Published Date: 09 January 2002

Speech by Mr Tharman Shanmugaratnam, Senior Minister of State For Trade & Industry and Education, at the 28th Annual Report Award Dinner, The Mandarin Singapore

Date : 9 Jan 2002

Disclosure and Corporate Governance
Challenges in Moving Ahead

Chairman and Members of the 28th Annual Report Award Committee,
Distinguished guests,
Ladies and Gentlemen,

1   It is a pleasure to be here tonight at the 28th Annual Report Award Dinner.  After more than a quarter of a century, the Award remains, more than ever, a mark of prestige that Singapore companies aspire to gain.  Its objective of promoting corporate transparency and disclosure has become more vital as our capital markets have developed, and as our approach to regulating the markets has evolved.

The New Capital Market Environment

2   Across the globe, the capital markets are undergoing a sea change. Ageing populations are putting increasing strain on pay-as-you-go pension schemes, where contributions by the working population are redistributed almost immediately to pensioners.  Governments are being forced to introduce funded pension plans, with workers contributing to their own personal retirement accounts.  Individuals are also taking up private pension plans, as well as investing more aggressively on their own to build up their retirement nest eggs.  Wealthy individuals are turning increasingly to alternative investments, including hedge funds and private equity. 

3   As a result, new classes of investors are emerging, with different needs from those that traditionally dominated the markets.  In Asia, pension assets are expected to grow from US$2.7 trillion in 2000 to US$4.8 trillion by 2010.  This will allow for the growth of a stronger class of institutional investors, and deepen liquidity in Asian markets.

4   Technology has also opened new channels for retail investors to access almost instantaneously a wide range of investment information, previously available only to large players.  Early projections of how the Internet would dominate the trading world were premature.  But the trend is unmistakable.  Investors will increasingly transact over the Internet, often without the advice or assistance of market intermediaries.  Technology is democratising the markets.  It is also increasing the speed with which capital responds to developments in a country, sector or company, and thereby leading to greater volatility in global capital markets.

5   Financial innovation continues apace, as intermediaries seek to structure new products to meet the increasingly diverse needs of investors.  More complex instruments keep emerging, to meet preferences for reduced risk or enhanced returns and, one suspects, to allow financial intermediaries to make their margins in new ways.  For example, there is now rapid growth in securitisations of private equity fund of funds and hedge fund of funds - also known as alternative investment collateralised debt obligations - which aim to reduce the volatility of returns on alternative investments.

Regulatory Responses to the New Environment

6   Amidst this rapidly changing environment, regulators are rethinking their approaches to overseeing the capital markets.  The objectives of regulation have basically not changed - preserving investor confidence in the markets, and safeguarding the stability of the system.  But the methods of achieving these objectives have taken new shape.  Greater emphasis is being placed on market discipline and less on what has been called merit-based regulation, where the regulator sought to pre-judge the risks and appropriateness of investments for the investing public.  Merit-based regulation has become less necessary, and increasingly untenable, with the investors now comprising a more diverse spectrum, with distinct investment objectives and risk appetites, and with the markets offering a wider and more complex range of instruments catering to their appetites.

7   In Singapore, we decided four years ago to shift away from the merit-based approach to a market driven, disclosure-based regime of regulation.  The new approach gives investors greater choice and more information with which to assess investments and take calculated risks for themselves.  But it works only if investors are able to make decisions on the basis of accurate information, and transact in markets that are not rigged.  The regulator therefore has to promote high standards of corporate disclosure, and set clear rules to preserve fair and transparent markets.  Strict enforcement of the laws and rules is also needed to penalise those who manipulate the market, deter sharp operators and give investors confidence in disclosure-based regulation.

8   Market-based regulation is therefore not about 'lighter' regulation than the old, merit-based approach, but a change in method of regulation that recognises a new environment of investors, instruments and technology.  Indeed, market-based regulation requires stronger regulatory capabilities and in some senses more rules.  Companies and the professionals who advise and audit them will have to observe more guidelines and standards on market conduct. More diligent surveillance of the market by the regulator and greater reliance on enforcement will also be needed.

