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Malaysia: Selected Issues

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International Monetary Fund
Published Date:
September 1999
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IV. Malaysia: Issues in Corporate Sector Restructuring1

A. Introduction and Summary

1. Issues relating to the corporate sector, especially those related to its financial and governance structures, have recently risen again to the limelight, largely because of the role they have played in the currency and banking crises in Asia during the past two years. In particular, researchers and policymakers have become interested in the sources of corporate sector distress, the links between vulnerabilities in the corporate capital structure and broader financial sector distress, and methods of resolution of corporate sector problems. In this paper, the focus is on the corporate sector in Malaysia which, like in the other crisis countries, has been badly hit by the financial and economic crisis of the past two years. In particular, the paper attempts to provide the context for the current situation in the corporate sector in Malaysia, assess the causes and the extent of distress, describe the authorities’ efforts to address problems in the corporate sector, and provide recommendations for how this process may be improved as well as for measures to safeguard against the recurrence of widespread problems in the future.

2. The rest of the paper is organized as follows: Section B provides a brief historical background sketch of the development of the private sector in Malaysia; Section C describes key financial characteristics of the corporate sector; Section D outlines the impact of the crisis on the corporate sector; Section E describes the strategy that the authorities have adopted to deal with financial restructuring and strengthening corporate governance, and makes recommendations for improvements; and Section F contains some concluding remarks.

3. The main findings are that Malaysia’s corporate sector vulnerabilities are partly a result of the ownership structure, particularly the large number of diversified holding companies, and the capital structure, which was characterized by a substantial degree of leveraging.2 The impact of the crisis has been significant, and was transmitted to economic activity both through the impact on consumption and investment of the negative wealth shock, and on cash flows of the change in the exchange rate and interest rates. Several measures have been taken to address the immediate priorities of financial restructuring of the corporate sector. In addition, the authorities have also begun to design and implement reforms to strengthen corporate governance, and regulatory reforms to prevent the reemergence of the fragilities in the corporate capital structure. In addition to completing the reform agenda that has been launched, the key priorities for the future are to ensure that the process of debt restructuring is transparent and balances the interests of debtors and creditors, and that sufficient operational restructuring accompanies the debt restructuring.

B. A Historical Perspective on the Development of the Corporate Sector in Malaysia

4. The development of the corporate sector in Malaysia is closely related to the government’s policy of developing the private sector to promote industrialization while restructuring society in terms of ownership and participation. In response to the race-based social tensions in the late 1960s, the government launched in 1971 the New Economic Policy (NEP), which equated national unity with greater equity among the ethnic Malays or bumiputras, and the Chinese and Indian populations. The primary thrust of the NEP was “accelerating the process of restructuring Malaysian society to correct economic imbalance so as to… eliminate the identification of race with economic function… and the creation of a Malay commercial and industrial community…” The measures designed to empower the bumiputra population focused on developing Malay entrepreneurship and providing Malay businessmen with the finance and facilities necessary for success. The NEP set specific quantifiable goals for ownership distribution as follows: “Within two decades, at least 30 percent of the total commercial and industrial activities… should have participation by Malays…in terms of ownership and management.”

5. To accelerate the increase in bumiputra ownership, the government introduced the Industrial Coordination Act (ICA) in the mid-1970s with the key provision being that the granting of industrial licenses would be conditional on compliance with NEP ownership guidelines. The primary instrument for promoting the position of bumiputras was the requirement that at least 30 percent of initial public offerings (IPOs) of companies being listed on the Kuala Lumpur Stock Exchange (KLSE) be allocated to bumiputra investors. However, given the relatively small group of qualified bumiputras at the time, the fulfillment of the ownership requirement was proving difficult. Initially, a small select group of bumiputras was allocated shares at a substantial discount. To widen bumiputra ownership significantly, discounted corporate shares were given to unit trusts set up by Permodalan Nasional Berhad (the National Equity Corporation or PNB). Also, large state-owned corporations—PERNAS, a state investment holding company, MARA, a trust for ethnic Malays, and State Economic Development Corporations (SEDC)—were set up to promote bumiputra participation. Bank Bumiputra was set up, primarily to extend credit to bumiputra businesses at concessionary rates. Amongst the early investments of PNB and PERNAS were the purchase of the large British firms such as Sime Darby, London Tin, etc.

6. To minimize the disincentive effects on investment of the ownership restrictions, the authorities remained pragmatic and amended the rules and guidelines, over time, to grant exemptions to firms that were export- and high-technology oriented. Annex I summarizes the ownership restrictions in Malaysia as they currently stand. Most recently, in an attempt to accelerate the recovery and induce foreign investment inflows, the authorities have announced that, for new manufacturing projects commencing between July 31, 1998 and end-2000, all restrictions on equity ownership and export content will be waived.3Table IV.1 summarizes the change in the ownership structure between the 1970s and the 1990s.

Table IV.1.Malaysia: Ownership of Share Capital (At Par Value) of Listed Companies1(In percent, unless otherwise specified)
Ownership Group19851990199219951998
Bumiputra18.519.218.220.619.4
Individuals and institutions11.314.115.918.617.7
Trust funds27.25.12.32.01.7
Nonbumiputra49.546.840.043.441.1
Chinese48.245.537.840.938.5
Indians0.91.01.11.51.5
Other0.40.31.11.01.0
Foreigners24.025.432.427.731.8
Nominee companies8.08.59.58.37.7
Memorandum item:
Total value of share capital (RM billion)83.1108.4130.9179.8294.6
Source: Data provided by the Malaysian authorities.

Excludes shares held by federal, state, and local governments.

Shares held through trust agencies, such as PNB, and the SEDCs.

Source: Data provided by the Malaysian authorities.

Excludes shares held by federal, state, and local governments.

Shares held through trust agencies, such as PNB, and the SEDCs.

7. The second factor underlying the development of the private sector in Malaysia is the state-led process of industrialization. The aim was to move Malaysia from a commodity-based economy producing tin, palm oil, and rubber to a manufactured goods producer. The authorities saw the development of heavy industries as the key part of this process as it would have important spillover effects to other sectors of the economy. A company—HICOM—was set up to be responsible for the development of heavy industry in Malaysia and the flagship company was the automobile manufacturing plant Proton. This and other companies (e.g., Perwaja Steel) were developed with the aid of large subsidies from the government.

8. After a brief period of import substituting industrialization, the focus shifted to one of export orientation in the early 1970s. To promote exports and investment in export-oriented activity, the government set up several incentive schemes. Important amongst these were Pioneer Status (offering tariff and tax exemptions for 5–10 years) and Investment Tax Credit which offered tax exemptions equivalent to the amount of investment incurred in the incentive period. Free trade zones were established in 1972. These incentives generated a steady influx of export-oriented firms in the 1970s, but it was not until the late 1980s that investment surged, as in the rest of the region. Investment rates averaged 30 percent in the 1980s and 35 percent in the 1990s. Between 1989–95, foreign direct investment (FDI) averaged nearly 7 percent of GDP compared to an average of 3 percent between 1975 and 1988. Much of this FDI was concentrated in export-oriented manufacturing industries. Consequently, exports rose from about 43 percent of GDP in the mid-1970s to nearly 80 percent of GDP in the mid-1990s.

