Sunday, 10 July 2011

The regulator's role in the ENRC Fiasco

Back from holiday and catching up. One of the first things I saw was an excellent article in the FT by John Plender. Unfortunately, it is behind their paywall, but the FT allows you to sign up at no cost to access a limited number of articles.

To recap, ENRC, a Kazakhstan mining company  listed just over 18% of its shares in 2007 and promptly joined the FTSE 100 index. This means that UK index funds have to hold its shares.  Plender points out that when it was allowed derogation from normal listing rules demanding 25% of shares be floated this was
"Far from being unique this was symptomatic of the pre-crisis “light touch” regulatory approach that was designed to enhance London’s position as an international financial centre." 
A number of similar mining companies listed at that time, all with a small number of wealthy controlling shareholders and with a history of related party transactions. How did the London Stock Exchange and the Financial Services Authority deal with these additional risks? Plender writes...
"To address these risks the LSE and the FSA, which acts as the listing authority in the UK, have put their faith in relationship agreements with controlling shareholders and in independent non-executives. These directors have often been highly experienced business people, but most have had little knowledge of mining. Their fees tend to be well above average, which does little to reinforce their independence. Against that background the ENRC fiasco demonstrates, among other things, that the UK approach to governance is not designed for a system in which controlling shareholders call the shots. It is structured to address the problems of dispersed ownership."
Whilst well expressed, this is too kind. The LSE was desperate for the business and bent its rules while the FSA was just asleep on the job, unless they were a lapdog for the LSE, which is scarcely less demeaning.

One of the key points of good corporate governance is that the rules and regulations need to be policed by regulators. I would go further and say that the regulators need also to apply judgement. The FSA surely has a duty to protect investors and that should have included wondering about the level of governance risk attached to these mining companies. Old City practices were opaque and decisions were often made by unaccountable individuals in smoke filled rooms. Nonetheless, I think that in the past these companies would not have been allowed to list in London without stronger safeguards for investors.

Plender finishes by saying

"The low standard of governance among foreign owned mining companies is not just a potential threat to investors. If valuations in the wider stock market become tainted by a governance discount as a result, the cost of capital to UK companies will rise. ENRC should never have been allowed in and nor, in my view, should the others. But since they are here, pension fund trustees who run indexed portfolios should consider asking their managers to exclude these companies from the index."
 Which is true but insufficient. The government really needs to get a grip on the FSA.

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