Anda di halaman 1dari 86

ASIAN FINANCIAL REFORM AND CORPORATE GOVERNANCE DUALITY OF DEVELOPMENT1

World Bank-Japan East Asia Prospects Project International Steering Committee Meeting Shanghai 28 June 2002

87

I.

Introduction

My thesis is very simple: the historical dual-track mercantilist model of Asian development, a globally efficient export sector with highly protected domestic agricultural and service sectors, while successful in the past, is no longer sustainable in the New Economy. The Asian models of corporate governance and financial sector strategy have to change accordingly. In the World Bank, I coined the five key factors or Ps of financial markets. A financial market is all about People, trading financial Products across a process/Platform, under a set of Policy and Prudential framework. Now that I have had more experience in the securities markets and dealing with corporate behaviour, I like to analyze Asian financial reform issues in the four key functions of financial markets: I am grateful to Ms Lim Yam Poh for research assistance in preparing this paper, to Dr Geng Xiao and Ms Tan Gaik Looi for valuable comments and Ms Rosetta Chiu for secretarial assistance. The views expressed here are entirely the personal views of the author and not attributable to the Securities and Futures Commission, Hong Kong.
1

31

Asian Financial Reform and Corporate Governance Duality of Development

price discovery resource allocation risk management corporate governance

The financial markets can also be broken down into seven key Is factors: 1. 2. 3. 4. 5. 6. 7. II. information incentives issuers intermediaries infrastructure investors; and finally, I the regulator. Asian Policy in Financial Sector Reform

Asian policies in financial sector fundamentally and historically stemmed from its mercantilist approach to development. Given scarce resources and management skills, Asian policy makers took calculated but large bets in industrial policy, supplemented by mild financial repression to generate resources for development through an export-led growth policy, as the World Bank study on Asian Miracle demonstrated. Because Asian enterprises were initially weak, the export-led strategy selected key firms (either stateowned or politically connected families) to spearhead development in leading industries, such as iron and steel, shipbuilding and in recent years, electronic chips. These industries were fostered through a combination of direct grants, tariff protection and also cheap financing. Hence, the banking and securities sector were tightly controlled or guided towards backing the winners or priority sectors.
32

Asian Financial Reform and Corporate Governance Duality of Development

In North Asia, this gave rise to large industrial groups, such as Japanese keiretsus, Korean Chaebols and Chinese State-owned Enterprises (SOEs). In Southeast Asian economies, where industrial policy was not so obvious given their high natural resource base, state backing was generally for government-led companies (Singapore GLCs) or politically connected family led companies, such as Indonesia congloms. The state-enterprise nexus took different forms in different Asian economies, but by and large and to different degrees, a dual economy emerged. The export-led sectors, closest to global competitive forces, were the most efficient, with corporate governance standards to match. The more protected natural resources and services sectors were political franchises to give to favoured firms, backed by protective barriers to foreign entry. These vested interests explain largely why few of these inwardlooking firms or banks adopted international standards of corporate governance and many are still resistant to change. This basic dual nature of Asian policy thinking had huge implications on the shape of the Asian financial sector and the evolution of its corporate governance. As long as the duality exists, it will retard Asias migration into the New Economy. Resource Allocation Because of the export-led industrialization strategy, Asian dragons and tigers basically protected their banking systems, kept lending and deposit rates low to fund industrialization and infrastructure, without overly distorted resource allocation during the exportled phase. The result was a bank-dominated financial system. For example, Japanese households have 53% of their financial assets with the banks, compared with
33

Asian Financial Reform and Corporate Governance Duality of Development

11.4% for US households. Asian banking systems account for 80-140% of GDP in asset size, compared with only 60% of GDP for the US banking system. In other words, too many resources were concentrated in the banking system, and if it allocated resources inefficiently (through non-performing loans), then the high level of Asian domestic savings was actually wasted. This was exactly what happened during the Asian asset bubble. The Asian crisis economies spent as much as 50% of their GDP to resolve NPLs. In some economies, this inefficiency has neither been fully recognized nor written off. By and large, Asian policy makers did not like to encourage their domestic savers to invest abroad because this would reduce their source of cheap funds. This derived from the mercantilist policy, which can be called a fish-trap mentality. We like money to come in, but we do not like capital to flow out. As can be seen later, this mentality, which may not have been wrong during the early stages of development, had huge consequences for efficient resource allocation, price discovery, risk management and corporate governance. Price Discovery The dual nature of the Asian economy meant that domestic prices did not always reflect internationally competitive supply and demand conditions. While this was feasible in early stages of international trade, when transactions cost of goods, services and information were high, this cannot be sustained in a WTO and Internet world, where such transaction costs are coming down rapidly. Arbitrage in the New Economy is happening very fast, as domestic

34

Asian Financial Reform and Corporate Governance Duality of Development

consumers have global choice of suppliers of goods and services. This is particularly clear in the financial system, as can be demonstrated from two sets of Asian prices, interest rates and securities prices. Because of the fish trap mentality, excessively high domestic savings on top of the inflow of foreign funds when securities markets were opened up, led to domestic asset bubbles, particularly where there was rigidity in local planning and land use laws. Excessive liquidity did not lead to high inflation in consumer prices, because most of the food and consumer durables were at internationally competitive price levels. Asian policy makers, who were basically financially and fiscally quite prudent, understood that in order to keep the domestic labour force happy, you needed to keep key consumer supply prices stable, and this was achieved not through subsidies, but supply side efficiencies. However, in many service sectors, there was protection, but such inefficiencies did not show up in the CPI, but rather through NPLs. As I have said elsewhere, Asian bank restructuring policies are currently doomed to failure if the credit risks are not priced correctly. Currently, Asian banking spreads [lending rate minus deposit rate and administrative costs before bad debt provision] are between 1.5% to 2%, but Asian non-performing loans (NPLs) are between 10% to 50% of the banks books. Clearly, many Asian banks cannot clean their NPLs through their own cash flow. If the cost of funds is excessively low, it is likely that the borrowers will waste their usage. Property
35

Asian Financial Reform and Corporate Governance Duality of Development

developers found that they could borrow very longterm funds at cheap rates, leading to a self-fulfilling asset bubble. The more the banks were willing to lend for property, the larger the bubble. Similarly, in the stock market, Asian PE ratios [with the exception of Hong Kong and Singapore] have tended to be high. There are structural and policy reasons why the PE ratio in Asia tends to be high. First, the float in public hands tends to be low, either because it is held by families, or by institutions that are within industry groups. In Japan, institutions, such as affiliated companies, insurance companies and pension funds, hold the bulk of equity so that these cross-holdings ensure that control is kept within the same keiretsu or conglomerate. Secondly, high PE ratios would insulate the Asian corporations from being raided by foreign multinationals cheaply. Asian companies tend to be much higher leveraged than their US or European competitors. The high leverage means that with a smaller equity base, the majority shareholders retain their control without seceding power to minority shareholders. Risk Management Financial systems are supposed to distribute risks of the real sector. However, with a dominant banking system, too many risks are absorbed in the banks. Moreover, since the banks have low capital adequacy ratio, the ultimate risks in Asia are absorbed by the implicit or explicit deposit insurance schemes. In essence, Asian banking system suffers from inherent moral hazard.

36

Asian Financial Reform and Corporate Governance Duality of Development

Moreover, fish-trap mentality was bad risk management. By keeping savings in domestic markets, Asian policy makers were concentrating risks, rather than diversifying them. The principle of risk diversification is to distribute the portfolio in assets that are negatively correlated with each other. Thus, the best way to diversify out of a domestic economy is to invest in foreign investments. The late de-regulation of exchange control and rules allowing Asian investors to invest abroad meant that retail investors were not able to diversify their risks in the event the domestic market declined. Corporate Governance The price and resource allocation distortions described above are a manifestation of the failure of Asian financial markets to evolve as an important check and balance on domestic corporate governance. Indeed, transparency and accounting practices worked against improving corporate governance. Trade protection and non-tariff barriers against investments by foreign strategic investors prevented weak companies from being taken over and restructured. Asians have tended to resolve problems by internalizing losses through mergers of failing institutions. For example, banking problems were solved initially through mergers and consolidation into larger banks. But the management problems that gave rise to financial failures were not addressed. Poor accounting standards also hid the scale of losses. Asian banks also did not apply generally accepted Basle loan classification standards in accounting for non-performing loans. The result was that the true extent of Asian NPLs has always been debated between market analysts and the authorities.

37

Asian Financial Reform and Corporate Governance Duality of Development

The historical legacy of dominance by SOEs or closelyknit bank-corporate relationships, meant that generally there was insufficient protection of minority rights for investors in Asia. This is beginning to change. Currently, institutional investors are either domestic, which have close relationship with the companies, or foreign fund managers, who are less interested to put pressure on companies they invest in to improve corporate governance. Consequently, the internal and external pressures for change at the management level have not that been strong. Many succeeded by seniority or family/political connections and not necessarily by merit. Although the export business was kept vibrant and highly productive by their exposure to international competition, the bulk of the non-trade business primarily agriculture, business services, construction and real estate were highly inefficient with poor corporate governance and transparency. These inefficiencies do not necessarily show up as bankruptcies, but as NPLs in the banking system. III. The Three Disciplines

Good corporate governance is like a three-legged stool of key disciplines. First of all, we rely on the management or controlling shareholders to exercise self-discipline. This works when the controlling shareholders or management are highly ethical and treat minority shareholders fairly. But if the morality and ethics are lacking, and when the internal checks and balances, such as independent board committees, internal and external audits, and the transparency of disclosure do not function well, then you need outside forms of discipline.

38

Asian Financial Reform and Corporate Governance Duality of Development

This is where regulatory discipline comes in. Regulatory discipline requires not only clear rules and regulations, but also good enforcement. But self-discipline and regulatory discipline are not enough, without market discipline. Companies, when protected from competition, may develop cartels or monopolistic tendencies that do not treat consumers or investors fairly. These may deter foreign or minority investors from entering the market when they perceive that they are not treated equally. Market discipline comes from two inter-related forces, market competition and global standards (1) To compete globally, the market demands professionalism and more effective management models. Previously protected industries will have to meet challenges from international competition and have to meet global standards of quality, code of conduct and accounting and disclosure rules. Greater transparency to global standards will force the enterprises and their management to greater accountability. In well-functioning markets, the markets assessment of corporate performance is reflected in the prices of equities and bonds. Corporations that fail the test could find difficulty in raising new capital, and eventually be competed out of the market.

