China, it’s widely agreed, is the new engine of world growth. But it’s an engine that might need some tuning. As one industry after another – banking, telecoms, resources – gains new global champions from mainland China, some less esteemed names and practices are being pulled into the international spotlight along with them.

Bankers are watching this with some alarm, but really it’s international accountants who have most to worry about. So far this year, three of the big four accountancy groups have either been caught up in controversy about their overseas-listed clients’ accounts, or have stepped away from a client out of growing concern about their books.

The biggest incident involved Sino-Forest, a Chinese timber company that listed on the Toronto Stock Exchange in the 1990s and grew to become one of the largest forestry groups listed in Canada. It appeared a success story, raising more than C$3 billion in debt and equity over the years and reaching a market capitalization of C$6 billion by March this year, reporting almost C$400 million in profit for 2010 from a 780,000 hectare forestry portfolio in China. But following a damningly negative research report from a hedge fund, triggering a share price plunge, it was suspended from trading by the Ontario Securities Commission in August for acts intended to “perpetuate a fraud” – specifically, that it didn’t have the assets it said it did, nor the profitability. It’s now also being investigated by the Royal Canadian Mounted Police. Ernst & Young has been named in two class action lawsuits around Sino-Forest.

Elsewhere, big four accountants have started to become wary of their own clients. In May Deloitte stepped aside as auditor of Longtop Financial Technologies, a financial software provider from Xiamen, citing concerns about its accounts. In what is surely one of the most self-abrasing press releases ever assembled, Longtop itself said Deloitte had quit after identifying false financial records on cash and loan balances, the deliberate interference by Longtop management in Deloitte’s audit process, and the unlawful detention of Deloitte files. Deloitte itself has been sued by the SEC over turning over documents on Longtop, but says it has not been allowed to do so by Chinese regulators; Longtop itself is now facing administrative proceedings from the SEC.

And in January KPMG said it had found possible irregularities in the books of China Forestry, which is listed in Hong Kong; China Forestry’s shares were then suspended. Other problematic examples include Nasdaq-listed RINO International, which makes pollution control equipment, but admitted in March that two previously reported contracts didn’t exist (it has since been delisted); and Duoyuan Global Water, listed in the US, which has been suspended after it borrowed money from related parties and booked it as sales.

It’s hard to say how widespread this problem is, but some estimates are troubling. A Moody’s report in July assigned red flags to the corporate governance of 61 rated Chinese companies, including some big names like Hong Kong-listed Winsway Coking Coal. It spoke of “the inherent challenges in assessing these Chinese companies: their short history of operations, their diverse industries with limited peers for comparison, their concentrated family ownership structures, and their high-growth environments.”

But however widespread, it is causing a major challenge for the bankers and, in particular, the big four accounting firms who have worked long and hard to build businesses in China. Auditing Chinese firms who are readying themselves for international listing is a lucrative source of revenue. But at what risk?

At the very top level, there’s no obvious problem; corporate governance at some Chinese blue chips is in line with international best practice. The problem comes in smaller companies, often private sector seeking to float on the rising tide of investor interest in the China story. Here, auditors face a challenge: stick with the big names they are comfortable with, and forsake other revenue? Or spread the net wider and run the risk of it catching unscrupulous companies?

“My personal view is that the big four may step away from some high risk Chinese clients for the sake of their own reputation,” says Helen Yang, lecturer in accounting at Victoria University, who is working on a study of Chinese convergence with the IFRS international accounting standards. “If you look at those cross-listing companies controlled by the central Chinese government, a majority of them have the Big Four as auditors. To protect themselves, perhaps in the future they should have their own niche targeting these big Chinese companies rather than focusing on revenue accumulation only.”

But that would be to abandon a vast source of revenue: the private sector constitutes an ever greater part of the potential revenue pool for accountants in China. All four of the big four names declined to comment on this story; however, before they all stopped talking, Paul Winkelmann, the partner in charge of risk and compliance for PWC in Greater China, was quoted as saying “costs have gone up, fees have gone down, as competition for fees is enormous. You can easily see there is a real risk of an audit firm failing.” Another big four auditor in China, asking not to be named, says: “I wouldn’t say we have changed our procedures exactly. But people are being careful.”

The generous interpretation of recent malfeasance is that it represents teething problems in Chinese corporate engagement with the world. “The way we read what’s going on in China among these smaller companies is that clearly many of them are relatively new to being listed, and aren’t entirely sure what they should be doing,” says Jamie Allen, founder and secretary-general of the Asian Corporate Governance Association. “We see some companies listing in Hong Kong, private Chinese companies that have only been in operation for a few years. If you look at governance, track record and continuity, it often raises lots of questions. If these are to be allowed to list on overseas exchanges, then it is absolutely to be expected that some are going to run into problems.”

Allen says this is not new – several years ago many companies listed on Nasdaq were sued for disclosure problems. “There has been a certain history of Chinese companies listing in the US then not fully disclosing material events and issues, then being sued through class action law suits.” But one of the things that is new is the scale of institutions that are being caught up, and that is turning it into a matter of concern for international regulators. Fidelity, for example, held 14.5% of Longtop’s stock as of its last filings on March 31, with major hedge funds also well represented. John Paulson, famous for spotting the problems in mortgage- backed securities early and making a fortune from them, was a Sino-Forest investor – selling out before suspension but at a heavy loss.

It has been sufficiently alarming for the US audit watchdog, the Public Company Accounting Oversight Board (PCAOB), to send a team to Beijing in July, for what was subsequently billed the “Sino-US symposium on audit oversight”. This pledged closer cooperation, and arranged for Chinese officials to come to the US in October; beyond that, PCAOB spokeswoman Colleen Brennan told IFR: “The PCAOB does not talk about any open enforcement investigations. Our recent trip to China was to talk about opening China to PCAOB inspections of auditors that are registered with us.” Elsewhere, the Ontario Securities Commission is to review all companies listed in Canada with significant business operations in emerging markets, focusing on roles played by auditors and underwriters.

One common pattern in all of this has been that companies have often listed through reverse takeover, or back-door listing, which have less onerous standards than a whole new listing; this was the case with Sino-Forest, for example (although not Longtop, which raised US$210 million in an IPO in New York). PCAOB published a study in March which identified 159 Chinese companies that had listed on US capital markets alone through reverse mergers between January 2007 and March 31 2010 – and that’s without looking at Toronto, which has many more. That’s almost three times as many as the 56 Chinese companies that launched US IPOs during the same period. Between them, the 159 back-door listed companies had a market capitalization of $12.8 billion as of March 31 2010.

While the US and Canada allows this approach, Hong Kong has banned any attempt to get around listing requirements through a reverse takeover. “The US allows back door listings, which effectively means you do get much riskier companies,” says Allen. “In Hong Kong we started controlling these back in 2004. If you do a back door listing the exchange is not simply going to let that through; it treats it as an IPO and holds you to the same standards.”

“In the US there is a whole cottage industry of investment banks, accountants, auditors and law firms who specialise in these back door listings,” he adds. “Our problem with that is, they effectively undermine the IPO process and investor protection.”

The problems have come at a time of dramatic evolution in China’s domestic accounting industry. China is in the process of entering a new accounting regime, called Chinese Accounting Standards for Business Enterprises, which are largely in line with IFRS. CASBE was announced by the Ministry of Finance in 2006, and a roadmap for further convergence with international practice was released in 2010.

Are challenges in Chinese disclosure related to this evolution? Professor Colin Clark, also at Victoria University and co-author of the Chinese accounting study, says that the varied quality of reporting is “a consequence of the stage of development of the profession. There are issues in the adoption of IFRS, issues around translation into a foreign language, and the shift from a more prescriptive basis of standard setting to a more principle-based system.” This inevitably gradual process of on-the-ground transition is a bigger problem than the regulatory infrastructure above it. “I don’t think the problems we’re referring to are problems of an absence of professional framework. The standards are in place. The problems are around implementation and enforcement.”

On top of that, there are clear issues around staffing. “The challenge is enormous,” says Clark. “The industrialization of the country has meant there has been enormous demand for accounting professionals, and a real challenge in producing sufficient graduates.” Other issues may be cultural – less willingness to speak out in a hierarchical structure, for example. (The Chinese Institute of Certified Public Accountants refused to answer IFR’s detailed written questions on the profession and what is to be done about disclosure issues.)

Even if big four groups are expected to have world-class standards in their accounting, there is some sympathy even at this level for those who have been duped by dishonest companies. “Even among state enterprises there have been significant frauds where bank statements or invoices are fraudulent, where a whole web of fraudulent deals has been set up with suppliers, customers and banks,” says Allen. “If you’re auditing that, it can be extremely difficult. On a typical audit you assume the documents companies are giving you are legitimate, so you’re cross-checking the trading and transactions the company is doing with the bank statement. Most are not forensic audits; that would cost a lot more money and effort.”

It should be said, too, that big four accountants resigning from auditing their clients’ books is not really a bad reflection on the accountants themselves; indeed, it’s what they should do. But nevertheless they find themselves in a challenging position with some tough decisions to make around, expansion, revenue, reputational risk and strategy. The coming years will be interesting.

