Headline: Loosening the rules to tighten the game
Source: Asiamoney
Date: Dec/Jan 2000
Author: FIona Haddock

United Overseas Bank is in the courts for its handling of an IPO in Singapore. But many believe the bank’s actions to be far from unusual, and that it was simply unlucky to be caught, reflecting a change in standards among equity transactions. At the root of it all is increased competition that drives not only banks but exchanges themselves to be less stringent. By Fiona Haddock.

On November 3, United Overseas Bank Asia (UOB Asia) was charged in a Singaporean court over its handling of the IPO of a retail company, eWorldofSports.com.

At the time of the IPO, the investment bank declared the retail tranche of the eWorldofSports.com issue to be 1.3 times subscribed. What it neglected to reveal was that this was due to the underwriter, UOB Asia, absorbing a hefty 10 million of the 16.1 million shares on offer. In fact, the public portion of the sale was just 42% subscribed. Consequently, UOB Asia, a subsidiary of UOB Ltd, has been charged with committing an offence under the Securities Industry Act, including knowingly making a “false or misleading statement” which is “likely to induce the sale or purchase of securities.” [See sections 97(1) and 99(B). UOB was also charged under these sections in relation to its handling of the Hua Kok International IPO.]

According to the Monetary Authority of Singapore (MAS), UOB Asia is the first bank to be charged under the relevant sections. Yet bankers and investors suggest UOB Asia is not alone in carrying out such activities. Says one senior investment banker: “You’ve got to imagine that UOB is just one that got caught.”

In the months leading up to March this year, such dubious activities were unlikely to attract attention. In those hedonistic days the dot.com darlings held sway and it appeared that exchanges, bankers and investors were all prepared to overlook minor transgressions along the way. Says Sheree Tan, senior fund manager of Commercial Union Investment Management in Singapore: “During boom times, people close their eyes to how things are done in the IPO market.”

As of March this year, however, the tables have turned. With a large percentage of IPOs trading significantly below their issue prices right across Asia’s markets, attention has turned to who did what wrong.

The knee jerk reaction of a number of investment bankers is to blame the poor results on the world-wide phenomenon of collapsing internet stock prices: the bubble inevitably burst and took all and sundry with it. At the end of the day, it could not be helped, they say.

Meanwhile, Hugh Young, managing director of Aberdeen Asset Management focuses on the capricious nature of the investor: “Investors are fickle people. With the Asia crash they were saying due diligence was very important. But the same guys are buying tom.com.”

Yet the eWorldofSports IPO does invite questions. It is a prime example of how ill-conceived much of the internet hype was. Although the company was largely a bricks-and-mortar outfit, it had grand aspirations to escape its revenue blues by reinventing itself as a glamorous dot.com, and going public (See box: Health Warnings.)

The fact that eWorldofSports launched in August, some months after the IT stocks crash, indicates the markets are facing issues that go beyond the bubble. This is not just a typical investment banking tale of greed and excess. Rather, it reflects the intense pressure both exchanges and investment bankers are under to compete.

This explains why UOB Asia took such a risk, going so far as to inject its own capital in to a weak deal to ensure it performed. It also explains why the Stock Exchange of Singapore (SES) relaxed its listing requirements last year, allowing companies to come to the market under a more liberal disclosure-based regime rather than a merit-based regime (see table for comparison with other exchanges’ listing requirements). Its grander ambition is to become the financial services hub of Asia. But more simply, it wishes to survive.

The SES’s experience
The SES went public in November this year. In its listing prospectus it was obliged to undergo a relentless self-examination in order to reveal the risks that might possibly undermine its future performance. It stated for the record: “We face intense competition from other securities and derivatives exchanges, both regionally and globally, as well as ECNs [electronic communication networks] and other non-traditional trading networks. This competition is likely to intensify in the near future.”

It is not surprising, therefore, that the exchange felt it necessary to relax its listing requirements in a bid to attract more companies. It would have been particularly appealing last year, given the number of start-ups coming to market around the world. It would also ensure other boards such as Nasdaq or Hong Kong’s Growth Enterprise Market (GEM) did not tempt its potentially high growth companies away. Says David Gerald, president of the Securities Investors Association of Singapore: “There’s a lot of pressure. Singapore is a very small market and its players have to perform. We are competing with Hong Kong and if we want to plug in to the global market, the rules have got to match.”

However, there have been complaints by investors that these new rules have led to sloppiness on the part of investment banks (see box Health warnings) and – in the case of UOB Asia – outright dishonesty. And given that 70% of IPO share prices are below their issue price, there is also talk among bankers and investors that some of the companies that came to the market were simply not ready. One could be justified in questioning just what the SES has achieved.

Yet the SES did see an increase of 79 companies listed this year with a market cap of about S$406.68 million (US$234.38 million) at the end of October compared to S$382.09 million at the same time last year. Ronald Ong, head of investment banking for Southeast Asia at Morgan Stanley Dean Witter, believes the rules have resulted in some notable successes. “Other factors contributed to improved performance but I would say about 50% of the IPOs this year are attributable to the relaxation of the rules,” he says.

