Bahrain was caught up in one of the Middle East’s largest ever business disputes this year, when two Manama-based institutions, The International Banking Corporation (TIBC) and Awal Bank, found themselves unable to meet their obli-gations to creditors.

The two banks are subsidiaries of, respectively, Ahmad Hamad al-Gosaibi & Brothers Company and Saad Group, two Saudi conglomerates involved in multi-billion-dollar lawsuits with each other over allegations of fraud. The two subsidiaries, which both had far more liabilities than assets, appear to be among the firms that have suffered as a result of the dispute.

The problems led the Central Bank of Bahrain to place TIBC and Awal into admini-stration on 30 July. The central bank says it is also reviewing the actions “of certain persons connected with the management” of the two banks to ensure they were complying with its standards.

Reputation boost

The assurance with which the central bank dealt with the problems at TIBC and Awal has meant there has been no spillover to the wider financial community and has helped to bolster Bahrain’s reputation as a place to do business. But more commercial disputes are likely in the coming years as companies start to lose money from ill-advised deals struck during the boom times, and Bahrain’s authorities will have to remain vigilant.

“We are beginning to see the fallout from the credit crunch in terms of litigation,” says Khawar Qureshi, a barrister based in Qatar and London who specialises in international arbitration cases. “The key question will be how effectively the local courts are able to assist the enforcement of contract rights and arbitration awards. The regulatory and legal system in Bahrain and many other GCC states has yet to be stress-tested. Nevertheless, the recent actions of the authorities in many of these states indicate that building strong structures is an increasing priority.”

To date, companies in Bahrain have either had to go through the courts or to dispute resolution centres abroad to settle any commercial dispute. But in January, they will have another alternative when Bahrain opens its own arbitration centre.

The Bahrain Chamber for Dispute Resolution is being set up in partnership with the American Arbitration Association (AAA) and its international arm, the International Centre for Dispute Resolution (ICDR). It fills a notable gap in the country’s regulatory system.

It will be open to international companies looking for neutral ground to resolve any commercial arguments, but the first cases are likely to be domestic disputes that have been referred by the local courts.

There is no shortage of similar centres around the Gulf, so the success of Bahrain in attracting international arbitration cases will give an indication of the health of its regulatory system and how it is perceived internationally.

Mark Appel, senior vice-president of the ICDR, says some interest shown has already been shown.

“The world is famous for [dispute resolution] centres that open and don’t do very much,” he says. “This is going to be different.

“I have already spoken to multinationals who are interested in referencing the centre in their contracts. I would be pretty surprised if we don’t see arbitration and mediation within months. The contract disputes will take longer.”

“Most of the GCC dispute resolution centres seek to adopt rules and procedures that are based upon internationally accepted standards,” says Qureshi. “The distinguishing features that will determine choice of centre include cost, ease of use [and] effectiveness of local court support for arbitration. Parties familiar with the US legal system are likely to favour the AAA rules.”

The centre is needed because enforcing contracts is one area where Bahrain, which is generally well regarded as a place from which to operate a business, fares badly. In the World Bank’s Ease of Doing Business report for 2010, it is ranked just 117 out of 183 countries when it comes to enforcing contracts – four places lower than in the previous year’s report.

“The world is famous for [dispute resolution] centres that open and don’t do much, This will be different”

Mark Appel, senior vice-president, ICDR

Bahrain’s government has acknowledged there is a problem that needs addressing.

“We recognised the need for such a centre, grounded in international best practice, in order to provide industry with an added dimension of surety to commercial transactions, and as a vital cornerstone for economic growth,” said Bahrain’s Justice Minister Sheikh Khalid bin Ali bin Abdullah al-Khalifa when the deal was signed with the AAA in August 2009.

In most other areas, Bahrain fares much better. The World Bank ranks it 20th overall as a place to do business, with only Saudi Arabia ahead of it among Middle East countries. Manama scores particularly well for the ease of regi-stering property purchases, paying taxes and employing staff, dealing with construction permits, trading across borders, and closing down a business.

Conditions are particularly amenable in the special trading zones, such as the Bahrain International Investment Park, Bahrain Investment Wharf and Bahrain Logistics Zone, all of which are close to the new Khalifa bin Salman Port at Hidd and offer perks such as zero corporate tax, exemption from GCC customs duties and 100 per cent foreign ownership.

