Insight: Asian governance needs reform

By Sundeep Tucker Published: January 15 2009 17:23 | Last updated: January 15 2009 17:23 It was not only investors who were hoodwinked by B. Ramalinga Raju, the former chairman of Satyam Computer Services. Just over a year ago the self-confessed fraudster collected the prestigious Ernst & Young India Entrepreneur of the Year gong. At the awards ceremony Rajiv Memani, country head for E&Y, saluted Satyam’s “transformational vision and leadership” while K.V. Kamath, a corporate titan, added that Mr Raju had “used the spirit of entrepreneurship . . . to meet and exceed analyst expectations”. While the fraud revelations sorely embarrass corporate India, it is institutional investors who are nursing heavy losses. Top of the list is Aberdeen Asset Management, whose Asian unit liquidated its 9 per cent Satyam holding following Mr Raju’s confession last week. EDITOR’S CHOICE Markets Q&A: Opportunities in credit - Jan-14The episode, which has severely jolted investors’ faith in Indian auditing and governance standards, follows a string of high-profile corporate debacles in Asia. In October, Citic Pacific revealed more than $2bn in potential losses on foreign exchange contracts. The Hong Kong-listed conglomerate waited weeks to announce the gap in its accounts, angering investors and sparking a regulatory probe that is ongoing. Foreign investors are shunning Bumi Resources – a former favourite – after the Indonesian miner recently made several opaque acquisitions that appeared linked to its dominant shareholder, the powerful Bakrie family. In the past five years developing Asia’s leading stock markets benefited from tens of billions of dollars in net inflows as overseas portfolio investors sought exposure to some of the world’s fastest growing companies. The global financial crisis sparked a capital flight: more than $10bn in Indian equities alone was repatriated last year, according to official figures. Markets such as India rely heavily on portfolio inflows to drive growth and the Satyam affair has ensured that every company in the country is going to have to fight harder to attract capital. In fact, the spectre of so many naked swimmers is forcing global institutional investors to fundamentally reassess their engagement with Asian markets where governance and audit standards are perceived to be weak. Issuers and promoters in the region should beware this revised mindset and the effect it will have on their cost of capital. For overseas investors, the term “related-party transaction” is now an automatic red flag. Deals that involve connected parties will arouse intense suspicion as to who is benefiting from a deal and why. Mr Raju’s disclosures were forced by the failure last month of his plan for Satyam to acquire two companies where his sons hold senior executive positions. Likewise, the dealings of the family dynasties who control more than half of India’s leading 30 listed companies will also face increased scrutiny. Witness the sharp falls in stock prices of the Reliance companies linked to the feuding Ambani brothers. Executives should also expect the timing of their share dealings to prompt investor questioning. Another major focus for global investors is the quality of the audit and internal financial controls. The Satyam case is especially worrying for investors because the company retained PwC and boasted an independent audit committee. Executive teams should expect a surge in visits from potential investors, who are now considerably less inclined to believe broker reports and corporate disclosure. Investors privately speak of a “back to basics” approach, where they spend time with various layers of company management, visit multiple offices and sites and speak with industry rivals, before deciding whether to invest. Bottom-up stock picking is back in vogue. For the foreseeable future, investor bias will sway towards larger companies with a long history, solid brand and a robust balance sheet. There is renewed attraction in those listed companies that have implicit sovereign backing. The perennial frustration for investor activists is that calls to reform regulatory architecture are ignored during bull markets. Management, analysts, regulators – and investors – overlooked the region’s relative lack of protections for minority shareholders in the search for a fast buck. Instead of embracing better transparency and governance, some intransigent family groups or dominant shareholders in Asia will play the waiting game and gamble that investor interest will return when markets pick up. That could be a dangerous tactic should the global recession be of the magnitude and duration that some forecasters predict. Better that the securities and accountancy regulators across developing Asia push through reforms that serve to reassure and protect portfolio investors, to help narrow an ever-widening governance gap with more investor-friendly markets. sunny.tucker@ft.com