Sidebar: The muddy waters of disclosure

A central character in recent Chinese accounting issues is a man called Carson Block, who founded a research firm and investment manager called Muddy Waters. The name comes not from the blues singer but a Chinese expression: Muddy waters make it easy to catch fish. In other words, there are opportunities to make money when things are opaque.

Block’s strong sell recommendation on Sino-Forest on June 2 set in motion its share price collapse and subsequent investigations and law suits. He really doesn’t pull his punches: the report, at a time when the company’s stock was riding high, said:  the company “was aggressively committing fraud since its RTO [reverse takeover] in 1995”, and was “a multi-million dollar ponzi scheme, accompanied by substantial theft.” More specifically, it claimed the company had dramatically overstated its forestry holdings and passed revenues through a host of intermediate companies in order to confuse auditors.

A look at the Muddy Waters research list shows only strong sell recommendations, in all cases on companies where fraud or at least mismanagement is alleged: Orient Paper, RINO, China MedicaExpress, Duoyuan Global Water. In Block’s view, fraud is widespread in China, and the big four firms face great challenges in detecting it. One of his central points is that a company can, in a sense, fake transparency, in that it provides a great deal of information but not the right sort. He argues that auditors might be looking for aggressive accounting, but not a situation where the underlying business doesn’t even exist.

There is another side to this coin though. Block is not just a good governance advocate in the mould of renowned Hong Kong gadfly David Webb, or Allen’s ACGA; he is there to make money, and in every instance has built a short position in the stocks he then hammers in his reports, profiting from their subsequent share decline. Block is open about this: whenever interviewed, he points out himself that he is conflicted.

But the power of raising a red flag can be very destructive. Raising doubts about accounts is all but guaranteed to knock a share price hard, providing gains to anyone shorting the stock. The latest name to appear is Silvercorp Metals, a Toronto-listed company, accused by an anonymous whistleblower in early September of a “potential accounting fraud” worth $1.3 billion. Silvercorp has strongly denied this, publishing many documents to support its accounts; it has retained analyst support, such as broker BMO, which maintained an outperform rating on the stock after the allegations; it has apparently come out of a KPMG forensic audit looking clean; and as yet the Ontario Securities Commission has taken no action. No matter, the share price fell 10% in a day anyway when the allegations were made; its management said there had been a dramatic increase in short positions on its shares in the previous two months.

And this is a central point: there’s actually nothing new in irregularity in accounts for overseas-listed stocks. What’s changed is scrutiny. “The difference is people like Muddy Waters and other hedge funds are realising there are problems, short selling, putting out reports and publicly criticising,” Allen says. “They are essentially taking advantage opportunistically of a problem that is real, but I don’t think you would necessarily find in every PRC company listed in the US.”

China, it’s widely agreed, is the engine of world growth, today and for the foreseeable future. But it’s an engine that might need some tuning. As one industry after another – banking, telecoms, resources – gains new global champions from mainland China, it seems that some less esteemed names and practices are being pulled into the international spotlight along with them.

So far this year, three of the big four accountancy groups have either been caught up in controversy about their overseas-listed clients’ accounts, or have stepped away from a client out of growing concern about their books.

The biggest incident involved Sino-Forest, a Chinese timber company that listed on the Toronto Stock Exchange in the 1990s and grew to become one of the largest forestry groups listed in Canada. It appeared a success story, raising more than C$3 billion in debt and equity over the years and reaching a market capitalization of C$6 billion by March this year, reporting almost C$400 million in profit for 2010 from a 780,000 hectare forestry portfolio in China. But following a damningly negative research report from a hedge fund, triggering a share price plunge, it was suspended from trading by the Ontario Securities Commission in August for acts intended to “perpetuate a fraud” – specifically, that it didn’t have the assets it said it did, nor the profitability. Ernst & Young has been named in two class action lawsuits around Sino-Forest.

Elsewhere, big four accountants have started to become wary of their own clients. In May Deloitte stepped aside as auditor of Longtop Financial Technologies, a financial software provider from Xiamen, citing concerns about its accounts. In what is surely one of the most self-abrasing press releases ever assembled, Longtop itself said Deloitte had quit after identifying false financial records on cash and loan balances, the deliberate interference by Longtop management in Deloitte’s audit process, and the unlawful detention of Deloitte files. In late August Longtop said it could face legal action from the US Securities and Exchange Commission for violating disclosure rules.

And in January KPMG said it had found possible irregularities in the books of China Forestry, which is listed in Hong Kong; China Forestry’s shares were then suspended. Other problematic examples include Nasdaq-listed RINO International, which makes pollution control equipment, but admitted in March that two previously reported contracts didn’t exist (it has since been delisted); and Duoyuan Global Water, listed in the US, which has been suspended after it borrowed money from related parties and booked it as sales.

It’s hard to say how widespread this problem is, but some estimates are troubling. A Moody’s report in July assigned red flags to the corporate governance of 61 rated Chinese companies, including some big names like Hong Kong-listed Winsway Coking Coal. It spoke of “the inherent challenges in assessing these Chinese companies: their short history of operations, their diverse industries with limited peers for comparison, their concentrated family ownership structures, and their high-growth environments.”

But however widespread, it is causing a major challenge for the big four accounting firms who have worked long and hard to build businesses in China. Auditing Chinese firms who are readying themselves for international listing is a lucrative source of revenue. But at what risk?

At the very top level, there’s no obvious problem; corporate governance at some Chinese blue chips is in line with international best practice. The problem comes in smaller companies, often private sector seeking to float on the rising tide of investor interest in the China story. Here, auditors face a challenge: stick with the big names they are comfortable with, and forsake other revenue? Or spread the net wider and run the risk of it catching unscrupulous companies?

“My personal view is that the big four may step away from some high risk Chinese clients for the sake of their own reputation,” says Helen Yang, lecturer in accounting at Victoria University, who is working on a CPA Global Research Perspectives project on China’s convergence with IFRS international accounting standards. “If you look at those cross-listing companies controlled by the central Chinese government, a majority of them have the Big Four as auditors. To protect themselves, perhaps in the future they should have their own niche targeting these big Chinese companies rather than focusing on revenue accumulation only.”

But that would be to abandon a vast source of revenue: the private sector constitutes an ever greater part of the potential revenue pool for accountants in China – and the majority, it should be stressed, are legitimate businesses. It’s a debate that is troubling accountancy groups. All four of the big four names declined to comment on this story; however, before they all stopped talking, Paul Winkelmann, the partner in charge of risk and compliance for PWC in Greater China, was quoted as saying “costs have gone up, fees have gone down, as competition for fees is enormous. You can easily see there is a real risk of an audit firm failing.” Another big four auditor in China, asking not to be named, says: “I wouldn’t say we have changed our procedures exactly. But people are being careful.”

The generous interpretation of recent malfeasance is that it represents teething problems in Chinese corporate engagement with the world. “The way we read what’s going on in China among these smaller companies is that clearly many of them are relatively new to being listed, and aren’t entirely sure what they should be doing,” says Jamie Allen, founder and secretary-general of the Asian Corporate Governance Association. “We see some companies listing in Hong Kong, private Chinese companies that have only been in operation for a few years. If you look at governance, track record and continuity, it often raises lots of questions. If these are to be allowed to list on overseas exchanges, then it is absolutely to be expected that some are going to run into problems.”

Allen says this is not new – several years ago many companies listed on Nasdaq were sued for disclosure problems. “There has been a certain history of Chinese companies listing in the US then not fully disclosing material events and issues, then being sued through class action law suits.” But one of the things that is new is the scale of institutions that are being caught up, and that is turning it into a matter of concern for international regulators. Fidelity, for example, held 14.5% of Longtop’s stock as of its last filings on March 31, with major hedge funds also well represented. John Paulson, famous for spotting the problems in mortgage- backed securities early and making a fortune from them, was a Sino-Forest investor – selling out before suspension but at a heavy loss.

It has been sufficiently alarming for the US audit watchdog, the Public Company Accounting Oversight Board (PCAOB), to send a team to Beijing in July, for what has since been billed the “Sino-US symposium on audit oversight”. This pledged closer cooperation; beyond that, PCAOB spokeswoman Colleen Brennan told IntheBlack: “The PCAOB does not talk about any open enforcement investigations. Our recent trip to China was to talk about opening China to PCAOB inspections of auditors that are registered with us.” She also says Chinese officials have agreed to come to the US in October. Elsewhere, the Ontario Securities Commission is to review all companies listed in Canada with significant business operations in emerging markets, focusing on roles played by auditors and underwriters.

One common pattern in all of this has been that companies have often listed through reverse takeover, or back-door listing, which have less onerous standards than a whole new listing; this was the case with Sino-Forest, for example (although not Longtop, which raised US$210 million in an IPO in New York). PCAOB published a study in March which identified 159 Chinese companies that had listed on US capital markets alone through reverse mergers between January 2007 and March 31 2010 – and that’s without looking at Toronto, which has many more. That’s almost three times as many as the 56 Chinese companies that launched US IPOs during the same period. Between them, the 159 back-door listed companies had a market capitalization of $12.8 billion as of March 31 2010.

While the US and Canada allows this approach, Hong Kong has banned any attempt to get around listing requirements through a reverse takeover. “The US allows back door listings, which effectively means you do get much riskier companies,” says Allen. “In Hong Kong we started controlling these back in 2004. If you do a back door listing the exchange is not simply going to let that through; it treats it as an IPO and holds you to the same standards.”