(2)

Good corporate governance requires all three disciplines to keep the checks and balances for healthy companies.

39

Asian Financial Reform and Corporate Governance Duality of Development

Let me now dissect Asian financial sector and corporate governance issues into the seven I factors. The first I is information. Accurate, timely and accessible information is a market fundamental. To have good information, you need to have international accounting standards (IAS) and good auditing standards. Enron, which is currently the largest corporate failure in history, has demonstrated clearly that without good information and good checks and balances, large companies can fail even in the best of regulated markets. But Asia was slow to adopt rapidly international accounting and auditing standards, and even after the Asian crisis, implementation or adoption of such standards, including the loan classification standards, has been relatively slow. Without good information, banks have not been able to exercise good credit culture and discipline. Management cannot exercise good risk management and decision-making and investors cannot exercise market discipline on the companies they invest in. The second I is incentives. Currently, Asian incentives are skewed because of the inherent moral hazard of dual economy policies to protect depositors, protect domestic industries and reluctance to pay for the job. For example, civil service salaries and salaries of many state-owned or even familydominated companies are not yet commensurate with the risk-reward structure of markets. For markets to function well, the incentive structure must be evenly matched. If the risks and rewards are imbalanced, the markets will be distorted by greed without the fear of the risks of failure. Underpaid bureaucracies do not
40

Asian Financial Reform and Corporate Governance Duality of Development

have the incentive to enforce laws that protect property rights. Underpaid bankers engender NPLs. Egalitarian pay policies do not encourage innovation and competition, resulting in talent leaving for foreign companies. Addressing the incentive structure is one of the most challenging of tasks in the Asian reform process. The third I is the Investor. The investor benefits most from globalization because of global choice. Currently, retail investors in Asia are not well educated. They have not been discriminating and have not exercised more discipline on the corporate governance of the issuers. Ignorant and uneducated investors can easily be cheated or be persuaded to invest in risky or bad assets by poor quality intermediaries or bad issuers. Investor education is clearly very high priority for promoting investor protection. The fourth I is intermediaries. The trend in international finance is that the wholesale and retail business will be more and more dominated by 10-20 large complex financial service providers, covering the whole range of insurance, banking, fund management and risk management. Asian financial markets generally face the following problems Financial markets are too bank-dominated. Lack of strong credit culture leading to inefficient capital allocation. Stock markets tend to be speculative and have not been very successful in providing funding for small and medium enterprises (SMEs). Too few incentives to compete in a protected environment leading to an inability to properly handle risks.

41

Asian Financial Reform and Corporate Governance Duality of Development

As Asian financial sectors open up, competition from foreign intermediaries will result in some domestic intermediary failure or the crystallization of their inefficiencies through large NPLs or losses. On the positive side, qualitative changes will arise from the emergence of a greater pool of foreign trained investment bankers, fund managers, lawyers, accountants and other service providers operating more and more to international standards. The higher the quality of intermediaries, the more the financial regulators can rely on the market to exercise discipline on the market participants. The fifth I is issuer. The quality of a market is determined by the quality of the companies that raise capital from the public. At the end of the day, they have to provide an appropriate risk-adjusted rate of return to investors. The first and foremost persons responsible for the quality of a company are its management and controlling shareholders. They set the standards of ethics and performance that the company is judged by. Currently, Asian family-led companies and SOEs are having problems re-organizing their management structures to compete effectively against non-Asian competitors. US management in particular have evolved matrix management styles with the use of technology to facilitate flexible and rapid response to market needs. As Asian enterprises compete globally, they will be able to have global reach and also tap global capital. But to do so, they have to learn to play by global rules of conduct, including standards of transparency and corporate governance. In practice, the benefits of opening up more to globalization would be limited in Asia if there is continuing local protectionism, fiscal favouritism, and
42

Asian Financial Reform and Corporate Governance Duality of Development

barriers to entry, complex ownership structures and insufficient disincentives against the expropriation of minority shareholders. Unless there is a change in mindset, the potential for Asian economies to benefit fully from global standards and processes would be constrained. The sixth I is infrastructure. The financial infrastructure comprises the platform and processes to ensure that markets function in an orderly and robust manner. It must also have a legal framework and efficient and fair judiciary that protects property rights of market participants. Asian financial infrastructure currently reflects the protective nature of the dual economy. This results in fragmented systems, without critical mass in technology and which are still subject to large operational inefficiencies and risks. The quality of the infrastructure determines the size of the operational risks. It can also determine the quality and efficiency of financial services, since important checks and balances are normally built into a worldclass trading, payment and settlement systems. September 11 has shown so dramatically the importance of good back-up systems and contingency planning. Last but not least, the quality of markets must depend on the quality of I, the regulator, and the regulatory framework. Because of the need to protect domestic intermediaries, Asian regulators have been accused of over-regulating and underenforcing1. Dealing with very inefficient domestic intermediaries in the face of rapid external
Corporate Governance Development in The Greater China: A Taiwan Perspective, by Lawrence Liu, November 2-3, International Conference at Hong Kong University Law School. PRNews Asia at http://prnewsasia.com/china
1

43

Asian Financial Reform and Corporate Governance Duality of Development

competition, with major pressures to bring domestic regulatory standards to global levels, is extremely demanding. IV. Where do we go from here?

It is necessary to consider the question of financial reform and corporate governance in Asia in the context of the New Economy. Part of this process entails an analysis of how technology is changing markets and society, and how the financial sector in Asia needs to adapt to protect investor rights through more efficient financial markets and better corporate governance. What is the New Economy2 all about? Financial markets can be likened to networks. The global network is a patchwork of local networks that have not been designed to operate on global capital flows. The combination of technology and entrepreneurship has re-written the old order, eroding old franchises and elites and creating new structures where the rules are as yet unclear. Technology is changing markets and society so fast that no one can claim any defining insights into the future. The overall effect of technological advance on investor rights is also unclear. Information, and hence knowledge, is a fundamental market requirement. Information is costly to produce, but through technology, it can be replicated and disseminated at very low
J Bradford Delong and Lawrence H Summers, The New Economy: Background, Historical Perspective, Questions, and Speculations, Federal Reserve Bank, Kansas City, 2001 Jackson Hole Conference material.
2

44

Asian Financial Reform and Corporate Governance Duality of Development

marginal costs. New entrepreneurial and market institutions are using technology to flatten structures to replace old hierarchical structures. This is achieved through empowerment of the consumer, worker, investor or manager and the institution of global standards. The social costs of downsizing obsolete and inefficient Old Economy institutions and labour force will be large. Policy makers will have to manage this in a socially stable manner, without provoking excessive protectionist measures and not killing innovation and ability to compete in the New Economy.

Network economies of scope and size3 means that those first to achieve global name recognition [branding] obtain winner takes all dominance. Liquidity begets liquidity, marginalizing the smaller players. There will therefore be greater pressure for protectionism. There will be shorter industry life cycles. Technology changes so fast that a monopoly in an industry can be shortlived, particularly as the industry becomes obsolete when rival technology emerges. Enterprises will therefore have to reorganize their own management structures to meet challenges for global competition. These trends and issues should lead to profound changes in how policymakers should act to provide for property rights, institutional frameworks and the rules of the game that underpin a market economy. Globalization of

Hal R Varian, High-Technology Industries and Market Structure, 2001, Jackson Hole Conference op cit.
3

45

Asian Financial Reform and Corporate Governance Duality of Development

capital markets is already a reality, but laws and regulatory frameworks are still national in scope and mindset. The design of national incentive structures and risk management will have to fit the New Economy model. Since change is so rapid and complex, social or system stability will therefore depend upon the ethics or knowledge foundations of the individual. In other words, investor, consumer or mass education will ultimately be the key to market or social stability and sustainability.

In particular, technological advancement can make more information available, and faster, and in greater quantity, and to more people. Much depends on the quality of information and the ability of investors to digest this information4.

Issuers and intermediaries may have incentives to distort the quality of information in order to raise stock prices. Intermediaries in turn may rely on companies for information. Some of them may also have incentives to suppress or distort information for their own interests. The marginal investor being less experienced and less sophisticated, will be less able to derive fundamental security values from raw information. Inevitably, the New Economy forces a major re-think of policies to grapple with issues of corporate governance and competitiveness within Asia -

Gene DAvolio, Efi Gildor, and Andrei Shleifer, Technology, Information Production and Market Efficiency, , in particular, page 132, 2001, Jackson Hole Conference, op cit.
4

46

Asian Financial Reform and Corporate Governance Duality of Development

How laws and regulations can properly prevent corporate insiders whether managers or owners from expropriating minority investors and from distorting information. Thus, the regulatory and institutional structure essentially the incentive structure must be designed in such a way that trust is rewarded and fraudulent acts are punished. The role of education at all levels for investors, managers, intermediaries, regulators and policy makers to enable them to function and compete in the New Economy. For the regulatory framework to be trusted, there must be a level playing field, and that the rules of game are by and large global rules according to global standards of conduct. Of course, not all standards are as yet global by consensus or by legislation. As Nobel Laureate Joe Stiglitz pointed out, the greatest value added comes from re-engineering global information and standards for local use. Those who succeed will benefit. Those who refuse to do so are likely to be competed out of business. Addressing obsolete policies and institutional structures, where vested interests resist new entrepreneurial and market institutions and opening up to competition, or which are involved in the capture of the decision-making process. Revisiting the historical dual-track mercantilist model of Asian development. This is no longer sustainable in the New Economy. Economies and entrepreneurs not geared to join the New Economy are less and less able to access either private or official capital without large spreads or additional conditionality.

47

Asian Financial Reform and Corporate Governance Duality of Development

In short, the current Asian models of corporate governance and financial sector strategy have to change.