9. A final aspect that helps to understand the evolution of the corporate sector in Malaysia is the process of privatization that has been pursued since the late 1980s/early 1990s. By that time, it had become clear that purely state-owned enterprises were not the best vehicles for achieving both rapid growth and social goals. By some estimates, the number of firms with substantial state involvement in 1991 was close to 1400, with some 900 being nonfinancial public enterprises (NFPEs). Of the latter, the number of large NFPEs was 46.4 As of the end of 1998, this number stands at 28. The first steps involved “corporatization” of public enterprises such as Telekom, Tenaga, etc., by listing them on the KLSE and selling part of the government’s shares, while retaining majority ownership.5 These were large companies and contributed to the rapid expansion of total market capitalization and to making the KLSE one of the largest stock markets in the region. For example, by 1995, 18 privatized corporations were listed on the KLSE and added nearly 25 percent to total market capitalization at that time. The next steps took the form of increasing private sector participation by privatizing new infrastructure projects. In the initial phases, the award of privatization contracts was done to directly promote the objectives of increasing bumiputra participation in productive activity. Over time, the procedures used to award these contracts have been criticized for being nontransparent, favoring well-connected firms, using government guarantees for loans from the banking system or from the Employees Provident Fund (EPF) without adequate studies of the efficiency of the project and its returns, and creating governance problems and unsound relationships between banks and the private sector. In recent years, the procedures governing privatizations have been reformed; awards of projects are no longer based on exclusivity and have increasingly been subject to more open-bidding practices.

10. The effects of the government’s efforts to diversify the economy and alter the ownership structure are illustrated in the tables below. The diversification away from agriculture and resource-based sectors is evident from Tables IV.2 and IV.3 which show the rapid growth in the share of the secondary and tertiary sectors and the share of manufactured exports in total exports.

Table IV.2.Malaysia: GDP by Sector of Origin, 1960–95(In percent of GDP)
196019651970198019901995
Primary444039312821
Secondary121518253036
Tertiary444543444243
Source: Data provided by the Malaysian authorities.
Source: Data provided by the Malaysian authorities.
Table IV.3.Malaysia: Composition of Exports, 1960–97(In percent of the value of total exports)
19601970198019901997
Rubber55.233.416.43.82.2
Tin14.019.68.91.10.3
Crude Petroleum--3.123.813.43.6
Palm Oil1.75.18.95.55.6
Manufactured goods16.311.022.358.880.0
Source: Data provided by the Malaysian authorities
Source: Data provided by the Malaysian authorities

C. Key Characteristics of the Corporate Sector and the Buildup of Vulnerabilities

11. The corporate sector in Malaysia in the 1990s is characterized by very rapid growth. Between 1991 and 1996, the number of listed companies grew by an annual average of 14 percent, and total market capitalization of the companies listed on the main and second boards of the KLSE grew at an annual average rate of 40 percent. This section outlines some of the characteristics of the corporate sector and the reasons for the rapid growth in the sector in an attempt to identify the key sources of vulnerabilities to the effects of the financial crisis.

Ownership patterns

12. The corporate sector in Malaysia is characterized by a high degree of ownership concentration.

  • In a study of 100 largest corporations in Malaysia, Lim (1981) found a high degree of concentration at various levels: (i) a major proportion of the financial assets and productive capacity of the corporate economy was concentrated in a few large corporations; (ii) the second level of concentration occurs at the level of stock ownership. Notwithstanding the relatively large market capitalization of the stock market in Malaysia, stocks are not widely distributed and are concentrated in the hands of a few institutional and corporate investors; and (iii) a third level of concentration is of control over the large corporations. A complex system of interlocking or pyramiding stock ownership has developed which enables a few individuals and entities to control an amount of capital many times more than what they actually own.6 In practice, the main form of “pyramiding” or cross-holdings in Malaysia took place through holding companies which own a minor but significant proportion of shares in a large number of corporations.
  • More recently, La Porta et al. (1998) and Claessens et al. (1999) have conducted studies of the ownership of corporations across East Asia using data from a large number of financial and nonfinancial corporations. The following are the key findings:On ownership concentration, Claessens et al. find that: (i) using a cut-offline of 20 percent of voting rights, it was found that about ⅔ of all Malaysian corporations are family-controlled, about 28 percent of market capitalization being controlled by 15 families;7 (ii) when the firms are weighted by size measured by market capitalization, the proportion of family-controlled firms falls from 67 percent to 43 percent and the proportion of state-owned or controlled firms rises from 13 percent to 35 percent.8 Likewise, La Porta et al. (1998) also find a high degree of ownership concentration in Malaysia. For example, the average share of common stock owned by the largest three shareholders in the largest companies is 54 percent in Malaysia, compared to 46 percent in Thailand, 20 percent in Korea, 18 percent in Japan, and under 15 percent in the United Kingdom and the United States.On the structure of assets and means of enhancing control, Claessens et al. (1999) find that: (i) some 40 percent of Malaysian corporations use pyramid structures, including through holding companies; (ii) cross-holdings, defined as when a company has shares in other companies in the chain of controls, are also relatively high in Malaysia (and Singapore) where some 15 percent of corporations have some cross-ownership; and (iii) over 40 percent of the sample firms are affiliated with business groups.9

13. For the purposes of tracing the sources of vulnerabilities in the corporate sector, there are three implications of the corporate sector development strategy:

  • The large private sector companies which were created as part of the industrialization and growth strategy tended also to have close ties to the government and, through loans made at the behest of the government to finance the development strategy, to the financial sector.
  • The cross-holding structures may have created additional incentives for “double leveraging” whereby holding companies borrow to inject equity capital into subsidiaries, some of which were financial institutions. As the degree of leverage of the holding company rises, growth in the profits generated by the subsidiaries became necessary to generate the returns to enable the parent to service its debt. In addition, often the shares in the subsidiary company were pledged by the holding company to increase its borrowing. An implication of this leveraging process is that a fall in the equity market has a “multiplier-type” effect in its impact on corporate wealth and cash flows and therefore for the extent of financial distress.
  • The existence of significant or controlling shareholders opens up the possibility of poor governance because of the control that a small group can exercise over the firm, effectively acting as insiders. Claessens, Djankov, Fan, and Lang (1999b) find significant evidence of expropriation of minority shareholders by controlling shareholders; in particular, they find that family control (as defined above) is an important factor in this regard.

Macroeconomic factors

14. Key reasons underlying the rapid growth in the corporate sector were the macroeconomic environment and the conduct of monetary and exchange rate policy in the 1990s. Rapid growth was fueled by capital inflows, the latter driven by the growing global interest in emerging markets. In turn, asset (property and equity) price inflation provided the incentive and the mechanism to fuel continued rapid growth (Chart IV.1). The conduct of monetary policy was complicated by these inflows; credit expanded rapidly and although interest rates were allowed to rise to tighten monetary conditions, liquidity in the banking system remained high. Moreover, greater flexibility was needed in the management of the exchange rate, so as to reduce the risk that changes in monetary conditions would lead to destabilizing capital flows.

CHART IV.1Malaysia: Growth and Asset Market Indicators, 1992-98

Sources: Data provided by the Malaysian authorities; and Fund staff estimates.

15. In general, the two key sources of vulnerability in the corporate sector during the Asian crisis have been through high leveraging and heavy reliance on unhedged short-term foreign debt. In Malaysia, as will be discussed below, exposure to external debt was not a major source of the problem. The impact of exchange rate management has been primarily to encourage large capital inflows and a consequent runup in equity markets. In an environment with a high prevalence of collateral-based bank lending, this rapid asset and equity price inflation set the stage for higher debt, especially through the domestic banking system. Several years of high growth led to an underestimation of the risks associated with the capital structure.

Financial structure10

16. How has corporate sector growth in Malaysia been funded? Two features stand out with respect to the financial structure during the 1990s: first, the rapid growth in equities measured both by the growth in market capitalization and by the runup in stock prices; and second, the increase in dependence on short-term debt fueled by rapid banking system credit growth. What factors explain these observed features of the corporate capital structure? The theory of corporate finance suggests that three factors determine the choice of financing through debt or equity issuance.11 The first is the cost associated with each of the different modes of external financing; the second is the implications of the capital structure for the riskiness of earnings; and the third concerns the control aspects of financing decisions, mainly the fact that the issuance of equity tends to dilute control over the firm.

