GOVERNANCE AND SUSTAINABLE INSTITUTION: A PERSONAL PERSPECTIVE
Remarks by Mr. S. Dhanabalan
Chairman, Temasek Holdings Pte. Ltd.
At the 6th Mizuho Global Seminar 2010 in Tokyo
17 May 2010
Mr Nobuhide Hayashi, Managing Executive Officer and Head of International Business Unit. Ladies and Gentlemen, good afternoon.
Introduction
1. Let me begin by thanking Mr Hayashi for inviting me to address the latest edition of the Mizuho Global Seminar.
2. As you have been told, I first attended a similar seminar organised by the then Industrial Bank Of Japan (Nippon Kogyou Ginko) which is now part of Mizuho when I was a young officer at the Economic Development Board of Singapore. It was back in 1968 which was before many of you were born. Soon after I came back from the seminar I was asked to be part of a team which set up the Development Bank of Singapore now known as DBS Bank. What I learned and observed during the IBJ seminar must have influenced and shaped my input of the formation of DBS Bank. It is indeed heartening to note that Mizuho has continued the proud tradition of engaging and interacting with institutions in the countries in which it operates, to share its perspective on Japan and its evolving role in the world.
3. When I attended the seminar in 1968, the world was a different place. Japan was the undisputed economic leader in Asia. Businesses from the U.S. were just starting to venture out into new markets both to sell their products and source their needs. Most developing countries did not welcome investment flows from developed countries as they feared domination by big foreign businesses and also because of the ideological battle that was going on between capitalism and communism in the larger world stage.
4. The world of tomorrow will be different. China and India are no longer closed economies and are instead engines of global growth, just as Japan was more than a generation ago. Today, while Japan remains the world’s second biggest economy and is home to some of the world’s most important private companies, it is evident that Japan will have to share that stage with others, particularly China, India and South Korea.
5. As you meet here today, we cannot forget that the global economy has just had a near-death experience. A year ago, we were staring at a deep, prolonged global recession. Some even went as far as to predict a depression on the scale witnessed only in the 1930s. The U.S. and U.K. had to step in to bail out their overleveraged banks. Virtually every major economy announced fiscal and monetary measures to save their economies.
6. While there is a global recovery underway it is a shaky recovery fuelled primarily by massive government infusion of funds into the financial system. Fundamentals are still weak and growth in the developed economies will remain anaemic for some time to come. Unemployment will remain high and the heavy borrowing by governments will influence the cost and the ability of companies to borrow. While there are international efforts underway to reform the global financial architecture, there is little certainty that there will be real reforms. Those who run the financial companies in the financial centre of the world will resist any attempt to make real changes to the way that they have conducted their business in the last two decades. Most lawmakers have little real understanding of the complexities of the financial system and how it has evolved into what it is today. And the few who do understand are under intense pressure from the lobbying power of the financial companies to not make real changes. There is therefore unlikely to be real changes and we can expect a repeat of the crisis in the medium term of 3 to 5 years.
7. Commentators have focused on a number of factors as the cause of the crisis: the availability of easy credit; the lack of oversight by regulators; greed; investor’s short term obsession with quarterly earnings regardless of sustainability, are all some of the causes. One key factor is the dysfunctional governance of the companies in the financial sector in the developed countries. Shareholders interest was glued on day to day stock prices, not on the fundamentals of the business. There was poor understanding of the composition of earnings, the risks involved, whether the profits are realised or only a reflection of market values at a point of time and whether the earnings can be sustained. Boards and management of financial companies naturally focused on what the shareholders seemed to think important.
8. Many of these failures and shortcomings can be traced to poor corporate governance in the companies in the financial sector. The present financial crisis has shown that what appeared to be top class companies had shockingly bad governance. It was all too prevalent that Boards were packed with friends of the CEO, or by a fraternity of fellow CEOs. CEOs allowed themselves to be intimidated by business heads who were involved in or gave the impression of being involved in complex businesses which the CEO or CFO did not fully understand. Boards did not question management lest they reveal their ignorance. But these companies were good at creating and projecting an image of themselves which was very different from the reality. Business ethics took a back seat and the principle of caveat emptor (let the buyer beware) was the cynical approach to dealing with investment counterparties. These companies had outstanding PR teams and brand strategists who managed to convince the world that they were well managed companies, which others would be well advised to emulate.
9. A proper governance framework is crucial to embed the values that are required for building a long term institution.
10. I want to take this opportunity to share with you how Temasek Holdings has gone about ensuring that the right values and principles are enshrined and applied in Temasek as a holding company and in the Temasek Linked Companies (which we call TLCs) which are companies in which Temasek has significant interests.
11. This framework that I will share is based on our experience in Singapore and my experience as Chairman of Temasek Holdings for the last 15 years. Temasek is a proud shareholder in many of Singapore’s most successful companies which are international in their operations with many deriving the major part of their revenues from outside Singapore. Thus by emphasizing good corporate governance in these entities we ensure good corporate practices in a significant part of the corporate world in Singapore.
12. I do not wish to suggest that Temasek and Singapore have in our possession a magic formula. We have taken decades to evolve to what we are today and we are not always getting everything right in what we do. We are still a work in progress. Most importantly, you must listen to what I have to say with the understanding that we are an institution which grew out of the Singapore environment and not all that we do may be relevant to your country or possible in other countries due to various factors.
Temasek’s Journey
13. Temasek Holdings is an investment company that seeks long-term sustainable risk-adjusted returns by investing in successful enterprises. This means that right now we seldom invest in start-up companies. Temasek is wholly owned by the Ministry of Finance. But what is critical to note about our ownership is that unlike many other state-owned companies– including those in the West –our business decisions are not directed by the government, and I will elaborate on this later.
