company’s compliance to the shareholders at each annual shareholders’ meeting. Any variation to or non-compliance with the Code should be explained.

This principle is intended to ensure that a company’s compliance with the Code is transparent to the shareholders and potential investors.

Shariah Supervisory Board

Directive 9.1 of the Code states that companies who refer to themselves as “Islamic” or which offer Islamic financial services or products will be subject to additional governance requirements and disclosures to provide assurance to stakeholders that they are following Shariah principles. The directive dictates that each such company should establish a Shariah Supervisory Board (SSB) of at least three Shariah scholars who will be tasked with ensuring compliance with Shariah principles.

The effect of this directive should be a consideration for banks wishing to enter the Islamic market in Bahrain.

Enforcement

Disclosure and transparency are underlying principles of the Code. However, market monitoring alone will not guarantee compliance and therefore enforcement of the Code is reliant on a combined monitoring system comprising the board, the shareholders and others including the MOIC, CBB, Bahrain Stock Exchange (BSE) and professional advisers. The Code does not create new penalties for non-complying companies, but does state that the MOIC (working closely with the CBB and the BSE) will be able to exercise the penalty powers already granted to it under the Commercial Companies Law 2001.

Conclusion

The introduction of the Code is a positive development for Bahrain which should ensure effective corporate governance in the Kingdom. Shareholders and potential investors will be able to take comfort from the fact that the Code brings together aspects of many international corporate governance regimes to introduce what can only be described as international best practice in Bahrain.

A version of this article first appeared on www.complinet.com.