“In the US there is a whole cottage industry of investment banks, accountants, auditors and law firms who specialise in these back door listings,” he adds. “Our problem with that is, they effectively undermine the IPO process and investor protection.”

The problems have come at a time of dramatic evolution in China’s domestic accounting industry. China is in the process of entering a new accounting regime, called Chinese Accounting Standards for Business Enterprises, which are largely in line with IFRS. CASBE was announced by the Ministry of Finance in 2006, began implementation for listed companies in 2007, and has since grown to cover local state-owned enterprises, commercial banks and insurers. A roadmap for further convergence with international practice was released in 2010.

Are challenges in Chinese disclosure related to this evolution? Professor Colin Clark, also at Victoria University and co-author of the CPA study, says that the varied quality of reporting is “a consequence of the stage of development of the profession. There are issues in the adoption of IFRS, issues around translation into a foreign language, and the shift from a more prescriptive basis of standard setting to a more principle-based system.” This inevitably gradual process of on-the-ground transition is a bigger problem than the regulatory infrastructure above it. “I don’t think the problems we’re referring to are problems of an absence of professional framework. The standards are in place. The problems are around implementation and enforcement.”

Naturally, no transition to international best practice takes place immediately. Yang says: “Because Chinese convergence with IFRS only started in 2007, it takes time for Chinese accounting professionals to catch up with international practice, and it is a steep learning curve for them to get used to IFRS.” And on top of that, there are clear issues around staffing. “The challenge is enormous,” says Clark. “The industrialization of the country has meant there has been enormous demand for accounting professionals, and a real challenge in producing sufficient graduates.” Other issues may be cultural – less willingness to speak out in a hierarchical structure, for example. (The Chinese Institute of Certified Public Accountants refused to answer IntheBlack’s detailed written questions on the profession and what is to be done about disclosure issues.)

There’s an issue here for the big four, because the near-monopoly they have held in being able to audit companies listing overseas appears to be ending. With convergence, it is understood that Chinese local accounting firms will also be allowed to do the auditing services for internationally listed companies. They will become direct competitors, and with much lower auditing fees. “The challenge for the big four is rising market competition in accounting services from local Chinese firms, and the need to localize their practices to be aware of the social and political context of China. Accounting reform in China goes hand in hand with economic reform.”

Even if big four groups are expected to have world-class standards in their accounting, there is some sympathy even at this level for those who have been duped by dishonest companies. “Even among state enterprises there have been significant frauds where bank statements or invoices are fraudulent, where a whole web of fraudulent deals has been set up with suppliers, customers and banks,” says Allen. “If you’re auditing that, it can be extremely difficult. On a typical audit you assume the documents companies are giving you are legitimate, so you’re cross-checking the trading and transactions the company is doing with the bank statement. Most are not forensic audits; that would cost a lot more money and effort.”

It should be said, too, that big four accountants resigning from auditing their clients’ books is not really a bad reflection on the accountants themselves; indeed, it’s what they should do. But nevertheless they find themselves in a challenging position with some tough decisions to make around, expansion, revenue, reputational risk and strategy. The coming years will be interesting.

Sidebar: The muddy waters of disclosure

A central character in recent Chinese accounting issues is a man called Carson Block, who founded a research firm and investment manager called Muddy Waters. The name comes not from the blues singer but a Chinese expression: Muddy waters make it easy to catch fish. In other words, there are opportunities to make money when things are opaque.

Block’s strong sell recommendation on Sino-Forest on June 2 set in motion its share price collapse and subsequent investigations and law suits. He really doesn’t pull his punches: the report, at a time when the company’s stock was riding high, said:  the company “was aggressively committing fraud since its RTO [reverse takeover in 1995”, and was “a multi-million dollar ponzi scheme, accompanied by substantial theft.” More specifically, it claimed the company had dramatically overstated its forestry holdings and passed revenues through a host of intermediate companies in order to confuse auditors.

A look at the Muddy Waters research list shows only strong sell recommendations, in all cases on companies where fraud or at least mismanagement is alleged: Orient Paper, RINO, China MedicaExpress, Duoyuan Global Water. In Block’s view, fraud is widespread in China, and the big four firms face great challenges in detecting it. One of his central points is that a company can, in a sense, fake transparency, in that it provides a great deal of information but not the right sort. He argues that auditors might be looking for aggressive accounting, but not a situation where the underlying business doesn’t even exist.

There is another side to this coin though. Block is not just a good governance advocate in the mould of renowned Hong Kong gadfly David Webb, or Allen’s ACGA; he is there to make money, and in every instance has built a short position in the stocks he then hammers in his reports, profiting from their subsequent share decline. Block is open about this: whenever interviewed, he points out himself that he is conflicted.

But the power of raising a red flag can be very destructive. Raising doubts about accounts is all but guaranteed to knock a share price hard, providing gains to anyone shorting the stock. The latest name to appear is Silvercorp Metals, a Toronto-listed company, accused by an anonymous whistleblower in early September of a “potential accounting fraud” worth $1.3 billion. Silvercorp has strongly denied this, publishing many documents to support its accounts; it has retained analyst support, such as broker BMO, which maintains an outperform rating on the stock; and as yet the Ontario Securities Commission has taken no action. No matter, the share price fell 10% in a day anyway; its management said there had been a dramatic increase in short positions on its shares in the last two months.

And this is a central point: there’s actually nothing new in irregularity in accounts for overseas-listed stocks. What’s changed is scrutiny. “The difference is people like Muddy Waters and other hedge funds are realising there are problems, short selling, putting out reports and publicly criticising,” Allen says. “They are essentially taking advantage opportunistically of a problem that is real, but I don’t think you would necessarily find in every PRC company listed in the US.”

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.

Asian companies are showing steadily more interest in corporate and social responsibility (CSR) in their business practices. While Asia is nothing like the US or Europe in terms of ethical and environmental policies becoming an investment class in their own right, much is changing nevertheless.

“In terms of the actions of the companies themselves, we have seen a lot of development,” says Richard Welford, chairman of CSR Asia, which provides information, training, research and consultancy services on sustainable business practices in Asia. “Compared with two or three years ago, we are now seeing many more companies involved.”

One of the drivers of this increased awareness is the behaviour of stock exchanges. For example, in August Singapore Exchange issued a policy statement on sustainability reporting, including a guide for listed companies and a series of principles. Among other things, the statement stressed that a company’s board is responsible for matters of sustainability; that environmental, social and governance factors are important for the long term performance of a company; and that companies should use appropriate reporting standards, such as the Global Reporting Initiative’s Sustainability Reporting Guidelines, linked to the UN Compact principles. “At this stage, sustainability reporting is voluntary,” it said at the time, as it sought feedback from the public. “SGX is of the view that as more companies become inspired to adopt sustainability reporting, it will be natural to take the next step on guidelines and standards leading to rules.” Singapore has not yet made these guidelines mandatory, but it is widely expected to be only a matter of time.

Malaysia is way ahead of it: Bursa Malaysia, the national stock exchange, made sustainability reporting mandatory for listed companies in 2006, and publishes a detailed framework to help them do so. And Hong Kong’s stock exchange has been developing its Guide to ESG Reporting, which is expected to make sustainability reporting there compulsory in due course.

Hong Kong provides a useful case study of the way sustainability has long appeared in corporate reporting. Its blue chip companies are considered some of the most open in the region, if not the world: MTR Corporation published its first sustainability report (also thought to be the first of its kind in Hong Kong) in 2001. But what’s most encouraging is a shift away from the obvious standard-bearers of governance and CSR towards others, and in particular Chinese companies. “For a long period of time it was the usual suspects like HSBC, CLP and Swire: what you could call the old British Empire companies,” says Welford. “Now we are getting to some big Chinese companies, such as Bank of China, Sun Hung Kai and Hang Lung, who are starting to think about sustainability as well.”

Thailand has been a particularly active market for CSR and governance development recently. PTT, for example, has set up a dedicated CSR policy and framework. Its national gas transmission business was developed with a CSR management system manual, winning a national quality award in the process, and it has adopted security, safety, health and environmental management standards. And Thai Airways is involved in reforestation programs, as well as conducting seminars on CSR earlier this year.

And in mainland China, the shift towards CSR and governance has probably been more acute than anywhere. State-owned companies face mandatory governance reporting requirements anyway, but in addition to that, many people feel that the terrible Sichuan earthquake in 2008 was something of a catalyst for CSR thinking in China.

A look at the annual reports that came out for China’s blue-chips in 2008 shows a major shift in the importance of CSR and philanthropy: all of China’s biggest companies made considerable donations (China Mobile, for example, eventually committing RMB282.6 million through a combination of company donations and staff collections, Sinopec RMB300 million, and China Telecom RMB330 million). Bank of China established tent banks to keep emergency financial services moving; other banks provided relief loans or grace periods on repayments; Petrochina distributed and transported a million of tons of refined products to the region in two months as part of an emergency response plan; China Life gave free accident insurance to rescue workers and used its charity foundation to fund earthquake orphans’ living expenses until they reach 18; and oil company CNOOC sent 14 helicopters in relief support.