  • From a cost point of view, financing through debt tends to have a tax advantage over equity because interest is deductible from corporate income. Thus, ceteris paribus, by increasing the amount of debt issues, a firm would increase the rate of return on shareholders’ investments. Within debt financing, the greater dependence on short-term debt was in part attributable to the relatively underdeveloped market for long-term private debt securities until the early 1990s. The establishment of the National Mortgage Corporation (Cagamas) in 1986, and a credit rating agency (the Rating Agency of Malaysia (RAM)) in 1990 have been important factors in promoting the development of the bond market. Starting in 1992, tax exemption of bond interest was also an incentive. The main impediments to the further development of the bond market are the absence of a benchmark interest rate, investment restrictions on the EPF and other provident and pension funds, the relative under-development of efficient trading and settlement systems, and generally weak professional portfolio management skills.12 The recent attempts to set a benchmark interest rate through the issuance of Khazanah (the government’s investment arm) bonds is aimed at developing the domestic bond market.
  • From the point of view of riskiness of capital structure, as firms incur more debt, their ability to meet interest payments out of current earnings diminishes, thus increasing the probability of insolvency. To correct the problem of too much debt, firms needed to issue more equity. Another reason for the rapid growth in equity is the fact that capital gains are not taxed, while dividends are; investors therefore have come to expect the major part of their return to be paid in the form of capital appreciation and share price increases.
  • From the point of view of the dilution of control through equity issuance, the role played by the PNB and the various trust funds in purchasing shares and the cross-holding and family-control structure (discussed above), made concerns about dilution of ownership and control less important in the decision to issue equities than in other countries. This is because when choosing the distribution of ownership at the time of the IPO, typically, initial owners recognize the possible emergence of a potential future buyer of the company. In Malaysia’s case, the various ownership and equity restrictions would tend to limit this concern.

17. Key features of Malaysia’s corporate capital structure are highlighted in Tables IV.4 and IV.5. Abendroth (1997) examines the capital structure of the companies listed on the KLSE between 1992 and 1996 and finds:

  • For financial enterprises (commercial banks, finance companies, merchant banks, insurance companies, and stock brokerages):Asset growth averaged nearly 40 percent per annum between 1992 and 1996, with stock brokerages leading the pack with an annual average growth rate of 63 percent.Notwithstanding the growth in equity markets, funds sourced from debt far exceeded those raised from equity. The ratio of debt-equity for financial enterprises averaged 240 percent for financial enterprises on average, with stock brokerages and insurance companies having much higher debt-equity ratios than finance companies and commercial banks. One explanation for the rapid asset growth was the introduction of the tiering system in 1995 under which a minimum level of Tier 1 capital was set at RM 500 million to rise to RM 1 billion by 1998. The measure was intended to encourage mergers and consolidation within the industry. Instead, it had the effect of generating rapid asset growth financed both by short-term borrowing and equity expansion.
  • For nonfinancial enterprises:Asset growth averaged 31 percent between 1992 and 1996, with enterprises classified as being involved in construction, diversified holdings, trading and services, and property growing at an average rate of over 40 percent annually. Unlike financial enterprises where net retained profits (profits after taxes and dividends) account for only 10 percent of asset growth, for nonfinancial enterprises, such internally generated funds accounted for 28 percent.Asset growth was financed more through borrowing than the issuance of equity, as indicated by the debt-equity ratios averaging 163 percent for all nonfinancial enterprises. There are also wide variations between different categories of enterprises with diversified holdings having an average debt-equity ratio of over 500 percent and industrial and construction enterprises with debt-equity ratio of between 200 percent and 300 percent and, at the low end, mining and plantation enterprises with ratios of below 100 percent.On average for all nonfinancial enterprises, short-term debt accounted for more than 50 percent of total debt. Clearly, for some sectors, where the nature of the business is more short term, such as trading and services, or consumption-related enterprises, this may not necessarily signal “vulnerability.” However, for property companies and diversified holdings, where there is not a clear case, ratios of short-term debt to total debt of 60–70 percent could suggest weaknesses in the capital structure that would make them vulnerable to the kind of crisis that Malaysia has been in the midst of since mid-1997.Most of the short-term debt was from the domestic banking system creating a close link between corporate sector distress and financial sector problems. Table IV.5 illustrates the rapid buildup in private sector credit in the early 1990s and the sectoral concentration of this credit.
Table IV.4.Malaysia: Asset Growth and Sources of Funds, 1992–96(Period average, in percent)
Rate of Growth

of Assets (in

percent)
Internally

Generated

Funds (percent

of total assets)
Debt/

Equity Ratio
Short-Term Debt

(percent of total

debt)
Financial enterprises39.310.023990.6
Commercial banks34.26.615498.8
Finance companies and Merchant banks26.86.820294.6
Insurance companies29.87.159262.2
Stock brokerages63.419.245295.9
Nonfinancial enterprises31.028.116359.7
Construction43.623.124538.3
Consumer18.748.640666.3
Diversified holdings40.314.551965.7
Industrial27.530.721873.1
Mining12.021.23520.0
Plantation26.833.79570.4
Property38.818.412357.1
Trading and services40.534.820268.9
Table IV.5.Malaysia: Private Sector Credit Growth, 1992–96(In percent)
Private Sector

Credit (growth,

end of period)
Private Sector

Credit

Outstanding/GDP
Loans to the

Broad Property

Sector (growth,

end of period)
Loans for

Consumption

Credit (growth,

end of period)
199210.7113.0
199312.9114.7
199416.7116.21.516.2
199528.9130.226.433.2
199625.4143.026.332.7
199725.2161.526.625.2
19981.2152.94.0
Sources: Data provided by the Malaysian authorities; and Fund staff estimates.
Sources: Data provided by the Malaysian authorities; and Fund staff estimates.

18. As for vulnerability to exchange rate movements, Malaysia has been better placed than its neighbors to withstand shocks to its exchange rate. Following the difficulties experienced with the rapid build-up of external debt in the mid- to late 1980s, BNM implemented changes to its policies on permitting external borrowing as follows:

  • Residents borrowing from abroad in foreign currency exceeding the equivalent of RM 5 million require central bank permission. Generally, approval is granted for loans for activities that generate export receipts (naturally hedged), if the terms and conditions are considered reasonable. No restrictions apply to credit granted by nonbank residents in foreign currency to nonresidents for amounts not more than RM 10,000 or its equivalent. Larger loans are permitted if payment will be made in foreign currency, and the resident has no domestic borrowing. Nonbank residents will require prior approval to grant loans in foreign currency exceeding the RM 10,000 limit, irrespective of whether the nonresidents have any domestic borrowing. Authorized dealers in foreign currency are allowed to grant foreign currency loans to nonresidents, subject to compliance with net open position limits.
  • Residents requiring foreign funding are encouraged to source their loans from the Labuan International Offshore Financial Center.

19. These restrictions on external borrowing resulted in reducing Malaysia’s vulnerability to the sharp exchange rate depreciations experienced during the past two years, as total external debt has been contained and the share of short-term debt has also remained manageable. The foreign exchange exposure of Malaysia’s banks is well hedged and nonfinancial private sector debt is relatively small. The only corporates that have faced significant capital losses due to the exchange rate depreciation and the increase in the risk premium and bond spreads are those that borrowed for infrastructure and utilities projects (e.g., Tenaga and Telekom).13

20. Overall, the discussion above suggests that, prior to the crisis, the corporate sector in Malaysia was characterized by a buildup in leverage, although the extent of the buildup varied significantly across sectors. In large part, this was due to the long period of high growth and interest rate and exchange rate policies which encouraged rapid growth in assets and sales. The construction and diversified holding companies were the most highly leveraged. Moreover, through the process of double leveraging, financial institutions became vulnerably linked with their nonfinancial holding company. At the same time, there was a decline in the return on assets, primarily in the construction sector, and an increase in the share of firms with interest obligations exceeding profits,14 both suggesting an increase in the riskiness of the corporate financing strategy.

