The downside of Singapore’s stock market expansion

Asiamoney, March 2011

On a rainswept January morning in Singapore, a listing ceremony is taking place in the Singapore Exchange’s second-floor event plaza. There’s a gong onstage to herald the company’s formal trading launch as the market opens at 9a.m., and a celebratory shower of coloured paper fills the air.

It’s an everyday SGX listing inauguration – all the more commonplace for the fact that the listing company is not Singaporean. Today, it’s a Thailand-based natural rubber processor called Sri Trang Agro-Industry, but had you come a week earlier you might have seen Zhongmin Baihui, a Chinese retail group that runs a department store in Xiamen; or a few days later, Malaysia Smelting Corporation, one of the world’s leading suppliers of tin. In fact, of the five Singapore IPOs that closed their books in January, only two were local, and it’s likely that the forthcoming listing of Hutchison Ports – another foreigner, and from arch-rival Hong Kong to boot – will be the biggest in Singapore all year.

This has been the pattern for Singapore for years, and it’s the way it’s going to stay. Today, 41% of the companies in Singapore are from outside the country; at the end of 2010 there were 321 of them and they accounted for 47% of market capitalization. At SGX, it’s a source of pride. “Fingers crossed, within a couple of years, we may be above 50%,” says Lawrence Wong, head of listings, and more than anyone the man whose job it is to pound the world’s pavements and bring foreigners to Singapore. “If you are an international exchange, you should not be worried about it.”

SGX calls this policy ‘Asian Gateway’, and from the local perspective it makes a lot of sense. Singapore has achieved a remarkable amount from modest means since its independence in 1965: with nothing to dig out of the ground, and no room for a meaningful crop or commodity industry, it has had to grow by hitching itself to trade from countries around it and further afield. And so it is with the exchange too: it can only grow so far on domestic companies and home-grown expansion, and has long sought to become a regional hub instead, to tap Asia’s vibrant economies. “We are a microscopic version of Singapore,” says Wong. “The exchange is no different from the economy.”

Fund managers in the region see the logic too. “I can understand where the ASX is coming from,” says Peter Sartori, founder of Treasury Asia Asset Management. “They are trying to grow as an exchange and remain relevant regionally, so they want to attract foreign companies. That all makes sense to me, and it is a positive thing for Asia, which in general is going to be dominated by Greater China. If they just relied on Singapore companies to list on their exchange, they would become marginalized.” And Singapore is thriving on this policy: Singapore’s 39 IPOs in 2010 represented a five-fold increase in new listing market cap on the previous year, with a commensurate hike in listing fee revenue.

But there’s a catch. Necessarily, as more and more of the listed companies come from outside of Singapore, it becomes harder and harder to supervise them. Consequently, the Singapore Inc brand – built on market-leading infrastructure, technology and best practice – risks being cheapened. “It’s always a little concerning,” says Hugh Young, Aberdeen Asset Management’s managing director for Asia. “It’s not just Singapore but London’s AIM, or Hong Kong Exchange. It’s inevitable, I fear, and applies to all exchanges, but especially to one with little hinterland.”

At one end, Singapore has clearly been enriched by the companies it attracts. Groups like Jardine Matheson and Noble Group choosing to list in Singapore are clear endorsements of the place and have been welcomed by the investor community from the retail to the institutional end. Singapore has, for example, built the region’s leading centre for real estate investment trusts (REITs) partly by being able to attract assets from around the continent.

At the other end, though, some unbecoming companies have made it to the Singapore boards – and the sector with the worst reputation by far is the so-called S-chip market. “There are some good companies, some bad: Jardine at one end, China S-chips at the other,” says Young. Another emerging market fund manager, based in London, is less polite. “We have a theory here for what the S stands for,” he says. “But I don’t think you’re going to be able to use it in your magazine.”

The theory of the S-chip market was that it gave a home to Chinese private sector companies that were being squeezed out of Hong Kong listings by the vast state-owned listings there. There was, surely, a treasure trove of opportunity here: young entrepreneurial mid-cap businesses needing more capital, a chance to get in on the ground floor of a future China titan. And, in fairness, there have been many successes: Cosco, China Fisheries and China Merchants Holdings are among them. But at least six have were delisted in the course of 2010, and at least 10 were suspended. It’s an increasingly lengthy roll call: FerroChina, which put out rosy quarterly results in 2008 and defaulted on loans a few weeks later; FibreChem Technologies, Oriental Century, Zhonghui Holdings, Sino-Environment (which also managed a default) and China Sun Bio-Chem, all caught for alleged accounting irregularities; Beauty China, Celestial and China Milk, all suspended for corporate governance or default issues. China Milk, as an illustrative example, is explored in detail in the box.

