‘The financial crisis awakened us to a sleeping time bomb with respect to poor management, bad corporate governance and no effective mechanism of corporate governance.’ So said Ahmad Shahab Din, president of the Malaysian Association of the Institute of Chartered Secretaries and Administrators.
For the Malaysian economy, the 1997 wake-up call was the equivalent of having a bucket of iced water thrown over you in the middle of a long and glorious dream about Asian miracles and tiger economics. The shock sent the capital markets reeling and a massive outflow of funds wiped more than 70 percent off the market capitalization of the domestic stock exchange.
Barely pausing to rub the sleep from their eyes, prime minister Mohamed Mahathir and his government swung into action, first choosing to point fingers at western peddlers of ‘hot money’ and then incurring their wrath by imposing capital controls on the markets.
Acknowledging the brouhaha that the IMF and other foreign devils were kicking up over corporate governance, they perfunctorily produced a Malaysian code of corporate governance before rearranging themselves around the time bomb, hitting the snooze button and drifting back to sleep.
Tick tick tick
Four years after the onset of the financial crisis, there are worrying signs that the sleeping time bomb has begun to tick. Since February of this year, the KL Composite Index has fallen by 22 percent. Foreign investors continue to shun Malaysia’s markets and local interest has also dwindled. ‘Malaysia as an equity market has been marginalized,’ says Jason Chong, head of research at Merrill Lynch in Kuala Lumpur. ‘If you look at the MSCI emerging market indices, Malaysia’s weighting pre-crisis was about 22 percent. Today it’s anywhere from 6-10 percent. Malaysia is not as important a market today compared to the early 1990s.’
Many believe that one of the reasons for the continuing Malaysian malaise is that little has been done by either business or government to address the fundamental flaws revealed by the crisis. The general perception is that standards of corporate governance remain low, accountability weak, and the rights of minority shareholders poorly protected.
According to a fund manager at a leading institution in Malaysia, when it comes to putting a price on a Malaysian company, corporate governance is definitely a significant factor. ‘We look at valuations but we also look at qualitative things,’ he explains. ‘We put an equal weight on management quality and integrity, liquidity, business franchise and shareholder value. When you put all that together, quite a lot of corporations don’t fare well. That has a lot to do with corporate governance.’
At the same time, a number of recent high profile cases have highlighted the government’s interference in the markets and a fault line of crony relationships. The IPO of TimedotCom is described by one research analyst as a listing that ‘breaks every rule in the book.’ When the public showed little interest in this newly created dot-com unit of the prominent Malaysian business, Time Engineering, the government plundered the state Employee Provident Fund to buy up the overvalued shares.
The government again demonstrated its generosity with taxpayers’ money in a M$1.67 bn (US$440 mn) bail-out of the wealthy Malay, Tajudin Ramli, from his investment in Malaysian Airlines System. Though the airline’s share price had halved under Ramli’s chairmanship, the government returned his investment in full but offered no similar deal for minority shareholders.
‘Investors have been disappointed with what the government has been doing with bailouts and public funds,’ continues our anonymous fund manager. ‘There’s no transparency. The government is so involved in the banking and corporate side that it has become difficult to invest money in Malaysia.’
If appearances are to be believed, things may be on the point of changing. The government has once again roused itself from its slumber and made moves to respond to the country’s troubled markets. The capital markets ‘Masterplan’, unveiled back in March, offers what’s described as ‘a roadmap for the future of Malaysia’s capital markets.’
The KLSE has also been busy producing new listing requirements on company disclosure that are in line with global standards. Annual reports are now required to provide statements on the state of internal controls and the extent to which companies have complied with the best practice of the Malaysian corporate governance code.
Back to school
Directors of listed companies must attend training programs prescribed by the KLSE and make additional statements in their annual reports detailing their responsibility in preparing accounts. Independent directors will be given greater prominence and board representation. Minority shareholder protection will also be strengthened. The new regulations expand on transactions with related parties and clamp down on inter-company loans. Though over 90 companies have admitted they would fall short of the new requirements, the response from the business community has generally been positive.
