Tuesday, 18 June 2019

Under examination

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The uproar over of a landmark London listing for Indonesia’s Bakrie family has put the spotlight back on South-East Asia’s shaky reputation for corporate governance. There are, however, some small signs of improvement.

A worker inspects light bulbs installed on a Christmas lantern on sale along a street in Manila.

Source: Reuters/Cheryl Ravelo

A worker inspects light bulbs installed on a Christmas lantern on sale along a street in Manila.

North Asia has been hogging the headlines for corporate governance scandals in recent years, with a spate of accounting scandals in China and the fraud at Olympus Corp in Japan. The spotlight, however, is now turning back on South-East Asia.

The bitter battle between Nathaniel Rothschild and the Bakrie family for control of Indonesian coalminer Bumi PLC hurt minority shareholders and savaged investment portfolios. While the public showdown has ended for now, the stock price is still 78% off its 2011 high. The dispute has also underlined the gulf in corporate governance expectations between the UK and South-East Asia. Governance is improving in South-East Asia, but remains far from being as robust as international standards.

Accounting practices in well-regarded Singapore have also been called into question following Muddy Waters’ criticism of commodities trader Olam International, which took to the Singapore courts in an attempt to clear its name.

Such high-profile cases have prompted investors to look at corporate governance more closely. They underscore what is at stake for investors and the reforms needed to address the governance concerns and protect the interests of minority shareholders.

The fallout may also prompt companies with international ambitions to review their practices, as well as encourage governments to fine-tune regulatory frameworks.

Still, the development of corporate governance remains a slow process in South-East Asia.

“Whilst money flows from foreign investors into the region have accelerated, we don’t believe companies across the region have accelerated their applications of strong corporate governance models to their businesses,” said Gary Dugan, chief investment officer for Asia and the Middle East at Coutts. For Dugan, only shareholder pressure over a prolonged period of time can bring about significant changes

“That would require foreign investors to remain committed for the longer term to equity markets, such as Indonesia Philippines and Thailand, applying constant pressure for change.”

Often corporate governance issues are overlooked during the good times, only for companies to come under pressure when trading times are already tough. Foreign investors tend to vote with their feet. They sell their positions when corporate governance issues hit share prices, rather than sticking with their investment and pressing the company to change.

Although individual companies may choose to turn a blind eye, governments are sending the right signals. Indonesia recently passed regulations requiring higher corporate governance standards in the insurance sector.

Michael Horn, a partner at law firm Clyde & Co, said: “As these new requirements, generally, are viewed as codifying best practices that were already typical for the industry, the regulations are not likely to drive great change. The new rules will likely most impact investment governance and, from a foreign prospective, will have the immediate effect of bringing onshore all non-resident directors and commissioners.”

Otoritas Jasa Keuangan, Indonesia’s new financial services authority, appears to be strengthening the monitoring of corporate governance across the finance sector. The regulator is still new and will inherit experienced staff from other government agencies as it takes over those roles.

“It is too early to judge performance, but there is every reason to believe it can achieve its mission of operating with the highest professional standards, independent from influence,” said Horn. “That said, there will always be those attempting to exert influence.”

While regulations are important for a minority shareholder, such as Aberdeen Asset Management Asia, the quality of a company’s management team remains key for head of corporate governance David Smith.

“We would like to invest without needing the regulatory backstops to fight our causes. We much prefer to invest in a high-quality management team, whose interests are in line with ours as shareholders,” he said.

It means looking at how the company is being run in the interests of all shareholders, not just a small subset. The “institutionalising” of management practices, more formal internal controls and professional ways of managing balance sheets are all higher up on Smith’s checklist than valuations.

“There are a lot of companies that appear to be screamingly cheap, but, once you dig into the quality of the management, you may find the reasons why they are screamingly cheap,” he said.

In South-East Asia, a listed company may offer greater transparency relative to a private enterprise, but investors would also need to ask how well the listing rules are enforced, who enforces them and the quality of the regulation.

“There are certain key areas around the region on, for example, related party transactions, that are weak in some markets and that’s tremendously important to us. If we’re investing in a company with a high-quality asset, good business, we want to be able to enjoy the economic benefits of the asset without it being transferred to a related party,” Smith said.

A typical feature in South-East Asia is the prevalence of large, family-controlled business groups – an important pillar of many of the region’s economies. Family businesses account for around 50% of all listed companies and 32% of total market capitalisation, according to a the Credit Suisse Emerging Markets Research Institute survey covering 10 Asian markets, including Malaysia and Singapore.

As the family grows and the various businesses expand, a pyramid conglomerate emerges. In some cases, family control – where the patriarch and family board members take the major decisions and there is weak monitoring of the governance process – may mean greater risks for non-family shareholders.

Many companies have substantial family holdings and small free floats, and many have cross-shareholdings with sister companies.

“It is very difficult for the mindset of the company to change to be accommodating of the interests of minority interests when the dominant investor remains a family,” said Coutts’ Dugan.

For minority shareholders, who are the co-investors with the family, it means understanding the culture, history of management and governance practices of the partner.

“The question for us is about the dynamics of the family. Are they going to run the company for the good of all shareholders or are they just going to use the company after IPO as a piggybank to transfer wealth to the controlling shareholder?” said Aberdeen’s Smith.

“The way a company has treated minority shareholders in the past is usually a huge indicator of how they will treat minority shareholders in the future. That’s really getting to know the families, really getting to know their attitudes towards minority shareholders.”

Still, change may be forthcoming as patriarchs grow old and the next generations take over the businesses.

“Anecdotal evidence from my discussions with the first and second generations of Asian family-owned conglomerates suggests that internal developments are importance sources of change in corporate governance,” said Clyde & Co’s Horn.

The next generation

“More than once, I have heard that the foreign-educated third generation has returned from positions in New York and London with views that reflect governance principles common to some of the world’s top companies. Arguably, a stint at McKinsey or BCG may do more to change the way business is done than external pressures imposed by regulators.”

In addition to the presence of family business groups, another feature in South-East Asia is the dominance of state-controlled companies. This is a fairly different ballgame in corporate governance for investors. “Again, it’s challenging,” said Aberdeen’s Smith.

Risks associated with state-owned companies vary from country to country, and a country’s national interests may have an influence on corporate governance of the enterprises.

“There may be a requirement to do national service or helping out a state company in one way or another or doing something that may be good for the society rather than shareholders,” said Smith.

Although corporate governance and oversight have improved over the past decade, investing in South-East Asian companies still requires investors to put in the legwork to know what they are buying into and understand the risks.

More importantly for Dugan at Coutts, companies must appoint truly independent directors, who can exercise some authority at board level, to represent the interests of minority shareholders – an argument Rothschild put forward in his failed bid to replace the majority of Bumi PLC’s board of directors.

Dugan also maintains that audit committees need to have a majority of independent investors to ensure they truly offer an independent verification of best-accounting practices within the company. The rule of law must also back up good corporate governance practices.

Investors know, however, that no degree of oversight can offer full protection against a motivated executive.

“Even as listing rules improve, securities laws improve, there are still innovative ways that controlling shareholders can find to expropriate assets from shareholders around the region,” Aberdeen’s Smith said.

“It’s like home security, just because it’s useful doesn’t mean you will leave the door open.”

To see the digital version of this report, please click here.

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