Here’s an old article of mine published in The Business Times in 2012 that may have some lessons for today.

______________

Published August 02, 2012

SGX should not punch above its weight

MAK YUEN TEEN, VINCENT CHEN AND EMILY SIM 

According to the World Federation of Exchanges (WFE), the SGX has the highest percentage of foreign issuers among the top international exchanges. As at the end of 2011, foreign companies made up more than 40 per cent of all companies listed on the SGX, a substantial increase from 13 per cent in 2000.

By comparison, the percentages of foreign companies are about 23 per cent and 21 per cent on the NYSE Euronext (NYSE) and London Stock Exchange (LSE), respectively. Chinese companies now make up 46 per cent of all foreign listings on the SGX, and regulatory enforcement for foreign listings has become a major issue in Singapore.

According to the WFE, foreign listings comprised a mere 1.2 per cent of the listed companies on the Hong Kong Exchange (HKEx). The HKEx classifies a foreign company as one that is incorporated overseas and has a majority of its business outside Hong Kong and China. Thus, companies that operate primarily in China are considered as domestic companies by HKEx.

To facilitate regulatory enforcement against Chinese companies listed on the HKEx, the China Securities Regulatory Commission (CSRC) and the Hong Kong Securities and Futures Commission (SFC) have been parties to the Memorandum of Regulatory Co-operation since 1993. A recent doctoral study by Gordon Chan at the Chinese University of Hong Kong reported that enforcement actions against Chinese companies listed in Hong Kong intensified in the mid-2000s.

There are two major issues with foreign listings compared to domestic listings in terms of regulation and enforcement. First, certain rules and regulations may not apply to foreign listings. In the case of foreign companies with a primary listing in Singapore but which are incorporated overseas, they are subject to the Securities and Futures Act and Regulations, but not to the Singapore Companies Act.

For foreign companies which have a primary listing and incorporated here, they are also subject to the Singapore Companies Act. However, even in such cases, it is often only an investment “shell” company which is incorporated here, and most of the operations of these foreign listings are conducted through foreign subsidiaries. As these foreign subsidiaries are not subject to the Singapore Companies Act, there is arguably a certain degree of regulatory “leakage”.

However, the far more important issue for foreign listings is arguably the enforceability of rules and regulations, rather than their applicability.

We conducted a research study on the valuation of foreign listings and the factors which affect their valuation. We were particularly interested in the impact of enforcement on valuation of foreign listings. Foreign listings are defined as companies with the major operations based overseas, based on the classification used by SGX.

Using 577 observations for foreign listings and 1,035 observations for domestic listings from 2008 to 2010, we first examined if there are differences in valuation between local and foreign listings. We then examined the impact of enforcement on the valuation of foreign listings.

We used Tobin’s q, calculated as the ratio of market value of the firm to its book value, as the measure of valuation. We also controlled for firm fundamentals such as sales growth, firm size and profitability. We also included the company’s governance ratings (using the Governance and Transparency Index score) and whether the auditor is a Big Four firm or otherwise.

We found that foreign listings have significantly lower valuations compared to local listings. When we restricted our analysis to foreign listings, we found that China listings have lower valuations compared to other foreign listings. We also found that companies, whether local or foreign, with a higher governance rating have higher valuations, as did those which were audited by a Big Four accounting firm.

We then conducted further analysis on the foreign listings. As for a proxy for enforcement, we added a variable to capture whether the country of domicile of the foreign listing has an extradition treaty with Singapore. We obtained data for this from the Singapore Extradition Act, as well as from various related sources. For the countries from which foreign listings in our study were drawn, countries with which Singapore has an extradition agreement include Malaysia and the United States. In addition, Australia and the United Kingdom are “declared Commonwealth countries” for the purposes of the Singapore Extradition Act, meaning requests for extradition can also be made under the provisions of the Act as is applicable.

Having an agreement for regulatory cooperation (as exists between Hong Kong and China) can also help in enforcement, but we do not have information about the existence of such agreements. We also classified foreign listings based on the country/region from which they come from – China, South-east Asia, Hong Kong, and others – determine if there is a country/region effect on valuation of foreign listings.

Our results show that the presence of an extradition treaty has a statistically significant impact on valuation, while the country/region did not have an impact once the presence of an extradition treaty was controlled for. In other words, the main factor is not so much where the foreign listings come from, but rather the ability to enforce rules.

The usual caveats relating to academic studies aside, the findings from our study suggest that the ability to enforce, rather than the rules and regulations per se, affect the valuation of foreign listings. Unfortunately, while attracting listings is the SGX’s business and it is a front-line regulator, regulators have limited enforcement ability when there is no extradition treaty or agreement for regulatory cooperation between Singapore and the countries from which the foreign listings are drawn.

As most countries have their own exchanges, there are no obvious incentives for those countries to agree to regulatory cooperation to protect investors when companies decide to list overseas, unless there is a quid pro quo arrangement encouraging our companies to list in those other countries.

The reality is that the SGX faces considerable challenges in growing its business without compromising investor protection. On the one hand, it does not have a large domestic economy to count on for local listings, nor does it have a rich “hinterland” providing a big source of listings, like Hong Kong does.

On the other hand, there are also no clear economic advantages for foreign companies to list on the SGX because companies typically make their listing decision based on factors such as proximity to major customers and major business partners, depth of the market and access to cheap capital, factors which other major exchanges (such as the two major US exchanges, London and Hong Kong) are more likely or just as likely to offer.

Even if the primary reason for companies to choose to list on an overseas exchange is to meet higher listing standards as a signal of quality (which we doubt would be a primary consideration), it is difficult to argue that listing standards and regulatory and shareholder enforcement are better here than in other developed markets.

Indeed, the greater concern is that companies will choose to list in countries with less restrictive standards and weaker enforcement – a “race to the bottom”. Two high profile large companies which have proposed to list here – Manchester United and Formula One – came knocking with strings attached in the form of dual class shares or stapled offerings. Hutchison Port Holdings Trust, which listed here in 2011, could not have listed in its “country of domicile” (Hong Kong) because the HKEx does not allow the listing of business trusts.

In the past few years, a number of foreign companies have decided to delist from SGX and list in Hong Kong or Taiwan because of perceived lower valuations on the SGX. If regulators do not take action to enhance the quality of foreign listings and restore investor confidence following the scandals involving such listings, this will continue to hurt valuations especially for foreign listings.

This will, in turn, drive away foreign companies of high quality with genuine economic reasons to list here, creating a vicious downward spiral in the quality of foreign listings.

The SGX can probably be an exchange for high quality companies if its ambitions are more realistic. For example, it could focus on helping good local companies list and access capital. Or it can focus on attracting quality companies with a large customer base or major business partners in this region, such as Asean companies – perhaps as dual listings, such as the recent case of IHH Healthcare. However, it is clear that the SGX wants to punch above its weight, and it is challenging when a natural welterweight tries to compete in the heavyweight division of global stock exchanges. Investors may be the ones facing the knockout in such a contest.

This commentary is based on a thesis written by first class honours graduate Emily Sim at the NUS Business School, under the supervision of associate professor Mak Yuen Teen and Vincent Chen who both teach at the school