Andrew Sheng 28 June 2002

48

THE FUTURE OF CAPITAL MARKET DEVELOPMENT IN EAST AND SOUTH EAST ASIA

88

10th SEC Thailand Anniversary Seminar: How Can NBFIs Play a Greater Role in a Bank-based Economy Bangkok, Thailand 6 September 2002

First of all, allow me to say my warm congratulations and thanks to Dr Prasarn and all members and staff of the Thai SEC on the occasion of their 10 th anniversary. There is an old Asian saying that it takes ten years to grow a tree, but a hundred to grow man. Of course, in todays language we do not use the word man, we use the word person as man or woman. And secondly I think obviously by man we mean institution. Ten years actually is very young in the life of an institution but ten years is a very important landmark. On behalf of the Hong Kong Securities and Futures Commission, I would like to say how much we have admired the growth and maturity of the Thai SEC under the able leadership of Secretary-General Prasarn. His standing and the Thai SECs standing in IOSCO is exemplified by their Chair of the IOSCO Emerging Markets Committee, even though for a short time. The depth of the ability, professionalism and tact of the Thai SEC was very well-demonstrated at the May 2002 IOSCO Annual Meeting in Istanbul when Dr Prasarn unfortunately could not be present at the final
49

The Future of Capital Market Development in East and South East Asia

Plenary Session. I could still remember how Ms Tipsuda very ably stood in front of this huge audience and delivered the message wonderfully and clearly on behalf of Dr Prasarn, showing how much has the work of the Emerging Markets Committee been carried forward under the leadership of the Thai SEC. I would also like to thank my good friend Michael Pomerleano and World Bank for co-sponsoring this excellent conference. This is the 10th Anniversary not only of the Thai SEC but ten years since I have known Mike, and in fact nearly 10 years since I left the World Bank. I think it is a good occasion to celebrate both the Thai SECs perspective of capital markets as well as the World Banks. I am also really grateful for Dr Prasarns invitation for me to be here to be amongst old friends like Chairman Herwidayatmo (Indonesia Bapenas), Lilia Bautista (Philippines SEC), Alan Cameron and also the highlyrespected Khun Chavalit, former Governor of Bank of Thailand, who was my model central banker in the 1980s, when I was then a young central banker. The theme of this Conference is very important because it talks essentially about a bank-based system. What I really want to do this morning is to give an overview of where capital markets in Asia are today. But I want to make this important caveat. You should never listen to securities regulators talk about the future. Securities regulators always understand you can never talk about the market because everything they say is market sensitive. The views that I express here are totally personal with no connection whatever to any organisation that I am associated with. I want to express my views as an

50

The Future of Capital Market Development in East and South East Asia

institutional economist, rather than as a securities regulator. Asian Capital Markets Today Where are our capital markets today? Specifically, how has Asian growth strategy shaped our financial systems? How have our financial markets performed their four key functions of resource allocation, price discovery, risk management and corporate governance? How has the global environment changed our Asian financial markets? And finally the important question: What conditions are required for regional integration? You cannot look at the future without looking at the past and the present. The really interesting feature is that, given the fact that Asia accounts for more than half of mankind, more than one quarter of global exports, one third of global GDP, how is it that we only account for 16% of global equity market capitalisation? In fact, if we exclude Japan, the whole of Asia is only 7% of global market capitalisation. This is amazing. If we really look at the MSCI weighting of market capitalisation (Table 1), calculated on a free float basis, the share of Asia in the MSCI weighting is in fact only 13% not 16%. Our share in global market capitalisation is shrinking, compared with US MSCI share of 55%, EU 17% and others 14%. Asia has one of the highest savings rates in the world. We have a current account surplus and more than US$1 trillion in foreign exchange reserves. Yet we are the biggest importer of capital, including foreign direct investments (FDI) in the world. According to BIS statistics, we account for one quarter of daily global FX
51

The Future of Capital Market Development in East and South East Asia

trading. Given our economic strengths, we are still dependent upon Europe and America as engines of growth. There are no strong signs that we have been able to develop our internal growth engines.
Table 1:

Asia in Global Economy (GDP, % of world, 2001)


PPP-GDP 7.3 3.3 12.1 4.7 5.4 32.8 21.4 19.9 25.9 100.0 Exports 6.0 9.4 4.0 0.9 4.5 24.8 13.6 37.7 23.9 100.0 Population 2.1 1.3 21.0 16.7 14.5 55.6 4.6 6.2 33.6 100.0 MSCI Weighting 9.38 1.82 0.26 0.12 1.57 13.15 55.30 17.14 14.41 100.00

Japan 4 Tigers China India Other Asia * Total ASIA * US EU Others TOTAL

*Excluding Australia and New Zealand Source: IMF, World Economic Outlook , April 2002

Table 2 demonstrates that the Asian financial system is still bank-dominated. Every banking system in Asia amounted to more than 100% of GDP in asset size, including India. With the exception of Hong Kong and Singapore markets, which are basically financial centres, the rest of Asia has equity markets that are significantly smaller and bond markets that are relatively small with the exception of Japan.

52

The Future of Capital Market Development in East and South East Asia

Table 2: Asia still Dependent on Bank

Financing (% of GDP)

China Hong Kong India Japan Korea Singapore Taiwan Thailand Germany US

Bank Assets Equity Market Bond Market 1998 2001 1998 2001 1998 139 160 25 45 12 214 215 206 313 32 69 133 24 26 21 145 139 64 55 101 233 233 35 46 53 220 243 112 135 20 226 262 97 104 41 176 134 30 32 23 273 65 155 63 51 158 58 136 97 141

2001 28 28 28 153 67 41 20 39 90 148

Rem ark: *1999 figure Sources: FIBV, CEIC, Bloomberg, various central banks and gover

nment websites

What has shaped East Asias financial structure? Finance is a derivative of the real sector. Financial strategy is a subset of overall economic strategy, and Asian economic strategy, if you have read the 1993 World Bank book on the Asian Miracle1, was essentially a mercantilist growth strategy. Essentially the strategy adopted up to the 1980s shows growth pursued through pushing exports. This was financed by a mild financial repression of the financial sector in order to mobilise resources to support the selective export manufacturing drive, and protecting the domestic natural resources, services and financial sectors. In doing so, and because of this financial repression, the banking system was protected in order to mobilise the bulk of savings, with certain guided lending to priority sectors at subsidised or lower than market interest rates. Of course, since the 1950s and 1960s, this old model has been changing, and changing very fast. But by and large the strategy and the mindset
World Bank (1993), The East Asian Miracle: Economic Growth and Public Policy. (New York: Oxford University Press)
1

53

The Future of Capital Market Development in East and South East Asia

have not changed. In Asia, we have what I call a fishtrap mentality in fund flows. We love money coming in but we dont like money going out. This is quite natural. We like to buy and we never like to sell. But this means that if there is too much money flowing into a domestic economy without compensating outflows, you end up with an asset bubble. For example, if we really look at our stock markets, it is very short-term speculative and we almost have no foreign listings in our domestic market. Asian stock markets are essentially national stock markets. Even in Tokyo today, the largest of the Asian equity markets, there are much less foreign listings than at the height ten years ago. Moreover, because the corporate sector is state-or family-dominated, corporate governance behaviour basically reflected that ownership structure. I always like to go back to basics and ask what is a capital market for? Allow me to compare Asian capital markets against the four major functions of financial markets Resource Allocation, Price Discovery, Risk Management and Corporate Governance. The first is to make sure that the savings are channelled efficiently to the users of savings, i.e. the borrowers and direct investors. As we can see, we have too much savings locked in the banking system. Because too much funds are locked up in the banking system, as the Asian crisis has shown, the result was a lack of credit culture, too much collateral-based lending, and too much excess liquidity that, coupled with a fishtrap mentality, created the classic asset bubble. Many of us are currently still paying the price of that asset bubble. What do non-performing loans (NPLs) represent? The Asian crisis cost the crisis economies as much as 50%
54

The Future of Capital Market Development in East and South East Asia

of GDP in rescuing the problem banks. This means that scarce domestic savings have been unfortunately wasted in inefficient investment. Post-Asian crisis, everybody agrees that we must develop deep and liquid bond markets, deepen equity markets, create derivative markets, diversify risks from the banking system, and impose greater market discipline on the intermediation of savings. Why hasnt this happened faster than we all would like to see? Part of the answer lies in the problem of price discovery. Because of capital controls and supply distortions, domestic fund prices get somewhat distorted from efficient market clearing. The interesting point is that this fish-trap mindset does not result in inflation because Asian economies are very open to trade. Asia is very efficient at the trade in consumer goods side that give rise to stable consumer prices at global prices. But the lending guidelines to priority sectors, listing guidelines and exchange controls of one form or other, meant that interest rates have been much lower relative to the credit risks and even the stock market PE ratios have tended to be speculative and high rather than reflective of the underlying overall earnings trend. If the Asian crisis showed that we had up to 50% nonperforming loans in some economies, how come the interest spreads loan rate minus deposit rate minus the administrative costs do not reflect that credit risk? And after the bank restructuring, why do they still not reflect the credit risk? This is a very important question we need to answer.