9   The US Securities and Exchange Commission (SEC) has battalions of lawyers and accountants engaged in scrutinising offer documents and disclosure statements, and talking actively with listed companies, their advisers and auditors.  Post-Enron, the SEC proposes to expand its consultative role, so that uncertainties in proper accounting treatment and disclosure requirements are sorted out with companies without waiting for problems to build up and losses to be eventually suffered in the market. 

10   Disclosure-based regulation will not work well if the regulator stands aside and waits to enforce the rules and laws after they are breached.  We need a healthy consultative culture between the regulator and the market, not just after-the-fact enforcement.  But there will be a thin line between 'consultation' with the regulator and 'vetting' by the regulator, and it is easy to see how market players and their professional advisers can end up relying on the regulator's judgement and decisions.  Responsibility has to rest on market players.  It is just as well that we lack spare battalions of lawyers in Singapore for the MAS to hire.

11   Market-based regulation will not be foolproof, and cannot provide certainty that markets will work well.  The regulator can put in place a framework of rules and incentives necessary for market discipline to work, but has no assurance that standards of corporate and professional conduct will rise to the mark.  Neither is there assurance that investors will take advantage of higher standards of disclosure in making their decisions, or that they will think hard about the risks they take. 

12   Markets will therefore not be perfectly efficient, and will sometimes be wildly inefficient.  Even where all rules and laws are complied with, they will remain prone to bouts of irrationality.  Dreams of untold riches will periodically emerge and cloud better judgement.  And there will always be stocks that defy gravity, until the market finally insists on the primacy of sound balance sheets and brings them plunging down to realistic values.

13   But the imperfections of the market do not weaken the case for a market-based regulatory regime.  Far better that we move to market-based regulation, where investors make decisions, know they have to accept the consequences of their own decisions and learn from past mistakes, than return to a regulatory model that is no longer practicable in a rapidly changing and more globalised market environment, and that no longer satisfies the needs of a diverse base of investors.

Lessons from Enron

14   The collapse of Enron Corp in early December last year - the largest bankruptcy filing ever - has highlighted the uncertainties and challenges involved in making market-based regulation work.  The US SEC, the Justice and Labour Departments and several Congressional committees are investigating Enron's dramatic collapse.  The details are still emerging, and responsibility for the failure has yet to be determined.  But it is already apparent that Enron's problems, and the lessons they throw up, were not single but multiple.

15   First, Enron used special purpose entities (SPEs) to move huge liabilities off its balance sheet and inflate its earnings.  (Whether Enron or its auditors exploited uncertainties in current accounting rules or flouted the rules remains unclear.)  Second, it did not disclose its weaknesses to investors until a few weeks before its collapse.  (A $1.2 billion write-off in shareholders' equity, which according to news reports was revealed selectively to credit rating agencies and analysts from early October, was disclosed only after the first week of November.)

16   Third, there are questions about conflicts of interests, and how they were managed.  Several Enron executives who operated the SPEs are reported to have profited substantially from them.  Several directors on the Enron board were associated with organisations that received financial contributions from the company.  Last year, Enron paid its external auditors more for non-audit services than for audit work.  Internal audit functions were also outsourced to the external auditors.

17   The Enron debacle has opened a renewed debate in the US on the standards and rules necessary to protect market integrity and preserve investor confidence.  These are issues that apply globally, and to Singapore.  I will touch on three issues here.

Clear and Up-to-date Accounting Standards and Policies

18   Clear and reliable accounting standards and policies are prerequisites for disclosure-based regulation of the capital markets to work.  Greater disclosure, without sound accounting standards and policies, will not enhance transparency and may in some cases even mislead investors.  There is still great divergence in standards internationally - not just accounting standards espoused but, more critically, the standards actually applied.  There are many markets, including some in Asia, where investors must be excused if they believe that, to borrow from an old dictum, 'there are lies, damned lies and financial statements'. 

