Wednesday, March 13, 2013

Interest Schemes, the Malaysian economy and the way forward

In early 2013, just days before the Chinese Lunar New Year, the management company for the Country Heights Growers Scheme (CHGS) announced plans to voluntarily terminate CHGS. 

In order to do so, it needed to convene a General Meeting of CHGS investors, also known as, Growers. The events surrounding the announcement and the lead up to the actual General Meeting was widely covered by the media. As such, there is no need to revisit the events.

Instead, it is far better to examine the nascent Interest Scheme sector and its economic contribution to corporate fundraising for SMEs and, even large corporations.

Fast forward to the present, media reports here indicate that the CHGS investors will begin to receive the first instalment of a full refund of their investment capital and the final annual nett yield payment.

In the wake of the announcement of the voluntary termination and the lead-in into the General Meeting of CHGS investors, many media commentators gave their views. As always, some views were pertinent and many others were borne from knee-jerk and a superficial understanding of the matter at hand.

Now that the dust is settling it is timely to better understand the burgeoning Interest Scheme sector and regulatory challenges.

Regulatory perspectives

Interest Schemes come within the regulatory framework governed by the Companies Commission of Malaysia which is better known as Suruhanjaya Syarikat Malaysia (SSM). 

This regulatory framework deals, among other things, with corporations, enterprises and businesses that seek to create a pool of partners and investors linked by contractual arrangements and a legal trust relationship. The pooling of partners and investors with the goal of sharing enterprise risk and reward is called a "common enterprise".

How did the current regulatory framework fare when tested by recent events?

Firstly, the mechanism followed assiduously by the voluntary termination of an interest scheme is materially similar  to many approved corporate debt financing schemes in the Malaysian and, even international, capital market. 

Secondly, the regulatory framework is in line with basic and internationally-accepted principles of corporate regulation on the matter of investor protection. In particular, each new partner or investor must be given the latest copy of the prospectus governing an SSM-approved common enterprise scheme. 

Thirdly, still on the matter of investor protection, risk factors are categorically set out in each prospectus together with an audited financial statement that details the state of play of the scheme promoter and the underlying enterprise. The prospectus for each common enterprise scheme is required to be renewed and updated every 6 months.

Fourthly, SSM requires an independent consultant with experience and familiarity with the underlying enterprise, be it oil palm plantations, agro-fisheries or technology enterprise, to audit the enterprise operations and prepare a report for inclusion in the prospectus and updated with each renewal.

Add to the above factors many compliance features including monitoring of funds flows and site visits and inspection by SSM officials and the scheme's trustees, there are adequate safeguards directed primarily at the basic principle of investor protection. These safeguards are in line with the best regulatory practices adopted by capital market regulations.

Business risks and returns

A reasonable comment from an objective reading of the the matters set out above would be; if the regulatory framework and safeguards were all that good, then, why was there a need for voluntary termination by an interest scheme?

The starting point is to recognise that investing in a  business enterprise is all about risks and returns. As such, in the context of good corporate governance and regulations, every corporation that seeks to reach out to the investing public for funds are required to prepare a prospectus.

This is true for corporations operating in the capital market regulated by the Securities Commission and true also, for bank and financial institutions regulated by Bank Negara Malaysia. This is equally true for corporations seeking to raise funds under common enterprise schemes regulated by the SSM.

Even with the detailed regulations and guidelines for corporations operating in the capital market there have been occurrences of  corporate issues surrounding so-called privatisation exercises by public-listed corporations. For example the privatisation of Maxis and more recently MISC. In almost all cases of such privatisations, there have been minority shareholders who disagreed with the privatisation plan. Still, in accordance with the rules and regulations available, the will of the majority prevailed. This is how it should be under current corporate governance principles.

In fairness to SSM and the Interest Scheme sector, there are many material similarities between privatisation exercises in the capital market when compared with voluntary termination of an Interest Scheme. This is something media commentators overlooked.

Investor protection

What do these capital market occurrences tell us when we review the Malaysian Interest Scheme sector?

We can surmise that regulators and stakeholders must be ever vigilant about corporations that tap public investment funds. This is the all-important corporate governance principle of investor protection.

In spite of the best efforts of regulators and stakeholders, do investor protection provisions cater for the ever-changing environment of businesses?

In the event where there is intentional corporate malfeasance, do the investor protection provisions truly protect the investors?  Can more be done to protect investors?

What happens when business enterprises are operating properly, as was  evidently the case with CHGS whose oil palm plantations was in profit, except that the level of profits was not commensurate with the nett yield obligations?  Would investors wish to vote for the Scheme to remain operating and for the nett yield obligations to be varied?  Or would a buyback option or put option mechanism accord a better protection?

The intent behind corporate regulations including those applicable to Interest Schemes is to institute and ensure disclosure of business risks by requiring timely disclosures of corporate financial and operational health. 

A closer examination of the prospectuses published by Interest Scheme companies will show that such disclosures are contained in chapters on the accountant's report and the report of the independent consultant.

Disclosure obligations under Interest Scheme regulations compares favourably with disclosure rules in the capital market. Naturally, there is always room for improvement.

That said, public investors and regulators need to recognise that it is impossible to eliminate business risks.

The way forward for Interest Scheme regulations

It should be noted that in spite of occasional controversy by participants in their jurisdiction neither the Securities Commission nor Bank Negara Malaysia has ever shrunk away from regulating existing corporate activities in their respective jurisdictions.

Nor have either regulator shrunk away from further approvals of new corporate activities.

The SSM should, likewise, continue to strengthen the regulatory framework for Interest Schemes and continue to encourage and cultivate SMEs and large corporations to conduct corporate fundraising through Interest Schemes.

The Australian experience in this self-same area is very relevant and instructive. What we, in Malaysia, call Interest Schemes are known as Managed Investment Schemes (MIS) in Australia.

Has the Australian MIS sector been problem-free since its rise in the 1980s? Of course, not. You can read about some bad episodes here and here.

The point for the SSM to note is that its fellow regulators in the form of the Securities Commission, Bank Negara Malaysia and, even the Australian Securities and Investments Commission (ASIC) have endured corporate failures by market participants in their respective jurisdictions.

And, more to the point, not once did any of these regulators declare that they were abandoning the processing and approval of new entrants.

The reason is pure and simple; corporate activities such as corporate fundraising via Interest Schemes are part and parcel of the economic rubric.

Remove avenues such as Interest Schemes and the Malaysian economy would be that much poorer.

And, let's not even get started on the futility of policing unregulated corporate fundraising schemes if there is no avenue to allow promoters of such schemes to comply with regulations.

So, the hope expressed here is that SSM shrugs off the naysayers and dusts off the negativity in order to move forward to strengthen Interest Scheme regulations and continue the all-important role of processing and approval of new entrants for the benefit of the Malaysian economy.

Additional perspectives can be found here.