The earthquake notwithstanding, in the same year ICBC moved its CSR report into line with the 2006 Sustainability Guidelines of the Global Reporting Initiative, with an independent third party appointed for verification, and imposed limitations on loans to industries with high pollution and energy consumption (by the end of that year 99% of outstanding loans were to borrowers meeting China’s environmental policy). Sinopec devoted 26.8% of its capex for the year to the development and production of cleaner energy, and passed an Employees Code of Conduct, as well as supporting public welfare and charity programs in Tibet; Petrochina implemented a new accountability system on safety and environmental protection; CNOOC, which was already running a poverty alleviation program in Tibet and making education donations, published details of new pollution prevention measures; China Life ramped up its involvement in the New Village Cooperative Medical Schemes, which affects 30 million rural residents; China Mobile increased its involvement in a program supporting children orphaned by AIDS, and another training 3,600 primary and middle school principles (it also became the first mainland Chinese company to be listed on the Dow Jones Sustainability Index);  China Telecom built primary schools and a hospital in Sichuan; and Ping An, long involved in the Hope school-building program, engaged 600 of its staff in voluntary teaching programs, and became a party to the Self-Disciplinary Convention on Environment Protection for Listed Companies.

“We must never confuse philanthropy with CSR, but I think there was a sense that some companies were not perceived as giving enough” after the earthquake, says Welford. “People were saying: you’re a multibillion dollar company, giving one million RMB is not enough. The earthquake also led people to realise that it’s not all about money: sometimes it’s about equipment, or water, or providing skills.”

Welford adds that, in China, “the leadership from government has been quite interesting. Senior politicians have been talking about the role of the private sector in contributing to a harmonious society. And their notions of the harmonious society contain strong sustainability dimensions.”

But if 2008 was a spur for new behaviour in CSR, some feel that it was also a cause of lost ground in the related field of corporate governance.  “The 2008 global financial crisis was a wasted opportunity,” said Amar Gill, CLSA’s Head of Thematic Research, when he presented CLSA’s latest annual Corporate Governance Watch survey in September 2010, produced with the Asian Corporate Governance Association. “Rather than using it to push reform forward, most governments have taken a complacent view, happy that the crisis this time did not start in Asia. Not enough has been invested to make best practices work and the negative trends we see may lead to a build-up of governance risk for the coming years.” The survey, a benchmark in Asian corporate governance and now covering 580 companies in 11 countries, concluded that corporate governance was improving in Asia, but was well short of international best practice, with regulators making it too easy for companies to simply tick boxes rather than effect genuine change.

One of the reasons governance and CSR have not gone as far as they could do is that there is not the same push from institutional investors in Asia for governance as exists elsewhere in the world. Asia is not yet home to a vibrant SRI fund industry of the kind that exists in Europe, the US and Australia. “They are appearing,” Welford says. “There has been quite a track record in Japan, particularly for environmental funds, and to some extent Korea. But they have not shot up as one might have predicted five years ago.”

That said, Welford does believe that “mainstream as well as socially responsible investors are getting more interested in disclosure from companies. They are recognizing there are risks associated with making sustainability mistakes.” He cites the example of Foxconn, the Chinese company that became internationally controversial when 14 of its workers committed suicide in the space of 2010 alone; a report by several Chinese universities subsequently described its factories as labour camps. Foxconn did then change some practices and increase wages, but its share price has plunged – partly because of reputation damage, and partly presumably because of the impact of the wage increases on the bottom line. “I think investors are aware of these sorts of stories now, and are looking for more information.” Others have argued that the revolt in Thailand illustrated how social inequality is, to be pragmatic about it, plain bad for business.

CSR Asia was one of the backers of the Asian Sustainability Ratings initiative, alongside Responsible Research, a Singapore company that provides CSR-related research to global institutional investors. The initiative has its roots in a business barometer of the top 10 companies in four countries several years ago; it has been progressively expanded and will this year rate 750 all over Asia. Tellingly, the ratings appear to be more popular with European pension funds seeking to understand Asia than Asian institutional investors themselves. But it does demonstrate the increasing level of information and research growing around these areas of business.

On top of regulation and research, another prompt for improvement in CSR practices has been peer pressure. “More companies are looking at peers and realizing that they are laggards,” says Welford, “and that’s not good. It would be too strong to say they are being embarrassed into doing things, but they are certainly recognizing that big brand name companies do this. In particular, Asian companies with global aspirations are beginning to realize CSR is a big part of their brand and reputation.”

Across Asia, there are numerous examples of CSR practices gaining greater traction. The Ministry of Company Affairs in India, when it announced a new Companies Bill, required some companies to allocate 2% of net profits for the previous three years to CSR. It’s not without criticism – it lacks specificity on what CSR spending actually is – but it shows an increasing willingness to legislate for CSR. Interestingly the Indian bill, which is not yet law, will be self-regulated, relying on shareholders and other stakeholders to make companies do the right thing. India already imposes mandatory CSR spending on the mining industry.

In Malaysia, the 2011 budget includes several green policies, including tax breaks, soft loans and a general encouragement to invest in green innovation, provide information on energy usage and carbon footprint, providing green products without a premium for the greenness, and adopting green living in everyday life.

Alongside this comes a general change in multinationals behavior in Asia. Coca-Cola, for example, is now engaged in a project with the World Wildlife Fund to improve water quality on the Yangtze. This will involve working with rural farmers to turn animal waste into biogas instead of allowing it to enter the river; as well as community education projects on environmental issues for rural farmers. Coca-Cola is an example of a multinational taking the approach of issues-based reporting: taking a global issue and writing detailed studies of that issue, in Coca-Cola’s case water. Unilever was an early mover in this area, writing reports on poverty alleviation.

And one can even make a case for arguably Asia’s most obscure state, the mountain kingdom of Bhutan. It has introduced a new index of development called Gross National Happiness, combining psychological well-being, health, education and environmental diversity into one single measure. Perhaps we’ve all got something to learn from the Bhutanese.

Euromoney, April 2011

Records are made to be broken, but you normally have a fair idea of the candidates for breaking them. Had you laid bets a year ago on what would replace Malaysia’s Petronas Chemicals as southeast Asia’s largest ever IPO, you might have plumped for an Indonesian resources play, or a Singaporean sovereign wealth fund spin-off, or even another arm of Petronas. You’d have had a lot of guesses before you came up with a port operator that isn’t based in southeast Asia, doesn’t have a single asset there, is owned by Hong Kong’s ultimate tycoon and has opted not to list as a company at all, but a trust.

But this is the curious case of HPH Trust, the owner of about 60% of Hong Kong’s Kwai Tsing container port, Shenzhen’s Yantian container port, and a few auxiliary assets. HPH Trust is sponsored by Hutchison Ports Holdings, by some measures the world’s top port operator; that, in turn, is owned by Hutchison Whampoa, the conglomerate controlled by Li Ka-Shing – the tycoon’s tycoon, as central and iconic to Hong Kong as the Bank of China building. Yet this two-port trust of Pearl River assets raised US$5.5 billion in a listing on the Singapore Exchange in March, breaking the southeast Asian IPO record by over US$1 billion.

So what was this jewel of Hong Kong doing seeking a listing in Singapore? For the Singaporeans, this is a coup to beat all coups. Attracting foreign listings has been a mainstay of the SGX’s approach to business for years: it calls it the Asian Gateway strategy, and by the end of 2010 it had resulted in 321 non-Singaporean companies accounting for 47% of the market’s overall capitalization. In a country – no more than a city state – too small to grow much further on homegrown listings, attracting foreigners is the future. But many of them have been Chinese private sector mid-caps of variable quality; few heavyweights, beyond Jardine Matheson and Noble Group, tend to opt for Singapore. Bringing in a multi-billion dollar IPO from a foreigner, and a Hong Kong conglomerate spin-off to boot, is more than they could have hoped for.

But there is really only one reason this prized Hutch asset has made its way to a Singapore listing rather than Hong Kong, and it has nothing much to do with the rivalry between the two Asian cities, or getting out of the way of Chinese state-owned listings in Hong Kong, or even valuations. It is all about a structure called the business trust.

The business trust structure was launched in Singapore in 2006 with the world’s first shipping trusts, Pacific Shipping Trust and Rickmers Maritime. It’s sort of a cross between a company and a real estate investment trust (REIT) – and Singapore is unarguably the ex-Japan Asia leader in REITs (it has 22 of them, worth US$27 billion). The idea of it is that it allows assets such as property or infrastructure to be monetised so that they pay their income distributions out of cash flows instead of accounting profits. For a business with stable cashflows and high initial capex, like a utility or an infrastructure business, a business trust structure gives it greater freedom in how it pays dividends.

It is, from the investor perspective, a yield play. “Our market participants and investors are familiar with such yield instruments,” says Lawrence Wong, head of listings at SGX. “The tax incentives and business friendly regulations have made Singapore the choice venue for the listing of such structures.”

When business trusts first came along, they were touted as an important new line of business alongside the REITs, but the truth is that until now they have been nothing like as impressive. Wong says SGX has nine business trusts with a combined market cap of US$11.9 billion, but US$8.8 billion of that is the post-IPO market capitalization of HPH Trust itself.

