By Mak Yuen Teen
First published in Business Times, July 16, 2013
Talking point:Â While the business trust model is attractive to sponsors, who are able to raise significant funds while retaining tight control, and is ‘good business’ from the point of view of stock exchanges and intermediaries, it is difficult to see how they are beneficial to public investors. –Â PHOTO: REUTERS
THE recent announcements by First Ship Lease Trust (FSLT) regarding the resignation and appointment of directors of its trustee-manager, First Ship Lease Trust Management Pte Ltd (FSLTM), and the correction of the earlier disclosure regarding an extension of loan covenant terms (“Four directors leave FSLT Management”, The Business Times, July 5, 2013) raise three major issues.
These relate to the governance and transparency of FSLT and FSLTM; the application of the concept of independence of directors to business trusts; and the governance of business trusts and the sustainability of the business trust model as a listing vehicle.
The resignation announcements indicated differences of opinion either with regard to the management of FSLT/FSLTM or with the conduct of a board meeting. This is obviously a red flag, but what is also of concern is the apparent lack of proper procedures and governance in FSLTM. In response to questions in the cessation template regarding the director’s interest in the listed issuer and its subsidiaries, and past and current directorships in other companies, it was stated that this information will be obtained and a further announcement will be made.
These is standard information that directors are generally expected to declare and issuers are expected to disclose. The fact that the erroneous announcement of an extension of loan covenant terms, clearly a material disclosure, was made without the prior approval of the board of directors, further reinforces the lack of proper governance.
FSLT’s earlier announcements on June 17 and 28 regarding the appointment of two new independent directors and one non-independent non-executive director also raise questions. The announcements indicated that two of these directors have no prior experience as directors in listed companies, while one director has experience in one overseas listed company and was also a director of a Singapore private company which was struck off. The appointment template requires that the board comment on their appointment, including the rationale, selection criteria and the search and nomination process.
In all three announcements, the board did not do so. Instead, it was simply stated that these directors accepted invitations to join the board from the sponsor (that is, controlling unitholder) of FSLT and the substantial shareholder of FSLTM. Unlike listed companies where the nominating committee or the board assesses and confirms the independence of the directors, two of these directors were appointed by the controlling shareholder of FSLT and FSLTM as “independent directors” apparently without the board’s confirmation of their independence.
The sudden departure of independent directors from the trustee-manager of a business trust in Singapore is of course not new. About a year ago, three independent directors were dropped from the board of the trustee-manager of Treasury China Trust (now called Forterra Trust) and replaced by two new independent directors. The independent directors publicly expressed their unhappiness over their removal.
The (incorrect) announcement by FSLT on June 10 stated that the lenders may choose to review the relaxation of the loan covenants “if a majority of FSLTM’s independent directors or any of its senior management executives resign or are replaced on an involuntary basis”.
It appears that FSLTM appointed the new directors in anticipation of the resignation of the two independent directors since their resignation would have resulted in two out of the three existing independent directors resigning, potentially causing a review of the relaxation of the loan covenants. However, since FSLTM’s CEO and CFO also resigned, the appointment of the two new independent directors may not matter anyway.
Further, I would be rather surprised if the lenders accept any “independent directors” foisted onto the FSLTM’s board to “technically” meet conditions they have imposed. Things certainly do not look good for FSLT’s unitholders.
The Business Trust Regulations 2005 require the board of the trustee-manager to have:
(a) at least a majority of the directors to be independent from management and business relationships with the trustee-manager;
(b) at least one-third of the directors to be independent from management and business relationships with the trustee-manager and from every substantial shareholder of the trustee-manager; and
(c) at least a majority of the directors to be independent from any single substantial shareholder of the trustee-manager.
The Regulations also contain extensive requirements on what constitutes independence from management, business relationships and substantial shareholders. However, they also allow the board to determine that a director is independent even if the specified relationships exist “if the board of directors is satisfied that the director’s independent judgment and ability to act with regard to the interests of all the unitholders of the registered business trust as a whole will not be interfered with, despite the relationships” (Regulation 12(6)).
Flexible about independence
Therefore, after spelling out in great detail the requirements for independent directors and what constitutes independence, the end result is that any director can still be considered independent if the board says so. This elasticity in definition of independence is of course not unique to the business trust regulations. The Singapore Code of Corporate Governance for listed companies is also flexible about independence.
The business trust regulations look good on paper but there are loopholes and implementation and enforcement issues. But perhaps the more fundamental issue is whether the concept of independent directors in the context of business trusts makes any sense at all, given the externally-managed model whereby the directors of the trustee-manager can only be appointed and removed by the trustee-manager itself, which is itself controlled (and generally wholly-owned) by the sponsor.
Even more so than other listed companies with controlling shareholders, independent directors in the case of business trusts are in effect completely dependent on the sponsor. Further, we can see that FSLTM appointed “independent directors” onto the board without any confirmation by a nominating committee or board about their independence.
The third major issue raised by the FSLT’s case is the governance of business trusts generally and the sustainability of the business trust model as a listing vehicle. There are currently 21 registered business trusts, with 15 listed and one pending listing. Of the 15 which are listed, 11 are trading below their initial public offering prices. FSLT listed in March 2007 at S$1.50 per unit and last traded at S$0.11 per unit.
The externally-managed business trust structure has significant governance risks because it introduces a wedge between ownership and control. Unitholders invest in the trust, but the responsibility for governance and management lies elsewhere with the trustee-manager. As pointed out earlier, unitholders have no power to appoint or remove directors. The trustee-manager can only be removed by a super-majority of unitholders.
Real estate investment trusts (Reits) in Singapore, which are also externally managed, alleviates these governance risks to some extent because of constraints on the behaviour of the manager. In particular, there is a gearing cap of 35 per cent (and a maximum of 60 per cent with a credit rating), high (90 per cent) dividend payout each year, and restrictions on permissible investments and composition of these investments. Business trusts are like Reits on steroids.
While the business trust model is attractive to sponsors, who are able to raise significant funds while retaining tight control, and is “good business” from the point of view of stock exchanges and intermediaries, it is difficult to see how they are beneficial to public investors.
Investors should bear in mind that sustainable businesses must be based on a strong business model, ethical and competent management and sound governance, and not creative business structures, financial engineering, or incorporating in poorly regulated jurisdictions. My worry is that the business trust sector will become our next S-chip sector and public investors will be fried again.
The writer is an associate professor at the NUS Business School, where he teaches corporate governance and ethics
