“Towards a world class regulatory framework: enhanced transparency
YBhg Datin Zarinah Anwar
Deputy Chief Executive, Securities Commission, Malaysia
on the occasion the first meeting in Malaysia of CPA Australia’s
International Board of Directors
16 August 2003
Shangri La Hotel, Kuala Lumpur
Yang Berhormat Tan Sri Dato’ Haji Muhyiddin Mohd Yassin, Minister of Domestic Trade and Consumer Affairs,
Mr David Baulch, President of CPA Australia
Mr Albert Wong, President of the Malaysian Division, CPA Australia
Distinguished guests, ladies and gentlemen.
Allow me to add my word of welcome to the Board of Directors of CPA Australia to Malaysia. It is an honour to be invited to deliver a keynote address today in conjunction with CPA Australia’s first meeting in Malaysia.
Objectives of Financial Regulation
The World Bank in a publication in 1990 aptly stated that the goal of financial regulation is not perfection, but a system which (i) mobilises resources efficiently (ii) minimises allocative mistakes (iii) curbs fraud and (iv) stop instability from turning into a crisis.
In 1998 the International Organisation of Securities Commission (IOSCO) of which Malaysia is a member, released a document called the Principles and Objectives of Securities Regulation setting out 30 principles which are all aimed at achieving three key objectives, namely (i) protection of investors (ii) ensuring markets are fair, efficient and transparent and (iii) reduction of systemic risk.
Both documents are clearly premised on the assumption that financial and capital markets must be regulated. Hence the focus is on ‘How’ and ‘To what extent’.
Most of us would also be familiar with economic theory that suggests that in a market economy regulation is only necessary and desirable in cases where independent actors in free economic exchanges produce socially undesirable results. Some would even argue that there is no need for banking and securities legislation because the market provides self-correcting mechanisms.
All these beg the question, what is a world-class regulatory framework for the securities market in particular, and the corporate sector in general?
Ladies and Gentlemen,
A World Class Regulatory Framework
The role of the securities market in a market economy is to allocate capital to most efficient uses. The regulatory framework provides the facilitative and enabling mechanism to support this role. Hence in my view the characteristics of a world-class regulatory framework include:
(i) Laws and regulations that facilitate and not impede capital market development. This calls for an appropriate balance between competing goals and objectives, for example protection of investors against fraud versus allowing businesses to flourish without being shackled by burdensome regulations.
(ii) The regulatory framework must provide clarity and certainty to market participants. Simply put, the rules of the game must be clear.
(iii) Laws and regulation must be based on performance standards and not command control edicts. Laws must provide for minimum standards rather than a laundry list of “Dos” and “Don’ts”. A highly prescriptive approach to regulation with extensive, detailed and specific rule books not only stifles the market but also encourages a culture of ‘loophole mining’ among lawyers and compliance officers.
(iv) Finally but very importantly, the cost of regulation should not exceed its benefits. This includes not merely costs that are directly quantifiable but others that affect efficiency and competitiveness.
All these may perhaps point to the need for minimal regulation. The SC fully subscribes to this. In the Capital Market Masterplan, we have made it clear that there will be ‘no more regulation than necessary’. However, a variety of other factors such as the level of investor awareness, the adequacy and reliability of financial and other information, the state of shareholder activism, the level of professionalism of advisers and professionals such as lawyers, valuers and accountants – in general the level of maturity of a market as a whole – will determine the actual amount and complexity of the laws that need to be in place.
In fact it is often observed, that the amount of laws in a particular market is inversely proportional to the level of professionalism, integrity and ethical conduct within that market. In an environment where any or all of the above are lacking, more laws may be inevitable. The US is a classic example – having moved away from one end of the spectrum that focussed on strong regulatory framework towards self- regulation and market regulation, the Sarbanes-Oxley Act has brought back strong and possibly onerous regulation. No thanks to the high profile corporate scandals and massive corporate failures which made Sarbanes-Oxley a necessity.
Enhanced Transparency and Governance
Securities markets are built on the interdependent pillars of confidence and information. These in turn are dependent on good governance and transparency. Hence, a review of corporate and securities laws which is often undertaken in response to high profile corporate failures or systemic crises would inevitably involve enhancing transparency and governance. This was true in the 18th century when the ‘South Sea Bubble’ burst, ruining the fortunes of thousands in all ranks of society and resulting in the revolutionising of business laws and practices in England. Similarly, the stock market crash in 1929 resulted in much of the development of securities laws in the United States and indeed the birth of the Securities and Exchange Commission a few years later. More recently, the fallout from Enron, WorldCom and other high profile cases have raised, amongst others, issues of the quality of financial disclosure and accounting standards, corporate governance and the effectiveness of management oversight. It has also resulted in the creation of an accounting oversight board and the introduction of the Sarbanes-Oxley Act. These are perhaps the most significant and pervasive changes affecting corporate America since the creation of the US SEC in the 1930s.