According to Edwin Wong, secretary-general of the Malaysian Institute of Corporate Governance and chief executive of BDO Governance Advisory Sdn Bhd, the attitude of many directors attending the mandatory training has been ‘refreshing’, indicating a willingness to change. ‘It’s a matter of experience. They’ve never really known what practical things were important for investors.’ Now, says Wong, there has been ‘a genuine realization that the paradigms they have aren’t quite high enough.’
Does this signify a paradigm shift for corporate governance in Malaysia? Will the new measures be the effective mechanism of corporate governance that defuses the ticking bomb? There are a number of reasons why people think not.
According to Wong, the issue isn’t whether companies will comply, but whether compliance will actually lead to improvements. ‘Everyone will comply because it’s easy to do so,’ says Wong. ‘It’s really just a disclosure-based requirement.’ A company could, in theory, disclose that it’s not doing much about corporate governance and internal controls. ‘If they disclose, then they’re in compliance but they may not be meeting best practice.’
Wong anticipates intense scrutiny of the KLSE’s response to this situation. ‘If a company continually chooses to disclose that it’s not doing anything, then the KLSE will be under tremendous pressure to do something. But what will it do?’
The KLSE chooses not to provide a direct response to that question, but a spokesman says that regulators had to allow due process in investigation and enforcement. ‘Due process does not mean slow or late. It means giving the affected party adequate opportunity to explain and taking into account all relevant factors,’ he adds. ‘With the revamped listing requirements, the KLSE’s power in investigation and enforcement have been substantially expanded to include directors, advisors and any other parties to the public listed companies.’
Disclose and be damned
With disclosure-based regimes the onus is on the market to act as regulator, but Wong believes that in Malaysia that may not be effective. A number of listed companies don’t depend heavily on the markets for financing and so aren’t too concerned about their image. While some rely on speculative retail investors, others are majority owned and controlled by wealthy families. ‘They see corporate governance as an additional cost of doing business and totally unnecessary,’ explains Wong. ‘Only the largest players that know they have to get foreign investors will change their practices.’
The fund manager agrees that a significant proportion of Malaysia’s listed companies are unlikely to be motivated by the new requirements to mend their ways. ‘Corporations that can get away with it really won’t care.’ He notes that many companies have abandoned the troubled equity markets and turned to debt for financing. Thus we may not see the impact of the new regulations until investors lose confidence in the debt market which, he predicts, could take a year or two. ‘Once you start to see defaults, that will scare a lot of investors into looking at credit risks, and they’ll shun anything on the risky side.’ Only when companies find they can’t get financing from equity and bond markets will they ‘face a wall’ and get serious about corporate governance.
‘It’s the same with the government and corporations,’ he adds. ‘They have to crash into a wall before they change.’
Politics as usual
The biggest question mark for the new regulations hangs over the government itself. Is Mahathir serious about enforcing the rules and tackling the cronyism that plagues the economy?
‘The crux of the issue is political will,’ says Merrill Lynch’s Chong. ‘Malaysia has ample rules and regulations and there have been continuous new guidelines and directives to improve corporate governance. The problem is enforcement. If you are politically well-connected, then you may get waivers.’
‘Malaysia is basically doing the right thing,’ he continues. ‘But it uses selective enforcement and loses a lot of credibility. Whatever good the authorities have done has then been undone.’
Such selective enforcement relates back to the government’s long standing New Economic Policy (NEP) aimed at improving the welfare of entrepreneurial bumiputras (indigenous Malays). ‘The government has spent the last 20 years trying to increase the wealth of bumiputras,’ explains Chong. ‘Mahathir is saying that we’re not going to let one financial crisis wipe out this pool of bumiputras which we have spent so long trying to build.’
Some argue that this policy has been pursued at the expense of the credibility of Malaysia’s markets. While with one hand, the government works to create a well-regulated, investor-friendly business environment, with the other hand it continues to defend and favor one sector of the economy purely on the basis of race.
‘A lot of companies in Malaysia are doing things to make themselves more attractive to investors, but it’s not working,’ says Wong. ‘We are putting in rules, and a lot of companies are abiding by them. But there are black sheep who say, I am not going to do it because if something happens no-one is going to touch me. Good companies operating within this system will find it hard to avoid being tainted.’