Instead, several businesses have struggled under the structure, including one of the first, Rickmers, which in 2010 received a report from its parent group’s independent auditor, PricewaterhouseCoopers, questioning its ability to survive owing to its debt load. Rickmers did stay afloat, but it – and, to a lesser extent, fellow shipping trusts First Ship Lease Trust and Pacific Shipping Trust – has struggled within the business trust model precisely because of being positioned as a dividend play. On one hand they are obliged to pay out as much of their operating cash flows as possible as dividends; but that doesn’t leave much margin for debt repayment or capital management, particularly when the shipping industry itself is under pressure. Even those trusts that have not struggled have been somewhat illiquid.

So why take this structure? After all, Hutch had considered a lot of alternatives for a listing venue. Those close to the deal say that it undertook feasibility studies for a listing in Hong Kong, the US, Australia and Europe besides Singapore, declining on first choice Hong Kong precisely because it lacked this seemingly underwhelming business trust structure.

It’s true that ports are the sort of operations that business trusts are pitched at: infrastructure with steady and reasonably predictable inflows. And Canning Fok, group managing director of Hutchison Whampoa, pointed this out when asked at a pre-listing press conference in Singapore about why he had chosen this route. “Why are we listing in Singapore instead of Hong Kong? If you look at the characteristics of our assets, most of the capex has been spent in the past, and in the next five to six years there is no significant capex that needs to be spent,” he said. “The business trust is welcomed by the investment community on this aspect, because then the cash flow generated by this business can be distributed.”

But then he added something else: “These two ports are important parts of our portfolio going forward. With our business trust structure, we can aim to avoid potential hostile situations with regards to our shareholders.”

And that, more than anything, is the point.

On page 71 of the vast, 600-page-plus prospectus, one finds this. “Under the Trust Deed and the Business Trusts Act, the Trustee-Manager may only be removed by Unitholders by way of an extraordinary resolution (that is, by the approval of not less than 75% of the voting rights of all Unitholders who vote on such resolution). Accordingly, a Unitholder who owns or controls more than 50% but less than 75% of the Units and has statutory control of HPH Trust may not be able to remove the Trustee-Manager.”

In other words, you could become a majority shareholder of this thing and still not have the right to change the trustee-manager, which in this case is Hutchison Port Holdings Management, and by extension Hutchison Whampoa. And there’s no special treatment been given to Hutch here to attract this listing: this is what Singapore’s business trust rules say for anyone who uses this structure.

Approached by Euromoney, Fok confirms that this was a key consideration. “It is an integral part of our strategy,” he says. “We don’t want somebody to end up in our door asking me to step aside. It is a central part of the strategy.”

People close to the deal confirm this was the clincher. “From an issuer perspective, if you own 25% of the company there’s no hostile takeover scenario that can happen,” says one. “For an issuer who’s not looking at a straight disposal but an extension of their business, which they want to keep running, it makes a lot of sense.”

While that’s great for the issuer, it has caused some consternation among corporate governance activists. David Webb, the Hong Kong-based independent analyst and thorn in the side of many a company and regulator, came out strongly – and uncharacteristically – in Hong Kong’s corner when the listing was announced. “There’s been much hand-wringing amongst legislators and media in Hong Kong about losing out to Singapore as a choice of listing,” he says. “We don’t think Hong Kong is losing out at all, and it would be a loss if Hong Kong were to lower its standards to attract such business.”He points out that Hutch plans to retain only 25% of the listed trust – a key number given the business trust rules (the precise number it ends up with will depend on the greenshoe, and it was not clear as Euromoney went to press if this would be exercised). “If HPH retains 25% plus one unit, then HPH Trust will be bid-proof. Even if HPH is prohibited from voting, it would be an uphill struggle to get the required majority,” he says.

“Short of that, unitholders will have very little say, except on connected transactions, because they will not be able to elect directors of HPH Management, unlike a listed company. In short, the only way to change the directors of a trustee-manager is to own the trustee-manager.” He also points out that under the structure of the deal, although Hutch’s interest in HPH will be reduced to 25%, it will still retain 100% of its operations and receive fee income for doing so. “Nice work if you can get it.”

“We can see no good reason for Hong Kong to emulate Singapore business trusts,” concludes Webb. “There’s no tax reason for doing so, and there are governance reasons why we shouldn’t. We should not race to the bottom just to win business from tycoons who are not willing to work with existing corporate governance standards.”

Hutch and its bookrunners take a different stance: that HPH works best with Hutch involved, so anything that blocks a potential takeover is good for investors rather than bad. “The company needs good management,” Fok tells Euromoney. “To raise this kind of money around the world, it can only be delivered, the business plan, with the support of HPH. That is very important. With the kind of shareholdings we have, 25%, we can deliver the result to the shareholders and the management is a crucial part of it.”

Bookrunners also say this didn’t turn up as much of an issue on the roadshow. “Investors are not concerned,” says Eng-Kwok Seat Moey, managing director and head of asset-backed structured products at DBS Bank. “In fact, investors view it as a sign of the sponsor’s commitment and see it as an alignment of interests. They would like the sponsor to provide continuity through managing the assets. For REITs , the sponsors’ stake is on the average about 30%.”

If Webb’s concerns were shared by institutional investors, it wasn’t immediately apparent as the three bookrunners – DBS, Deutsche Bank and Goldman Sachs – hit the road pre-marketing in pursuit of cornerstone investors. By the time the deal launched, they were able to announce eight cornerstones taking up US$1.62 billion of the deal. That would prove a vital anchor and vote of confidence in getting the rest of the deal away in record time.

The eight – Ally Holding, Aranda Investments, Capital Research and Management, Cathay Life Insurance, Lone Pine Capital, Metropolitan Financial Services, Paulson & Co and Seacrest FIR – make for a curious combination. On one hand there is some suitably steady or Singapore-linked money: Aranda, in for US$100 million, is owned by Temasek, the Singapore sovereign wealth fund; Cathay Life, from Taiwan and up for US$100 million too, is a natural holder of a yield-producing infrastructure asset. Capital Research, the biggest buyer with US$634 million, is also a natural holder. But Paulson & Co is John Paulson’s vehicle: a multi-strategy event arbitrage investor (a hedge fund manager, in other words). And at US$350 million, he made the second-biggest commitment of all the cornerstones. Lone Pine Capital, too, is not an obvious candidate; founded by Steven Mandel, it is also seen as a hedge fund group (it put in US$186 million). Ally and Seacrest are BVI companies, in Seacrest’s case representing Jenkin Hui, a Jardine Matheson director who runs Pointpiper Investments; and Metropolitan represents “various reputable individuals from the South-East Asia region” with “substantial stakes in both private and public companies in the natural resources sector,” according to the prospectus.

Those close to the deal say the diversity was intentional. “We were very selective in our cornerstones,” one says. “We wanted a wide range: long funds, hedge funds to provide liquidity, and also the family, high net worth investors.”

This eclectic gathering would represent 30% of the total deal. The rest of the deal was structured in four parts: a global offering, a public offering without listing (POWL) in Japan led by Daiwa and Mizuho Securities (the global offering plus the POWL eventually made up 88% of the base offer, cornerstones excepted), a Singapore public offering (just 3.4% of the deal) and a preferential offering to Hutchison Whampoa shareholders (8.6%). There were two roadshow teams, one led by Fok and the other by long-standing Hutchison Whampoa CFO Frank Sixt, in both cases alongside members of the Hutch Ports team.

The strength of the anchor book meant that when the roadshows started, they were able to get what they needed and stop pitching a day earlier than expected; this would prove crucial when the POWL in Japan ended on the morning of Friday, March 11, just hours before the earthquake and tsunami wrecked the country’s northeast.

Those who saw the roadshows say that governance issues rarely came up: questions focused much more on the growth profile of the ports, the ability to sustain cashflows, and on gearing. Fok says the global offer part, including the institutional book bar the cornerstones, was three times covered. Still, some institutions stayed away, fearing an operator as canny is Li Ka-Shing was selling his assets for top dollar at the top of emerging market buoyancy. “We let that one go through to the keeper,” says one fund manager. “A bit expensive, with other listed options more attractive.” In the end the deal priced in the middle of a US$0.91 to US$1.08 range, settling at US$1.01 per unit.

Business trust structures aside, there were some other reasons for the Singapore listing too. Hutchison Ports Holdings (the company not the trust) features PSA International, the Singapore state-owned port operator, as a 20% shareholder; PSA has bought assets from Hutch before.  Also, Singapore offers a tax break for trustee managers in offshore infrastructure: 10% for the first 10 years, assuming HPH Trust is deemed to qualify.

And there’s no denying that these are good and well-positioned businesses. Yantian is a play on Chinese export strength; Hong Kong, while clearly more mature, has become a regional transhipment hub. “Despite the global financial crisis, both assets achieved record throughput in 2010, both exceeding 10 million TEU each,” says Ivor Chow, CFO of the trustee-manager. He says growth over the last 10 to 15 years has been 10 to 15%, and that in future it is realistic to expect 8-10% throughput growth, driven not just by Chinese export growth but imports too, for which the trust owns the longest berths and largest yards with deepwater access in the region. “We have very long-term relationships with our customers with some spanning over 30 years,” Chow adds. Investors will go into the deal with an expected yield of 5.9%.