In Malaysia, the Asian financial crisis had a catalytic effect on on-going efforts to improve and enhance corporate governance. Several high profile cases which demonstrated blatant disregard by substantial shareholders of the interest of minority shareholders, self-dealing and the siphoning of assets of PLCs to private purses through related party transactions resulted in immediate changes being introduced to the Take-over Code and the Listing Requirements of the Kuala Lumpur Stock Exchange. These were supplemented by recommendations for extensive changes to Company and Securities legislation. Most of these have since been implemented while a few more are being worked on.
Corporate failures as a result of negligence, fraud and abuses have had similar effects in most jurisdictions, resulting in the examination of weaknesses in the corporate governance system, and adoption of measures to address weak links in the chain, including strengthening of the regulatory framework.
The history of capital market regulation has been described as a history of adaptation and reaction to abuse. As a result laws are often introduced in a reactive rather than anticipatory manner – frequently laws are tightened as new schemes or abuses emerge. Understandably securities regulators are often accused of trying to close the proverbial stable doors after the horses have bolted.
It is precisely to pre-empt this ad hoc reactionary approach towards policy and regulatory development that the Securities Commission launched the Capital Market Masterplan in February 2001. The Masterplan is a ten year blueprint for the development of the Malaysian Capital Market. It presents a comprehensive, strategic roadmap formulated with the participation of all industry participants to enable the capital market to position it self to contribute towards the economic and financial goals of the country and to meet the increasing challenges of international competition and globalisation. The recommendations in the Masterplan are aimed at enhancing the value proposition of the capital market to all market participants, while ensuring a strong and facilitative regulatory framework that provides a high degree of confidence in the context of a changing market environment.
Ladies and Gentlemen,
A Multi-Dimensional Approach
Enhancing transparency and governance calls for a multi-dimensional approach.
It is for this reason that the approach adopted in Malaysia has been to effect legal reform alongside the introduction of voluntary codes, facilitating investor as well as director education and intensifying shareholder activism.
While Malaysia’s efforts to inculcate good corporate governance were already on-going even prior to the Asian crisis, events of 1997/1998 increased the momentum of the reform efforts. This multi-dimensional approach to enhancing transparency and governance is particularly apparent in the Report of the High Level Finance Committee on Corporate Governance.
This High Level Finance Committee, comprising of both government and industry participants, was established in the aftermath of the Asian Financial Crisis to identify the weaknesses in the then governance framework. The Committee set out their recommendations to overcome these weaknesses in the Report on Corporate Governance which was released within a year of the Committee’s establishment. Apart from recommendations that call for reform of laws, the Finance Committee Report gave equal attention to non-statutory reforms. Examples of these recommendations that have since be put in place include:
The introduction of a Code of Corporate Governance, which sets out the principles and best practices on corporate governance.
The requirement for directors of public listed companies to undergo a Mandatory Accreditation Programme and Continuing Education Programme;
The formation of a Minority Shareholder Watchdog Group, led by major institutional investors;
The introduction of Internal Audit Guidelines for public listed companies; and
Enhanced enforcement efforts supported by increased supervisory and enforcement capabilities of regulators, including civil enforcement powers and enhancement of compounding powers.
Public listed companies are required by the Listing Requirements of the KLSE to include in their annual reports, a statement of how they apply the relevant principles of the Code and to state the extent of compliance with the best practices set out in the Code and the rationale for any departure.
Ladies and gentlemen
Regulators together with the legislature can build strong legal and institutional frameworks which are supported by timely and effective enforcement where transgressions have occurred. However, the primary driver for accountability and responsibility and indeed good corporate governance, must be corporate management and market participants themselves. This would include CEOs, directors, investors, as well as the professional advisers like the lawyers, accountants and auditors. The point has to be made and emphasised that the test of good corporate governance is not in compliance with the law. It is beyond that; it is about what is right, it is about values and ethics and about the highest level of individual and collective responsibility all of which should be translated into impeccable conduct.
The Financial Reporting Framework
Let me turn my attention for a while to the financial reporting framework. It is trite but true that financial reporting is the bedrock of sound corporate governance. Good financial reporting is critical to the effective functioning of the capital market.