55

The Future of Capital Market Development in East and South East Asia

The listed corporate earnings yield is equal to 1/PE ratio. If the earnings yield is excessively low relative to a risk-free asset like a government bond, something is wrong. There is a price distortion somewhere. Why is there no risk premium or equity premium over and above a risk-free government bond? This distortion is partly due to the restricted free float of shares as major shareholders (state or families) liked to have high leverage and therefore control the shares tightly in order to prevent takeovers by other parties, including foreigners or competitors. Add to this bank herding into property with cheap loans fuelled the property asset bubble. Secondly, as you are aware, the bond spreads in Asia before the crisis never reflected the bond credit risks. During the Asian crisis there was an overshoot of bond spreads when bond spreads rose as high as 800 basis points over equivalent US Treasuries. But today the bond spreads are even lower than pre-crisis even though we know there remain many structural and risk issues in Asia. For example, PE ratios remained around 80 in Japan, as the Nikkei 225 plunged from a peak 38,000 to around 10,000 today. China PE ratios peaked around 60, declining to 30+ today. The point that I really want to make is that such price levels are due to the quantitative distortions. Such mispricing means that if we are not careful the large domestic savings could be wasted in channelling towards inefficient investments. The third point is all about risk management. Ten years ago I wrote a paper with Prof Yoon Je Cho at the World Bank comparing Ghanas growth with Malaysias growth2. The paper pointed out that in the globalised
Andrew Sheng and Yoon Je Cho (1993), Risk Management and Stable Financial Structure, World Bank Financial Policy and Systems Working
2

56

The Future of Capital Market Development in East and South East Asia

economy today, developing economies, including large economies, need to have national balance sheets and an overall national risk management strategy. You cannot have the left hand taking risks that the right hand does not know about. Given global volatility in terms of trade or financial shocks, you have to have a strategy to manage national risks. It goes back to the old development economies debate in the 1960s of balanced growth versus unbalanced growth3. If you adopt a mercantilist approach, you are going for unbalanced growth. You are taking calculated risks in pushing growth in one direction. If you are not careful and you dont manage these risks well, you pay for it. Bank-dominated systems with high NPLs and low capital base carried high moral hazard risks because of implicit and explicit deposit insurance. If we realise that we need to develop all these derivative markets to spread the risks, why did we not spread these risks? The answer is, if you have a fishtrap mindset, it runs counter to the Modigliani-Miller Theorem that tells you to diversify your risks into an asset that is negatively correlated with your domestic assets. These are clearly foreign exchange assets. If you put all your eggs into a domestic basket, if anything happens to the domestic economy, your people suffer from it. In the 1960s and 1970s, Malaysia diversified its assets into foreign assets, and diversified its production from just natural resources to manufacturing, petroleum, palm oil etc. Malaysia diversified and was therefore much better able to cushion global trade shocks than Ghana. You will
Paper WPS1109, March. 3 See Gerald M Meier, Leading Issues in Development Economics, Oxford University Press, 1964, - Growth-Balanced or Unbalanced? pp250-266 57

The Future of Capital Market Development in East and South East Asia

remember that in the 1960s, Ghana with gold and cocoa was one of the richest economies in Africa. Malaysia at that time was totally dependent on rubber and tin exports. Both economies were subject to highly concentrated terms of trade shocks. A risk diversification strategy would allow an economy to cushion global trade and financial shocks. The world is still suffering from such shocks today. Shocks from one part of the world are being transmitted to another part of the world through trade and financial links. Consequently, we should have a national risk management strategy, not just at a sectoral level but at the national level, and of course larger net foreign exchange reserves. Allowing domestic residents to invest abroad spreads the risks. This comes back to Professor Mukul Ashers point about insurance funds or pension funds also being allowed to invest abroad in order to spread their risks. This is because if you crowd all your pension investments in your domestic economy and if your domestic economy is yielding only 0.5% to 2% per annum, when real growth in a foreign currency asset is earning 4-5% per annum, then actually you are taxing your pension-holders by the opportunity cost of higher yields and lower risks in holding high quality foreign assets. As the Cho-Sheng paper indicated, diversified economies grow faster and more stably than highly concentrated economies. If you have a domestic financial crisis then the pension fund (by implication, retiring investor or next generation) also suffers together with everybody else. So having a choice of financial instruments and markets and the participation of different types of specialist market intermediaries are extremely

58

The Future of Capital Market Development in East and South East Asia

important in the national strategy to improve asset allocation and in hedging market risks. The fourth issue is all about corporate governance. We all know that financial markets, because they transmit information to investors, should allow investors to price the quality of corporate governance as well as the quality of assets in the company. Financial markets should reinforce corporate governance. If a company is doing badly, its share prices fall indicating investors are not satisfied with corporate performance. Why is it that Asian capital markets do not appear to reinforce corporate governance? It is clear that post-Asian crisis we need to improve accounting, we need to begin to privatise SOEs, and we need to disentangle corporate-bank relationship which has traditionally marginalised minority shareholder interests. Moreover, domestic pension funds and Asian institutional investors have close links with corporations, while entry barriers to foreign strategic investments protected companies from takeovers/restructuring. Furthermore, Asians prefer the strategy of merger of failing institutions rather than liquidation or opening up to foreign participation. These factors limited the ability of investors to impose corporate discipline. All these mean that Asian corporate governance is not as strong as it should be. What is corporate governance? Corporate governance is actually three key disciplines selfdiscipline, regulatory discipline and market discipline. Asia has traditionally focused very largely on selfdiscipline and regulatory discipline. But if you protect against competition by various ways and means, you dont allow the market discipline to ensure that the
59

The Future of Capital Market Development in East and South East Asia

prices reflect the risks and that the resource allocation is efficient. So it is extremely important that you allow all three disciplines to work. Each country must tailor their own corporate governance framework because corporate governance cannot be divorced from the domestic cultural, historical, legal and institutional background. But you have to understand that the existence of self-discipline, regulatory discipline and market discipline is universal. It is a question of what combination of discipline is used to improve corporate governance. So what does globalisation now mean for the Asian economy in this post-mercantilist environment? What does globalisation truly mean? Globalisation really means that domestic financial markets which are networks are being linked with every other national network to form a global financial network. The Asian crisis demonstrated very clearly that the global network is only as safe, as risky, as the weakest link in that network, which sometimes happens to be a domestic network. When one part of that network blows a fuse, the whole network malfunctions. What we are now seeing globally is that the network effects are growing. Liquidity begets liquidity because liquidity will move from smaller markets to bigger markets as bigger markets offer deep liquidity, higher efficiency, greater economies of scale, lower transactions cost and perhaps better rules that protect the minority shareholders. So if we are not careful, there is a real danger that globalisation is being imposed on us whether we like it or not. First, it is being imposed by technology because telecommunications are getting better. Secondly, under WTO and IMF rules, there is continual peer pressure on financial opening and adherence to global standards. So its only a matter of time that a
60

The Future of Capital Market Development in East and South East Asia

domestic economy must begin to open up to foreign trade and finance. Globalisation marks domestic prices to global prices. If domestic prices are higher than world prices, this shows up in the national balance sheet as a loss. This loss is an economic loss, not always recognised in accounting terms. At the corporate level, these networks are linking together. What is a bancassurance company? It is the banking network linking with the insurance network and the asset management fund network to form a very large supermarket network for financial services. Globalisation means that consolidation is happening in the financial sector, mergers are happening, and liquidity is being improved4. At the exchange level, exactly as Alan Cameron, Jeffrey Carmichael and Michael Pomerleano had discussed in an earlier session in this Conference, there have been vertical and horizontal consolidations in order to extract greater efficiency, better safety, better infrastructure and greater competitiveness. Accenture has estimated that if they are able to integrate the EU securities market, back-office savings alone is US$1 billion annually. Back-office cost by the rule of thumb is sometimes four times the front-end trading cost for securities trading. Consequently, there are huge efficiency gains for exchanges to merge or consolidate. If this is happening in Europe, as it has already begun to happen in America, what is happening in Asia? Essentially, we are now working in a global three time zone market. New York accounts for 50% of global market trading, with US$12.8 trillion market capitalisation. Some Latin American shares are
Andrew Sheng (2001), Securing the Third Zone of the Global Markets. Speech at the ASAF 2001 Conference (Hong Kong, 3 December)
4

61

The Future of Capital Market Development in East and South East Asia

migrating to New York for trading, where liquidity is greater than in their home markets. I am told some Australian shares have also begun to migrate to New York. In Europe, they are consolidating because of the EU and Euro, and some South African shares have begun to migrate to London for better liquidity. Asia has tremendous savings but totally fragmented financial markets. Our capital markets are very retail driven. Our institutional markets are highly concentrated and generally conservative, requiring the institutional funds to invest mainly in domestic government bonds and some domestic equity. Under this policy, you essentially lock away large amount of funds with very little trading. It is clear that the network effects of liquidity begets liquidity do benefit the issuer, the investor and intermediaries. However, our liquidity is flowing to the major markets and coming back as FDI and as foreign portfolio investment. Arent we back to the old 1950s colonial debate which argued how all the colonial monies used to go to the imperial centre and came back in the form of colonial investments? If you look at this as a financial historian, you wonder how much has changed in the flow of global funds. One point that most people tend to forget is that the Asian miracle is demographically driven. I am extremely grateful to Jeffrey Williamson, for his paper on Demographic Shocks and Global Factor Flows5, to point this out to me. In fact the biggest lesson to me from what is happening in Asian markets today, including the Japanese economy, is that if we do not pay attention to this demographic factor, we are going to have a lot of financial problems on our hands.
Jeffrey Williamson (2001), Demographic Shocks and Global Factor Flows, Federal Reserve Bank of Boston Conference Series, No. 46 (Federal Reserve Bank of Boston, June)
5

62

The Future of Capital Market Development in East and South East Asia

Figure 1:

East Asian Miracle is Demographically Driven

Source: Jeffrey G. Williamson, Demographic Shocks and Global Fac

tor Flows

In the early period, Asia has grown faster because we have a young working population (Figure 1), with high savings, high productivity and very export competitive. Our leaders had great foresight to open up to international trade. We entered in the post-crisis period into an era of peace, of lowering tariffs, of greater competition, and we benefited from it. But what has happened to all our savings? The Asian crisis has shown that some of us have had to use half of our savings to bail out inefficient enterprises. What people have not noticed is that if we are not careful, if we stuffed all our retirement funds with inefficient bonds and equity, bought at historically high prices, our future generation will pay for the deficits in the pension funds that have insufficient assets to meet the growing social burden as the population ages. In fact, the point that Professor Mukul made yesterday which I thought was very good is that if the return to capital on the retirement fund is below the global benchmark average, that lower return is a tax on
63

The Future of Capital Market Development in East and South East Asia

retirees. In the long run they will not benefit from the opportunity cost in investing in diversified global assets with global yields. So essentially as Asia begins to age, and in North Asia the population is aging very fast already, we require more and more retirement funds. But having these retirement funds without a deep bond market, derivatives market, good equity market to absorb those savings, you may be digging yourself deeper and deeper into trouble in future generations. In essence, if we keep on pumping our scarce resources into the existing systems which do not appear to be able to absorb these savings efficiently, you are going to miss a great window of opportunity when you have that growth period. This situation is like a young person when we are growing up. We are very happy to spend on whatever we like. But when we begin to reach middle age, you really begin to think whether you have enough savings for your retirement. If you have spent all that savings and invested wrongly, then you have to save even more when you are beginning to retire, which is now increasingly the case in North Asia. As North Asia begins to age, its economic growth is slowing and it will require more retirement funding. South-east Asia is still young, but must avoid North Asian retirement funding mistakes. There is an urgent need to develop deep and well-diversified retirement institutional funds in Asia. It is extremely important that we avoid the mistake of some policy makers who use pension funds to avoid historical policy errors, by postponing the cost to the future. This is exactly what I mean by the importance of market discipline in the financial sector.