Governance structures

21. Malaysia stands out in the region as having had relatively strong regulatory structures and legal framework for corporate sector problem resolution even before the crisis. The main laws governing the Malaysian corporate sector include the Companies Act of 1965, the Companies Regulations of 1966, the Securities Industry Act of 1983, the Securities Commission Act of 1993, the Futures Industry Act of 1993, the Banking and Financial Institutions Act (BAFIA) of 1989, the Malaysian Code on Takeovers and Mergers of 1987, KLSE Guidelines on Stock Exchange Listing, and the Foreign Investment Committee (FIC) guidelines. Malaysia’s accounting standards are also good and are generally much stronger than those in the region with many international accounting standards having been adopted by the Malaysian Accounting Standards Board. On balance, Malaysia does well in terms of legal protection of external financiers of corporations (Table IV.6).

Table IV.6.Malaysia: Selected Countries: Legal Protection of External Financiers
CountryShareholder

Protection 1/
Creditor

Protection 1/
Degree of

Judicial

Enforcement 2/
Accounting

Standards 3/
Malaysia347.776
Japan329.465
Korea236.776
Thailand335.964
Latin America 4/2.516.253
United States519.571
United Kingdom449.478
Germany149.462
Source: La Porta et al (1998).

Scale of 1 to 5, with 5 being the strongest and 1 being the weakest.

Scale of 1 to 10, with 10 being the highest and 1 the lowest.

A higher number represents higher standards.

Average of Argentina, Brazil, Chile, and Mexico.

Source: La Porta et al (1998).

Scale of 1 to 5, with 5 being the strongest and 1 being the weakest.

Scale of 1 to 10, with 10 being the highest and 1 the lowest.

A higher number represents higher standards.

Average of Argentina, Brazil, Chile, and Mexico.

22. Prior to the crisis, the two main avenues for dealing with corporate distress were:

  • Winding up under the Companies Act of 1965, under which creditors can petition the high courts to wind up a company which fails to pay its debts. The Act provides for the appointment of a liquidator or a receiver, establishes the priority and ranking of debt within different creditor classes, and generally provides a comprehensive basis for winding up.15
  • Restructuring of companies as going concerns under Section 176 of the Companies Act. The debtor can petition for court protection under Section 176 until a group of creditors, representing three-fourths of the outstanding debt, agree to a reorganization plan. Once approved, the agreement is binding on all creditors. Pending the approval of the arrangement, the court may restrain any winding-up proceedings against the debtor company.

23. However, many problems existed with the enforcement of the laws, including the autonomy of regulators, transparency in exercising regulation and confusion over jurisdictional boundaries, which may have contributed to the buildup in vulnerabilities, although it is difficult to establish this link precisely. For example, while the general legal framework governing takeovers and mergers in Malaysia is comprehensive, a potential weakness in its implementation arises from the role of the FIC, a regulatory body set up to guard against unregulated takeovers resulting in concentration of wealth in minority hands and increased imbalances in ownership. In practice, the FIC has broad powers to approve or disapprove mergers and takeovers depending on whether it deems the proposal to be in the national interest. Thus far, there has neither been a clear definition of the criteria that would define being in the national interest nor has there been much scope for appeal or review of the decisions of the FIC. The weaknesses in the Section 176 avenue of corporate distress resolution is that there are no detailed provisions for the rehabilitation of troubled companies through judicial management such as the appointment of independent managers to design a rehabilitation plan and the suspension of claims against a company pending rehabilitation. In addition, there have been recent instances of misuse of protection under Section 176 in which debtors have sought protection without presenting a reorganization plan. Recently, the authorities have made good progress in strengthening corporate governance and the debt-resolution frameworks (see Section E).

D. Impact of Crisis on the Corporate Sector

24. The effects of the financial crisis on the corporate sector can be seen in the following interrelated indicators (Chart IV.2):

  • The sharp decline in the exchange rate which, at the lowest point in January 1998, had fallen by some 49 percent since July 1997.
  • The very rapid decline in the stock market, which had already begun in early 1997, but accelerated after the regional crisis broke; in the first six months of 1997, the stock price index fell by 13 percent, but by August 1998, the lowest point since the crisis, the stock market had fallen by close to 80 percent since the beginning of 1997.
  • Massive short-term and portfolio capital outflows: from a net inflow of $2 billion in 1996, net short-term outflows amounted to a total of $13 billion in 1997 and 1998, and another $7 billion expected to flow out in 1999.
  • An increase in sovereign bond spreads from about 200 basis points in 1997 to a peak of 1,000 basis points before declining to around 300 basis points at present.
  • An increase in domestic interest rates from 7½ percent in June 1997 to a peak of about 11 percent during the period February to July 1998.
  • A collapse in demand, both from external and domestic sources: export volume growth fell from almost 11 percent in 1997 to below 3 percent in 1998 and real domestic demand, which grew by 7 percent in 1997 declined by a massive 26 percent in 1998.
  • A decline in the total value of property transactions of 48 percent and in the value per transaction of 23 percent.
  • Domestic credit, which had grown by close to 30 percent on average between 1995 and 1997, declined by 1½ percent in 1998.
  • A sharp increase in nonperforming loans (NPLs) of the financial system from below 4 percent at end-1996 to 21 percent at end-1998 with an expected peak of 25 percent in 1999. The increase in NPLs is concentrated in the broad property sectors, financial services and manufacturing sectors.
  • Growing corporate sector distress measured by the very sharp decline in earnings before interest and taxes (EBIT) and by the number of corporations that have filed for court protection under Section 176, applied for debt workouts under the Corporate Debt Restructuring Committee (CDRC) or have been taken over by Danaharta.
  • For the 40 largest listed companies, the growth of average EBIT fell to 5 percent in 1997 from 35 percent in 1996. In 1998, average EBIT of the 23 companies for which data are available declined by nearly 100 percent. Of these, some 40 percent generated negative EBIT.
  • By mid-1998, close to 1,000 winding-up petitions had been filed by creditors under the Companies Act.
  • Following the imposition of the requirement by the KLSE for listed companies to immediately report defaults on debt-service obligations, some 28 listed companies had filed such reports by end-1998.
  • The number of corporations that have been downgraded by RAM rose sharply from 40 in early 1998 to 52 in the third quarter before subsiding sharply in the fourth quarter of 1998 and the first quarter of 1999.
  • As of end-March 1999, 40 public-listed companies had applied for protection under Section 176, of which more than one-half are involved in the property, construction, and finance sectors.
  • As of May 25, 1999, some 57 companies with debts totaling RM 31.2 billion had applied for debt workouts under the CDRC. Of these, more than 60 percent were diversified holding companies and construction and property development companies.
  • As of end-March 1999, Danaharta had appointed special administrators in ten companies, of which seven were stock-broking firms.

CHART IV.2Malaysia: Indicators of Corporate Sector Distress, 1997-99

Sources: Data provided by the Malaysian authorities; and Fund staff estimates.

1/ Includes loans sold to Danaharta.

25. How were the proximate effects of the crisis transmitted to the corporate sector, and then to the economy at large, and how large is the potential distress? There are no simple summary measures of the impact of the financial crisis on the cash flows or the stock of wealth in the economy. Three different ways of measuring the impact of the shock are discussed below.

