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Following is the full text (English only) of the speech by the Financial Secretary, Mr Donald Tsang, at the Plenary of the WEF East Asia Economic Summit in Singapore today (Tuesday):
Facing the Challenge of Good Governance:
Acquiring the Software of Globalisation
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Mr Chairman, Distinguished Guests, Ladies and Gentlemen,
I am honoured to be invited to address you today on the issue of good governance: acquiring the software of globalisation. This is an intriguing question and deserves an intriguing answer. It also begs the question - did Asia suffer the recent financial crisis because it lacked the software of globalisation?
Asian crisis revisited
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I have no doubt in my mind, the Asian crisis was not just Asian but a global phenomenon that began with the Mexican crisis, spread to Asia, then to Russia, and finally to the LTCM. The debate on the international financial architecture is still raging. And while history books and serious economic textbooks are still being written on the exact causes, I believe that at the heart of the issue was the efficiency and effectiveness of Asian corporate borrowers.
Allow me to elaborate. Just before the crisis, East Asia was the fastest growing region in the world. It was a region with no overall fiscal deficit, the highest savings rates, and no perceptible inflation. For East Asia as a whole, there was no overall current account deficit: some economies ran current account deficits of up to 5-6% of GDP, but these were compensated by surpluses in North Asia, notably Japan and Mainland China.
What was not apparent to either foreign investors or some governments was the size and depth of external borrowing by the corporate sector. Essentially, there were two mismatches:
- short-term borrowing to invest in long-term assets that did not necessarily have high yield to sustain interest costs; and
- foreign currency borrowing to invest in assets, such as real estate, that did not generate foreign currency to repay such debt.
Thus, when foreign investors and banks panicked and withdrew their loans and short-term funds in Asia, a virtuous circle of investment and growth became a vicious circle of deflation.
Of course, we have all gradually begun to recover from that crisis. But one thing is for sure: post- crisis, we have all become much more conscious of both the benefits and risks of globalisation. Large flows of foreign investments came into Asia, attracted by good fundamentals, as much as the hardware of growth. Our cities, industries and infrastructure have all the glass and glitter of modern hardware. But as this Conference has asked: do we have the software of globalisation?
The Software of Globalisation
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So what do we mean by the software of globalisation? Recent buzzwords, such as transparency, international standards, and corporate governance are all part of that software. But to answer this properly, we need to scratch the surface one level deeper.
As technology and telecommunications advance, we have become increasingly aware that financial markets behave like networks. People trade financial products and information across a hardware platform of screens linked by telecommunications networks. The order flows are matched, cleared, settled and paid through manual and electronic processes. This is the software that runs the hardware.
But this software - the trading practices and behaviour - is governed as much by local history, tradition and law and regulations, as by the software packages supplied by Microsoft. Herein lies the complexity of globalisation: we have global markets, but all law and regulations are still local.
And this is the challenge of the new Millennium. As the world becomes more integrated into a global economy, each corporation and nation struggles with the need for integration into global norms and the search for self identity. Globalisation is as much a challenge to individual identity as nationalism. We each have to find our own niche or role in the global economy.
Corporate Governance and the New Economy
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What does this mean for good corporate governance?
The reason why corporate governance is such a sexy topic is that corporations today are the key components of national and global markets. To put it simply, in a competitive world, the efficiency of economies depends critically on the efficiency of their enterprises, irrespective of whether they are public or privately owned.
Indeed, corporate competitiveness is no longer about possessing the competitive edge in technology, but a combination of technology and managerial processes that delivers new products and services cheaper, faster and better than the competitor Technology and knowledge per se are not useful unless they are managed well. And good management is all about corporate governance.
The UK Cadbury Report of 1992, which put corporate governance on the map, defined it as the system by which companies are directed and controlled. Corporate governance centres on the processes or software, which ensures that the directors, managers and controllers of companies are accountable to the shareholders. The power to manage has been delegated by the owners to the managers or controlling persons who must perform their fiduciary duties with integrity and be subject to the checks and balances which prevent the abuse of power.
In other words, corporate governance is all about delegation and trust. In economic theory, this is called the principal-agent problem. It boils down to the human factor or corporate ethics. Corporate governance involves the fiduciary duties of the directors or management, and even the auditors, legal advisers and regulators.
Unfortunately, in this global world, there are still huge legal and behavioural differences. Asian corporate managers and family majority shareholders have tended to be paternalistic in the way they run listed companies. This often leads to the shortage of transparency, checks and balances and minority shareholder protection. What follows is the refrain of complaints, most notably from foreign shareholders that the controlling shareholders or managers have exploited the minority shareholders.
The majority shareholders often take the view that shareholders always have the right to sell out if they do not like their performance. In more legalistic markets, such as the US, however, minority shareholders have not hesitated to take the shareholders and management to court.
In a dynamic market environment where new products, procedures and practices emerge rapidly, the discipline on corporate governance can be exercised by competition, corporate law and regulations that protect minority rights, more independent monitoring by banks, creditors, and often institutional investors and better monitoring by legal advisers, audit committees and independent directors.
On the other hand, getting the regulatory authorities too much involved in enforcing corporate governance could induce moral hazard. To minimise moral hazard, market participants should be allowed to make their decisions based on full and timely information available in a transparent market, where the rights and responsibilities of each stakeholder, including the regulators, must be clearly understood.