‘It’s difficult to say whether the [new regulations] will be applied uniformly or not,’ he adds. ‘We’ll have to look one year down the road to see whether there are recorded cases of non-prosecution or non-uniform prosecution.’ Unless the rules are enforced, he believes, the certainty that foreign investors seek will remain elusive. ‘We’ve had too many incidences of where officially we’ve said one thing and then done something else altogether, or we’ve done something good but the rule doesn’t apply to everybody.’
The KLSE spokesperson refuses to speculate on the possibility of political interference in the enforcement of the new requirements.
Wake up and smell the dynamite
Asia stands at a critical juncture. As the region’s governments wake up to the importance of corporate governance there is a genuine opportunity to do things better and restore the confidence of western investors in Asia-Pacific markets. But once-burnt investors will be looking not just for regulatory change, but for signs of more fundamental economic and political reform.
The implications for Malaysia are significant. Rhetoric aside, if the government continues to favor bumiputra protectionism over open and regulated markets, then investors will stay away. Genuine reform efforts by governments in Singapore, Korea and even China are being recognized by investors, but Mahathir’s attitude continues to keep them away. Malaysia risks being further marginalized, not just on a global level but on a regional level too. Recently ING Barings named it as one of just four Asian countries clients should steer clear of.
While Mahathir pays lip service to corporate governance, foreign investors will pay a premium for it in Asian markets. Some of Malaysia’s top companies are beginning to get the message on governance, but their efforts will be undermined by the political situation.
‘Investors are not looking at the companies any more, they’re looking at the country as a whole as a risk,’ observes Wong. ‘If you have political risk, you automatically have business risk. Criticism is not leveled at the stocks – investors are saying avoid the country. When that happens, it unfortunately punishes companies that are doing a good job.’
The fund manager, who remains as skeptical as he is anonymous, concludes, ‘Corporate governance comes from the top. We’ve been talking about this for a long time, but there’s obviously no will to change things. A lot of people were expecting the government to change – to try and promote professionalism. But it’s the same people doing the same thing. Nothing’s really changed.’
Even good regulations operate in a political context. The new rules will not work unless the government backs them with tough enforcement, creating an environment of certainty. ‘Malaysia is a country that is promoting things on the one hand but somehow demonstrating by its actions that it’s not quite there,’ says Wong. If the recent bailouts are anything to go by, the cronyism uncovered by the crisis is alive and well.
And the time bomb ticks on.
‘Corporate governance cannot be the end in itself,’ insists Wong. ‘You need certainty about rules, certainty that when you put your money in a company the rules won’t change overnight. If you have that certainty and corporate governance, it’s good. But if you have a whole set of rules and you’re still sending messages of uncertainty, then corporate governance is not going to work.’
Depositary Receipts
Stock exchange
The growing band of Indian DR issuers has received a boost after the New Delhi government agreed to allow ordinary shares to be exchanged for DRs and vice versa. The move should end price discrepancies between DRs and ordinary shares that develop when the supply of ADRs or GDRs decreases. Previously, if any DR investor canceled their shares, then the DRs would be automatically converted into underlying stock, often leading to a shortage of DRs and premium prices for the in-demand depositary receipts.
The government acted after receiving complaints from investors and companies that rules restricting the exchange of local stock for DRs were reducing the free float of DRs, making them difficult to trade. The new rules will not permit extra DRs to be issued in place of ordinary shares, rather the amount of ADRs or GDRs will be limited to the total number initially issued.
Foreign policy
New data released by the US Federal Reserve shows that US investor holdings in foreign equities (ADRs and local shares) hit $1.8 trillion in 2000, compared to $1.2 trillion in 1999. However, interest tailed off late last year, with overseas holdings falling a modest 3.8 percent in the final quarter.
The global market downturn triggered heavy selling of European, Latin American and Asian equities, the figures show, though defensive buying of UK, Dutch and Swiss stocks has been seen.
The benchmark Federal Reserve figures are seen as a good barometer of US investor confidence in foreign equities, which have performed poorly in recent months as global market conditions deteriorated.
