Malaysia corporate governance roundtable

Emerging Markets, September 2011

EM: Malaysia has a stated ambition to transform itself into a high-income nation by 2020. How important, in your view, is good corporate governance to this ambition?

David Smith, ISS Governance: Hugely important. In essence, corporate governance is about ensuring the efficient allocation of capital, with well-run companies that generate value for shareholders and incomes for individuals and families receiving funding from capital markets. Where companies on a systemic basis do not add or destroy value, countries would invariably see growth rates slow if capital is not put to work effectively.

Jamie Allen, ACGA: We think it’s extremely important. I wouldn’t directly link corporate governance to high income necessarily, just as you have to be careful linking it to profits. But it’s important to improve governance in a market so investors feel more confident, and put more money in. And while it’s only one element of creating a robust financial system, over time it can certainly contribute to the real economy.

It takes time, and faith that the government is clean and well run: you need a strong sense of public governance if you are going to have good corporate governance. That’s something Malaysia needs to work on, although the regulatory system has improved. We think that having an ICAC [independent commission against corruption] in a country is critical.

Phillip Armstrong, Global Corporate Governance Forum: The ambitions of Malaysia presuppose a lot of growth from Malaysian private sector companies. A lot of the capital needed for that growth will have to be obtained from capital markets, potentially from overseas investors, and corporate governance is an aspect they will always look at: how the companies are run, the integrity of financial reporting, and the conduct of their boards of directors. It is also critical on the state-owned side: even a fully government-controlled company may still raise funds through a debt instrument from foreign markets, and again holders will look at corporate governance.

Clarence Yang, BlackRock: A balanced and appropriate CG framework is one of the key foundations required for sustainable growth. It engenders trust and confidence among investors, and can reduce the cost of capital. This in turn can increase investment from local and foreign investors, which will lead to business opportunities and job creation.

EM: Are you familiar with corporate governance standards in Malaysia, and the CG Blueprint it has launched? What are your views on the blueprint and what it aspires to achieve?

Allen: It covers most of the right areas: if you want to improve a culture of governance in a market, you’ve clearly got to focus on companies, shareholders, and on what auditors and intermediaries are doing. The fact that they recognized the importance of private enforcement as well as public enforcement is also good. It’s a positive document, it shows the Securities Commission has accepted there is an issue around the culture of corporate governance in Malaysia, and it’s clearly a step forward. Now it’s a question of socializing it and implementing it.

Yang: BlackRock participated in the panel discussion at the launch of the CG Blueprint. Overall we are supportive, as we believe the Securities Commission has taken a thoughtful and considered approach, consulting with key stakeholders and reviewing global CG reform, and evolving best practices while ensuring relevance to the Malaysian market. We applaud the SC for taking a leadership role and sincerely hope the proposed recommendations are successfully implemented.

Smith: I am familiar with the blueprint. I think that the SC has done a great job of seeking views of various market participants on the current state of corporate governance in Malaysia, synthesising those views, and integrating them into the final document. I think that there are some really great recommendations in the blueprint that I think many in the investment community would welcome.

EM: What challenges arise when initiatives like this are put into practice at a company level? How hard is it to change a company’s attitude to corporate governance, particularly at the board level?

Yang: In our experience, reforms that have involved practitioners – both companies and investors – in the consultation process tend to be implemented more effectively. Where reform is imposed, companies tend to meet the minimum possible standards with boiler plate information in their public disclosures that does not capture the spirit of the corporate governance recommendations.

A company’s attitude to corporate governance is influenced by a range of factors: ownership structure, the size of their international business and exposure to global practices, and the diversity of experience of their board members, to name but a few. For family-controlled and managed companies, receptiveness to corporate governance can improve when the younger generation move into key management positions. Moving towards higher standards does not happen overnight: often a gradual, considered approach is less disruptive.

Allen: It is very hard. It depends on what the company wants to do and want to be. If it wants to be an internationally recognised company with international branding accessing international capital markets, governance tends to be more important than for a local business – and most businesses, in most countries, tend to be local. Also Asian companies tend not to be too concerned about brands.

