Published April 30, 2009

Time to rein S-chips in - but don't stifle foreign listings

By R SIVANITHY

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THE woes afflicting China stocks listed here, or S-chips, are by now well known: accounting irregularities, missing cash, profit warnings, and the resultant going-concern doubts that have emerged. And they have led to the sector's spectacular collapse; on Tuesday, 34 out of the 51 S-chips that comprise the FT ST China Index (67 per cent) traded for below 20 cents, while 43 (84 per cent) traded for below 50 cents.

To make matters worse, there is an e-mail message circulating within the financial industry titled 'Confessions of an S-chip CEO' that describes in graphic detail how easy it was to cosmetically transform an ordinary, struggling China company with little profits and assets into a seemingly exciting entrepreneurial play with eye-catching earnings, and to offload shares in such a company to unsuspecting Singaporean investors via a listing on the Singapore Exchange (SGX).

BT pointed out over the weekend that it doesn't really matter who the CEO is or who the parties are that facilitated the scams; the more important point is that because there is some element of truth to the claims, it is necessary to learn the appropriate lessons and take the necessary precautions.

To those who are either in the industry or have tracked it closely, revelations of cooking the books and insiders working in cahoots with dealmakers, 'angel' investors, fund managers and analysts to basically hoodwink the public by presenting a misleading investment story (or, to quote from the e-mail, 'by making a fake company real') are probably not surprising because it has long been thought to happen.

How prevalent the crookedness is, of course, is open to debate and so the first and most important thing to note is that a few bad apples do not make the whole barrel of China or overseas- based companies bad.

Playing the blame game

Second, while it is tempting to point the finger at SGX and ask what it was doing to protect the public's interests when dubious China companies were getting listed, it is quite impossible to expect the Exchange to police all aspects of IPOs. It is actually the financial intermediary community that should shoulder a large part of the blame for the collapse of confidence in S-chips in the past year.

Furthermore, had SGX clamped down on S-chips via a tightening of its listing rules in 2004-2007 when the China growth theme gripped the world's imagination and stocks were racing up, it would have undoubtedly come under severe criticism from an investing public desperate to play the China theme at any cost.

So, yes, while regulators should shoulder some blame and, yes, while financial middlemen are culpable, the public was also partly responsible for rushing to buy heavily into a largely unknown and risky sector on the strength of hastily prepared IPO prospectuses (most probably even without reading those documents) and the accompanying shallow broking research.

As one observer put it: 'S-chips are no different from Malaysian speculators who used to trade on Clob International - investors knew they were suspect, speculative and risky but liked to play them because you could make quick money.'

Easy to look the other way

The truth is that, in a bull market, when there's plenty of money to be made, everyone prefers everyone else to look the other way, and it is only when things go awry because of a sudden, prolonged bear market that scams get uncovered and the finger-pointing begins.

Accountants, lawyers, auditors, analysts, fund managers, underwriters and the public all chose to look the other way (or to gloss over important omissions) and hoped SGX would not interfere too much during the S-chips' heyday because everyone was making money and there was no compelling reason for official intervention.

Does this mean SGX should now tighten its rules? Yes, but it has to be judicious in making any changes and not go so far overboard as to stifle the influx of foreign listings.

As an observer once correctly noted, 'it is a fact of life that all markets are subject to some form of funny business all the time - rigging, manipulation or whatever. If we clamp down too much, the business will simply be diverted elsewhere and we will lose out.'

Bearing this in mind and the need to be alive to the realities of the business world, the most important issue that the authorities will have to grapple with in the fallout of the sad S-chips episode is: how much regulation is enough without being too much?