19   As you know, Singapore companies will be required by law to comply with prescribed accounting standards from next year, as recommended by the Disclosure and Accounting Standards Committee (DASC).  Further, Singapore will adopt the standards issued by the International Accounting Standards Board (IASB) as our prescribed accounting standards.  It is a bold statement of what Singapore represents as a global financial centre, and a statement of Singapore companies' global intentions.

20   The responsiveness of accounting standards to new market developments and business structures will increasingly matter in a rapidly changing environment.  But it would be unrealistic to expect new standards to follow immediately after every market innovation.  The impact of a new market development will typically take time to become evident, and its significance digested.  What becomes critical in the interim, when new standards have yet to be defined, is for companies to explain their accounting policies clearly to investors.  Harvey Pitt, Chairman of the US SEC, has proposed that companies and their auditors be required to highlight and explain to investors the key accounting policies - the three, four or five key accounting practices - that are critical to the interpretation of their financial statements.  (The proposal goes beyond the current practice of routine reporting of significant accounting policies.)

21   Investors must be told, clearly and concisely, of the range of possible effects on the company's financial status depending on how the key accounting principles are applied.  This is particularly important for areas where standards are ambiguous, and which involve subjective decisions or assessments.  The more complex the financial structure of the company, the greater the need to provide investors with clear, concise and intelligible explanations on the accounting policies. Audit committees should review these critical policies with management and the external auditors, why they were chosen and how they are applied, and have basis for believing that the end result provides a fair picture of the company's actual state. 

22   This proposal, to require companies to highlight key accounting policies and explain them, will be debated in the US and elsewhere.  We should also study if it should be made a requirement in Singapore.

23   The misleading use of SPEs to shift liabilities off Enron's balance sheet highlights another area of needed improvement.  In deciding on the accounting policies to adopt, the fundamental accounting principle of 'substance over form' is meant to prevail.  There has been a tendency over the years however for companies and their auditors to neglect the substance, and focus instead on the legal form of financial structures.  We have to reverse this trend.  Boards, audit committees and auditors should assess the economic substance of transactions to determine how best to account for them, and provide investors with a 'true and fair' view.

Timely Disclosure

24   Besides complying with prescribed accounting standards and sound policies, disclosure has to be timely for market discipline to work and for financial stability to be preserved.  Delaying disclosure until there is no choice but to disclose is a formula for shocks in financial markets.  It hurts both companies and investors.  Prompt disclosures also help forestall possible leakage of material information that could lead to the creation of a false market. 

25   Enron's failure to come clean with investors earlier than it did compounded the impact of its retrospective restatement of accounts since 1997 (eliminating US$590 million in profits over the period and increasing its debt by US$630 million).  The eventual disclosures led to huge price movements and large losses for investors, including the loss in retirement savings of thousands of employees holding the stock in company-sponsored savings plans. 

26   In Singapore, continuous disclosure of material information by listed companies has long been an SGX listing requirement.  This rule will be given force of law under the new Securities & Futures Act, to emphasise to companies and their advisers the importance of making adequate and prompt disclosures.  From next year, listed companies will also be required under SGX rules to announce their interim results on a quarterly basis (instead of half-yearly now).

27   The challenge all markets face is in providing prompt and more frequent disclosure to investors while avoiding a culture of short-termism in corporate strategy and in the financial markets.  In the US, industry leaders and regulators have been concerned about the drift toward short-term investment behaviour in recent years, fuelling volatile markets and being fuelled in turn by volatility.  The average holding period for a stock on NASDAQ was down to 120 days in 2000, compared to about 12 months a decade ago.  The average tenure of a CEO amongst US-listed companies is also down to four years.  Shorter CEO tenures have been most visible among listed dot.coms, but are not limited to them.  It has raised questions of whether CEOs have adequate focus on developing the operating capabilities required for long-term competitive advantage and whether companies are now too focussed on short-term movements in their share prices.