64

The Future of Capital Market Development in East and South East Asia

What is the relationship between the Asian Third Time Zone and the OECD? The Third World and the OECD are in two demographic cycles. The older OECD countries are aging much faster than the Third World. The Third World has labour surplus and capital shortage, the OECD has scarce labour and capital surplus. But Asia in fact has both labour surplus and capital excess because it is still running current account surpluses. Essentially we are funding the OECD capital markets which rechannel these funds back to Asia. This brings me to the next question: How can Asia institutionalise our savings within Asia for better resource allocation? What then are the lessons from the above analysis? Historical problems and barriers have hindered our ability to intermediate our own savings more efficiently. The North Asian markets are large, but relatively domestic oriented. There has been too much volatility in prices, and markets are still inward looking. The South-east Asian markets are relatively small. We have the Australia and New Zealand markets that have very sophisticated systems but they are not well integrated with the rest of Asia. If we have no integration, how do we compete with the large markets that are integrating very fast? What therefore are the conditions for regional integration or cooperation? In my personal view, these are clearly the following. First of all, bank reforms must go on, as NPLs remain a drag on the domestic economy and really must be cleaned up. But bank reforms cannot succeed unless corporate governance standards are raised to improve corporate efficiency. So we must have a higher standard of transparency and disclosure with a move to
65

The Future of Capital Market Development in East and South East Asia

international accounting standards, international auditing standards and shortly international disclosure standards. There are the 5 Ps in the financial sector I think we really need to think about. First, we really need to develop people skills. We still have not moved fast enough in this area. We need investment banking skills, assets management skills and risk management skills. You cannot build these skills domestically overnight. With global competition, one may have to hire such skills from the global market. It is exactly like football. If you cant compete, you hire somebody with the necessary skills, like Korea hired a Dutch coach. Why? Because you cannot get that skill overnight to be able to compete in the World Cup. The same is true in respect of capacity building to strengthen corporate governance and make investors more discerning and demanding. Second, the pricing of the spreads has to reflect the risk. Third, we have to develop the right products for better risk management. Fourth, we have to develop common platforms. Our technology is so disintegrated as everybody is trying to protect their own domestic markets, and the result is that they cannot connect except at a very high cost. This is what Europe is currently experiencing. This is why Europe is moving towards integration at the platform level. And fifthly and finally, it is political will. Do you want to have cooperation or not? If you dont want it, there is very little any one of us can do to make it happen. In my personal view, improving market liquidity is clearly a priority. The segmented market fragments liquidity and the negative feedback effects of declining liquidity are bad for capital markets. To improve liquidity, we need to develop common products,
66

The Future of Capital Market Development in East and South East Asia

common rules and common markets. This is very clear from what Chairman Dato Ali Kadir from the Malaysian Securities Commission said yesterday at this Conference. The questions I want to ask concern, Can we afford marginalisation? Are we ready to adopt international accounting standards and codes? We do have competitive threats, but do we have common goals? I dont have the answers. I am just posing the questions. If we want to be part of the global market, one has to play by global rules and standards. This is the biggest lesson from Africa and Latin America. If you follow the wrong theory that you should be inward-looking and import-substituting, history has shown that this is the wrong strategy. Asia did the right strategy but did not move to a full global strategy. It went totally global in export and manufacturing but did not go global in the protected dualist sectors, such as services. Actually what the Asian crisis is all about is that we have marked all these dualistic sectors to market. In very crude terms, when we marked to market the losses and inefficiencies, they emerged as NPLs in the national balance sheet. If we are to have successful integration, we need equivalent standards. Currently, the US and EU are setting these standards and Asia is at the moment a free rider on these standards. We are lucky that they are doing all the hard work in developing these standards. But we have no say in shaping these standards because even though we are big in population, big in production, we are very small in capital markets so our ability to influence these standards is very limited. Isnt that sad? Global markets must have global representation. That is what markets are all about. If you have market
67

The Future of Capital Market Development in East and South East Asia

power, you have a greater say in those standards. And if you dont, you dont have a say. What we clearly need is common Asian standards. Im not saying that Asian standards must be unique to Asia. Im saying that these standards need to be inter-operable with European and American standards because that is where the current global standards are. And because we currently have no common voice to influence these standards, we need to build critical mass to get that communication and influence through. I must confess that at the moment in Asia I do not see a common platform where this voice can be developed. My personal view, and I want to stress that this is only in the financial area, ASEAN + 3 is not representative of the Asian financial markets as long as the major players like Australia and Hong Kong are not part of this round table for discussion of Asian common financial interests. In practical terms, everybody understands that domestic considerations out-weigh regional interests. At the moment, it is not surprising that regional cooperation has been a low priority because everybody is busy focusing on their domestic issues and domestic reforms. But if we do not standardise, at least we should talk. We should not talk in political terms but we should talk at the level of technical terms. We need to standardise for liquidity and differentiate for value added. What do I mean? There is a very important article which was written by a British think tank on why products migrate globally and why some products stay domestically. The answer is information intensity. Low intensity financial products such as
68

The Future of Capital Market Development in East and South East Asia

bonds and foreign currency are very easily traded in other markets. High intensity products like equity generally do not tend to migrate. For example, Hong Kong has got more than 30 40 shares that are traded both in New York and Hong Kong. And New York is obviously a deeper and larger market. However, the liquidity of these shares traded in Hong Kong is actually three to four times higher than in New York, because Hong Kong people and international traders understand that liquidity and knowledge in these shares is concentrated in Hong Kong. New York is superior in information intensity in US shares. On the other hand, Asian bonds and currencies, which are relatively straightforward products with the information intensity, are traded significantly in London, New York and elsewhere. So clearly we need to standardise for liquidity but differentiate for value added. Can we have a phased approach to regional integration? Gordon de Brouwer6 from the Australian National University has written a very good paper, providing an excellent overview of issues on regional integration. I am grateful for his comments on this paper. He basically suggested that some of the slightly more developed markets like Australia, Hong Kong, Japan and Singapore work at free trade in services in the financial area first and then talk about integration with others. My personal opinion is that Im not sure if this phased approach will work in practice. If we have a phased approach, we can cause greater market differences and tensions. I think my point today is very simple. We need a common forum for technical discussions first. Work out the technical issues before you think about the political issues.
Gordon de Brouwer (2002), Financial Markets, Institutions and Integration in East Asia, Mimeo, Australian National University, May.
6

69

The Future of Capital Market Development in East and South East Asia

As I said, the previous proposals such as the Asian BIS and the Asian Monetary Fund were too politically charged. With such different regional perspectives, you cannot get agreement. What I am proposing here, tentatively, is that we should establish an Asian Financial Institute. There will be no physical headquarters. There are chapters in every market who are interested, so that we dont have to fight over where to establish the headquarters. We are all friends. We are all masters of our own destiny. We can sit down and talk technically what are the issues, whether we agree or not, the debate on issues, standards, goals and processes. This is the lesson from Europe in the 1950s and 1960s where they began this kind of common platforms for common discussion, before they even think about working together technically. Europes experience is that cooperation is not possible unless there are not only common goals, but also common channels of discussion at the operational level. So what are the conditions for increasing the liquidity? Clearly we should work on common products, we should work on inter-operability, we should lower transaction costs, we should work on interconnectivity. I dont have the solutions. I am just posing these questions so that we can put them forward for better debate. Clearly any talk about Asian financial cooperation and even integration is, I believe, a long journey. But it is clear to me that the right approach is clearly a win-win situation and not a win-lose situation. What we need is actually an independent and nonprofit making research institute that studies these areas from an Asian perspective. The conduct of research on issues with strategic significance for Asia
70

The Future of Capital Market Development in East and South East Asia

would deepen our understanding of the implications of global developments and provide a basis for an objective debate on win-win solutions for us all. And we can attract the best and brightest from around the world to work on this. Knowledge is no longer domestically exclusive and the whole idea of discussions of the Asian Financial Institute is to strengthen our capacity building. To conclude, basic to what I am saying today is that the Asian growth model which was based on a dualist model of development must be re-written in order to have a globally efficient and regionally fitting model, where markets perform their functions much more efficiently, and the inherent risks from imbalanced growth need to be addressed. When we were younger economies, we could afford large bets and more risks. As we mature, we need to move towards more balanced growth and better national risk management. So one priority is to improve corporate governance, where trust is rewarded, and fraudulent behaviour is punished. The quality of all our markets and players must be enhanced to improve the quality of our markets. In my personal opinion, non-integration is not an option, but we have to play by global rules and standards. We should cooperate to set our own standards, have a say in these global standards, and work together to improve the liquidity of our markets. Either we do this or we continue with our individual agenda and see continued marginalisation of our individual markets. To me that would not be the optimal future for Asia. Personally, I do believe that the future of Asian financial markets is very very bright indeed. Thank you very much.
71

POST-ENRON IMPACT ON REGULATION OF FINANCIAL MARKETS


Vocational Training Council 20th Anniversary Distinguished Lecture Series Post-Enron impact on regulation of financial markets 23 September 2002

89

Professor Lee Ngok, Professor David Lim, Distinguished Guests, Ladies and Gentlemen, I am extremely honoured to be invited to deliver the third of the Vocational Training Councils 20th Anniversary Distinguished Lecture Series. Following a distinguished scientist and new Chancellor of HKU, as well as the Chief Executive Officer of the Hong Kong Science and Technology Parks, is no easy feat. I want to start this lecture with the usual caveat as a securities regulator. The views expressed in this lecture are totally personal. I have consulted some of my colleagues in the preparation of this lecture, but I want to stress that these views are not necessarily those of the Commission7, including non-executive directors. I want to put these views out for airing, since I believe that we have reached an important crossroad in our objective of promoting investor protection in Hong Kong.
I am grateful to Ashley Alder and other colleagues in the Commission for valuable comments and to Rosetta Chiu for secretarial assistance. All opinions, errors and omissions are those of the author.
7

72

Post-Enron Impact on Regulation of Financial Markets

As you are all aware, post-Enron and WorldCom, corporate failure and the failure of corporate governance has become a household topic. In the last year, the total market cap loss for Enron and WorldCom was US$80 billion (HK$624 billion), roughly equivalent to the drop in the whole Hong Kong market capitalization during the same period. I propose to divide this lecture into three parts:

An overview of what went wrong and what the major markets are doing to fix it; The current structure of regulation of listed companies in Hong Kong; and The role of the SFC in tackling corporate misconduct.

