Addressing push factors for capital market development

This article first appeared in Capital, The Edge Malaysia Weekly, on September 27, 2021 - October 03, 2021.
Addressing push factors for capital market development
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THE third Capital Market Masterplan (CMP3) unveiled by the Securities Commission Malaysia (SC) last Tuesday highlights the importance of strategic thrusts that focus on catalysing competitive growth, empowering investors for a better future and shaping a stakeholder economy, while embedding shared accountability, prioritising efficiency and outcomes, and embracing technology.

Although not new, here are three main issues that are worth highlighting so that a thriving capital market can be established in the next five years.

Funding for various segments

The SC says it will make mid-tier companies (MTCs) one of its key development focus areas in the coming years, and hopes to offer financing options that will enable them to accelerate growth, including potential expansion into other business verticals or overseas markets.

Former central banker Andrew Sheng acknowledges that MTCs suffer from a funding issue because they do not have the scale and understanding of markets and their technology is not on a par with the giants or multinational corporations (MNCs). “The pandemic has revealed serious issues in terms of funding for enterprises, whether big or small. Capital market funding is really for larger companies, since there are only 41,000 listings in the world, when there are hundreds of millions of small and medium enterprises (SMEs), more if micro firms are included,” he tells The Edge.

Traditional bankers have not invested enough in their clients, he points out, preferring to work through conventional lending plus collateral. At most, they either do debt restructuring or encourage mergers and acquisitions.

“This is where the universal banks can play a major role. You can no longer just sit back and wait for the customer to do everything, otherwise your non-performing loans (NPLs) will rise. Thus, banks must also gear up on understanding customers and how to work with them,” says Sheng.

This can be done through at least two approaches, he suggests. “First, MTCs really need help in terms of strategic positioning and assessing whether they have a viable strategy and business model going forward. If they don’t get their act together, no amount of extra financing or fiscal subsidy will help.

“Second, assuming that you separate the good from the non-viable, how should the finance industry help? Helping the real sector deleverage and also invest in the future is the way to go. We need to move to Islamic finance [risk sharing], rather than risk transfer.

“A bank is actually a ‘fund of funds’, with a lot of data that they don’t use, and expect customers to come to them. The fintech platforms now show that data is more valuable than collateral. So, when you know your customer and his industry well, your NPLs will not only be lower, but your return on equity will be higher with a debt/equity restructuring. That is the true benefit of universal banking, in which banks can take an equity stake in their clients. Flexible business needs flexible financing platforms, including equity funds.”

He suggests that Bank Negara Malaysia and the SC encourage banks to form clusters of sukuk “fund of funds” to help MTCs turn around, sort out those that will not survive due to integrity and competence issues, and then help “champion candidates” move to the next level. “In other words, the financial institutions, especially asset managers and investment houses, will need to beef up their analytical and business upgrading/restructuring capabilities.”

The Institute for Capital Market Research Malaysia chairman Tan Sri Dr Munir Majid opines that high-growth, high-potential MTCs no longer just need pure financial capital but “smart” capital.

“The recent Covid-19 pandemic has clearly distinguished the winners from the losers, with digitalisation and agility being the key differentiating factor. Thus, these MTCs would need financing options that include advisory and business development services and support to expand their network/products beyond the limited domestic market,” he says.

“Such financing options will need to encompass greater ancillary services in relation to accounting, hedging options against currency fluctuations, credit rating assessment and a platform to test and launch products quickly, among others. These are the examples of existing services available in the market, but the challenge is that these services are currently found scattered everywhere.”

Munir observes that some global private equity players do not just provide capital to their investee companies, but also advisory services in relation to mergers and acquisitions, credit facilities, continuous valuation and liquidity through follow-on financing series from other institutional investors.

“As such, the market needs a unitised financing platform that could offer all of these services to MTCs easily, an increase in numbers and diversity of private capital providers [for example, private equity and venture debt] to broaden the types of long-term risk financing and patient capital available to MTCs.”

For micro, small and medium enterprises (MSMEs), he says more measures need to be taken for the micro-establishment sector to ensure better financial inclusion.

“First, the government or policymakers can explore a way to ‘institutionalise’ the MSMEs similar to the FELDA scheme, which effectively lifted people out of poverty and allowed smaller businesses to leverage based on economies of scale and further grow their business. This form of ‘cooperative’ movement model can further leverage technological advancements to create a ‘digital platform cooperative’, which can connect independent producers to consumers in various industries such as agriculture, halal or food distribution, or financial services, which are mutually owned by the members.

“Second, there should be more Islamic financing options for MSMEs. Malaysia is already well positioned to accelerate the transformative potential of Islamic finance through digital technologies such as blockchain. This needs to be further explored, where innovative and efficient use of technology, such as smart contracts on blockchain, could further address the key challenges seen, such as the lack of availability of data and poor historical records. An example of this is the Finterra WAQF Chain platform, which combines blockchain technologies with wakaf and crowdfunding.

“Third, the public sector could support MSMEs through bridging the early-stage commercialisation process via public procurement, providing support through revenue commercialisation for MSMEs or start-ups that need to establish a track record before expanding beyond the domestic market.”

In the CMP3, the SC indicates that it may explore establishing a framework for angel funds and angel syndication lists for early-stage financing. Given the high risks involved in early-stage financing, the presence of a credible cornerstone or lead investor that is willing to put up the initial share of capital in early-stage deals would increase the confidence of other investors to also put in funds. This, in turn, would increase the likelihood of success in fundraising.