28   Boards and management have to avoid going short-term as we move toward quarterly financial reporting and ensure continuous disclosure of material information.  Better disclosure will reduce uncertainty in the market on a company's prospects and help avoid large share price movements.  Companies should find the external discipline of the market a useful internal management tool.  But conscious effort will be required to avoid short-termism, particularly where management is heavily incentivised through stock options. Corporate success will ultimately require leaders who stay focussed on the long-term - building strong teams, motivating employees to put in their best year after year, developing capabilities for continuous innovation, and running sound operating systems. 

Managing Conflicts of Interests

29   Sound corporate governance is fundamental to a successful disclosure-based regime.  A central concern among investors is how potential conflicts of interests are managed.  Just as a perceived competitive advantage will drive up market valuations of a company over time, so a conflict of interest that is left untended or seen to be poorly handled will undermine investor confidence in a company.

30   The Corporate Governance Committee (CGC) has set out guidelines that will raise standards significantly in Singapore, particularly in the management of conflicts of interests.  The guidelines, especially on the composition of boards and their committees, seek to enable boards to exercise diligent oversight of management, and to protect the interests of all shareholders rather than substantial shareholders alone.

31   The progress we have made in introducing a stronger independent element on company boards will become evident next year, when listed companies disclose in their annual reports whether and how they have observed the Code of Corporate Governance.  Some companies are already meeting the requirements, and may go further than what the CGC has recommended.  The local banks, in particular, have decided to go beyond the recommendations of the CGC as well as those of the Disclosure and Accounting Standards Committee (DASC) in some regards, and will be announcing their planned improvements soon.

32   These governance processes on boards, committees and audit functions are necessary, but a far from sufficient condition for superior corporate performance.  It seems obvious enough but bears repeating that corporate governance is not an end in itself.  Too much attention to the structures and processes of corporate governance can also produce a false sense of performance on boards.

33   What companies have to avoid is a wooden approach to corporate governance, ticking the boxes in terms of attendance, composition of committees, and so on, and focussing on processes that are easily observed from outside rather than on the quality of governance, which is less easily measured.  Whether boards are effective will ultimately depend on their substance - whether directors have the skills, knowledge and good judgement, individually and collectively, and whether they retain the spirit of entrepreneurship that distinguishes the successful companies from the rest.  This will mean accommodating strong individuals around the table, including substantial shareholders, who will care more about the business than other shareholders, and outstanding managers. Potential conflicts of interests will arise.  They arise as long as we seek to harness the entrepreneurial drive of owners and the expertise and flair of management.  The issue is therefore not about the existence of conflicts of interests, but how they can be best managed in the interests of all shareholders. 

34   Seeking quality in boards should also mean exposing non-executive directors to the company's business.  The typical life of a director has in the past comprised of reading board papers before meetings, and then discussing them in boardrooms that are remote from the real activity and business of the company.  This has to change.  Directors have to spend more time, often in informal discussions, with management and employees, and even customers, suppliers and investors.  An understanding of the business will increasingly matter if directors are to collectively chart strategies for their companies, make major risk decisions and oversee management effectively.


35   We have made good progress in the four years since we embarked on a shift towards disclosure-based regulation.  Our listed companies have raised their standards of disclosure.  The vast majority of them have improved their scores on the Business Times Corporate Transparency Index.  In November 2001, the Political & Economic Risk Consultancy Ltd ranked Singapore highest among 12 Asian countries for the transparency of its business environment, and by a good margin.  In the same month, Singapore companies and their Australian counterparts came up at the top of Standard & Poor's inaugural Transparency and Disclosure Standards Survey.

36   We must continue to push ahead in the next few years.  Confidence in our markets will depend on the quality of information that allows investors to decide when and where to put their hard-earned money.  We have some way to go in making disclosures more meaningful and comprehensive to the average investor.  A major priority in the next two years will be in implementing the DASC and CGC recommendations.  This involves changing mindsets, more than reporting systems. 

37   We should ensure that we keep our sights on the true drivers of corporate performance, and that efforts to protect shareholders do not snuff out the sources of growth in shareholder value within the company.  In both disclosure and governance, substance matters more than form, and a balance has to be maintained.  The winners tonight have obviously found a balance that commands the respect of their peers.  I congratulate them, and wish you a pleasant evening.