As with elsewhere in the world, the news from the Middle East has not been great of late. Dubai's debt crisis was allied to the unravelling of a regional lending practice in which both individuals and companies were given substantial loans with no clear active back-up, collateral or cash flow projections that would validate the terms of the loan, writes Constantin Salameh.
This toxic mix has created a shockwave in the region's family office community, which has begun to think seriously about whether it has the right structures in place to avoid defaults and financial distress more generally. Specifically, this means progressive family offices understand that they must improve their corporate governance structures and become more transparent. They do so at a time when many of the region's wealthiest families stand on the edge of a vast transfer of wealth from one generation to another. In the UAE family offices are moving from first to second generation, while in Saudi Arabia they are moving from second to third generation.
In many cases the wealth holder is still the wealth manager or, if not, still likes to keep close control of the decision-making processes. The notion of investment committees and external board members are still in their infancy, but on the plus side the next generation realises such changes need to occur. Many of them realise the importance of implementing such corporate governance structures as they have worked overseas or have been exposed to family offices elsewhere in the world that have different approaches.
One of the most pressing problems that generations young and old must overcome is a traditional reliance on dangerously high concentrations of risk. For example, there is a preference of Middle Eastern families for particular asset classes such as real estate, particular sectors such as financial services and construction, and particular geographies that were largely confined to GCC countries.
Family offices need to act on this or they risk long-term value destruction. Over the last few years there has been a shift from maximising returns through asset growth to wealth preservation and ensuring the smooth transition from one generation to the next. However, this delicate shift is accompanied by an increase in tensions within many families.
In the past, decisions regarding investment strategies, asset allocation and manager selection were simply rubber stamped by families used to seeing double-digit growth. Now, families are asking more questions and divisions are emerging between family members over which way is the right way.
Consequently the risks are not simply financial. Even in a region where family unity is such a cherished commodity, it is not too dramatic to say that families can split into factions with separate family offices and a simmering ill feeling. It is something I have witnessed first hand, but not something I would recommend – grouping assets and expertise is much more to a family's advantage.
When it comes to implementing change, it is essential not to throw the baby out with the bath water. You still have to understand and respect the values of the family and, if there is one, the operating business. Morality and trust are key values, accountability less so. It is also important to understand the notion of time – it is not about weeks or months, it is about years.
As we have seen, Middle Eastern families prefer traditional investments. We say they like to "touch" their investments, which is why land and real estate are so important. Hedge funds and private equity are still regarded as pure speculation by many families.
Once such values and traditions are understood and accepted, the family office should be able to build on them by selecting appropriate corporate governance strategies that complement them. I am confident it will happen, although not overnight.
The crisis has been the best catalyst for change. It has shaken people to the extent where they are now starting to ask questions of each other and share best practice. There will be some nasty surprises and bumps along the way but they will only serve to underline the importance of implementing corporate governance and transparent strategies.