Says Young of Aberdeen Asset Management: “Singapore has generally been quite sensible. Certainly there were some new issues of small companies that were instantly forgettable. But on the whole, Singapore stands out as making more of an effort: the classic comparison being Hong Kong.”

Upon amending its listing criteria in September last year, the SES asserted: “The new listing criteria do not represent a lowering of listing standards. Companies seeking listing under the new criteria will still have to appoint issue managers who must satisfy themselves that the companies are suitable for listing. Using the disclosure provided [by companies] and their own judgement, investors themselves must decide on the merits of investing in the companies.”

But still there is need for strong regulation. Adequate disclosure by companies cannot be a given in Asia’s fledgling markets and the UOB case, if proven, suggests investment banks may not be playing it straight either. One senior investment banker queries whether the regulatory regimes of countries like Singapore are sophisticated enough to support a merit based regime. “If you have a flexible regulatory environment which involves a listing committee using its judgement – deciding which companies should or should not come to market – as opposed to merely ticking off a check list, then that’s a much more difficult job to do.” Gerald of the Securities and Investors Association confirms that Singapore’s regulations still have a long way to go before they meet the standards of the US Securities and Exchange Commission.

Nevertheless, despite some reservations, investors in Singapore appear satisfied the SES will look after their interests and ensure a strict line is followed. The fact the MAS came down so hard and fast on UOB Asia in the eWorldofSports case has only served to strengthen this belief.

The investment banker experience
When the eWorldofSports case first came to light in August, Singapore’s deputy prime minister, Lee Hsien Loong, was questioned about the matter in parliament. He replied that the case reflected a deficiency in professional judgement and conduct on the part of eWorldofSports, rather than a shortcoming of the rules and regulations. He added: “It is not surprising that during the transition from merit- to disclosure-based regimes some participants will test the limits of what is permitted. But I am confident that after a few salutary test cases, they will discover where the limits lie and the consequences of transgressing these limits, and a new balance will be established.”

One would assume this balance will be more readily achieved in the discriminating bear market. But perhaps not. As the deals drop off, the pressure on underwriters to compete may only intensify. It is this stress that investment bankers interviewed by Asiamoney pinpoint as the reason behind UOB Asia’s alleged misconduct.

Says Scott Ferguson, head of equity capital markets at Salomon Smith Barney: “It’s such a competitive market place. What those guys allegedly did – to put their own capital up to complete the deal – was, in fact, a bold thing to do. As it turned out, if the market had been unaware of this, it may have been illegal. That they might have been willing to do this shows just how much pressure they felt – either from their client, or from a business perspective. Certainly, we [at SSB] feel considerable pressure to ensure that our deals are completed at a price that is fair for both the issuer and the investor. We will, where legally permissible, consider the aggressive use of our own capital, particularly in the after market.”

Micheil Steenman, head of equity capital markets for Chase JF agrees there is considerable pressure, particularly on the smaller banks, to perform: “What you are seeing in Asia is the big players becoming more dominant in the larger deals. Eight years ago there was far less concentration.” He also points to the squeeze on investment bank and brokerage margins. “Secondary market margins are shrinking every year. Therefore, because the margins remain larger in IPOs and placements, there is more pressure to do these kind of deals.” Steenman compares the 25 basis points (bps) a bank might get on a secondary offering to the 500 bps for an IPO on Hong Kong’s Growth Enterprise Market: “The attraction is clearly there.”

In Singapore, fees are notoriously low and the deals few and far between. Says Young of Aberdeen Asset Management: “Historically these investors relied on investment banks to do the weeding out – well, at least that’s the glamorous version of the past. Recently, investment banks have been very bottom line driven. More and more the risk is placed with the end investor.”

He adds: “But it takes two to tango: banks and investors.”

The investor experience
Young, and others, stress the need for thorough education of investors as the financial landscape is reinvented. Steenman of Chase JF notes that past practice of the SES was to give a clean bill of health to companies that listed. Hence, there was limited downside for investors – they would invest in IPOs without even reading the prospectus.

“The Singapore government is now discouraging that,” says Steenman. “They are encouraging investors to adopt a ‘buyer beware’ mentality.” The general consensus is that the MAS and the SES have been fulfilling their obligations in terms of increasing investor awareness. Confirms Steenman: “Singapore is doing the right thing in educating investors.”

The Hong Kong experience
It is not just Singapore that has passed more responsibility over to the investor. Its main rival, Hong Kong, has also been keen to tap the high growth market. But rather than relaxing its main board’s listing requirements like Singapore, it launched a second board – the Growth Enterprise Market (GEM). This represents something much more ambitious. Indeed, GEM’s internet site includes the words: “A ‘buyers beware’ market for informed investors”.