Dr Yeah Kim Leng, professor of economics at Sunway University, sees further room to expand the financing sources of both mature companies and start-ups.

“It is even more difficult for start-ups because they don’t have a track record. You need to identify new capital-raising platforms for them. Start-ups usually go through the two traditional major routes — venture capital and private equity. We need to boost their presence in Malaysia in terms of capacity and funding sources.”

While digital financing looks more exciting via peer-to-peer financing and equity crowdfunding, Yeah is of the view that these have to be well regulated to prevent any disruptions to the capital market. “A regulatory framework is needed to allow these platforms to flourish in Malaysia and offer funding opportunities to local companies. It is very critical when you talk about the digital economy to have financial inclusion to reach out to more potential companies and entrepreneurs.

“Also, we should not neglect further improving or upgrading our conventional financing sources, which include the stock market as well as the venture capital and private equity industries. If these areas can be expanded, then it will be a big push for the capital market.”

Similarly, for the bond market, Yeah sees there is still an “unmet” area to cater for higher risk profile companies, such as those with “BBB” or “BB” ratings. “We need to focus on that to reach more potential candidates in order to expand the financing sources, as typically companies receive much less than what they need,” he says.

On Malaysia’s plans to create multiple unicorns, Yeah highlights that the government has to provide a conducive environment for them with supporting factors such as co-financing and co-investment. This will contribute to the country’s GDP.

Bigger role for intermediaries

As the private market grows, there is potential for a much larger pipeline of late-stage growth companies that may seek to tap into the public market. To better enable Malaysia’s profile of late-stage growth companies, the SC says there is a need to gradually expand the pool of recognised principal advisers to include a variety of firms such as smaller advisory firms, specialised legal firms and, in the longer term, foreign-based principal advisers.

In view of intermediaries playing a very important role in identifying opportunities for the capital market, Yeah calls on the government to make it an important key performance indicator. “By increasing the number of advisers, perhaps it can bring our companies to the next level. We need to have a new vision and capitalise on the new technology.”

Currently, principal advisers mainly consist of investment banks.

Very often, there are not many “bankable projects” in the eyes of venture capital and private equity firms, says Yeah.

“Over 98% of Malaysian companies are SMEs. Thus, we need advisers to identify and take them to a new level. This is something we are lacking now.”

He points out that there is also a need to “corporatise” family-run businesses to further realise their potential. The barriers to such a move include a sense of complacency, lack of ambition, and management capability.

Another aspect that could be relooked is the business investment landscape, according to Yeah. “We need to see the value creation part. Some of the restrictions may not be that conducive to scale up business opportunities, which are expected to emerge post-pandemic because of the potential of technology to increase efficiency and productivity as well sustainable values in line with the ESG (environmental, social and governance) goals and aspirations.”

MIDF Amanah Investment Bank Bhd research head Imran Yassin Yusof highlights that Malaysia has many good companies with the potential of being listed. An expansion of a pool of registered principal advisers will help create a more vibrant stock market, he says.

Also, a streamlined listing process may lead to faster turnaround time, which augurs well for the capital market.

To enable greater listing efficiency moving forward, companies listing on the ACE Market will see a more streamlined regulatory framework. The SC says efforts are already underway to migrate the ACE Market regulatory framework, including registration of prospectuses, to Bursa Malaysia.

Imran is of the view that a good early-stage investment ecosystem is crucial to prepare for the future development of the stock market. “While it is not directly linked to the stock market, if you have that, angel investors would be willing to put money into these companies, and that could be a pipeline for future listings.”

Sheng notes that the whole ecosystem can be built with a greater variety of advisers as well as private equity and venture capital-type catalysts. “That is far more difficult than it looks, but more regulatory flexibility is very encouraging for innovation to thrive. At the same time, you have to crack down on fraud and scams,” he adds.

Investor activism

Amid the push for a more resilient capital market, one should not ignore the role of investor activism and advocacy — powerful tools that can help shape the accountability landscape.

Minority Shareholders Watch Group CEO Devanesan Evanson says, as the success of a company is very often in the board oversight, it is encouraging to note that there are plans to limit the tenure of independent directors to 12 years.

“For independent directors whose tenures are between nine and 12 years, they should be subject to a two-tier voting under the Malaysian Code on Corporate Governance. This two-tier voting is powerful empowerment for minority shareholders as they have a say as to whether these independent directors should be re-elected. It would be a shame if minority shareholders do not exercise this powerful right to have a say in the long tenure of independent directors,” he opines.

Devanesan stresses that minority shareholders must realise that if they act in tandem with other minority shareholders, they can change the outcomes. “This ability to change outcomes is more evident when minority shareholders and institutional investors are on the same page. And this is often the case as they are both shareholders with common interests.

“The collective vote of minority shareholders can make a difference — even if they cannot defeat resolutions, they can be used to send a powerful message of their displeasure to the board.”

He highlights that investor education is a twin responsibility of both the regulators and investors. “Investors must invest in education to safeguard themselves. There is no dearth of avenues for such education, which range from training programmes to blogs, books and articles. The internet is a fertile ground on which to equip oneself with such information at no cost.”

Devanesan says there is no substitute for hybrid engagements in a post-pandemic world. There should be physical engagements as well as engaging remotely (virtually) with shareholders.

“The former allows better articulation of thoughts and questions while the latter permits remote participation. In lieu of hybrid sessions, companies can have both a physical and a virtual session separately — it need not necessarily be combined in one session if the logistics are tricky. The end game is not just to have the AGM (annual general meeting) as the sole engagement session with shareholders.”

 

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