Prior to 1997, the promulgation of accounting standards in Malaysia rested primarily with the accounting profession, which issued accounting standards for adoption by respective members. While the standards have been based on IAS since 1978, there were differing degrees of compliance, as well as a lack of structured approach towards resolving differences. This led to the introduction of the Financial Reporting Act in 1997, almost on the eve of the Asian financial crisis. This Act sets out the first formal financial reporting framework for Malaysia. In fact at that time, it was the only statutory framework for accounting standard setting and compliance within the region.
The Financial Reporting Act established the Malaysian Accounting Standards Board (MASB), the first such independent standard-setting body in Asia. MASB standards are mandated by law and cover both listed and non-listed companies. The Financial Reporting Foundation which was also established under the Act has oversight over the MASB.
It is worthwhile noting that while the introduction of the Financial Reporting Act was a significant milestone in the development of Malaysia’s financial reporting framework, we did not start from zero. In fact prior to 1997, Malaysia already had in place some of the requirements that have only recently been introduced in other more mature markets. For example Malaysia’s requirement for the establishment of audit committees by listed companies, was introduced as far back as 1993. The Accountants’ Act which provides for the registration of accountants and the establishment of the Malaysian Institute of Accountants was introduced in 1967 while directors’ and chief executive officers’ responsibilities over financial statements have been incorporated in the Companies Act since 1965.
Following the Enron and World.com debacles auditors and their auditing practices have also been put under the regulatory microscope. Efforts are currently being pursued to enhance the role of auditors and to strengthen supervision over them. This includes the strengthening of the Licensing Committee which assists the Minister of Finance in the issuance and revocation of auditing licences to include representatives from the SC and the Central Bank. Additionally licensing conditions are also being reviewed with a view to introducing continuous compliance obligations by auditors while efforts are also underway to enhance supervision of audit practices.
The enforcement of MASB standards over their respective constituents are entrusted to the Securities Commission, the Companies Commission and the Central Bank. The SC, through its Financial Reporting and Corporate Surveillance programme, undertakes a two fold surveillance programme on public listed companies. In addition to ensuring compliance with approved accounting standards and other financial reporting requirements in the preparation and presentation of their financial statements, the SC reviews and examines all corporate improprieties by past and present directors and initiate appropriate action against the perpetrators.
Another aspect of our regulatory efforts that may be interest to you is whistle blowing – a term used to describe the disclosure of information that one reasonably believes to be evidence of contravention of any laws or regulation or codes or that involves mismanagement, corruption or abuse of authority.
In Malaysia, the issues that gave rise to the need for whistle blowing provisions in the law were identified and addressed in the context of auditors in the report by the Finance Committee on Corporate Governance. The Report included the recommendation to enhance the current provisions in the Companies Act 1965 to extend the auditor’s duty to report to include any serious offences in addition to breaches of the Companies Act. Additionally it was recommended that the subjective element be removed and the auditor be required to base his decision on his professional opinion. The Report also recommended that protection be afforded to auditors against defamation suits in respect of the reporting obligation. Taking this further, the SC proposed to amend the securities laws to impose a similar obligation on auditors with respect to breaches in securities laws with the requisite protection from being sued in any court for any report made in good faith and in the intended performance of such obligations.
Additionally, it was felt that to assist in curbing abuses and promoting better corporate governance there was a need to extend the protection of the law to key employees of the company privy to such information, such as the chief executive officer, officers responsible for preparing or approving financial statements, company secretaries and internal auditors. It is with this in mind that the SC has included whistle blowing provisions in the amendments to the Securities Industry Act 1983, which formed part of the law reform package that was tabled to Parliament for first reading at the June 2003 session.
Ladies and Gentlemen,
I started by identifying the objectives of securities regulation. Let me end by reiterating that the regulatory framework must ensure that the markets and the participants in those markets perform their functions efficiently. A well designed facilitative framework can promote investor confidence, stimulate economic growth and create vibrant markets, while rigid, excessive or burdensome regulation can retard growth, stifle risk-taking and entrepreneurship and result in the non-alignment of risks and rewards. Crucially, in this increasingly globalised environment, burdensome regulation can reduce the competitiveness of businesses, entire industries and indeed the country. Additionally it is important to remember that one size does not and cannot fit all. In our zeal to enhance transparency and governance, we must be cautious not to impose the same requirements on small businesses with a few family shareholders as those we impose on public listed companies with thousands of public investors. Otherwise the cost of compliance will destroy the small businesses – the very engines of a country’s economic growth.
Hence in the pursuit of world-class regulatory frameworks, transparency and good governance, a fine balance need always be drawn between the control needed to prevent fraud and instability and the freedom necessary to stimulate competition and growth.
hank you for your attention.