GEM has also experienced controversy over the past year. But while most would agree that Singapore is on track, there are few supporters left for GEM. As one banker bluntly tells Asiamoney: “It smells”.

GEM’s first birthday was on November 25, but the celebrations were decidedly muted. The market saw only 42 companies list this year to date, well below the target of 100. Meanwhile, the share prices of those companies shot down by two-thirds.

It has not attracted flak for its plummeting share prices alone. It has also been soundly criticized for waiving listing requirements with what some interpret as an indiscriminate approach [see Why GEM has got its fists up, Asiamoney, June 2000, p29]. Business plans rather than businesses were put up for public sale – leaving the market wide open to disappointment. Says Hong Kong-based independent commentator, David Webb: “The relaxation of the GEM listing rules has been a big contributor to its failure.”

Too early on in its life, its image has become seriously tarnished. The perception is of a get-rich-quick, tycoon market. Says Webb: “It was to be for small and medium enterprises. Instead it was commandeered by large companies with the wrong business interests.” During the month of November, 20 companies received approval to list, yet all chose not to do so.

The Hong Kong Exchange for Securities and Clearing defends GEM on a number of grounds. It points out that in terms of its capital formation, GEM has been very successful, raising US$1,830 million to date this year – notably its very first. Says a spokesperson for the exchange: “Singapore did what it considered in its best interests. I suppose the proof of the pudding is in the eating. Twice the amount of capital has been raised on GEM in less than a year than on SESDAQ in 12 years.” So far as the fall in stock prices goes, the exchange puts the blame squarely on the ill fortunes of stocks world-wide: “The scale of its decline is a reflection of timing, rather than market quality.”

John Simpson, managing director of equities at HSBC, downplays some of the criticism levelled at GEM, pointing to how daunting a task it is to launch a successful board for high growth companies: “It’s a very difficult thing to get right,” he says. Meanwhile, Greg Feldberg, head of convergence team at Indosuez WI Carr securities, preaches patience: producing a successful market takes time, and until GEM sees a Microsoft of Asia list it will inevitably remain highly vulnerable.

Yet Simpson is less convinced GEM chose the appropriate course. He believes Singapore’s approach merits praise: “Singapore actually did what may have been best here in Hong Kong – which is change the rule book to look at companies without profitability. As opposed to setting up GEM, which whether we like it or not has been heavily criticised over its performance.”

It is perhaps not surprising UOB struggled to sell all of eWorldofSports’ shares. The company, a retailer of sports goods and equipment established in Singapore in 1991, was facing shrinking revenues at the time of the IPO. The company had little exceptional to sell itself, other than its new ‘e’ title. On-line finance analyst WallStraits.com is scathing in its description: “A company adding an “e” in front of their name and a “.com” in back of their name for IPO, even though only a tiny portion of their sales are via e-commerce today.” Indeed, the e-tailing business had only been launched in February, presumably to kick start a struggling bricks-and-mortar operation.

Revenue has been declining for the past three years with a huge drop in 1998. The risk factors set down in the prospectus admitted to no operating profit record and negative working capital. In fact, long-term liabilities of the group amounted to S$34.15 million as of August 31 1999. Meanwhile, through the wiles of a “group restructuring exercise” S$21 million of accumulated losses and S$12 million net deficits were wiped clean from their books to prepare for this offering, according to a WallStraits.com analyst.

Yet eWorldofSports hardly compares to some of the other companies that came to market in the earlier part of the year. Although its fundamentals do not look appealing, at least it had some fundamentals. True, it is trading some 50% below its issue price – the worst performer by more than 20% in the retail sector – but this may to some extent be ascribed to the controversy surrounding its issue.

Health warnings
It was not only UOB Asia’s conduct that came to light this year. A degree of sloppiness was apparent in some of the other banks’ IPO work. Merrill Lynch was caught out in May in relation to its listing prospectuses for Singapore Airlines’ two subsidiaries, SIA Engineering (SIAE) and Singapore Airport Terminal Services (SAT). Both prospectuses contained statements that suggested the bank would step in to the market to stabilize the companies’ share prices if deemed appropriate. Yet this is in fact not permitted in Singapore in the primary markets.

Investors started asking questions when the shares didn’t perform well in the secondary market and Merrill Lynch did not move to stabilize the price. As Asiamoney went to press, SAT was trading 36% below its issue price and SIAE, 33% below.

Says a senior investment banker: “The SIA deals have been quite controversial. There you had Singapore’s retail investors thinking the price was going to be stabilized and, whether they understand what stabilization is or is not, the shares dropped a lot – and quick for one that was ostensibly oversubscribed.”

Hugh Young, managing director of Aberdeen Asset Management, believes it reflects badly on more than just Merrill Lynch: “There is a tendency globally for prospectuses to be very thick with lots of healthcare warnings. Merrill Lynch’s mistake on the greenshoe is symptomatic of things world-wide. Mistakes are being made and people are relying a bit too much on health warnings covering all sorts of issues.”

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