Wong defends Singapore’s structure for vetting new listings. “When a company comes to list, the army of people working over it is unbelievable,” he says. “And not just Singapore people working on it: a Singapore guy can never know a China company as well as a local person, so every time there is a home country professional involved.” Measures include requiring foreign companies to provide a private investors report, asking them to appoint a compliance advisor, getting an audit committee to report on it, appointing two independent directors who must be resident in Singapore, and insisting on a CFO who has been in place for at least six months pre-listing. While he acknowledges there have been problems in Chinese stocks, he says it is “a very small number, five to seven out of 150-plus.” He also says the local independent directors provide a level of leverage to ensure that things are fixed. But the fact is, in cases where companies have run into trouble, investors have rarely got money back. “We cannot act on behalf of shareholders, that’s for sure,” he says. “I don’t think any exchange has the power to go to a company and say: I sue, or launch a police complaint. But your rules must allow you to be able to go in and find out what is happening, and make certain people who are responsible do what they are supposed to do.”

Asked if the continued courting of foreign businesses raises a risk of reputational dilution, Wong says: “Companies will still fail. That’s a risk. That is beyond your control. We make sure we do our job, first to vet as much as possible, second to monitor and third to pursue – publicly. That is the best way to show people this is not a regime that does not know what it is doing, and that this is not a regime to sit back. That is the best protection against dilution.” Singaporean shareholders in delisted Chinese companies may wonder, though, just how much this sentiment is carried out in practice – because if a suspended company has its assets outside Singapore, there is simply nobody to pursue.

At the heart of this debate is a central point, one that is directly relevant to the proposed takeover of the Australian Stock Exchange. Stock exchanges being listed on themselves is no longer an unusual arrangement, but it does create a thorny issue if exchanges are expected to generate the best possible return to shareholders – partly through listing fees – yet at the same time are supposed to be the supervisor of companies on that exchange. Different places have dealt with this in different ways; Singapore has kept both commercial and supervisory functions within the same company.

“It is a conflict of interest to be a for-profit regulator in any field,” says David Webb, the Hong Kong-based commentator and governance advocate, speaking about exchanges generally. “There is a short-term incentive to lower standards to attract listings, and to cut regulatory costs to boost profits.” When the London Stock Exchange listed, he says, the regulatory function was moved out of it and put into the Financial Services Authority, a separation that neither Hong Kong nor Singapore’s exchanges conducted. Australia’s exchange has also moved some regulatory functions out of itself – which will be an interesting point of difference if the takeover completes.

For his part, Wong argues that the separation between church and state is sufficient. “I’m the guy who is doing the promotion,” he says. “But when I bring a company in, it is not me who says this company will list. It is my issuer regulation colleague, who after going through all the checks quite independently of me will say if this is a company good enough to be listed.” This part of the exchange, he says, has a link to the Monetary Authority of Singapore, which regulates SGX. “I can’t say: this is going to affect my bonus and your bonus so you’d better pass it. I have no power.” He says that this division does, in practice, often decline a company or ask for changes to be made before a listing.

The fear of dilution through foreign listings is not unique to Singapore: it’s arguably bigger still in Hong Kong, where a clear majority of market capitalization is made up of companies from outside Hong Kong, chiefly China. “The problem is that securities regulators have limited cross-border reach,” Webb says. “It depends on the level of co-operation received from counterpart regulators in the jurisdiction in which the listed company is based, and on extradition treaties between the two.” Such treaties are particularly unfeasible for Hong Kong and China given the one country two systems framework.

For companies themselves, Singapore has a huge amount to recommend it as a listing venue. Back at the listing ceremony, Kitichai Sincharoenkul, executive director of Sri Trang, is elated at his company’s new listing. “Most of the investors in this round [of fundraising] in Singapore are new investors,” he says. “We are very pleased to have those first tier investors who normally wouldn’t have invested in Thailand. Singapore is a very important centre for natural rubber trading; it’s good for us to be here.” (It should be stressed there is no indication that Sri Trang, an increasingly regional player, is anything other than a sound company.)

At the top of Singapore Exchange, new CEO Magnus Bocker is involved in a grander game: his proposed acquisition of the Australian Securities Exchange mirrors a remarkable sequence of mergers he oversaw in the Baltic and Nordic regions, culminating with a merger with Nasdaq. Since the ASX deal will be a merger of holding companies if approved, it’s a different theme again to the grass-roots regionalization of Singapore. But he’s been able to do it because of the profit-making heft SGX has built from foreign listings. And as globalization does inevitably come to Asian exchanges, it will be interesting to see if the norms of supervision and company vetting move with it.

BOX: China Milk

In 2006, a company called China Milk listed on the Singapore Exchange to widespread acclaim. It came with a simple premise: to revolutionize the Chinese dairy herd. Chinese cows produce three to four tons of milk per year, compared to eight to 10 for Canadian cows, yet each cow consumes the same amount of feed. So the company brought in a herd of Canadian Holstein cows and bulls – the champions of milk production in the bovine world – and set about building a business based on bull semen, cow embryos and raw milk. It was, to use an oil term, an attempt to redefine the upstream end of the Chinese milk industry.