But it’s hard to shake the sense that HPH represented a great deal for Singapore, and a great deal for Hutch, without quite the same certainty that it will be a great deal for investors. Singapore gets a landmark upon which to base a whole new push for overseas infrastructure assets. Hutch gets a lot of money to pay down debt and invest in more ports. Investors get a play on Chinese exports, decent yield – and an unproven structure from which its managers could not be removed with gelignite. Time will tell if that’s a smart call.

Box: The big moment

Having won such a trophy, Singapore paraded it with pride. On the day HPH Trust began trading, March 18, newspapers – international as well as local – carried two full pages of ads apiece using the listing to promote Singapore as the “home of infrastructure companies tapping into Asian liquidity.” And the moment of listing was set at 2pm, the start of the afternoon session, rather than the morning bell in order to accommodate maximum participation at the listing ceremony.

These ceremonies come and go regularly at SGX on the second-floor foyer of the exchange’s Shenton Way building, but this attracted a particularly senior crowd. Ho Ching, chief executive of sovereign wealth fund Temasek, was there to greet the great and the good of the Hutch empire including Canning Fok, Frank Sixt and a host of executives from the port business and the new trust. Singapore Exchange had its top brass out: chairman Chew Choon Seng, president Gan Seow Ann, listings head Lawrence Wong – in fact everyone bar CEO Magnus Bocker, no doubt embroiled in SGX’s continuing tilt for the Australian Securities Exchange.

A screen had been erected behind the stage showing the bid and ask prices ahead of commencement of trading; in front of it, as the big moment approached, Chew and Fok made speeches. An SGX spokeswoman announced there would be a 10-second countdown to the start of trading. Then she started counting down to the countdown. It began to feel like a Space Shuttle Launch.

The crowd – and it was quite a crowd – obediently counted down to 1.59pm whereupon Fok, Chew and HPH group managing director John Meredith started hammering at a gong with mallets, a swirl of gold confetti filled the air and two dragons commenced a lion dance to a clash of cymbals. It was a perfect moment: except for the fact that, at that moment, on the big screens behind this exuberant melee, the stock opened 4% down on its listing price.

Nobody seemed to be looking in that direction.

It is a truism of the financial markets that investors have short memories, but they are never shorter than in a market rally. The peerless liquidity for emerging market equity over the last six months has brought no end of landmarks to the Asian capital markets – and allowed a few interesting names to raise funds alongside them.

At the time of writing, Sateri International was marketing an IPO expected to raise up to US$686 million, post-greenshoe, through Morgan Stanley, Credit Suisse and Bank of China International.

Sateri is being marketed as an emerging market growth story combining Chinese consumption with Brazilian resources. The pitch being delivered to investors runs like this: Sateri is one of the largest speciality cellulose producers in the world; it owns wood plantations in Brazil; it is the largest supplier of rayon grades of dissolving woodpulp to China, which is the largest market by demand in the world; and its products can be used for a range of consumer applications, chiefly textiles but also lip gloss, sunglasses, toothpaste, shampoo, cigarette filters and ice creams, among other things.

Emerging markets, consumption, commodities, pictures of children with lovely ice creams – what’s not to like? Well, some investors and bankers are rather surprised to see Sateri come to market, not because of the quality of the business itself, but because its owner: Sukanto Tanoto.

Lots of people know Sukanto well. One is Bank Mandiri, which published a list of its top bad debtors in 2006, with Sukanto’s Raja Garuda Mas pulp and paper company at the top by an absolute mile, owing Rp5.35 trillion in principal and interest at that time. (Mandiri did not respond to requests for an update on that debt position.)

Sukanto’s conglomerate of interests – which also includes the pulp, paper and fibre group April, the palm oil group Asian Agri and the resources group Pacific Oil and Gas – was badly hit in the Asian financial crisis, which came just as April was in the middle of a US$2 billion fundraising exercise for expansion. For years subsequently, Sukanto companies struggled to repay their debts, a position that observers have struggled to square with his great personal wealth. In particular, the member companies of the April Group – Riau Andalan Pulp & Paper (RAPP), Riau Prima Energy and Riau Andalan Kertas – wrestled with the almost US$1.5 billion they owed in 1999, with many creditors claiming attempts at commercially workable restructurings had been blocked or delayed. Foreign banks thought to have had to sell out of their claims at steep losses include Citi, ING and Standard Chartered.

Another group that knows Sukanto well is Deutsche Bank, which has been stuck in court with a Sukanto-backed company since 2006 in a dispute going all the way back to a $100 million bridging loan Deutsche bank extended to a company called Asminco in 1997. The company, owned by Beckkett, a vehicle whose owners include Sukanto, defaulted in May 1998, and three years of subsequent standstill agreements failed to yield a restructuring agreement. As collateral on the loan, Beckkett had pledged 40% of the shares in a coal company called Adaro, so by 2002, in order to recover its losses, Deutsche sold the pledged shares for $46 million to a group called PT Dianlia Setyamukti, run by Edwin Soeryadjaya of the Astra dynasty. The various parties have been locked in court for more than four years now on issues around the ownership of the shares, Deutsche’s efforts to find the best price for them and their right to sell them – and they’re still in court now. It has been an uncommonly acrimonious case, and it is understood at least one Deutsche banker has been unwilling to take the witness stand.

These days, Sukanto – regularly named Indonesia’s richest man by publications such as Forbes – has reinvented himself as a philanthropist and environmentalist, whose Tanoto foundation has “the aim of educating and empowering marginalized members of the community so they can improve their lives,” according to his own website. April, in particular, is painted as an environmental champion, a signatory to the UN Global Compact and a crusader against illegal logging; its branding is based on green leaves in nurturing hands. It’s a far cry from the institution whose Indorayon pulp and rayon fibre plant in north Sumatra had production halted by community protests in 1998.

Is Tanoto reformed, and his companies creditworthy? As marketing got underway, opinions were divided. “We will take a look, obviously, but instinctively we are likely to avoid it,” says one major global fund manager.

Others were more direct. “I cannot believe he is coming to the capital markets,” says one. “It really reflects to me how short people’s memories are.”

But a third camp suggests that Sateri may get its money after all, seeing the seniority of its bookrunners and the scale of its capital raising ambitions as an endorsement of the business’s propriety. “If he [Tanoto] was front and centre in the deal, I’d be amazed if Morgan Stanley and Credit Suisse could touch it,” says one manager. “We will look at the company on its merits.”

Certainly, the issuer and its bookrunners appear to be aware of how it looks: you only have to get a few pages into the summary section of the 446-page draft information material lodged with the Hong Kong Stock Exchange before the question of the controlling shareholders is raised. The prospectus confirms that Sukanto, his family, and the Gold Silk investment holding company he owns are the ultimate controlling shareholders, but is at pains to stress he “is not, and has never been, a director of our company or any of our subsidiaries and has not been involved in the day-to-day operational decisions of the group since January 1, 2007.” It adds that Sateri is not operationally dependent on Sukanto, stresses that all amounts due to and from him have been settled, that Sateri can still access third party financing without him, and that it has an internal control and financing system with its own accounting and finance department independent from him, including a separate treasury department. If there’s been a more strident attempt to distance a company from its owner in the eyes of the investing public, we are not aware of it.

Consequently, when one reaches the risk factors section, amid the usual disclaimers about resource price fluctuations and the global economy is a two-page section about “adverse claims and media speculation”. These include the Beckkett litigation, problems around Sukanto’s previous ownership of PT Unibank (which went under in 2001, although he was not a majority holder by then), allegations of tax evasion around the Asian Agri companies, illegal logging, and allegations of embezzlement dating back to the Asian financial crisis. All of these questions are raised by the issuer itself, presumably on advice from lawyers that it’s better to disclose them up front. “Whether or not justified,” the prospectus says, the claims “could adversely affect our reputation and our corporate image, or otherwise affect our ability to conduct our business.”

For their part, Sukanto’s representatives find criticism of their man misguided and out of date. IFR asked if investors should be worried about his history on debt repayment, and if he continued to hold bad debts to Indonesian or foreign lenders today. “No is the answer to both questions,” said a spokesman. “And additionally, the loan issues in no way relate to Sateri.” The spokesman says that although some loan obligations, such as the US$1.5 billion Mandiri syndicated loan connected to the RAPP plant in Riau, were restructured, “restructuring of loans was not at all unusual at that time in history, and RAPP has continued to pay back the loan. Many other troubled companies went bankrupt during the crisis, but RAPP continued to pay back the loan.” Sukanto’s team says that Mandiri publicly stated in 2006 that Riau Pulp Group had fulfilled its payment obligations under the syndicated loans.

“Although some of Mr Tanoto’s various companies went through difficulties during the Asian financial crisis, we believe these have been dealt with appropriately,” the spokesman says. “Across Mr Tanoto’s businesses there is now a large banking network from many different countries across several continents. The robust health of Mr Tanoto’s businesses today is further demonstrated by the strong positioning they have had coming out of the recent financial crisis.”

It’s not the first time Sateri has attempted to come to the capital markets since the Asian financial crisis. In 2005, it hired CSFB and Merrill Lynch to lead a US$300 million high yield bond. The bond was abandoned even after adding an additional security package, which investors had required before lending to a company owned largely by Sukanto. At that stage the company had Ebitda of US$43.5 million on turnover of US$228 million, plenty strong enough to get most bond deals away in that market, but the connection to Sukanto appeared to derail the deal even after the stock of two plantation companies were added as security. It did, however, subsequently raise the money it needed in a loan from WestLB.