  • Table IV.7 presents some economy-wide measures of the impact of the exchange rate depreciation, interest rate increases, and stock market declines on total wealth or net worth and on cash flows. Note that this measure does not account for the collapse in external demand and other transmission channels of the effects of the crisis.
  • The World Bank (1998) provides a measure of the direct impact of the shocks on the corporate sector. The exchange rate shock is approximated as the increase in the domestic currency value of foreign debt resulting from the change in the exchange rate from the first half of 1997 to the first half of 1998. The interest rate shock is approximated by the increase in lending rates in the first few months of 1998 over the same period in 1997. These shocks were then applied to the end-1996 balance sheets of all nonfinancially listed firms in Malaysia and the impact on profitability (return on assets) is calculated. For the median firm, in Malaysia, this calculation suggests that profitability would have declined by 40 percent (but remained positive) and the share of firms with losses greater than equity would have been almost 20 percent.16
  • Another analysis—conducted by Goldman Sachs (1998)—is based on projecting NPLs for the banking system using a “bottom-up” approach. Based on financial statements from 607 listed companies in Malaysia for 1997 and some interim results for 1998, this exercise projects financial results for each company for 1998 and 1999.17 Earnings before interest, taxes, depreciation, and amortization (EBITDA) are calculated and compared to projected interest expenses. If EBITDA is less than interest expenses, the company’s debts are classified as becoming nonperforming. The analysis suggests peak NPL ratios for Malaysia of the order of 20–25 percent.18 The analysis then goes on to examine whether the NPLs are likely to be “structural,” defined as when companies will not generate positive EBITDA, or “temporary,” defined as when EBITDA is positive but less than interest expenses. The results suggest that about one-half to three-fourths of all NPLs may be structural. The implications of these results are (i) that foreclosures and/or operational restructuring are likely to be needed for many of the borrowers in addition to financial restructuring; (ii) the ultimate recovery rates are likely to be quite low; and (iii) unless growth and earnings pick up, financial restructuring is likely to have limited success, because many companies may continue to make operating losses.
Table IV.7.Malaysia: Assessing the Damage of the Financial Crisis
A. Wealth shock due to stock market decline
Market capitalization at end-1996RM 807 billion or 323 percent of GDP
Market capitalization at end-1998RM 375 billion or 135 percent of GDP
Loss in wealth approximated by loss
In market capitalizationRM 432 billion or 155 percent of GDP
B. Total effect on borrowers’ cash flow of interest
Rate increases and exchange rate depreciations
Outstanding variable rate loans to the private sector And NFPEs at end-1997RM 370 billion or 134 percent of GDP
Impact of 1 percentage point increase in interest rates on Interest paymentsRM 3.7 billion
Peak increase in average lending rates from end-19973.5 percent
Total impact on cash flows of increases in interest ratesRM 13 billion or 5 percent of GDP
Outstanding external debt at end-1997
Impact of a 10 percentage point depreciation of the ringgit 1/
• On net wealth2.8 percent of GDP
• On cash flows1 percent of GDP
Peak depreciation of the ringgit50 percent
Impact of peak exchange rate depreciation on
• Net wealth14 percent of GDP
• Cash flows5 percent of GDP
Total impact on cash flows of interest rate increases
And exchange rate depreciation at peak interest and exchange rates10 percent of GDP
Total impact on net wealth of stock market losses
And external debt at peak exchange rates and lowest stock market capitalization169 percent of GDP
Sources: Data provided by the Malaysian authorities; and Fund staff estimates.

Assumes amortization rates on medium- and long-term debt equal to the average of actual amortization in 1995–96; assumes 50 percent amortization each year of short-term debt. On hedging of medium- and long-term debt, the calculation assumes the proportion of unhedged debt to be 100 percent, 50 percent, and 25 percent for the federal government, NFPEs, and the private sector, respectively. As for short-term debt, 50 percent is assumed to be unhedged.

Sources: Data provided by the Malaysian authorities; and Fund staff estimates.

Assumes amortization rates on medium- and long-term debt equal to the average of actual amortization in 1995–96; assumes 50 percent amortization each year of short-term debt. On hedging of medium- and long-term debt, the calculation assumes the proportion of unhedged debt to be 100 percent, 50 percent, and 25 percent for the federal government, NFPEs, and the private sector, respectively. As for short-term debt, 50 percent is assumed to be unhedged.

E. Measures to Deal with the Crisis

26. By most measures, the impact on the corporate sector and the economy at large of the financial crisis has been considerable. The authorities recognized, by mid-1998, the need to reorient macroeconomic policies towards stimulating a recovery in growth and that comprehensive structural reforms were necessary to restructure the corporate and financial sectors. To this end, fiscal policy was eased in July 1998, followed by reductions in interest rates in August. The pegging of the exchange rate combined with controls on capital outflows in September 1998, provided the scope for further reductions in interest rates.19 At the same time, a concerted effort was made to restructure the financial and corporate sectors through the establishment of Danaharta, an asset management company, Danamodal, a special purpose vehicle to recapitalize banks, and the CDRC modeled after the London Approach.20 In addition, the authorities have implemented several reforms to improve corporate governance and to strengthen regulations over banking and other financial institutions.

Corporate sector restructuring

27. Key provisions of Section 176 were tightened with a view to preventing its misuse by companies as means of delaying adjustment. Amendments made to Section 176 of the Companies Act in September 1998 require: (i) borrowers to pay RM 5,000 for filing a petition for protection from creditors; (ii) 50 percent of creditors, measured by the value of their debt, must already have agreed to a proposed restructuring plan and therefore have agreed to the filing of the petition; (iii) an independent director, approved by 50 percent of creditors measured by the value of their debt, must have been appointed; and (iv) restraining orders are initially granted for three months; failure to reach agreement within this period will require another filing which satisfies all the new, tighter requirements.

28. The second forum for corporate restructuring is available through Danaharta’s special administrator (SA) functions. The legislative framework is provided in the Danaharta Act which was passed in September 1998, and confers two special powers. First, the ability to buy assets through statutory vesting, which enables Danaharta to acquire assets with certainty of title while preserving existing registered interests over the asset. Second, the ability to appoint special administrators to manage the affairs of distressed companies. If a corporate borrower is unable to pay its debts or fulfill its obligations, Danaharta may choose to appoint an SA. The specific steps involved are:

  • Danaharta obtains approval to appoint an SA from an Oversight Committee (comprising one representative each from the Ministry of Finance, Bank Negara Malaysia (BNM), and the Securities Commission).
  • Once appointed, the SA takes over the control and management of the assets and affairs of the company. To preserve those assets until the SA is able to finish its job, a 12-month moratorium automatically takes effect during which no action can be taken against the borrower.
  • The workout proposal prepared by the SA is then given to an independent advisor approved by the Oversight Committee (usually a merchant bank or an accounting firm). The independent advisor’s mandate is to review the proposal taking into consideration the interests of secured and unsecured creditors and shareholders.
  • The proposal and the independent advisor’s evaluation are presented to Danaharta for approval.
  • Once approved, the SA will call a meeting of secured creditors to vote on the proposal. A majority in value of secured creditors at the meeting must approve the proposal.
  • Once approved, the relevant regulatory approvals need to be obtained before the proposal can be implemented.

Box IV.2 contains an outline of the first workout proposal completed through the SA process in March 1999 and Box IV.3 outlines the principles governing loan restructuring and the guidelines to apply these principles. The guidelines are intended to promote transparency and expedite the formulation of workout proposals.

29. For restructuring the larger loans (over RM 50 million), the CDRC was set up. The main rationale for setting up this alternative framework was that the insolvency legislation does not provide the range of solutions required to preserve value to stakeholders in a multi-lender and large debt situation. The CDRC was set up to provide the impetus to informal workouts between financial institutions and borrowers through compromise and consensus to expedite the restructuring of corporate debts. The CDRC has a close working relationship with Danaharta which can, by virtue of having taken over NPLs, be one of the creditors in a workout proposal under the auspices of the CDRC. Key features of the CDRC are based on the London Approach and is described in detail in Box IV.3.

