This article first appeared in Forum, The Edge Malaysia Weekly on July 3, 2017 - July 9, 2017

Who says corporate governance does not matter? It does.

Just look at what happened in Hong Kong recently — dozens of local companies with small capitalisation crashed suddenly, dropping between 9% and 90%. Over US$6 billion of market value was wiped out.

This vaporised confidence in the entire sector, which was indicated by the loss of nearly a 10th of the value of Hong Kong’s small-cap Growth Enterprise Market (GEM).

And like many other crashes that preceded this one, there were prior warnings but none of them was heeded.

A month-and-a-half ago, Hong Kong-based corporate governance activist David Webb warned in a report, which he ominously titled “The Enigma Network: 50 Stocks Not to Own”, that risks existed in these closely related companies because they shared common shareholders and showed numerous related-party transactions.

When these individuals faced margin calls, the collective edifice of their holdings — the same 50 companies he wrote about — melted at the same time.

The 52-year-old Webb, who once sat on the board of Hong Kong Exchanges and Clearing Ltd, has made many pointed objections to the region’s management of its capital markets — most of them ignored — which led him to famously quit his HKEX seat in 2008, a year before the expiry of his term.

Those objections bear repeating in Malaysia. And here is why.

Webb says there are inherent conflicts between the commercial and regulatory roles of HKEX and has for years pushed for a super-regulatory authority to assume the roles.

Those conflicts exist here too. As both a publicly traded company and frontline regulator, Bursa Malaysia suffers from precisely that conundrum. As a result, it regularly grapples with schizophrenia, having to switch repeatedly between managing trading activities and simultaneously encouraging more transactions so that it can get more stockbroking commissions to meet its profit targets.

Bursa also shares regulatory oversight with the Securities Commission Malaysia, with the duo occasionally tripping on each other’s toes on jurisdictional matters. Yet, no centralised overseer as envisaged by Webb exists in Malaysia.

Webb has also argued vigorously for improved representation of small investors on HKEX, saying that the larger players enjoy outsized benefits and influence to the detriment of the minority shareholders.

And on Bursa? There is an 11-member board populated by a banker and former minister in the PM’s Department, the current Bursa CEO, a government-linked company (GLC) director, a former managing director of an EPF-controlled bank, the current chair of an industrial group that has approved permits for Jaguar luxury cars, a former director-general of the Malaysian Industrial Development Authority, the managing director of a large local stockbroking firm, a former partner of a management consulting firm, an accountant who was a member of the Malaysian Accounting Standards Board and a lawyer who was a managing partner of legal firm Shearn Delamore & Co.

All well and good. Nice CVs, really. But who represents The Little Guy?

Shouldn’t there, for example, be a representative from the Minority Shareholders’ Watchdog Group, which, like Webb, buys shares in listed companies so that it is eligible to attend annual general meetings to vote formally on resolutions that are possibly detrimental to the interests of the minorities?

Or maybe a senior journalist with a media group that is NOT controlled by a government entity?

Yes, Bursa counts four public interest directors on its board. But they occupy (or used to occupy) the posts as mentioned above AND are (drum roll, please) appointed by the (ahem!) Minister of Finance.

What else?

Webb has also opposed the size of the Hong Kong government’s stake in its stock exchanges (at various times, its second-largest single investor), disagreeing with the state’s view that HKEX is a “strategic asset”.

He protested against the size of Hong Kong and Beijing’s interest in local listed entities, which he said violated stated principles of “big market, small government”.

And on top of the number of government-appointed directors on HKEX, he argued, the state exerted undue influence on the public market by voting on crucial resolutions at shareholder meetings.

And here?

Well, the oft-cited ratio of GLCs and government-linked investment companies on Bursa is a conservative third of total interests, although this number could well have swelled in recent years as their monopoly businesses grab more market share from the private sector.

Lastly?

Webb is opposed to HKEX’s proposal to add a third board that caters for startups, arguing (quite presciently, given what just happened to GEM) that the boards already in existence were sufficient; in fact, he believes they should be merged and placed under the jurisdiction of the Hong Kong Securities & Futures Commission.

In Malaysia, there are already the Main and ACE markets, catering for mature and smaller companies. But we now also want a third, even smaller market to offer a fresh avenue to small and medium enterprises (SMEs) to raise capital from the public.

Should Malaysia tread carefully? Absolutely.

Such fledgling markets not only risk the traps mentioned above but like all ultra-small-cap exchanges, they also feature extreme volatility, frequent market misconduct, multiple relationships between different companies and listed stockbrokers, high shareholding concentration, low trading volumes and small public floats. All these are the right conditions for corralling by syndicates and traders to manipulate share prices for extreme short-term gains.

These are the same traits that tripped GEM last week, not to mention Singapore’s entire small-cap sector in 2013 when Datuk John Soh Chee Wen (he of Promet-KelanaMas-Uni­phoenix and Kuantan Flour Mills fame in the 1990s) co-masterminded the now-infamous Asiasons-Blumont-LionGold fiasco.

Bursa says it wants to introduce the all-new, all-singing, all-dancing SME market to “boost Malaysia’s dwindling IPO performance” but doesn’t it realise that the problems are structural? Last year, there were only 12 initial public offerings in Malaysia, a figure that has been on a downward trend since 2010. And of those choosing to list, a great many were either relistings, government-linked or feeding off government contract largesse.

Those not feasting off the government buffet table have chosen to go abroad. Some, like the local big data company Fusionex, went all the way to the UK’s small-cap market instead of listing on the ACE Market. Others, like technology companies Flexiroam and iCandy Interactive, went to Australia. Yet others, like the integrated professional service company Axcelasia Inc, chose to list on the Singapore Exchange’s Catalist board instead.

There are many, MANY reasons why local entrepreneurs choose to raise capital and incorporate abroad even while still doing business here. They are the same reasons why hundreds of thousands of skilled Malaysians live abroad, only returning occasionally for holidays or to visit their families.

Like the omissions listed above in regard to Malaysia’s capital markets, the reasons are structural — which remain largely unaddressed to date.

The billions lost due to The Enigma Network might have happened far away in Hong Kong but that does not mean it has not already happened here — or will not be repeated in the future.

As Hong Kong amply demonstrates, Malaysia does not need another smaller, even more junior exchange. It needs change.

Khoo Hsu Chuang is contributing editor at The Edge Malaysia

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