The Heritage Foundation, a conservative US think tank, gives the country an even more positive review in its 2009 Index of Economic Freedom, ranking it the best out of 17 countries in the Middle East and 16th in the world overall.

While Bahrain scores well in terms of low tax and tariff levels and financial freedom, the foundation says more could be done to boost property rights and tackle corruption.

Berlin-based Transparency International ranks Bahrain 43rd out of 180 countries in its corruption index, where a ranking of 1 indicates the least corruption, behind Qatar, the UAE and Oman, among others.

Labour reforms

However, the Heritage Foundation says that labour market reforms are making a positive contribution. The most recent reform came on 1 August when Bahrain abandoned its policy of tying foreign workers’ visas to particular employers. That should make it easier for expatriates to switch jobs and thus make the market for work far more competitive.

But while it means Bahrain falls in line with most developed economies around the world, other Gulf countries have resisted making similar moves.

“All that is doing is putting you in the real world, and I don’t have a problem with that,” says Andrew Trevis, plant director for US food giant Kraft, which began operations in the country in November 2007 manufacturing cheese, powdered drinks and other consumables.

A more onerous restriction on companies is the quota for the number of locals they must employ. Almost a third of a company’s workforce (32.5 per cent) must be Bahraini, according to local regulators, although international companies can gain an exemption when they set up, and the long-term aim is to end the system of ‘Bahrainisation’ entirely.

Kraft, which was given a five-year exemption when it started up its plant, currently has a workforce that is 18 per cent Bahraini. Although Trevis says his firm employs locals whenever possible, he acknowledges that increasing that to 32.5 per cent by 2012 will not be easy. “We are going to have a bit of a challenge,” he says.

The economy as a whole is failing to get close to this target too. At the end of June this year, there were 460,352 foreign workers in Bahrain, according to the Labour Market Regulatory Authority (LMRA), while 138,665 Bahrainis were employed, or just under a quarter of the total.

The growth in expatriates coming to the country is slowing down, however. In the second quarter of 2009, the LMRA issued 27,665 new work visas, a 37.4 per cent drop compared with the same period a year previously. The annual rate of increase in the number of foreign workers was 16 per cent at the end of June 2009, compared with 18.8 per cent at the end of March. But while it may be slowing, this is still far faster than the 4 per cent annual growth in the number of locals in work.

One of the central aims of the government’s Vision 2030 reform initiative is for the Bahraini economy to provide more high-paying jobs for locals.

The most likely area they will find such jobs is the financial sector, which is the largest single employer in Bahrain and accounts for 27 per cent of its gross domestic product (GDP). The number working in this sector rose by more than 1,700, or 14 per cent, last year and 57 per cent of those jobs went to locals.

With 145 banks, 173 insurance companies and 49 investment firms, Bahrain’s finance sector is one of the most established in the region.

The economic troubles in nearby Dubai and among large Saudi conglomerates offer Bahrain an opportunity to restate its credentials. Unlike some other Middle East countries, the entire financial industry is regulated by the central bank, with the regulations set out in its rulebook and updated on a regular basis.

In February, the central bank issued a directive setting up a new regulatory framework for takeovers, mergers, acquisitions and share repurchase transactions, which now forms part of its capital market rules. The changes were made in part to enhance the image of Bahrain as a centre for raising capital.

It followed this in July with new regulations for the insurance industry, including a minimum qualification for representatives of insurance firms wanting to practice in Bahrain.

Such actions have been gaining plaudits from international observers. In early September, the International Monetary Fund (IMF) commended Bahrain’s “prudent macroeconomic policies and strong financial oversight, which have contributed to Bahrain’s robust macroeconomic performance and to the resilience of the financial sector”.

Statistics from the UN Conference on Trade & Development offer further reason for cautious optimism. Although the value of foreign investments in Bahrain was lower in 2007 and 2008 than in 2006, the number of projects in which international firms have invested is growing. In the first quarter of this year, 28 projects gained the backing of international investors, almost as many as in the whole of 2007.

Even if some large Saudi companies are forced to retreat from the market, it seems there are plenty of others willing to take their place.