Post-Enron change in regulations The importance of good corporate governance came sharply into focus after the Asian crisis, and attention to this became universal after the tech bubble of 2000, when both US and European regulators realized that the bubble may have been partly fuelled by bad accounting and corporate misconduct. In other words, after the party (or when the tide goes out), the hangovers (or rocks) begin to appear. The stories of Enron, WorldCom and others are still unwinding. Reasons for their failure are still being debated, but it would appear to be, as one senior US regulator told me, the perfect storm of corporate governance failure in the United States. Corporate governance has failed because the various checks and balances within the system have been weakened by the conflicts of interest that exist at different levels. Because the United States is the largest and deepest
73

Post-Enron Impact on Regulation of Financial Markets

of securities markets, with the most sophisticated regulatory structure, it is worth spending some time to explain the differences between the US system and the Hong Kong system (which is broadly based on the UK and Australian common law framework). Corporate governance is steeped in each jurisdictions financial, legal and market history. The US securities framework stems from the 1929 Wall Street crash, which led to the 1933 and 1934 securities legislation that founded the SEC. It is premised on statutory disclosure, with companies seeking public funding being required to file statutory information with the SEC, now under the famous EDGAR8 system. This rules-based system is based on caveat emptor, or buyer beware, with a set of rules that specify the disclosure that issuers must make to investors and the public, and which is presumptively material. In the US, there are in fact four important lines of defence against corporate misconduct. The first line of defence against corporate misconduct is clearly the management or Board of Directors itself, including the independent non-executive directors, who should represent the public interest. The US Senate report on the role of the Board of Directors in Enrons Collapse9 clearly stated that there was fiduciary failure The Enron Board of Directors failed to safeguard Enron shareholders and contributed to the collapse of the seventh largest public company in the United States, by allowing Enron to engage in high risk accounting, inappropriate
Electronic Data Gathering, Analysis, and Retrieval system. Committee on Governmental Affairs, US Senate The Role of the Board of Directors in Enrons Collapse, Report 107-70, 8 July 2002
8 9

74

Post-Enron Impact on Regulation of Financial Markets

conflict of interest transactions, extensive undisclosed off-the-books activities, and excessive executive compensation. The question whether underpaid non-executive directors can stop important corporate misconduct is still being debated in many jurisdictions. The second line of defence lies with the corporate advisers, such as auditors, lawyers, professional valuers, sponsors, investment bankers, bankers and rating agencies who should provide independent and professional advice on corporate performance, including compliance with the relevant codes of conduct, rules and laws. As the recent cases show, when these professional advisers draw substantial fees from their clients, the question of independence of opinion has sometimes been called into question. This is where the regulatory oversight of such professionals comes in. For example, in the US and some parts of Europe, the auditing profession comes under public oversight, whereas in UK, other parts of Europe and Hong Kong, the profession is by and large still self-regulatory. The third line of defence is the regulatory framework for listed companies. In the United States, the exchanges such as NYSE and NASDAQ assess eligibility according to their rules and quantitative criteria, but all the issuers must file statutory information with the SEC. The US has a huge range of sanctions, ranging from fines to jail sentences, on the provision of false or misleading information. Generally, willful violation of securities regulations is a criminal offence. In addition, the US exchanges closely monitor companies listed on their exchanges and frequently delist companies that do not perform. For example, NASDAQ delisted 770 companies last year,
75

Post-Enron Impact on Regulation of Financial Markets

of which 390 were delisted for non-compliance with listing requirements, nearly 2.7 times more than the 145 companies that were newly listed. In addition, the US state and federal prosecutors offices can take severe action against corporate stealing, cheating or fraud. Finally, the three lines of defence are buttressed by the class action-contingency fee system, whereby shareholders can jointly undertake direct legal action against management or majority shareholders where they feel that they have been disadvantaged. Such a powerful weapon in the hands of minority shareholders ensures that directors, controlling shareholders and their advisers are more careful to act without provoking costly class action suits. I want to point out that such class action-contingency fee system is not available in the UK, Australian and Hong Kong legal systems, because of a different legal tradition and the view that it would encourage a litigious society. Nevertheless, even under such powerful checks and balances the cases of Enron and WorldCom have slipped through. To be fair, the US authorities have quickly enacted the Sarbanes-Oxley Act on 30 July, 2002, which seeks to strengthen corporate governance and auditing oversight by: Creating an independent Public Company Accounting Oversight Board to enforce professional standards, ethics and competence for the accounting profession; Strengthening the independence of firms that audit public companies by having the SEC prohibit the provision of consulting services to

76

Post-Enron Impact on Regulation of Financial Markets

audit clients, when these services create conflicts of interest; Requiring CEOs and CFOs to personally vouch for the veracity of their financial statements and providing much stiffer penalties for fraud; Strengthening disclosure requirements for public companies, notably in the areas of offbalance sheet transactions and insider trading; Protecting the independence and objectivity of securities analysts by directing the SEC to review rules ensuring their independence; Directing the SEC to undertake comprehensive reviews of corporate governance, the separation of audit and nonaudit work, and the role of rating agencies; and Increasing the resources available to the SEC.

I have spent some time on the US system because market analysts who are familiar with the US system often wonder why we cannot adopt US-type legislation and rules into the Hong Kong system. This is founded on a popular misconception. As I hope to show later, each system is very different, and we need to understand how best to protect shareholder rights within our own legal and regulatory framework. In Europe, the European Commission has issued a series of major reform directives aimed at harmonizing and strengthening the securities markets in Europe. These include the development of the Prospectus Directive, the Transparency Obligations Directive, the Investment Services Directive, the Market Abuse

77

Post-Enron Impact on Regulation of Financial Markets

Directive and the amendment of the Admissions to Listing Directive. The United Kingdom has also been upgrading its company law and securities regulatory framework: In May 2000, the function of the Competent Authority for Listing was transferred from the London Stock Exchange (which had held this role since 1984) to the Financial Services Authority (FSA). The Competent Authority for Listing is responsible for making the Listing Rules, which lay down the requirements that issuers of securities to the UK primary markets need to meet, and for policing compliance with these Rules. It is also responsible for admitting securities to the UKs Official List; On 16 July 2002, following the final report of the Steering Group of the Company Law Review, the UK Government issued a White Paper indicating that the companies law would be simplified and modernized for all companies; and On 30 July 2002, the FSA issued a consultation paper on the review of the listing regime10.

In Australia, the Corporate Law Economic Reform Program Act was passed in October 1999 and came into force on 13 March 2000. Amongst the major reforms were: The introduction of a statutory derivative action against corporate wrongdoing, which modified the common law action and
Financial Services Authority, Review of the Listing Regime, Discussion Paper 14, July 2002
10

78

Post-Enron Impact on Regulation of Financial Markets

circumstances under which shareholders can enforce their rights; The clarification of directors duties of care and diligence; and The establishment of new institutional arrangements for the Australian accounting standard setting process. In the Mainland, the China Securities Regulatory Commission has also made impressive strides in corporate governance measures for listed companies, such as: Rules requiring the appointment of independent non-executive directors; Quarterly reporting; Delisting of poorly performing companies; and Strengthening enforcement by closer cooperation with the police.

All these go to show that major markets, including the Mainland market, are actively reforming their corporate governance and their securities market regulatory structure. Corporate Governance & Protection of Investor Rights in Hong Kong Hong Kong has not been idle in pushing for reforms in corporate governance. As the Financial Secretary said in the 2001-02 Budget Speech, our primary objective is to establish Hong Kong as a paragon of corporate governance, ensuring that those investing in Hong

79

Post-Enron Impact on Regulation of Financial Markets

Kong are afforded the best protection and that our listed companies are managed with excellence11. The major initiatives include the following: A major consultation paper by HKEx on changes to the Listing Rules relating to corporate governance, which covers protection of shareholders rights, directors and board practices, and corporate reporting and disclosure of information. The consultation was completed in May, and the results of that consultation are awaited; A comprehensive review of corporate governance by the Standing Committee on Company Law Reform (SCCLR) began in 2000. A Consultation paper on specific proposals relating to directors duties, shareholders rights and corporate reporting enhancements was issued in July 2001. The SCCLR has received widespread support from the community on many subjects, which are very close to measures being adopted in the major markets. The Administration is looking at how best to take forward these recommendations; SCCLR is now forging ahead with the second phase of the review to examine the role and functions of Audit Committees, developing financial reporting standards for different companies, and the efficiency of our present corporate reporting regime.
Much of the material in this section is taken from the report by the Financial Services Bureau to the Legco Panel on Financial Affairs, Continuous Efforts to Strengthen Corporate Governance: Review of Listing Rules and Other Initiatives, February, 2002
11