Why do companies need to have CG? Some do it for altruistic or philosophical reasons, but in most cases they do it because it’s in their interests. Banks, for example, have been under pressure to do a lot more in corporate governance over the last 10 years than other companies, because Bank Negara puts higher standards on to them. Smaller, local companies are not under pressure from shareholders or regulators to improve. Regulators can set rules and regulations and, by strong enforcement, get people thinking more, but if you really want to change a culture of a company it needs to be internally driven from within.

Armstrong: There are many and varied challenges. One would start with board composition: seeking to structure a board that truly represents the strategic objective of the business, with directors who are qualified to serve and have a professional understanding of the market the business operates in, and a chairman with a strong and effective relationship with the CEO and management. Particularly if you are a company seeking international expansion and funding, it is important to ensure the way you structure your board and run your business conveys an aspiration towards international standards of good governance, while at the same time recognizing there are ways businesses are run and conducted in a domestic business environment. International standards alone are not the answer: they need to be adapted to specific cultural aspects of local markets, otherwise it’s nothing more than a box-ticking exercise.

The external focus is on developing relations with the market – shareholders, and a broader range of stakeholders. As Malaysian companies become more international it’s important the board understands the local risks and challenges that face it. Boards have to make important choices.

Another challenge under the blueprint will be to demonstrate that good governance is important because it’s good business sense, not just because there’s a rule or regulation that requires it.

Smith: This is the hard part, where the rubber hits the road. There are really two issues here – how will companies take to the new corporate governance environment, and how will shareholders engage with those companies on corporate governance issues?

The SC has been very canny in highlighting that shareholders have a role to play. The code would “require institutional investors to explain how corporate governance has been adopted as an investment criteria and the measures they have taken to influence, guide and monitor investee companies”. That is a fairly wide-ranging statement, but one that has certainly put Malaysia towards the sharp-end of best practice.

Companies should now also be aware that with the increased emphasis on the role of shareholders, they too will come under perhaps greater scrutiny than previously might have been the case. But this is not necessarily something that companies should be too concerned with. Many institutional investors operating in Malaysia do have a very good reputation globally for their corporate governance engagement work. This engagement is usually out of the public spotlight (press coverage being a great fear of companies and shareholders alike), and constructive (as opposed to confrontational and activist).

Essentially, it takes two hands to clap – evolving corporate governance requires shareholders to act as owners, and company directors to act as responsible and effective stewards of companies.

EM: What patterns do you see in the way that institutional investors in Asia seek to push for shareholder rights, transparency and other governance issues?

Allen: The one standout is the EPF. Their corporate governance principles are a very good, enlightened document. But if you look at large national and state pension schemes around Asia, and ask which ones have corporate governance or proxy voting policies, there aren’t many that do. EPF is ahead of the curve, taking a thoughtful, structured approach to the whole issue. Khazanah, too, promotes good governance in the work it does in GLC restructuring. But what about the other big institutions in Malaysia? We don’t see enough of them.

Yang: Effective engagement on these issues requires patient, constructive dialogue with suggestions for reform presented as a value proposition. The use of the media, or calling a special meeting to propose a shareholder resolution, ought to be a last resort. Domestic investors and international investors with local offices will have stronger links to the key stakeholders in the market as well as a better understanding of the salient issues. Regional investor groups such as the ACGA play an invaluable role in coordinating the views of investors and promoting universal best practice.

Armstrong: With the global financial crisis, institutional investors are going to be much more engaged in the more high-growth emerging markets. It’s a very competitive market for international capital: they can invest in Malaysia, Thailand, Indonesia or elsewhere. They will be looking for good and transparent reporting – beyond what the rules require. They will want good engagement, to develop a relationship. uch more engaged in those markets, particularly Asia.

Two areas institutional investors worry about in many emerging markets are around related-party transactions and conflicts of interest. In the west we are very preoccupied with director independence; in Asia, it’s more about independence from controlling interests than from management.

Smith: I think that the push for greater rights, and for greater transparency, takes place at two levels. First, there is regulatory engagement, whereby investors pro-actively go to regulators and establish dialogue on areas where markets may fall below best practice in terms of certain protections, such as from abusive related-party transactions.  There is a growing consensus across many Asian markets about certain issues that institutional investors are looking for – poll voting, for example – and that consensus is as a result of investor engagement.

