The global financial crisis was a combination of a failure of regulation, with the authorities too distant from common industry practices, as it was of governance, with executives often grossly unaware of malfeasance in their own shop.
That experience has left its mark, with regulators since ramping up efforts to increase oversight. The problems haven’t gone away: failures of governance since the subprime mortgage crisis have piled up to between $20tr and $25tr, according to consulting firm Management & Excellence (M&E).
This has often come in the form of fines for breaches, showing there is still a gap between introducing governance and enforcing it.
“This has meant that often investors have been taken by surprise by governance-driven events,” William Cox, CEO of M&E, told Asiamoney. “Investors and executives just don’t know the extent of the governance risk in their companies.”
Such lack of understanding can have a concrete impact on investments. Cox’s firm has developed a governance discount rate to apply to company valuations. By his measures, most investors price in a discount that is only between a third and a half of what Cox estimates are the real risks for most listed companies.
That gap has been on display in some of the more recent cases to grab the headlines.
“If something happens it will hit the social media platforms within hours,” said Cox. “Volkswagen lost 30% of its market cap in days due to the emission software scandal. And this was a leading company on the Dow Jones Sustainable Index, it was checking all the boxes. Nowadays the speed with which you are hit by the consequences of bad governance actions is tremendous."
Where is Asia?
While much of the attention has been on high-profile cases, mostly affecting firms from developed markets, Asia cannot afford to gloat. Even the most sophisticated markets in the region are playing catch up with the standards enforced elsewhere.
And with rare exceptions, most emerging economies are just beginning or have made little effort to create a framework around what is known as environmental, social and corporate governance (ESG). In most cases, the fault lies squarely with regulators, who have been slow in following best practice.
But with Hong Kong firms winning three of the top five spots in Asiamoney’s annual Corporate Governance Poll, companies from the territory seem to be doing at least something right in the eyes of investors across the region.
The Hong Kong Exchange (HKEX) issued changes to corporate governance, risk management and internal controls practices in December 2014, with the new rules coming into force for accounting periods starting in January 2016.PwC took a look the annual reports of some 230 listed firms across the past two years to evaluate standards of corporate governance, with some 70% of the firms covered being among the early adopters of the new disclosure requirements set forth by HKEX.
The study found that financial services companies were outperforming real estate, retail and technology businesses, and also revealed that Hang Seng Index firms were better prepared than Hang Seng Chinese Enterprise Index entities, PwC wrote in a report published on September 29.
"What we saw is that the financial sector is much more advanced than other industries," Eric Yeung, partner with PwC's risk assurance practice told Asiamoney. "And in terms of the disclosures, the other sectors have quite some work to do."
But the new HKEX measures will hardly do the job as they have been seen as rather broad and open-ended, allowing plenty of leeway for listed firms in their application. This is made worse by an environment where few companies take the initiative.
"We see a lot of the listed companies here that are very regulatory and compliance driven, meaning that they need to be pushed into action. This means that they take action mostly when new rules or guidelines are issued,” said Vivian Chow, a Hong Kong-based senior manager for risk advisory services at BDO Financial Services.
Taipei sets the bar
Taiwan firms, meanwhile, have taken the lead, with first and second position in the Asiamoney survey going to Taipei-based companies.
Demonstrating its commitment, the Taiwan Stock Exchange held meetings in Hong Kong on November 24 to discuss changes to its ESG regime with local investors.
In terms of achievements, TWSE noted that 87% of listed companies have appointed independent directors, a 20% improvement over a year ago, and that 49% increased transparency by adopting a nomination system for directors and supervisers, up 34%.
One firm that has moved in that direction is Sercomm Corporation, a broadband technology firm listed on TWSE, and the winner of this year's Corporate Governance Poll.
Paul Wang, chairman of Sercomm, told Asiamoney that early input for the firm’s approach came from his personal overseas experience.
"I have worked in the United States for over 20 years and the large firms there are all very focused on corporate governance,” he said. “So at Sercomm we wanted to implement it as one of the important principles of our management."
Sercomm has seven board directors, with four of them external. Wang stressed that the focus has been on appointing external board members such as lawyers with expertise in the field, academicians, and industry leaders.
"We don't want to be like some other companies that use close friends as board members, we have chosen to appoint only reputable and knowledgeable board members that can give independent advice, play a check and balance role," Wang said.
PwC's Yeung agreed on the importance of making the right appointments.
"The changes that we are seeing are partly driven by independent non-executive directors who have more personal accountability in the companies that are implementing these frameworks, and not just paying lip service to it," said Yeung.
Sercomm has also reinforced its audit committee, with the board reviewing operations on a regular basis, Wang said.
The fact that the firm has been keen to apply a strong framework does not mean that there were no challenges, however.
"We persist in our approach, but the concern is that the company has grown too fast. We have had a 30% annual compound growth rate for the past 16 years," said Wang. "The business expansion itself is the easy part, but after the expansion, the big challenge is how to continue to monitor operations that are far away."
And, when looking at a growing global footprint, Wang's answer to how to handle the unavoidable changes was an even greater focus on transparency.
"With so many offshore companies and businesses, we will need to enhance and strengthen the communication channels within the company across market sales, research, manufacturing, financing and human resources."
Ready, steady, go?
For most firms, however, the main risk is still that corporate governance rules will be looked at as something they do not have to take seriously.
"Companies need to pay attention to the spirit and substance of the rules that are put in place," said PwC's Yeung. "We often talk to companies that don't have a systematic and formalised approach to risk management and don't even understand the need for this systematic approach. If you don’t tie that mindset and embed it in the corporate culture, it doesn't really help the business."
M&E's Cox pointed out how steep the path ahead is if firms and regulators in Asia want to catch up to jurisdictions like the US.
"In most sustainable companies in Asia, you look at their annual reports and don't find any statements on items such as cyber-threats, which is now recognised as a universal problem, for example. But they don't like to admit that it is a problem."
He noted that even broader investments in IT were not typically reported on, a practice that is already taking hold among US and European listed firms. Another key issue, executive compensation, was also not on the radar in Asia yet.
"The reporting in Hong Kong is still very superficial,” said Cox. “In Brazil and Europe it's already compulsory, with many firms detailing compensation packages for executives. I just don't get that in Hong Kong reporting, much less in China or other Asian markets."
The responsibility, ultimately, falls on companies’ boardrooms. With the largest global investors increasingly sensitive to failures of corporate governance and adopting stricter criteria on how to allocate their portfolios, the window of opportunity for firms to clean up their act is closing fast.
"The worldwide phase of compliance via box-checking is coming to an end," said Cox. "That's a static measure that does not tell investors or regulators how the company will perform. A lot of companies that checked these boxes have failed over the last years. If the right measures are not taken in governance, sustainability, and compliance, they are going to hit a brick wall."