However Sateri fares, it is already clear that buoyant markets have helped to rehabilitate troubled names in both the debt and equity side of the market. In September, Vista Land and Lifescapes completed a US$100 million five-year bond through Morgan Stanley, UBS and BDO. This was despite the fact that Vista Land is partly owned by Manuel Villar, also its chairman, who ran a company called Camella and Palmera Homes that defaulted on a US$150 million floating rate note in the wake of the Asian financial crisis. Several banks lost money as a consequence of the restructuring of the notes. Vista Land – which now has C&P Homes as a subsidiary – had to go offshore for its recent capital raising as memories are still somewhat sour within the Philippines.

Asia has also proven to be a forgiving place for issuers that, while they have no troubled financing background, have nevertheless been rejected elsewhere. Trony Solar, the Chinese renewable energy company, raised US$223 million in September in a deal covered on the first day of its roadshow – this after abandoning an IPO in New York late last year. Xinjiang Goldwind Science & Technology raised HK$7.1 billion in October, just four months after having abandoned a similar sized deal.

And it’s been a market that has allowed two major shareholder vehicles to sell US$156 million of stock in Chinese dairy group China Mengniu just two years after the company was involved in a scandal in which melanine was discovered in milk, killing four babies. Those shareholders got out at a price higher than before that scandal, such has been the force of the rally.  Investors, it seems, have been willing to ignore a lot in order to participate in the world’s major growth story.

Asia’s best managed companies have come out of the financial crisis in better shape than their peers, and that’s no surprise: in most cases they went into it in better shape too. Prudent gearing, transparency, good governance and clear strategy have characterised these leaders, rewarded in this month’s Euromoney Asia’s Best Managed Companies poll, for years.

That’s not to say things have been easy for any of them. Take CapitaLand, for example. For many years the favourite Singapore blue chip among Asia portfolio managers, this time last year its whole approach to business was being questioned. “As global liquidity tightened and real estate transaction volumes dried up, analysts were raising concerns that our business model – which focuses on capital recycling and capital productivity – was broken,” recalls Olivier Lim, group chief financial officer at CapitaLand.

“What they forgot was that all real estate businesses need to recycle capital. We just articulate it and execute it diligently as a business strategy and this gives us more financial flexibility than others across market cycles.”

That was of little comfort when CapitaLand’s share price fell more than 70% from its highs in a shade over a year; its many listed satellites fared worse still. “Whilst we were very confident of our business model and viewed the dislocation as part of the cyclical nature of the real estate business – albeit more severe than a normal recession – it was difficult to convince the investment community,” says Lim. “Partly I suspect they were facing their own business model stresses with the loss of AUM from large redemptions and falls in portfolios values. They saw no light at the end of the tunnel during the crisis.”

But Lim and his team put the building blocks in place to weather the storm and flourish when it passed. Seeing trouble ahead it divested over S$9 billion of property assets and reinvested only S$4 billion over a two year period heading into the financial crisis. Some of this, such as the sale of an iconic tower in Beijing, looked like a forced or panicked sale at the time; in fact, it proved to be a great deal in that the price it raised would have been unthinkable only months later. By the time the crisis hit in earnest, CapitaLand had built up a cash reserve of over S$4 billion, with a low gearing ratio. It slowed business development; it bolstered itself with a S$1.3 billion long-dated convertible in mid 2008; it pulled in another S$1.8 billion in a pre-emptive rights offer in February 2009, heavily oversubscribed. And investors have continued to back it in the capital markets, first with a seven-year S$1.2 billion convertible in July, the largest and longest tenor convertible for an Asian listed issuer at the time.

And finally, in a move that would have seemed implausible a year ago, it launched an IPO of another listed satellite, CapitaMalls Asia, with a placement 2.5 times oversubscribed and a public offering 4.9 times subscribed. “We patiently built this capital-intensive business over the last seven years,” says Lim. “We polished it, and gave it its own access to the capital markets so it can aggressively take advantage of its first mover position in Asia.” The funds allow CapitaLand to recycle capital, rebalance the portfolio and put the money into business units.

At Infosys, the challenges were rather different. Infosys has no debt whatsoever: 60% of its balance sheet is cash and cash equivalents. So there was no need to navigate the perils of refinancing in debt or loan markets, or to keep bond investors happy. That clearly helped. “It was a lot of comfort for investors,” says V Balakrishnan, Infosys’s CFO, in Bangalore. “People realise cash is God in that kind of environment: companies with a lot of cash can fulfil their strategy much better than anyone else.”

But Infosys had other headaches to deal with. “Today, 98% of our revenues come from outside India: we are a global company based out of India,” says Balakrishnan. “The majority of our revenues [66%] come from North America. Anything happening in the large economies around the world will have an impact on our revenues.” Infosys guidance at the end of the last quarter forecast revenues could decline 1 to 1.3% year on year, although the company has been insulated by the growing interest in moving IT services offshore to countries like India, as a way of cutting costs: hence recession has in some measure helped part of Infosys’s business.

Infosys is perhaps known best for its efforts in corporate governance, taking the best ideas from around the world and implementing them at home. Ideas like independent boards, bifurcating roles for CEO and chairman, committees for investor relations and risk management, are more common in Asia now but they have been standard practice at Infosys from the start. “We clearly believe that we are not the owners of this company,” says Balakrishnan. “We are only managing the investors’ money. They are the owners.” Infosys has a long track record of getting bad news out early. “All the bad news has to get to the market. Good news can wait,” he says. Transparency is a by-word at Infosys, which gives its annual results against the GAAP requirements of six different countries, several in their local languages, as well as additional but un-required information such as land and human resource valuations.

Companies like Infosys say they thrive in the bad times because of good governance. “It helps a lot in difficult economic times, because in this environment what investors want is management who are credible, who are honest, so they won’t see any shocks like they saw with Enron.” India had its own equivalent of Enron this year with the fraud around software services group Satyam. “But it you look at Indian stocks on the day the news about Satyam broke, they all went down – except Infosys. Investors want good corporate governance.”

The company that swept the board in this poll was China Telecom, winning not just in its own country but most regional titles too. Part of the increase in voter support for China Telecom may be because of its realisation of a long-term strategic goal. “Near the end of 2008, we successfully completed the acquisition of a mobile business in China and became a full service operator,” says chairman Wang Xiaochu. Wang talks of integration synergies between mobile, wireline and internet services, while rapidly expanding the mobile business. “Although these have brought short term pressure to our profitability, we firmly believe that they will significantly enhance the company’s future sustainable development and value creation.”

Bringing a strategy to fruition is one thing, but investors want to be kept up to date with it too. Wang says the company has frequently updated investors on the strategy and its progress, and thinks this is one reason investors have trusted and supported the company despite short term profitability pressure.

Alongside this, China Telecom has been a standard bearer for corporate governance and investor relations in China. Listed in both Hong Kong and New York, it has to adhere to requirements such as the Sarbanes Oxley Act and COSO Internal Control Framework, and uses these international standards “as our foundation of corporate governance,” Wang says. Five of the 14-strong board are independent, and the standing board committees only comprise independents. “We strongly believe that sound corporate governance can ensure management effectiveness, prosperous corporate culture, successful business development and a sustainable increase in shareholder value,” Wang says.

Other moves that have appealed to investors include holding the annual shareholder meeting in Hong Kong in 2005, despite being a mainland incorporated company, to have direct communication with public shareholders; monthly disclosure of operating metrics and quarterly disclosure of financials; and regular investor and press conferences.

China Telecom had a few advantages in the crisis. For one thing, China’s debt markets were basically fine throughout. “Given our solid fundamentals and the abundant capital liquidity in the domestic Chinese market, we did not experience funding challenges during the global financial crisis,” says Wang. This year it issued a RMB10 billion three-year corporate note. Additionally, Chinese telecoms was not one of the world’s danger areas in the financial crisis, although it did affect customer demand for services, especially on long distance voice service and business customers. Consequently the company shifted development emphasis to broadband and value added services, and promoted bundled services.

While most companies that featured well in our survey consider themselves innately conservative in their approach to risk, good management also means knowing when to act decisively. In the middle of the financial crisis, Fubon Financial bought ING’s Taiwan life insurance subsidiary, concluding the deal in February 2009. “We took advantage of the financial crisis by buying into some assets at a very reasonable price,” says Victor Kung, president of Fubon Financial. “That has given us the opportunity to emerge out of this crisis stronger than at the beginning.” But at the same time, Fubon knew when to stay away: it considered accessing the capital markets in support of a bid for Nan Shan, AIG’s Taiwanese unit, before deciding the pricing was too high (the business was bought by Primus instead). Investors will need to continue to trust Fubon’s judgement as it takes the lead in trying to take advantage of thawed relations with mainland China. “That is our main strategic focus right now,” Kung says.

The best companies learn from the bad times. “We learned a lot during the crisis,” says Kung. “We further strengthened our risk management systems and we have come out of this stronger than we used to be.” Like others who have been rewarded in this survey, Fubon has looked out for investors by getting bad news out quickly: Kung says it was the first Taiwanese institution to write down the value of its investment in Taiwan’s troubled high speed railway. Others have had to follow. “That boosted confidence in our investors, that we are serious about being transparent,” he says. “All this demonstrates to investors that they can have confidence in the management of the company: that we are working hard to make sure their investment is well taken care of.”