80

Post-Enron Impact on Regulation of Financial Markets

This work is expected to be completed by the end of 2002; The Securities and Futures Ordinance (SFO) was passed in March and is expected to be in force in early 2003. It will enhance the transparency of listed companies, establish a Market Misconduct Tribunal, and augment the SFCs investigatory power, as well as providing investors with a private cause of action for false or misleading public communications; The consultation paper on May 6, 2002 on subsidiary legislation to be made under amendments to the regulations under the SFO was issued to empower the SFC under the SFO to become the statutory regulator of listed company disclosure. This moves Hong Kong closer to the US SEC model, where the exchange (e.g. NASDAQ or NYSE) handles the listing, but the statutory regulator can enforce if listed companies disclose information that is false or misleading; and On the international front, the SFC has cochaired with the Italian securities regulator, CONSOB, a Task Force on Transparency and Disclosure to develop a set of International Ongoing Disclosure Standards. If these are adopted by IOSCO, we could readily apply them for Hong Kong. While these initiatives are being pushed forward, Hong Kong has also begun to witness its fair share of corporate incidents. Recently, there has been a spate of minority shareholder activism, which called for regulators to intervene in corporate transactions. Minority shareholder activism in Hong Kong is a very healthy sign, and there is a very good reason why
81

Post-Enron Impact on Regulation of Financial Markets

there are currently more investor complaints. Suspicious transactions are less obvious during a bull market, because all investors hope that asset prices would rise. However, during a bear market, minority investors are concerned that majority shareholders may enter into transactions that may dilute their interests or that are prejudicial to their rights. There is a need to regulate listed companies because entities that raise funds from the public have a duty to the public to be honest and fair in their dealings. Hence, listed companies are normally regulated through entry requirements [under the Listing Rules], their conduct in transactions [under the Takeovers & Mergers Code and Listing Rules] and the enforcement of applicable legislation, such as the Companies Ordinance and the SFO. As you can see from Figure 1, the rules covering corporate behaviour comprise both codes and rules, such as the non-statutory Listing Rules for listed companies, as well as legislation, such as the Companies Ordinance. There is, for example, a Code of Conduct governing the behaviour of corporate finance advisers. The main difference between codes and legislation is that sanctions for breach of the former do not have statutory backing, whereas the latter can include statutory sanctions, ranging from civil damages to jail sentences. Under the current regulatory regime in Hong Kong, we have one regulator in charge of the entry requirements for listed companies [Stock Exchange], and many more with oversight over the conduct of their business [such as the Stock Exchange under Listing Rules, the SFC under the Takeovers Code, and in insider dealing and market manipulation, ICAC in corruption and CCB in fraud and theft]. The Financial
82

Post-Enron Impact on Regulation of Financial Markets

Secretary can appoint special inspectors under Section 143 of the Companies Ordinance. The exit of companies from the Exchange depends upon the Listing Rules and also on the liquidation process. Since corporate misconduct cuts across many areas and the jurisdiction of several regulators, the core issue is whether there should be a single lead corporate regulator or co-ordinating body that ensures a consistent, coherent and firm response to corporate misconduct in Hong Kong. Corporate misconduct can be divided into different levels of seriousness, ranging from incompetence, and unfair transactions to outright stealing. I would like to make three relevant points:

First, most listed companies in Hong Kong obey the law. Indeed, as the recent Standard & Poors review of Hong Kong Corporate Governance12 says, compared with other Asian countries, Hong Kong is a leader in the corporate governance domain. We do have some of the best run companies in Asia; Second, the fundamental principle of full and fair disclosure is that the listed entity should provide all information that would be material or relevant to an investors investment decision as to its financial condition and future prospects. This is where enforcement against false and misleading information comes in; Third, the regulators involvement in transactions of companies after they are listed come in two areas a middle

Standard & Poors, Corporate Governance in Hong Kong, 15 February, 2002, available on http://www.standardpoor.com
12

83

Post-Enron Impact on Regulation of Financial Markets

ground of transactions where the regulators are often involved in ensuring that their own rules are complied with before the transaction happens. Then there are the after-the-transaction enforcement actions, which require investigation and prosecution of wrongdoing. These involve our Enforcement Division, the Police and sometimes the ICAC. I shall concentrate in this section on the middle ground of corporate transactions, which are largely the preserve of the Exchange and the SFC. In the next section, I shall elaborate on our enforcement functions. Under the 1991 Memorandum of Understanding between the SFC and Stock Exchange of Hong Kong, the Stock Exchange (now part of HKEx) is the frontline regulator of listed companies. This is because the Stock Exchange administers the Listing Rules, which governs the entry of listed companies, a large part of the conduct of listed companies and their exit or delisting. The Stock Exchange basically operated a merit-based regulatory system in vetting the entry of listed companies for the Main Board. A disclosure-based regulatory system was adopted for the Growth Enterprise Market (GEM) when it was established in 1999. After demutualization and listing of the exchange in 2000, the perception of the nature of its regulatory role began to change. Firstly, a for-profit exchange could not be given statutory enforcement powers. Its

84

Post-Enron Impact on Regulation of Financial Markets

relationship with other listed companies is contractual in nature. Secondly, the market perceives, rightly or wrongly, that a for-profit exchange has a commercial incentive to encourage listings, but tackling corporate misconduct involves cost and risk, and often no commercial gain. Tough enforcement cases can lead to lawsuits that hurt corporate value. Third, there is a widely held view that a listed company should not regulate other listed companies.

As I explained earlier in describing the US regulatory system, the first and second lines of defence against corporate misgovernance lie in the integrity and conduct of the management of the company, the Board committees, and their auditors, legal advisers, sponsors and investment bankers. The bulk of these corporate governance attributes, therefore, fall to be regulated within the purview of the Listing Rules, which carry no statutory sanctions, unlike in the US or UK where the SEC or FSA can impose civil fines. Others are regulated by self-regulatory organisations. Thus, in the middle ground of day-to-day corporate transactions, the third line of defence depends on the role of the regulators in overseeing such transactions. This middle ground is currently covered by two sets of codes, the Listing Rules, administered by the Exchange, and the Takeovers Code, administered by the SFC. Listed companies in Hong Kong engage in thousands of commercial transactions every day. The bulk of these transactions do not involve regulators because, as I said, Hong Kong has overall a good corporate governance framework.
85

Post-Enron Impact on Regulation of Financial Markets

There are, however, transactions that can be disputed by shareholders, creditors and other corporate stakeholders that should fall under the purview of the courts, which is the fourth line of defence. Under our common law system, it is only the courts that are, quite properly, entrusted with deciding whether a transaction is legitimate. However, litigation is expensive in Hong Kong, and there is no class action/contingency fee system, so it is not surprising that shareholders call for the regulators to intervene in disputed transactions. When these transactions fall under the Listing Rules or the Takeovers Code, the responsible regulator does the due diligence on compliance, which would involve considering whether the applicant or their advisers had done their work properly, whether there is full and fair disclosure, and in specific cases, requiring voting by independent shareholders. Such due diligence may include requirements for greater disclosure, requests for clarification and independent valuations. At the controversial end of the spectrum of transactions are those that appear unfair but comply with the non-statutory rules. These should lead to rule changes, which would then go through the appropriate market consultation and due process. The issue really boils down to whether corporate behaviour can be effectively regulated through nonstatutory rules or codes, where private/public reprimands or censures are seen at best as slaps on the wrist. Codes of conduct can work where breaches can be disciplined as conditions of exit, such as the threat of withdrawal of licences, or where those who do not comply can effectively be excluded from the market, as in the Takeovers Code. But in the case of
86

Post-Enron Impact on Regulation of Financial Markets

listed companies, delisting has so far not been used as a disciplinary tool. The Commission has identified this gap in the enforcement of corporate disclosure, particularly with respect to the disclosure-based regulatory framework for the GEM. In order to strengthen the sanctions on disclosure, we consulted the market in May on dual filing, which would make the Commission the statutory regulator of listed company disclosure. We are pleased that the results of the consultation exercise supported the suggested rule changes, and the Government has approved this move. Consequently, under the SFO subsidiary legislation, which should be effective at the beginning of next year, all information to be filed with HKEx will be required to be dual filed with the SFC too. For example, if disclosure is materially false or misleading, the SFC can exercise its Section 182-3 SFO investigatory powers to investigate. It also has a range of enforcement options, such as: Suspending trading in listed securities; Applying for court orders to remedy oppression, inadequate disclosure, unfair prejudice or crime or misconduct in a listed company; Injunctions to restrain breaches of the SFO; Recommending to the FS civil actions before the Market Misconduct Tribunal for disclosing false or misleading information about securities; Criminal prosecution for disclosing false or misleading information about securities; Winding up applications; and Disciplinary action (including fines up to $10 million, reprimands, revocation and suspension of
87

Post-Enron Impact on Regulation of Financial Markets

licences) against a listed company's SFC licensed corporate finance advisers. The problem is that, despite reforms like these, we currently have a middle ground that has a front-line regulator looking after entry and exit, the corporate governance structure and transactions under the Listing Rules. The SFC is directly responsible for the Takeovers Code and is also tasked to monitor and supervise that front-line regulator. This is where the current dual or split regulator roles lack clarity and add complexity and costs to the whole process. The need to coordinate regulatory roles leads to delays in regulatory response, because no one regulator has the total picture of what the perpetrator is up to. Indeed, as some recent cases have shown, regulatory arbitrage can occur since if one transaction fails the regulatory test under one set of regulations, such as the Takeovers Code, the company may try a modified transaction with a similar motive under the Listing Rules, much to the frustration of minority shareholders. In sum, the present Hong Kong model is very different from the US model of regulation and minority protection, where the US legal system enables aggrieved shareholders to sue on bad disclosure and other grounds through class action/contingency fee arrangements. There are also many other differences, in SEC powers and remit, institutional investor pressure, and quick delisting action by the Exchanges. The UK is closer to Hong Kong so far as minority shareholder suits are concerned. Legal action is also costly to pursue there. But there the Listing Rules are
88

Post-Enron Impact on Regulation of Financial Markets

administered by the FSA as statutory regulator and it has the ability to impose fines for breach of the rules. Stern administrative sanctions enforced by a strong independent agency covering the full range of core listed company regulation is a credible deterrent it is quick, efficient, generates public confidence and is checked by administrative appeals and the possibility of judicial review. It is vital in Hong Kong that this middle ground of regulation, currently administered by the Exchange and the Commission, is able to function at its full potential. It is the main bulwark against corporate misconduct when, in practice, legal remedies are hard to pursue. If the middle-ground regulators are weakened, there are no other compensating mechanisms and the result is that the whole area of investor protection cannot operate at its full potential. In other words, two major policy issues need to be addressed. First, whether we should move to a statutory regime to improve corporate governance to protect shareholders rights; and second, whether the present middle ground regulatory structure and processes should be simplified so as to avoid duplication and delays in regulatory response to corporate misconduct. These are important questions that only wide public consultation and the government and legislature can answer. All I can do is to point out that there is ample international experience and debate on these issues that we can draw upon. My colleagues and I do understand that there are complexities involved in making such policy choices, nor do we underestimate the resources and expertise that are needed to undertake this task. I personally,
89