30. The progress to date with corporate debt restructuring is shown in Table IV.8. The six cases that have been completed represent less than 1 percent of the total debt to be restructured under the CDRC. They include cases in which debt-restructuring proposals have been accepted by creditors and cases where restructuring has been taken over by Danaharta under its special administrator powers. Of the completed cases, two are diversified holding companies, two are in property and construction, and two are in finance and services. Of the outstanding cases, close to 50 percent are diversified holding companies and another 20 percent are in property and construction. The rest are in the manufacturing and finance sectors. In recognition of the need to expedite the restructuring process, the CDRC has recently announced that it expects to complete restructuring of RM 30 billion (about 60 percent of total debt and more than 10 percent of GDP) by mid-1999 and to complete its function by mid-2000. Measures to accomplish this include a shift in the responsibility for hiring consultants from creditors to the CDRC and expansion of CDRC staff especially those with more experience in corporate restructuring.

Table IV.8.Progress with Corporate Debt Restructuring
Status

(as of May 31, 1999)
Number of

Companies
Amount of Debt

(RM billion)
Percent of Debt
Viability study being conducted94.614.7
Awaiting restructuring proposal149.229.5
Awaiting revised restructuring proposal93.410.9
Awaiting creditor’s decision79.931.7
Completed/Sold To Danaharta92.47.4
Total5731.2100.0
Source: Data provided by the Malaysian authorities.
Source: Data provided by the Malaysian authorities.

Box IV.1.Restructuring CapitalCorp Securities An Example of the Application of Danaharta’s Special Administrator (SA) Functions

CapitalCorp is a stock-broking company which, prior to Danaharta’s involvement, had been under a Section 176 restraining order for almost one year, after having being suspended from undertaking securities trading activities by the KLSE. For an exposure of RM 30 million, Danaharta was able to facilitate resolution of about RM 220 million in nonperforming loans. It appointed an SA in January 1999. The SA went in and took over the control and management of CapitalCorp. A diagnostic review was then conducted, including of all creditors and their relative positions, a review of the viability of the business (with stringent sensitivity analysis), an analysis of the factors that gave rise to the current situation, and an identification of the areas of strength and weakness.

The main features of the workout proposal are as follows:

1. Secured creditors are to be paid in full in cash over time. Their rights to the security are preserved but as they are paid down, the security value to which they have claim will decline.

2. Unsecured creditors will be repaid in full in cash by way of a combination of redeemable convertible and nonconvertible preference shares. A part of the loan repayment (50 cents on the dollar) will be settled y shares that are redeemable at the end of five years with a coupon rate of 5 percent. Another 15 cents on the dollar will be repaid in year seven and the remaining 35 cents will be nonredeemable preference shares with the value dependent on the recovery of the company’s bad debts. Creditors get to share in any recovery during the first five years.

3. Group companies and shareholders are required to inject cash and assets, accept waivers of intercompany debts, convert existing intercompany debt into preference shares, and accept a write-down of the value of existing shares.

CapitalCorp has been returned to its original shareholders who were also the “white knights.” The value of their original shareholding was written down to 20 cents on the dollar and they injected new capital in the amount of RM 250 million for common stock. The management team is currently being strengthened.

At the moment, the proposal has received approval from the Foreign Investment Committee and is awaiting approvals from the Securities Commission and the Kuala Lumpur Stock Exchange. The proposal has been held up as exemplary and will become the model for other workout proposals under the SA function of Danaharta.

Box IV.2.Danaharta’s Loan Restructuring Principles and Guidelines

Loan management strategies will be applied to loans found viable after careful evaluation.

Loan restructuring exercises are to strictly adhere to the following principles:

  • The original shareholders must take a proportionately bigger haircut than creditors.
  • Settlements to secured creditors must be more favorable than those to unsecured creditors.
  • The workout schemes should not result in a dilution of the security of the lenders, unless collateral is in excess of the outstanding loans.
  • Danaharta will give the borrower only one opportunity in implementing the scheme so as to prevent borrowers from making revisions once the scheme is being implemented.
  • Viable borrowers will be given the time and opportunity to make good their obligations, but their performance and their efforts to repay lenders will be closely monitored.
  • The use of funds under a workout scheme should be clearly identified and strictly adhered to; the scheme should involve equity kickers such as warrants, convertible loans, etc.
  • The repayment period for the restructured loans should not exceed five years.
  • Any value realized in excess of the book value of assets (written down as part of the scheme) should be subject to a sharing ratio between the borrower and the lender.
  • The schemes will include an anti-dilution clause to prevent existing shareholders to dilute eventual shareholdings of creditors through issuance of new shares.
  • The scheme should include covenants for intercompany lending, transfer of assets, dividend payments, and future borrowing.
  • All individual borrowers must make a statutory declaration of their net worth.
  • Legal proceedings are to be taken against the borrower should the scheme fail. Consent should be obtained from borrowers before the commencement of the scheme to allow Danaharta to apply all available avenues for recovery in the event the workout scheme fails.
  • Disposal of personal assets will only be allowed to settle outstanding debt.

Box IV.3.Malaysia: The Corporate Debt Restructuring Committee (CDRC)

A. Objectives

  • To minimize losses to creditors and shareholders through coordinated workouts.
  • To avoid placing viable companies into liquidation or receivership, thereby preserving jobs and productive capacity.
  • To provide an approach for banking institutions to play a greater role in the financial rehabilitation of the corporate sector.

B. Key elements of the approach

  • The CDRC does not have any legal status. It is meant to be completely voluntary and flexible To the extent that there are no “rules,” only “general principles.”
  • The approach enables creditors and debtors to reach well-informed decisions about whether, and on what terms, a company having cash flow difficulty will continue receiving support.
  • The CDRC approach does not guarantee survival of businesses. There will be no “steer” from the authorities on which companies should survive.

C. Principles of debt restructuring under the CDRC

  • Debt restructuring should be for viable businesses and not those in receivership or liquidation, with total aggregate bank loans of RM 50 million or more, from at least three institutions.
  • Companies that have obtained a restraining order on creditors under Section 176 of the Companies Act, may also apply on the condition that the restraining order is withdrawn when the standstill period (see below) is agreed upon.
  • Decisions should be made on complete and accurate information shared between creditors and debtors.
  • Creditors are to agree on a “standstill” period of 60 days (extendable) so that orderly decisions can be made. Moreover, existing credit lines must be kept open.
  • The creditors committee should represent the interests of at least 75 percent of total debt of all creditors.
  • A lead institution must be appointed early in the process to actively manage and coordinate it.
  • Creditors’ existing rights to collateral will continue.
  • New credit during the restructuring process will have seniority.
  • Debt trading is allowed, provided that it does not have a detrimental effect on the restructuring process.
  • Debtors will normally assume all costs involved in restructuring, but creditors must endeavor to control costs.
  • Debt-restructuring losses should be shared amongst creditors in the spirit of “shared pain.”

D. Operational modalities

  • A joint public-private sector steering committee is to be set up to facilitate meetings of the affected parties and to monitor the progress of all debt restructuring.
  • The steering committee is appointed by Bank Negara Malaysia (BNM), and a full-time secretariat to assist the steering committee has been set up in BNM.
  • The role of the creditors’ committees will be to assess and agree on the viability of the debtor on the basis of accurate and complete information; decide on the terms for the debtor to continue to receive financial support; and report progress to the steering committee.

Corporate governance reforms

31. Successful governance systems need to have some mechanism whereby shareholders can coalesce to have their preferences imposed on management, or can protect their rights and have legal recourse, if necessary. Typically in emerging market economies, market and regulatory institutions that can play an important role in good governance tend to be underdeveloped or subject to subversion. Foreign banks play only a limited role in funding corporations and tend to work with only the best corporate clients and the size of foreign institutional investors, albeit growing, is still not very large.

32. In recognition of the need to enhance standards of corporate governance in Malaysia, in early 1998, the authorities established a High-Level Finance Committee to establish a framework for corporate governance. The Committee’s report has developed the Malaysian Code on Corporate Governance which sets out principles and best practices for good governance; makes recommendations to strengthen the overall regulatory framework for listed companies; training and education of corporate participants in Malaysia to prepare them for the implementation of the recommendations. The recommendations cover duties, obligations, rights, and liabilities of directors, officers, and controlling shareholders, as well as various measures to protect the rights and financial stakes of minority shareholders. In addition, the SC and the KLSE have already introduced several measures aimed at reducing abuses, manipulation and, more generally, stock market volatility unrelated to fundamentals. The key measures are listed in Box IV.4.