At first the stock thrived: its management, particularly CFO Martin Choi, was impressive; they told a good story; and their glossy annual reports spoke of a strategy being well executed for the long term. Investors loved it as a play on the changing nature of the Chinese national diet. Revenues grew 186% annually between the 2003 and 2005 financial years; when the company floated, DBS Asset Management, JF Asset Management, Everest Capital and the Dubai Investment Group were anchor buyers.

Then, in January 2010, came a troubling announcement. China Milk had received valid put exercise notices from convertible bond holders seeking to make an early redemption on US$146 million in principal. Since the company hadn’t costed for this, expecting the bonds to be redeemed upon expiry some time later, they had a shortfall. “The board wishes to advise that the company is still currently awaiting clearance from the State Administration of Foreign Exchange… for the remittance out of the PRC of approximately US$170.56 million” to settle the bonds, it said. “The company believes the delay is administrative and procedural in nature and there is no legal obstacle to the remittance of the same.”

But on February 12 2010 its shares were suspended; one year on, they still are. Over the subsequent year, announcements – which at first focused on delays in coming out with annual results for the company – have become steadily more opaque and less useful and dried up altogether in October, when it told the market that despite being instructed by the exchange to appoint a quantity surveyor, it wasn’t going to do so. Since then the web site has been shut down. Go there now and one gets a maddening message saying simply: “…nothing here…” There was never an office in Singapore: the company is domiciled in the Cayman Islands and its assets are in far northeast China. True, its independent directors and company secretary, Ng Joo Khin, are in Singapore; but Mr Ng said he was “not in a position to comment” on Asiamoney’s written queries about China Milk, which begs the question, who is?

Few saw this coming. One fund manager, who asks not to be named, did sell out of China Milk before its suspension, having begun to doubt the management, but even he genuinely believed the problem was a temporary forex issue. “We’re scratching our heads here,” he says. “Was this fraud?”

On the Channelnewsasia talkboards frequented by Singaporean investors, the mood is miserable. “What is SGX going to do about it?” asks one. “These people are a bunch of #@#$%^$# crooks. How can SGX allow such companies to be listed here?” asks another.

Their frustration is understandable. The author is a shareholder in China Milk and wrote to the SGX as a shareholder in January, receiving this resplendently anodyne reply: “As the shares are being suspended, investors will not be allowed to trade until further notice. In the meantime, you may wish to enquire with the company directly if you have any queries.” But there is, of course, no way to “enquire” with the company: it doesn’t have so much as a desk in Singapore. Further correspondence brought a more detailed response saying that “the company has been repeatedly reminded and warned by SGX to comply with listing rules. The severity of these breaches has been noted and SGX will take targeted and appropriate actions.”

But what can SGX really do? It can shout and penalize all it likes, but there is not a single asset in town to seize or direct. And this is the risk that SGX takes: companies worldwide are attracted by its infrastructure, but that doesn’t mean the companies themselves are as attractive as they first appear to be.

Box: The ASX bid

When Magnus Bocker announced the SGX’s tilt for its Australian counterpart in October, it looked visionary. A few months on, it looks almost run-of-the-mill. The SGX-ASX bid may represent a landmark in Asia Pacific exchange consolidation, but the subsequent deals between the London Stock Exchange and Canada’s TMX Group, and between Deutsche Borse and NYSE Euronext, show that in global terms it’s just business as usual.

It is exactly this shifting of global exchange patterns that Bocker wants to lead by combining the liquidity, reach and infrastructure of Singapore and Australia’s exchanges. He should know: more than anyone else, he is closely associated with global exchange mergers, and says this attempt is his 10^th since being part of the team that put Sweden and Finland’s exchanges together in 2003. Bocker was, after all, Nasdaq OMX president after orchestrating the merger of those two groups; he knows plenty about consolidation.

At press time, though, there was still widespread doubt whether the SGX-ASX deal could go through. Of the major hurdles the deal must surmount to be approved, only one – approval from the competition regulator – had been achieved. The other three are to get the support of federal Treasurer Wayne Swan; the Foreign Investment Review Board; and perhaps most critically, a change of legislation that limits foreign ownership of the ASX to 15%. This last is particularly tricky since Australia’s parliament is divided with the slimmest of majorities – one that only exists at all because the ruling Labor party has aligned itself with a handful of independents – making it difficult to get any new legislation through, never mind something as controversial as selling the national exchange to a foreigner.

Recognising this, the terms of the bid have already been revised, turning it from a takeover to more of a merger of equals. On February 15 the two exchanges argued there would be an equal number of Australian and Singaporean citizens on the board alongside three international directors; the ASX and its subsidiaries would maintain boards with a majority of Australian directors; and senior management for the exchange would continue to be based in Australia. There is likely to be further tweaking on governance before Swan makes his final decision.

Those in the market tend to have no problem with the idea, recognising that the ASX will still look and behave much like it always did. “I would like to see them get something done,” says Sartori – who is Australian, running an Australia-based fund, but lives in Singapore and invests in Asia. “It’s good for both sides to get some scale, and to compete on technology in a very competitive landscape.” But it’s not professional opinion the SGX needs to convince: it’s political and public.