If the corporate governance is not solved to the satisfaction of minority shareholders, it is likely that the firms will have less and less credibility in accessing external finance. In this increasingly global market place, providers of funds vote with their feet. They find it easy to switch between markets. They no longer have to select investment opportunities available in their own jurisdiction.
The key needs of providers of funds, whether investors or creditors, are protection from exploitation and provision of appropriate information. Both of these needs are inter-connected; let me deal first with protection from exploitation. Providers of funds face a risk that they will not receive a return on their investments, because, to put it bluntly, the insiders will simply take their assets.
A good system of governance is one that protects against expropriation by insiders. Such expropriation may take many forms. But, no matter which one - in the end, insiders use the profits of the firms to benefit themselves rather than returning the profits to outside investors in the form of dividends or interest payments.
Thus the key feature of good governance is the protection of providers of funds, whether shareholders or creditors. Corporate self discipline is ineffective and breeds suspicion in the market place. That protection must be visible and certain. Protection can only come from two elements of the same theme: a legal system with appropriate enforcement. And there is no shortage of examples of inadequate or ineffective governance where only one of the two elements exists.
The other key area I identified earlier was the extent of information provided. All providers of funds, whether shareholders or creditors, need to receive certain corporate information in order to exercise their rights.
An excellent global corporate governance model is the OECD Principles of Corporate Governance published in April this year. Looking at corporate governance from a company's perspective, it addressed major issues under the headings -- the rights of shareholders, the equitable treatment of shareholders, the role of stakeholders in corporate governance, disclosure and transparency, and the responsibilities of the board.
However, the principles of good corporate governance could also be furthered by external measures. Possible means include first enhancing the flow of corporate information to the shareholders and stakeholders, including the creditors, and, second, by ensuring that there is a legislative infrastructure which enables shareholders and stakeholders to enforce their rights.
A major stumbling block to recovery and reorganisation in South East Asia, in the wake of the 1997 crash, has been the inability of creditors to enforce their rights. We believe the rights of lenders should be seen as an integral part of an appropriate system of governance.
In Hong Kong, while we have in place a comprehensive and regularly updated set of company laws as well as securities and futures laws, we have spared no effort in further enhancing this legislative framework so that it is modern and user-friendly, fair to all players and effectively protects the interests of shareholders and creditors. We are at the final stage of a major review of our company law and more work will be done specifically on corporate governance next year.
In the securities and futures market, the pace of change is particularly fast. Recent years witnessed the arrival of new technologies, new financial products, new market participants, and new trading methods. Such financial innovation reduces costs, enables investors large and small to better manage their money, and should be encouraged.
However, it also gives rise to new concerns about investor protection, volatility, speculation, and market abuses. There must, therefore, be a balance between facilitating innovation and growth on the one hand, and minimising market misconduct and systemic risks, together with providing a reasonable degree of investor protection on the other.
Our new securities legislation is designed to consolidate nine different ordinances. I'm sure you wouldn't be surprised if I told you that quite a chunk of the existing legislation is nearly a quarter of century old. In that time financial markets and practices have developed far beyond what was originally envisaged. This has created gaps in the legal framework rendering certain regulatory approaches ineffective or inappropriate. Our work in modernising the securities and futures law is guided by the following principles.
First, it should strike a balance between certainty and flexibility (which is critical for encouraging innovation as well as for responding to new market development). Second, procedures and processes should be simplified and made user-friendly wherever possible to minimise regulatory burden. Third, investors should be empowered to help themselves. The bill will create a statutory right of action for any person affected by market misconduct or market malpractice.
I mentioned earlier on the importance of effective enforcement against manipulation and other market misconduct as an essential feature of good governance. However, experience has shown that investigating such conduct with a view to criminal prosecution is fraught with difficulties. Our proposed legislation will provide for the establishment of an independent Market Misconduct Tribunal, to be headed by a High Court Judge. It will handle cases of insider dealing, manipulation, as well as other market misconduct and will have the power to impose strong sanctions and hefty penalties.
Two other essential elements of good governance in any vibrant securities market are the observance by listed companies of their listing obligations and the accuracy and completeness of disclosures to the investing public. The financial turmoil has particularly exposed room for strengthening both the enforcement of the relevant listing rules and the quality of disclosures.
These changes will put Hong Kong in the forefront of the best international practice and overcome the present tangle of legal procedures and challenges.
By enhancing the supervisory, investigatory and enforcement powers of the Hong Kong authorities, the proposed legislation will give greater comfort to providers of funds and protect them against exploitation by insiders.
In closing, I would just like to add that these regulations will not be heavy-handed. With the right mix of checks and balances, they will provide optimum rules of the games played in the market, give sufficient protection for investors, and leave enough room for the market to grow in a fair, orderly and transparent way. In other words, encouraging, not stifling, healthy competition and market innovation.
As the economies of our region recover, I look forward to greeting a stronger financial industry, imbued with an even stronger sense of fairness and justice to all who seek to prosper in the commercial life of East Asia, and in particular, Hong Kong.
Thank you.
End/Tuesday, October 19, 1999
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