Box IV.4.Key Recent Corporate Governance Reforms

Governance reforms fall into three main categories: those that enhance transparency and overall corporate governance, those aimed specifically at minority shareholders, and regulatory measures to reduce volatility in the stock market.

Transparency and overall governance

  • September 1998: All dealings in KLSE-listed stocks will have to disclose the person on whose behalf the trading is being conducted. All new and existing nominee accounts will have to reveal the names of beneficiaries, and all dealings in KLSE-listed securities is to be effected only through the KLSE.
  • October 1998: New guidelines issued for share buybacks and transfers of securities. Share buyback guidelines have the effect of regulating the purchase by a listed company of its own shares. For share transfers, securities accounts can now only be opened in the name of the beneficial owner or an authorized nominee of the deposited securities, making the system more transparent.
  • March 1999: Quarterly reporting of financial statements by public limited companies (PLCs) was introduced, with reports to be filed within two months from the end of the financial quarter. Reports must include the balance sheet, the income statement, and explanatory notes. By keeping the market informed of financial position, market discipline can be brought to bear on the actions of the company.
  • March 1999: Restrictions were placed on the number of directorships to enhance corporate governance so as to enhance the quality of corporate governance practiced by directors of PLCs. Each director of a PLC can hold no more than ten directorships in PLCs and no more than fifteen in companies other than PLCs.

Strengthening the position of minority shareholders

  • July 1998: The rules on related and interested party transactions were revised to widen the definition of related and interested parties, to require all such transactions to be announced and approved by shareholders, etc.
  • January 1999: Enhanced disclosure by PLCs on matters related to takeovers and mergers. The standards set will result in improving the clarity, consistency, and timeliness of disclosed information and would thus protect minority shareholders.
  • Mid-2000: (i) Amendments to the related party transaction provisions of the Companies Act which include restrictions on a significant shareholder’s right to vote in transactions in which he has an interest, higher penalties for breach of this provision, and requiring prior approval of shareholders in respect of such transactions; (ii) amendments to the Companies Act to enhance the timeliness and quality of information that goes out to shareholders before a general meeting. These include amendments to increase the notice period for annual general meetings from 14 to 21 days and to allow proxy representation by mail. The latter provision is aimed mainly at foreign institutional investors; (iii) increasing and simplifying the ability of shareholders to take court action against errant directors which include the introduction of a statutory derivative action, simplifying procedures for a class action, allowing shareholders or a regulatory body to seek injunctions to prevent breaches of the company law, allowing shareholders access to company records for purposes of a court action, etc.; and (iv) organizing the setting up of a minority shareholder watchdog group. The Employees Provident Fund, as one of the largest domestic institutional shareholder is tasked with coordinating the establishment of this group. Technical assistance from the World Bank or the Asian Development Bank will be requested for this undertaking. This move is aimed at increasing shareholder activism, increasing adherence to corporate governance standards, and minimizing abuses by insiders against minority shareholders.

Regulatory improvements

  • January 1998: Tighter restrictions were imposed on stock-broking companies in terms of their gearing (or leverage) ratios, margin financing exposure to a single client and to a single security, as well as total trading exposures.
  • December 1998: New risk-based capital adequacy requirements were imposed on stock-broking companies
  • April 1999: Listing requirements for PLCs listed on the Main Board and the Second Board have been enhanced. Requirements for share listing, reverse takeovers, and the fixing of warrant exercise prices have been revised. Construction, trading, and retailing companies can only be listed on the main board Minimum share capital has been raised for listing on both boards, and track record requirements have been made more stringent, including for companies seeking a back-door listing or a reverse takeover, where a private firm acquires control of a listed entity by paying cash or injecting assets. Because most warrants that are currently traded are “out of the money,” PLCs can issue and list new warrants to replace existing ones, with exercise prices of the new warrants being based on market prices of existing warrants or at a discount.

33. The authorities have also announced several regulatory reforms to reduce the scope for the reemergence of the vulnerabilities that were exposed during the crisis. The key reforms are:

  • The discontinuation of the two-tier regulatory system for banks as of March 31, 1999. Incentives that were previously accorded to Tier 1 institutions will now be made available to all institutions. In addition, banks will no longer be permitted to open new branches without proof of financial and personnel resources.
  • The increase in the frequency of on-site inspections to at least once a year, and the examinations are to be conducted on a consolidated basis.
  • The announcement of plans to develop a system of prompt corrective actions that will be triggered by transparent prudential indicators so that emerging problems can be handled in a timely manner.
  • The announcement of plans to impose different minimum risk-weighted capital ratios on individual banks, taking into account loan concentration, sectoral exposures, and internal controls, to disallow lending to controlling shareholders, to improve credit risk management, and to review directors and CEOs of banks on a periodic basis to ensure that they remain fit and proper.
  • The announcement of plans to minimize systemic risk by distancing unsupervised entities from banking institutions, restricting financial exposure between the supervised and the unsupervised entities and requiring that future bank recapitalization by shareholders be funded through retained profits, equity issues, or long-term bonds, rather than short-term debt.
  • The announcement of plans to issue guidelines that would facilitate asset securitization and debt restructuring, including through allowing corporations undergoing debt restructuring to issue bonds rated below investment grade to convert existing loans to bonds.

F. Conclusions and Policy Recommendations

34. Overall, the Malaysian authorities are making progress with tackling the various measures needed to facilitate corporate sector recovery and to strengthen the sector. Corporate debt restructuring is under way, and regulatory reforms and reforms of corporate governance are being planned and, in some instances, are already being implemented.

35. In addition to expediting the planned reforms and announcing clear timetables for their implementation, the focus of attention now needs to turn to operational and asset restructuring, including asset sales and other cost-cutting and efficiency-raising measures. In particular, the CDRC process needs to be substantially strengthened, as it will ultimately be responsible for the resolution of a substantial share of total system NPLs.

  • While the structure of the CDRC process takes into account the need for “shared pain” between borrower and lender, care should be taken, in practice, to ensure that the process does not unduly favor borrowers at the expense of creditors. Moreover, since cases handled through this process represent many of Malaysia’s largest and most important corporations, it is important that the CDRC be seen as going the extra distance to ensure a proper balance between the interests of lenders and borrowers.
  • More importantly, the outcomes of the CDRC process will ultimately tend to have an influence on Danaharta’s effectiveness. Although not all Danaharta loans are eligible for the CDRC process, to the extent that there is a perception that borrowers are better off with the CDRC, Danaharta’s effectiveness could be undermined. Therefore, the treatment of all parties under the CDRC must be viewed to be as equitable as under Danaharta.
  • While being mindful that each workout will need to be designed on a case-by-case basis, it is necessary to put more structure to the CDRC process. Clearer guidelines need to be issued for restructuring proposals under the CDRC—the Danaharta loan restructuring guidelines provide a good example for this—so as to set out ground rules that are known in advance by all parties and impart greater transparency and objectivity to the process. In particular, the due-diligence process needs to be of the highest quality with clear sensitivity tests to business projections, assessment of management and business projections, specification of contingency plans, and clear operational restructuring, including asset sales, business reorganization, and other cost-cutting measures. For example, a criticism that has been leveled against the Renong workout proposal is that the cash-flow projections for the subsidiary that is floating the loan to repay Renong’s debts, may be adversely affected by the terms of the workout. This has caused concern among the subsidiary’s creditors about its viability. Therefore, there should be strict scrutiny of viability and rigorous adherence to corporate governance principles so as to reduce the likelihood that problems will resurface.