The second prong of engagement – with companies themselves, to encourage voluntary improvements to reporting and behaviour – is also one that has proved to be useful.

EM: What are the arguments for having corporate governance rules that are mandatory, versus a code in which corporate governance is self-regulatory for companies?

Armstrong: The problem with a rules-based or mandatory code system is, because of its prescriptive nature, you do it because you have no choice. It takes away the business judgement one would expect a well-run board to exercise.

A voluntary code is dependent on a culture of conformance: you have to have a culture in the country that it is a guideline to be observed, either by applying the requirement or explaining why you’re not applying it in a substantive and honest way.

Allen: Because of differences between companies, it makes sense to leave some flexibility about which bits of the system they follow. Some bits should be mandatory, like independent directors and audit, but beyond that there should be flexibility in choice. For example, we would rather companies not set up a nomination committee if it is just going to be window dressing. Setting up committees for the sake of it is not productive. In areas like number of independent directors, board composition and internal corporate governance, companies need to be given a degree of flexibility, and this is where codes and soft laws – at a level below legislation and listing rules – are useful.

The problem in Asia is that a lot of companies just want clear guidelines. The vast majority don’t want too much choice. In North Asia, for example, the view is: if something is important there should be a law or a regulation. If it’s a soft law they’re not going to take it too seriously. In southeast Asia it’s less explicitly stated, but I think companies think the same way.

Smith: There are inherent flaws to a system of corporate governance that is self-regulatory for companies. Corporate governance is about the relationship between principals and agents – we cannot expect agents to be self-regulating through sheer goodwill were we to exclude all other actors from the regulatory regime. So, a system whereby certain things are required to be disclosed, certain things are required to be discussed and explained, and where certain behaviours are fundamentally off-limits, works best. And this is, to a large extent, what we have in most markets now – the so-called ‘comply or explain’ model of corporate governance. This assumes, however, that shareholders are engaged and vigilant, and the regulators are willing to act in the face of breaches of listing rules. This is where the system runs into trouble in most regulatory regimes – not usually by design, but by the lack of action by market participants.

EM: What should be the priorities in improving corporate governance standards in Malaysia?
Yang: We believe that moving towards mandatory poll voting, eventually for all proposals; timely disclosure of detailed voting results; and the removal of restrictions on the number of corporate representatives are important standards to prioritise. This is the first step towards ensuring a fairer voting process, enhancing transparency and accountability and encouraging greater interaction with shareholders.

Armstrong: One thing any market needs to look at is enforcement capacity: the skills of departments or agencies that are tasked with supervision. To what extent are they familiar with the code of corporate governance requirements? Do they have substantive knowledge? Are they somewhat independent from the political system?

One area Malaysia has to look at is to ensure a system and an infrastructure that genuinely supports corporate governance codes: quality of directors and boards, their training, identifying independent directors.

Another level is to ensure the business media is informed on corporate governance issues, knows how to report on them, and that institutional investors play an active role in supporting an improved corporate governance environment.

Allen: The CG blueprint is good, but there is an awful lot of work that needs to be done afterwards. To implement it, they could run workshops, training programs and forums, to discuss the blueprint and why it is important. It will be a slow, incremental, long-term process. Though the regulatory system is good in Malaysia, the corporate governance culture is pretty bad. There are some specific things that can be done like having listed firms publish their audited annual results more quickly, and continuous disclosure of material events. In enforcement, there is a need to train judges: the judiciary in Malaysia is not particularly familiar with securities and companies law.

But apart from the blueprint, a bunch of other things in Malaysia have been positive: an audit oversight board; listing rules changes on shareholder approval for privatisations; and they have addressed several issues we had touched upon in our CG Watch publication.

Smith: I think that there are many positives to the Malaysian system. I think that what is lacking a little, though, is the overall culture of corporate governance. This is, unfortunately, one of the hardest things to develop. Having said that, there are some excellent people working in Malaysia right now – the SC is doing very well under a good team, Bursa has one of the best regulators in Asia in Selarany Rasiah, whilst the Minority Shareholders’ Watchdog Group has certainly contributed. So, the future’s certainly bright for Malaysia.