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Corporate Governance at Saudi Aramco

DUBAI – Since the announcement last year that Saudi Aramco, the world’s largest oil company and Saudi Arabia’s corporate crown jewel, would go public, the media have been abuzz with speculation – and not just about the company’s massive valuation. While the initial public offering is expected to happen in 2018, the timing – not to mention the approach the government will take – remains far from certain.

A short-term “fire sale” of a minority stake in Saudi Aramco does not appear to be warranted by Saudi Arabia’s current macroeconomic situation. Given slightly higher hydrocarbon prices, lower government expenditures, and potentially higher tax receipts, many predict that the country’s budget deficits will narrow. Sovereign borrowing is also expected to decline, in stark contrast to last year’s record-high bond issuance.

Furthermore, the Saudi government has identified dozens of other state-owned enterprises (SOEs) to privatize, in order to help fill government coffers, deepen the equity market, and boost the private sector’s role in the economy. Stimulating interest in the Saudi capital market with these listings prior to the Saudi Aramco IPO might be wise, given that IPOs throughout the Gulf region have slumped in recent years.

In any case, despite all the media speculation, the specifics of how and when Saudi Aramco will be privatized have not been considered thoroughly. Although the Saudi Stock Exchange, Tadawul, is by far the largest in the Middle East, it is neither large nor open enough to handle the listing of Saudi Aramco, valued by the authorities at $2 trillion.

But size is not the only problem. Qualified foreign investors, having gained access to the Saudi market in 2015, still account for only 4% of the market’s overall capitalization today. Domestic retail investors account for 12% of that capitalization – and are responsible for over 80% of overall trading activity.

These investors, together with Saudi institutional investors, are accustomed to the use of privatization as a wealth-distribution mechanism. But Saudi Arabia is not pursuing Saudi Aramco’s partial privatization to move money from one sovereign pocket to another; it needs to raise fresh capital to finance its spending needs. Furthermore, a dual-pricing approach to privatization – in which domestic investors are offered equity at a discount – could send the wrong message to international investors.

A further wrinkle in the pricing process, as Tadawul’s ex-CEO Adel Al-Ghamdi recently pointed out, is that Saudi corporate law prescribes a fixed-par-value regime for all of the country’s IPOs. Since domestic retail investors expect such pricing, they may be reluctant to accept Saudi Aramco’s much higher share price.

The mainstream media have left these issues largely unaddressed, preferring to focus on issues of governance. It is commonly assumed that a key impediment to Saudi Aramco’s international listing is that Saudi corporate-governance standards are low, and that the Saudi authorities are therefore “shopping around” for an exchange with similarly low standards. But the truth is that Saudi governance standards are more rigorous than those that would be imposed on Saudi Aramco by an international exchange.

In fact, Saudi Arabia’s corporate-governance rules, last revamped in February 2017, are among the strictest and most rigorously enforced in the Middle East and North Africa region. Unlike other regulators in the region, Saudi Arabia’s Capital Market Authority issues and discloses its enforcement actions, which have recently included criminal sanctions. Unlike some regulators in the Gulf region, the CMA takes the same approach to SOEs and private firms.

The truth is that most international listing standards are in many respects inferior to those of Saudi Arabia. For example, whereas listed Saudi companies have separate CEOs and board chairs, over half of S&P 500 companies in the United States are led by a single chair/CEO.

Even if Saudi Arabia does choose an exchange with high corporate-governance standards for its secondary listing, Saudi Aramco could be exempted from that country’s requirements. As competition for high-profile international listings among exchanges heats up, the temptation to water down standards and regulations for dual listings is becoming stronger.

Just recently, the United Kingdom’s financial watchdog announced that it is considering a new listing segment for international companies that would enable them to obtain a London listing without complying with domestic governance standards. The announcement highlights the risk of a regulatory race to the bottom, driven not just by Saudi Aramco’s impending listing, but also by financial deregulation in the United States and fears about Brexit’s consequences for the City of London.

It seems clear, therefore, that improvements to Saudi Aramco’s corporate governance do not rest, on which international venue the authorities choose for the secondary listing, as is commonly assumed, but on whether the company will be required to meet domestic standards. Because the Saudi capital market’s credibility depends on the credibility of the Saudi Aramco listing, it is critical that Saudi Arabia holds Saudi Aramco to domestic governance standards.

It is encouraging in this regard that Saudi Arabia has quietly made major improvements to Saudi Aramco’s corporate governance in the last two years. For example, until 2015, Saudi Aramco was overseen by the Supreme Petroleum Council, which included senior members of the Royal Family and government ministers; now, the company is overseen by a board of nine directors, three of whom are outsiders. In a region where some SOEs operate with no board of directors at all, this is a significant move.

Continuing on this path, and ensuring that Saudi Aramco fully meets the country’s stringent domestic standards, would be in line with the motives behind the company’s privatization, which include, as Saudi Deputy Crown Prince Mohammed bin Salman has explained, increasing transparency. With the state planning to retain a 95% share of Saudi Aramco, ensuring equitable treatment of all investors, as provided by Saudi corporate-governance rules, could not be more important.