The enforcer

Corporate governance is a woolly term. Since the baht went south in July 1997, it has been bandied about, misused and abused.

Only a few Asian companies’ owning families seem to “get it” – “it” being that corporate governance is ultimately in their company’s best interests and is not a Western conspiracy. For the most part, however, it has received mostly lip service.

And fund managers who made it their rallying cry in the aftermath of the financial crisis developed a startling amnesia in the wake of dotcom fever. All that talk of doing your credit research ... well done, boys.

If cajoling fails, if complacency sets in, if fund managers start to look the other way, then how does change happen?

John Lennon quipped, “Life is what happens while you’re making other plans.” In this case, plans for corporate governance are being made while index providers, in particular Morgan Stanley Capital International (MSCI) are changing the way funds will flow.

The growing dominance of passive investment – real index investors plus all the active manager hangers-on – has come to Asia. This American export has created huge market upsets when indices change, such as when MSCI chucks out a company such as Cheung Kong or a country such as Malaysia. So when indices don’t just tinker with an individual stock but redesign how they work, you can imagine this will have an enormous impact on fund flows. MSCI’s change: to adjust its indices to reflect a security’s free float. MSCI is actually behind rivals such as Dow Jones Indexes, Financial Times and Standard & Poor’s in this movement, but its impact in Asia will be the greatest.

So what?

So what does this have to do with corporate governance? A company’s weight in an index won’t be measured on its total market capitalization, but the proportion of that market cap actually available to the public. Adjusting for free float in the US or UK is almost meaningless. Not in Asia. Here governments own sizeable chunks of listed companies, and cross ownership is rife.

Peter Burnett, joint head of corporate finance, Asia at UBS Warburg, says these changes will result in capital flowing to companies with larger free floats. Cross ownership will be punished and these companies – whose share prices benefited from oversized market caps and restricted available stock – will suffer. At the same time, governments will be under increased pressure to divest.

“You might see sell-downs by families,” he says, “and also by governments who want to improve their liquidity and don’t want to see capital exiting their markets. One thing governments can do to improve liquidity in their markets is sell down their positions in listed stocks.”

Investment bankers and fund managers have been urging this on Asia’s bureaucrats and CEOs for years. Appeals to be good will now be joined by real punishment for ignoring the cold efficiency of the market.

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