China’s companies have begun to branch out over the last 10 years, taking stakes in foreign enterprises or bidding to acquire them outright. They’re likely to do so much more in the years ahead: many of China’s biggest companies are cash rich at a time when western companies have seen their valuations slashed and are in many cases desperate for capital.

This trend has implications for governance practices both inside China and at the acquired companies. It brings into focus cultural differences and the learning curve Chinese companies must go up about accepted practices overseas.

But before one even gets to that, there is a broader problem of perception, chiefly a political concern. Many western countries have reacted with suspicion and distrust when Chinese companies have sought to buy assets in their countries. CNOOC’s attempt to buy Unocal is one of the clearest examples of this: see the interview for CEO and chairman Fu Chengyu’s thoughts on this. But one sees it again in Australia today with the reaction to bids for OzMinerals and Rio Tinto assets by China Minmetals and Chinalco respectively: many politicians voice very strong objections to these assets being sold to companies controlled by the Chinese state.

“For many years, the West has viewed China’s state-owned enterprises in black or white,” notes Jonathan Woetzel, a director at McKinsey in Shanghai. “In one portrayal, they are infiltrators to be viewed with suspicion.” He cites Chinalco’s bid for a stake in Rio Tinto, which raised fears about just what China was up to in trying to acquire Australian resources, as example. “The other version sees state-owned companies as muscle-bound goons: without the smarts of a private company, but with plenty of brawn. In this characterization, they are relics of a failed economic experiment that still dominate the national economy, controlling natural resources, utilities, and many other vital sectors. Their power and influence – particularly their links to the ruling Communist Party and government – give partners and competitors pause.”

Woetzel finds those stereotypes inappropriate, and says that using out-of-date impressions of Chinese state owned companies “masks both opportunities and threats facing multinationals. A more current view would, for example, have them consider more favourably the value that certain state-owned companies might bring to a global partnership.”

Lawyers and companies who work in China find western attitudes towards their companies curious. They argue that when Chinese companies acquire overseas they will be at pains to understand management and governance practices in those countries and will mirror them accordingly.

“For any Chinese company when they go overseas, it terms of corporate governance it will be much better for sure,” says Guy Cui, managing director at Hopu Investment in Beijing. “They are going to a new country, they have less experience, so before they go out they’re going to carefully study the laws and regulations in that country and make sure everything complies.

“China generally does not have a lot of experience internationally: it’s only opened 30 something years ago and very few people understand foreign countries,” he adds. “So if China acquires a company let’s say in Australia, this company will be the same as all other Australian companies: they will make sure they use a company lawyer, for example, whereas in China they might not.”

Jane Jiang at Allen & Overy in Beijing agrees. “Chinese clients before they go overseas are well aware they need to understand the legal regime wherever they go, and that will include the corporate governance requirements,” she says. “I think the local management of Chinese companies when they go overseas are pretty professional and well prepared for the changes they have to go through.”

Chinese acquisitions overseas have run into criticism, but so far it has rarely been for governance issues. One of the real landmark transactions was Lenovo’s purchase of the home computer division of IBM in 2004. This transformed the company into a truly global player and was an indisputable landmark for Chinese corporate development. Today the company runs two headquarters, in Beijing and in the USA, and its board structures look much like boards do in the west. (Chinese boards do tend to have a lot more people on them – for one thing, there’s one regular board of directors and another supervisory board – but while that differs from the US model, for example, it is very common in other western markets such as Germany.) Lenovo had to accept some restrictions as a result of American political concerns in order to get the deal through.

Chinese corporate structures tend to come down to state-owned or private sector. And then there’s Haier. The Qingdao-based white goods heavyweight is something different again. “We are not a private company and we are not a public company,” says Philip Carmichael, President of Haier Pacific and the company’s most senior non-Chinese executive.

Haier is a cooperative enterprise, whose original foundation was as a municipality cooperative venture back in the early 1980s. It does have listings in both Hong Kong and Shanghai, “but they are only very thin slices of individual product categories so we’re not really a listed company,” says Carmichael. It’s a large and powerful presence despite that: Haier’s renveues in 2008  reached US$17.5 billion, 70 to 80% of it from China.

So where does governance and transparency fit in a company like this? There’s no quarterly reports, just annual figures, and even then only consolidated revenue and profitability percentages, with growth rates on a year on year basis. The statutory requirements that come with the Hong Kong and Shanghai listings are met, but “it’s very difficult to extrapolate that to the whole company,” he says. “It’s very complicated. The form we started as no longer actually exists in China today. We’re a legacy of something that’s been changed.”

Structurally, the management takes the model of a strategic thinker CEO, and a COO who executes that vision. A complicated matrix system separates the various businesses. While that doesn’t seem much of a corporate governance model to follow, on the other hand an internal audit department is run by a Korean 30-year Samsung veteran “who looks at all our overseas subsidiaries pretty much the same way as you would see any other internal auditor do anywhere in the world. Although we don’t have an outside board of directors, we do have very tight controls internally and they are consistent with GAAP.”

Like many Chinese companies Haier has been closely involved in corporate giving, and it made a striking promise ahead of the Beijing Olympics: that for every gold medal won by a Chinese, Haier would build a new primary school in the earthquake-hit areas of Sichuan. That’s over 80 schools.

Carmichael has a remarkable finding that sheds some light on the challenges Chinese companies sometimes have when acquiring or growing overseas. Haier’s financial department conducted some research indicating that Chinese companies operating outside China have a 10 times greater problem with uncollectible receivables from their customers overseas than the average in any particular country. “If you want to say it in a less polite way, it seems there are people who try to take advantage of these guys from China because they think we are less sophisticated.”

“Sometimes people in the west don’t realise the degree of sophistication here because it doesn’t come through in the translation,” Carmichael says. “To borrow a phrase from a former Chinese leader, we think of ourselves as a Chinese company with international characteristics.”

This article was one of several chapters in a detailed guide to corporate governance in China published with the June 2009 edition of Euromoney

Fu Chengyu is chairman, chief executive officer and executive director of CNOOC Ltd, the Hong Kong and New York-listed arm of China National Offshore Oil Corp. He talks to Euromoney about CNOOC’s approach to corporate governance and social responsibility.

Euromoney: Tell me firstly what corporate and social responsibility means to you and to CNOOC.

With globalisation in the economy, social responsibility has become very important not only for enterprises themselves but the areas they operate in. We have focused on further integrating CSR into our management system. It has become a philosophy of how we run our business, both for the management and for the employees.

For years, we have valued social responsibility as important to shareholder returns. Optimising profitability is no more important than corporate social responsibility. So, when we tell our employees to maximise returns to shareholders, it is based on social responsibility. Whatever we do, we will see whether or not we can meet the requirements from society, from the community, and from the customer. If we satisfy that requirement, then we maximise profitability.

As an energy enterprise we emphasise environmental protection, especially climate change. We have done many things to actively respond to climate change: environmental issues in China are presenting a great concern both to the government and the people. As an energy company the first priority for us, when we’re talking about corporate or social responsibility, is to try to have less emissions, provide more clean energy, and provide technology for businesses who use the energy. We have done a lot in these areas in the last few years.

Euromoney: That’s your philosophy. Could you give me some examples of what you’ve done?

Fu: We set higher standards in environmental protection than the government requires. For example, in water production, the government standard is 30 PPM discharge. Our standard has been 25 PPM, but now we are asking for zero discharge, even though this will cost more.

Second, we have introduced the recycling philosophy in the business. Whatever we can reuse, recycle, we do, and in the refineries and our chemicals business our criteria are a lot stricter than the government requires.

We also try to be good to the local community. For years we have run community environment programmes, particularly supporting the poor. This includes our programme in Tibet [the Tibet Aid policy]. We have a 10-year programme for the whole country for infrastructure; we have training and education programmes, helping students from poor families who lack financial support. Every year in the last 10 years we have a programme that totals from RMB100 million to 200 million per year supporting poor families in poor areas, for education, natural disaster relief, clean water projects or whatever is required by the local community. This lets people understand what we are doing. Our production is not just about physical materials or physical wealth, but distributing wealth and helping the local people.

Euromoney: How have you tried to implement strong corporate governance standards at CNOOC?

This is a very important area for the sustainable growth of the company. On the first day the company was listed, we adopted the listing rules from New York and Hong Kong to set up a corporate board. The members of the board are mainly from outside the company. And we have a lot of expats on our board, mainly from Hong Kong. Those board members are very responsible and have high requirements for the company, especially on the governance side.

Within the board we have committees, including one that looks at governance. As chairman, after every board meeting I will have separate meetings with the independent directors to see if they have other recommendations for the company which might be something they want to discuss separately from the board meeting. They make a lot of recommendations, most importantly to make sure the company follows the listing rules, especially in the area of public information release. This is important to make sure the public feels this is a transparent company. I don’t want investors to be guessing about the company, I want them to have all the information so they can judge for themselves.

We benefit from this. We have a lot of pressure from it too – because of transparency any single mistake is immediately noticed – but the good side is, when people know the company, they will pay a higher price for your stock, because they know what the risks are. If you make them feel uncertainty, they will pay less. In past years you will see our stock has always outperformed the market.