Saudi Arabia updates laws to strengthen trade environment

Increasing Saudi Arabia’s attractiveness as an investment destination is a broad effort, involving a number of government entities and alterations to the regulatory frameworks. Almost all of the ministry-level strategies found in the National Transformation Programme (NTP) 2020 have a bearing on the issue of investment, and their success will be measured in years rather than months. However, two major alterations already made to the legislative framework have allowed the Kingdom to make some immediate gains, the effects of which are currently being felt by the business community.

Companies Law

Saudi Arabia’s long-anticipated Companies Law, first implemented in 2016, came into full effect in May 2017. The new legislation replaces a framework that dates back to 1965, and is therefore designed to address the significantly altered business environment that exists today. The guiding principle that underpins the new law is the promotion of small and medium-sized business activity.

In addition, the legislation also introduces new rules on corporate governance, which will affect every business from the smallest local trader to the Kingdom’s biggest enterprises.

While the Ministry of Commerce and Investment (MCI) will remain the principal regulator of Saudi companies, the new law recognises the growing importance of the stock market in economic life, and appoints the Capital Market Authority (CMA) as regulator for the country’s listed joint stock companies (JSCs), therefore granting the body a central role in the law’s implementation.

Key Changes

The code makes a number of crucial changes to the process of establishing and operating both limited liability companies (LLCs) and JSCs. For example, an LLC can be formed with just one shareholder, as opposed to two required previously, and a JSC needs only two shareholders, compared to the previous five. Companies are also no longer required to produce feasibility studies prior to incorporation, and in addition, the requirement that directors provide guarantee shares to the value of SR10,000 ($2670) has also been removed.

Furthermore, it is now less expensive to establish both types of company in the Kingdom, with significant reductions in statutory reserve requirements for LLCs and minimum capital requirements for JSCs. Perhaps most importantly, the law contains a strong corporate governance element, the application of which brings Saudi Arabia in line with international best practices. This involves greater protection for shareholders, while strengthening the position of minority interests, as well as giving clear direction on central functions, such as the establishment and operation of the board of directors and the issuance of shares. All shareholders are now entitled to attend meetings, for example, a provision that removes a previous rule which limited attendance to shareholders with more than 20 shares.

The new law also addresses some areas for the first time. Merger and conversion protocols were missing from the old law, but the new framework establishes clear rules for these activities, such as the process by which shareholders can object to a company’s conversion from an LLC to a JSC and how to value net assets in these cases. The Companies Law provides a framework for the establishment and operation of business in Saudi Arabia, and is an important advance that is expected to be positive for investment.

The new Companies Law contains a strong corporate governance element, offering greater protection for shareholders, strengthening the position of minority interests and giving clear direction on central functions

Corporate Governance

The corporate governance provisions in the Companies Law apply to both LLCs and JSCs, but the Kingdom has also produced a set of rules that specifically apply to the nation’s listed companies. The CMA approved new corporate governance regulations in March 2017 and they came into effect the following month.

The new framework replaces a relatively modern set of rules, dating from 2006, but it nevertheless makes some significant amendments to the corporate governance requirements applied to JSCs listed on the Saudi Stock Exchange (Tadawul). Their introduction was deemed necessary for a number of reasons. First, the implementation of the new Companies Law required the CMA to harmonise its corporate governance regulations with the framework being used by the MCI. In doing so, the CMA was bringing itself in line with the international capital markets community, where corporate governance has been a salient issue since the 2008 global financial crisis. Second, the new rules come during the lead-up to one of the most widely anticipated flotations in Saudi Arabian history – the proposed initial public offering of 5% of Saudi Aramco shares on the Tadawul (see Capital Markets chapter). An enhancement of the regulatory oversight of listed companies was considered to be advantageous in the context of this event.

The regulations address a wide range of areas. Shareholder rights have been strengthened by prohibiting discrimination between shareholders of the same class, and by clauses on issuing fair distributions and providing equal access to corporate information. New conditions are applied to boards of directors, touching on points such as composition, conditions of membership, responsibilities, independence, and the distribution of competencies and duties.

Roles Defined

New articles concerning conflict of interest are a particularly significant advance. These rules require companies to establish policies for a range of scenarios, such as accepting gifts and dealing with conflicted persons.

The formation, powers and responsibilities of company committees – such as risk management, remuneration and audit tasks – are also addressed more comprehensively than before, as are the functions of both external auditors and internal control systems. The interests of employees, meanwhile, are addressed by a requirement to draw up polices for issues such as employee complaints and confidentiality.

Perhaps most important to the investment community is a general requirement to disclose up-to-date and accurate information to a company’s various stakeholders. As a result, boards must maintain policies on information disclosure, provide a regular board report along with the audit committee’s report and regularly maintain information on the company’s website. Taken together, these alterations to the corporate governance framework bring the Kingdom in line with more advanced jurisdictions and, if applied fully and consistently, will do much to boost investor confidence in the local listing regime.

Looking Ahead

As Saudi Arabia continues to improve its investment environment, there are likely to be more legislative changes. One proposed initiative addresses a persisting market irregularity. A broad range of business transactions are limited to Saudi citizens, and this arrangement has given rise to the phenomenon of tasattur, an illegal practice in which a citizen allows an expatriate to run a business in his name in return for a share of the profits. The practice costs the national economy billions of riyals in potential revenue and results in a reduced degree of visibility over economic activity in the Kingdom.

In March 2017 the local press reported that the government was considering a plan to allow expatriates to undertake trading activities across all business sectors in return for paying a tax. Two taxation schedules were suggested, the first being a direct levy on the accounts of an expatriate-owned business, calculated using a formula that would include revenue, expenditure and profit. The second suggestion would see a tax on estimated profits, with the rate varying from sector to sector.

In the first half of 2017 the General Authority for Small and Medium Enterprises announced that a study on how to combat tasattur was already completed, while the MCI reported that it, too, was examining the issue. For the time being, the government continues to deploy punitive measures in a bid to stamp out the practice. In early December 2017 the MCI announced 781 cases of tasattur were brought to the attention of the attorney general before going to the court in 2017, up from 450 cases in 2016.

Penalties in such cases can be large: expatriates are subject to imprisonment of two years and a maximum fine of SR1m ($267,000), as well as deportation. Saudi citizens are blacklisted by the ministry and their name is published in daily newspapers. A regularisation of this state of affairs would represent a significant advance in the domestic business environment.