36. Experience with strengthening the corporate sector suggests that an important step is getting the state out of the financial system and increasing competition in the financial system. For this reason, while recognizing that it is still early in the process of restructuring, it is imperative that Danaharta and Danamodal exercise their “exit” options the earliest possible.

  • In particular, there is the concern that the increased focus on speeding up purchases of NPLs by Danaharta may weaken the implementation of the strong procedures to conduct due-diligence and thus make ultimate asset disposal or management more problematic. Thus, Danaharta could, unintentionally, become an NPL warehouse ultimately resulting in a heavy fiscal “overhang.” For this reason, it is imperative that Danaharta retain only those assets to which it is able to add value. In cases where such value addition cannot be achieved, the assets should be liquidated either through outright sale of the loans or through the sale of collateral soon after foreclosure. Asset sales will also serve the important purpose of establishing reference prices for investors, which is a necessary step in the broader recovery process.
  • As for Danamodal, consideration could be given to relaxing the limits on foreign bank participation when the time comes for Danamodal to exercise its exit options, Malaysia’s banking system has had a significant presence of foreign banks for the past four decades and this has served Malaysia well in terms of generating competition for domestic banks and enhancing the efficiency of the banking sector overall. Permitting greater foreign bank presence in the country can therefore be a beneficial move, both in terms of further increasing competition and quality of banking services, and bringing in new capital into the industry. Recent announcements that foreign banks will be allowed to open more branches if they take over finance companies and their liabilities is a step in the right direction.

37. Finally, the overdependence on short-term borrowing and on the equity market reflects the relatively small size of the market for long-term private debt securities. Thus, measures need to be expedited to develop and deepen the markets for private debt securities, including through the promotion of asset-backed securities and strengthened regulation of these markets. To this end, BNM has strengthened its commitment to developing the ringgit bond market by announcing plans to introduce shelf registration for private debt securities, deepen the repo market, and facilitate greater asset securitization. Other measures to facilitate the development of long-term capital markets include a gradual relaxation of the investment restrictions on the EPF (which has a legal requirement to invest a significant proportion of its funds in government securities); greater reliance on public offer of bonds rather than the more prevalent private placement system so as to increase the depth and breadth of this market; the latter would require strengthening disclosure requirements, and accounting and auditing standards; and improving the skills of institutional portfolio managers to equip them to deal with a wider array of investment choices.

1

This chapter was prepared by Kalpana Kochhar (ext. 38770) who is available to answer questions.

2

This paper does not, however, undertake a comparative review of Malaysia’s corporate capital structure relative to other countries.

3

Under the new guidelines, foreign investors can hold 100 percent of equity irrespective of the level of exports. This will apply to all manufacturing projects, except those where domestic small- and medium-scale enterprises have the expertise. As long as the project retains its original features, there will be no need to restructure its equity after 2000.

5

Some important earlier privatizations were that of Malaysian Airlines System and Malaysian International Shipping Corporation in the late 1980s.

6

Pyramiding is defined by Berle and Means (1932) as “owning a majority of the stock of one company which in turn holds a majority of the stock of another—a process that can be repeated a number of times.”

7

Only Indonesia had a higher proportion of family-controlled firms than Malaysia when the calculations were done without weighting for size.

8

When adjusted for size, the proportion of family-controlled firms is the highest in Hong Kong and Indonesia, while Malaysia falls close to the Philippines, Singapore, and Taiwan Province of China. However, state ownership is the highest in Singapore (40 percent) and Malaysia (35 percent).

9

See Claessens, Djankov, Fan, and Lang (1999a).

10

The following discussion draws heavily on Abendroth (1997).

11

It is, however, difficult to provide benchmarks or international norms for an acceptable or desirable capital structure. Existing theories of firms’ financing decisions do not fully explain observed capital structures and, indeed, an extreme version of the theory, put forward by Modigliani and Muller, is that the capital structure is irrelevant and the value of the firm depends only on the cash flows that it generates.

12

See Lin (1994) and Callen and Reynolds (1997) for a more detailed analysis.

13

See SM/98/79, Malaysia: Staff Report for the 1998 Article IV Consultation, Annex II for a detailed analysis of Malaysia’s external liabilities.

15

More details can be found in SM/98/81, Malaysia: Selected Issues (4/5/98).

16

This study was conducted for the five Asian crisis countries. The results suggest that the effect of the crisis on the Malaysian corporate sector would be much less adverse than in all the other countries. The exercise showed that the 1996 return on assets would have turned negative in Indonesia, Korea, and Thailand and, albeit remaining positive in the Philippines, would have declined by 65 percent. Also, Malaysia would have had the lowest share of firms with losses exceeding equity, with the Philippines coming up second with about 30 percent, and Indonesia topping the list with close to 80 percent of firms with losses greater than equity.

17

The analysis, conducted in September 1998, assumes a decline in GDP of 6 percent, followed by a further small decline in 1999; a fall in interest rates of 220 basis points in 1998 and 1999; flat sales in 1998 followed by 1 percent sales growth in 1999; declines in operating profit margins; and unchanged corporate debt levels through 1999.

18

These results are similar to those derived from aging or trend analysis using bank-by-bank data on NPLs.

19

A detailed description of the evolution of macroeconomic policies is contained in the Recent Economic Developments paper.

20

Detailed descriptions of the operations of Danaharta and Danamodal are contained in Chapter III.

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ANNEX IV.1 Malaysia: Investment and Ownership Regulations

A. Guidelines Governing Foreign Ownership

Type of InvestmentForeign Ownership1
Export-oriented companies
Exports of 80 percent or more of output.Up to 100 percent.
Exports of 51 percent to 79 percent of output.Up to 79 percent depending on location, level of technology, size of investment, value-added, and local input content.
Exports of 20 percent to 50 percent of output.Between 30 percent and 51 percent depending on the factors mentioned above.
Exports of less than 20 percent.Up to 30 percent.
High-technology producers
Companies producing high-tech or other priority products for the domestic market (as determined by the government from time to time) and Multimedia Super-Corridor status companies.Up to 100 percent.
Resource-extraction activities
Companies involved in mining and processing of mineral ores.Up to 100 percent depending on level of investment, technology, degree of integration, and value-added.
Insurance companies
Insurance companies already incorporated in Malaysia.51 percent.
New entrants (who must buy into local companies, because no new licenses are to be given).30 percent.
Financial institutions
All financial institutions (other than insurance companies).30 percent.
Other
Telecommunications firms.61 percent.2
Shipping agencies.70 percent.
Forwarding agencies.49 percent.

B. Domestic Ownership

(In cases where foreign equity ownership is less than 100 percent)

Type of InvestmentBumiputra OwnershipNonbumiputra Ownership
Projects initiated by foreigners where no local partners have been identified
70 percent or more is held by foreigners.Balance reserved.None.
Less than 70 percent is held by foreigners.30 percent reserved.Balance available.
Projects initiated by bumiputras as joint ventures with foreigners
70 percent or more is held by foreigners.Balance reserved.None.
Less than 70 percent is held by foreigners.Balance reserved, unless bumiputras cannot take up the entire amount.None, unless bumiputra investors cannot be found.
Projects initiated by nonbumiputras as joint-ventures with foreigners
70 percent or more is held by foreigners.None.Balance reserved.
Less than 70 percent held by foreigners.Balance reserved, unless bumiputra investors cannot take it up or when special permission is granted by Ministry of International Trade and Industry(MITI).30 percent reserved, unless special permission is granted by MITI.
Nonbumiputra-owned domestic companies
For publicly listed companies.30 percent reserved.Balance.
For unlisted companies.No reservation.No restriction.
Bumiputra-owned domestic companiesNo restrictions.No reservation.
1

For new manufacturing projects, restrictions have been substantially relaxed (see paragraph 6).

2

Foreign equity should be reduced to 49 percent after five years.

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