Post-Enron Impact on Regulation of Financial Markets

therefore, welcome the announcement by the Financial Secretary that the Government is considering appointing an expert group to look at these complex issues. The Role of misconduct SFC in combating corporate

Finally, allow me now to describe how the SFC is combating corporate misconduct in the enforcement area. As explained earlier, there is no single corporate regulator in Hong Kong. The Stock Exchange is the front-line regulator of listed companies, and administers the Listing Rules. It is the gatekeeper in allowing companies to be listed. The SFC shares the regulation of conduct of the listed company sector in the policing of insider dealing, statutory disclosure of interests in securities (SDIO), and inspecting the books and records of listed companies if impropriety is suspected. The SFC also administers the Code on Takeovers and Mergers. In areas such as corruption, fraud and theft, and cases outside the jurisdiction of Hong Kong, the SFC cooperates with other regulators, such as the Stock Exchange, the CCB and ICAC, as well as overseas regulators to investigate and pursue enquiries. As a statutory regulator safeguarding the rule of law in the securities field, the SFC must also act within its powers under the law. It is important to understand that we cannot normally intervene in commercial transactions. This is for the Board of Directors, the legal and financial advisers, accountants, and professional valuers and in specific cases, for voting by shareholders, to determine.

90

Post-Enron Impact on Regulation of Financial Markets

Three significant factors unique to the Hong Kong market govern our approach to combating corporate misconduct: Nearly three quarters of the companies listed in Hong Kong are incorporated outside Hong Kong; Many of the listed companies in Hong Kong also have operations outside Hong Kong; and We therefore must cooperate closely with Hong Kong and overseas regulators to investigate companies listed in Hong Kong. Some of you may wonder why we have stayed silent on a number of high profile cases. The reason is that section 59 of the SFC Ordinance imposes an obligation of secrecy on SFC personnel in conducting investigations. There are good reasons for this. First, any announcement of investigation can lead to a sharp drop in the share price of the company being investigated, causing potential losses to the shareholders. Second, any information leakage may tip off those under investigation, leading to the destruction of evidence or abscondment. Third, such leaks may prejudice subsequent criminal trials. The same restrictions apply under section 378 of the new SFO. Whilst we cannot comment on live cases or investigations, I can say categorically that we are currently investigating a number of cases that have received high media profile in recent months. Mr. Alan Linning, our Executive Director of Enforcement, has already in his press briefing on 24 June stated that the top priority in 2002-2003 will be

91

Post-Enron Impact on Regulation of Financial Markets

corporate governance investigations. statistics should suffice:

A few simple

We have already initiated 4 section 29A investigations and 3 section 33 investigations into listed companies since March this year alone; We have 19 active cases that we are discussing with the CCB, including 7 cases that involve listed companies; We have one of the best records in insider dealing prosecutions outside the United States. Last year, we had 3 major successes, disgorging $22.8 million in profits and $23.2 million in penalties (involving shares in Tysan Holdings, Indesen Industries and China Apollo). 4 more cases are under investigation and 8 are awaiting referral to the Insider Dealing Tribunal; In the area of market manipulation activities, we had 4 people convicted in 3 cases last year (Good Fellow Group, Perfectech International and The Hong Kong Parkview Group). The courts are getting tougher - 2 jailed, 1 given suspended a sentence and community service, 1 fined; In the first quarter of 2002, 4 persons were convicted in 2 cases (Grand Field Group and Gay Giano International Group), with full cooperation with the CCB. The CCB has charged 2 more persons in the Gay Giano case; In the disclosure of interests prosecutions, which require increased transparency regarding insiders share dealings, 14
92

Post-Enron Impact on Regulation of Financial Markets

persons and 8 companies were successfully prosecuted and fined in the year to March 2002, with 72 warning letters issued. In the first quarter of this year, 4 persons and 2 companies have been prosecuted under SDIO, and 16 warning letters were issued; and In the last 12 months, we imposed 2 cold shoulders under the Takeovers Code, with 4 active investigations involving serious breaches of the Code, including 4 section 33 investigations.

In the matter of derivative actions, I wish to state that the Government has taken the advice of the SCCLR and asked the Commission to look into the possibility of developing a statutory derivative action. As the SCCLR Consultation document pointed out, the common law derivative actions for shareholders are complicated, but the Commission is actively studying the matter. As you are all aware, the Commission successfully undertook the first legal suit under section 37A SFCO in the case of Mandarin Resources for unfair prejudice, in which we withdrew our section 45 SFCO winding up application only after the defendant agreed to buy out the minorities at fair value. This investigation and case took 6 years, but we persevered to successful settlement. I would like to warn all those who engage in corporate misconduct that we will not hesitate to use our powers under the SFO to pursue them to court. My Enforcement colleagues are already actively looking. The Commission is currently beefing up its enforcement and corporate finance resources to tackle

93

Post-Enron Impact on Regulation of Financial Markets

these areas as a matter of priority. It will add 15 staff to this area by the end of the year. In addition, the Commission has strengthened its cooperation with both the CCB and the CSRC in the investigation of corporate misconduct in Hong Kong and also the activities of Hong Kong listed companies in the Mainland. We will increase our vigilance and we will strive to complete our investigations as fast as we can work together with our regulatory counterparts. In short, those who break the securities law are now warned. We will pursue them without fear or favour. They will be investigated and prosecuted in accordance with the law. Ladies and Gentlemen, The lessons of Enron and WorldCom are quite clear. Those who seek capital from the public have a fiduciary duty to the public to be truthful, honest and fair. If Hong Kong is to maintain its role as an international financial centre and the leading overseas fund raising centre for Mainland and other regional companies, then we must press ahead with our reforms in the regulatory and infrastructure areas. The opportunities are huge, but so are the pains of adjustment. In exercising regulatory functions, I am always reminded of the line that Dr Goh Keng Swee, former Deputy Prime Minister of Singapore used in paraphrasing an old Chinese saying, regulation [governance] is like frying small fish it must not be overdone. If we over-regulate, we can stifle the entrepreneurship of the majority of listed companies that are law abiding and seek to raise funds from the public as efficiently and with as low costs as possible.
94

Post-Enron Impact on Regulation of Financial Markets

Hong Kong has always prided itself as the freest of markets. On the other hand, if we under-regulate, a small minority that exploit loopholes or deliberately skirt the law can do huge damage to the integrity of our markets. Enron and WorldCom have already demonstrated what can happen in the largest and best regulated of markets. The regulation of financial markets needs to walk that delicate tightrope between rewarding trust and efficiency, and punishing those who break the law. Each market must find its own right balance. There is no easy solution. Under the new SFO, which has finally come into being after more than a decade in the making and which has strengthened our ability to do our job, the Commission is committed to defending the integrity of our markets. There are clearly structural issues in the Hong Kong regulatory framework that need to be addressed. Irrespective of these factors, the Commission will work closely with the Stock Exchange and all the other regulators in Hong Kong and abroad to tackle corporate misconduct as a matter of top priority. We all share the same objective to protect the integrity of our markets and the rights of shareholders. I want to thank the Vocational Training Council once again for giving the opportunity to present these personal views. Thank you very much.

Securities and Futures Commission


95

Post-Enron Impact on Regulation of Financial Markets

23 September 2002

96

Figure 1
Corporate Governance: Entry, Conduct & Exit
ENTRY CONDUCT & TRANSACTIONS EXIT

Post-Enron impact on regulation of financial markets

Code, Rules and Law

Listing Rules

Listing Rules Corpor ate disclosure Direct or & board practices Protec tion of shareholders rights

Takeovers & Mergers Code - Regulation of acquisitions & mergers

Securities and Futures Ordinance Investi gation Insider dealing Market manipulation Protec tion of shareholders rights Statutory

Companies Law - Special investigation - Prospectus law

Criminal Law - Stealing - Fraud

AntiCorruption Laws Corrupt ion

Delisting - Listing Rules Insolvency

Legal Status

Nonstatutory

Non-statutory

Non-statutory

Statutory

Statutory

Statutory

LR Nonstatutory Companies Ordinance - statutory

Regulator

HKEx

HKEx

SFC

SFC

FS Registrar of Companies

CCB, Police

ICAC

HKEx Official Receiver

98


2002 9 23

90

( ) 13 Enron() WorldCom( ) 800 (6,240 )



13

99

2000 ( )() ( ) 1929 1933 1934 (SEC) (EDGAR)14 (caveat emptor) 15


EDGAR Electronic Data Gathering, Analysis and Retrieval System
14

100

() ( ) 770 390 (145 ) 2.7

107-702002 7 8
15

101

2002 7 30 (Sarbanes-Oxley Act)


102

2000 5 ( 1984 ) (FSA) 2002 7 16 2002 7 30 16

1999 10 2000 3 13 ()


16

14 2002 7 103

2001-02 17

( ) 5 ( ) 2000 2001 7 2002 ( ) 2002 3 2003 2002 5 6

17

20022 104

( ) (CONSOB) 1 ( )( )

105

[ ()] [ ] 143 18
2002 2 15 http://www.standardpoor.com
18

106

1991 ( ) 1999 2000 ()


107

( ) 5

108

182-3 ( 1,000 ) ( )

109

110

(())

111

)59 378 624 20022003

329A 4 33 3 197 3 ( )2,280 2,3204 8 43 () 21

112

2002 42( Gay Giano International Group) Gay Giano2 20023 14 8()72 ( ) 42 16 122 4 4 33

37A 45 6 15

113

[] 10
114

2002 9 23

115

- - - -

- - - - - - - - -

- -

870

- -

Anda mungkin juga menyukai