14. To understand our journey, we have to go back to Singapore in the early days. When Singapore gained independence in 1965, the country’s per capita GDP was under US$400, unemployment was high and industrial infrastructure was bare minimal. Today’s per capita income was about US$40,000, a long way away from where we were in 1965. I think many developing countries today made the mistake of redistributing income, rather than focusing on creating it. The Government, as a matter of policy, put its full weight behind industrialization and economic development, and job creation was the top priority of the government, not redistribution of wealth. Through the Economic Development Board (EDB), the government shared the risk by taking minority shares in many ventures to attract local and foreign capital into manufacturing. When DBS Bank was established in 1968, the industrial loans that EDB had were transferred to DBS, and the Government took EDB’s equity holdings in these ventures into the Ministry of Finance and held it for a number of years. The Government also established new companies like Keppel Corporation as part of the reorganization of the old Singapore Harbour Board and Sembawang Shipyard which was established to take over the facilities left behind by the British when they decided to pull out their Naval Base from Singapore. The government also directly owned Singapore Airlines which evolved through a number of stages from the old Malayan Airways.
15. As Singapore rapidly industrialized, the Government decided that its role should also change and evolve. Instead of being a venture capitalist of sorts, it had to focus on the economy as a whole. In other words, the Government decided to separate its role as a policy maker, from its role as an owner of businesses.
16. And Temasek was an outcome of that decision. In 1974, Temasek Holdings Ltd was formed as a company under the Company Act to take over a mixed bag of these new investments and start-up companies, including Singapore Airlines and various shipyards which the government had established. Many became successful and were listed, and in that sense privatised, though Temasek did retain its share in many of these companies, in the 1980s. As part of the exercise to get out of managing businesses the government also corporatized public sector activities like telecommunications, power generation and transmission and port operations. These were all government entities formed under the law and later transferred to Temasek in the 1990s.
17. Here it is important to understand how Temasek is different from other state-owned investors, some of which are now termed sovereign wealth funds. While Temasek is owned by the Ministry of Finance, it is not a channel to invest foreign exchange reserves on behalf of the Singapore Government. It is not a fund manager of Government reserves. The Government is our shareholder and we in turn own the companies we invested in. We are not a fund manager.
18. Following an initial asset injection in 1974 of some S$350 million, the Government as a shareholder has from time to time made additional injections, for example, the Telecoms Authority of Singapore was injected into Temasek as assets. All in, the amount injected was about S$30 billion in assets and cash.
19. In fact, Temasek is not and has never been a conventional SWF. Singapore has no oil money, no natural resources. Temasek was formed simply to take a load off a Government which had other priorities and by forming Temasek, the government could be sure that there could be an independently focused, professionally managed and commercially disciplined approach to investments and managing businesses.
20. In the initial years the Board and management of Temasek comprised mostly civil servants on loan or civil servants who had retired. In the same way quite a few of the Boards and management of the TLCs were also staffed by civil servants. But the concept that the companies should be managed without interference from the political leaders or the policy makers was clearly established from the very start even though civil servants were Chairmen and Board members in quite a number of these companies. They were given responsibilities to run the companies. The Ministers or government could not interfere.
21. Having selected and appointed them the Government gave them full latitude to lead these companies. The Boards recruited the necessary management and ran the businesses by expanding and diversifying the business according to what was best for the company. So they bought and sold businesses all based on the decision of the management. Market forces and market opportunities shaped the activities of these companies and not the diktat of policy makers or politicians. This principle of running the businesses according to market imperatives and market opportunities has become even more pronounced as the Board and management of Temasek and the TLCs now comprise individuals who are recruited from the private sector. This does not mean that the government has given up its right as a shareholder. No, certainly not. As with any shareholder it requires periodic reports from the Board of Temasek on the financial performance of the company and information on the strategy to grow and improve Temasek’s performance going forward. But it does not get involved in the business decisions of the company which are left entirely to the Board and management of Temasek. This same philosophy of not interfering in the day-to-day operation is followed in Temasek’s interaction and relationship with the TLCs. As an example, when Singtel wants to buy the second largest telecoms company, they did not consult Temasek. When SIA bought billions of dollars of planes, we only read about this in the newspaper.
22. These factors – and not the benefits of the Government as our only shareholder– are largely behind our emergence as a respected international investment company with a portfolio valued at about S$172 billion or US$124 billion, as at July 2009. We have built this portfolio largely from our own resources.
23. Our shareholder return measuring changes in shareholder funds, including dividends paid and excluding new capital, is a healthy 16% p.a. over the past 36 years compounded annually. This performance reflects the healthy growth of our portfolio companies and the realized gains from our direct investment activities over the last 9-10 years.
24. Singapore and Asia account for nearly two-thirds of our portfolio, though we are now also investing in other regions such as Latin America and Africa. In the developed markets, we have exposure to Australia, Canada, U.S., U.K. and Japan. We have a diversified portfolio spanning a wide range of sectors such as financial services, transportation, resources, energy, technology, consumer goods and other industrial engineering companies.
Institutionalising Discipline
25. We have institutionalised discipline within the company. Temasek is a long-term investor. The annual 16% return we have earned and the S$172 billion or US$124 billion diversified portfolio we have built over the last 36 years is a result of keeping a long-term focus and a disciplined approach to investing. We remain obsessed about building our institution for the long term. A critical element is an owner mindset or culture in the board and management.
26. How do we nurture a ‘think-owner, act-owner’ mindset in the Board and the management?
27. It starts with our Board. While the Government is Temasek’s sole shareholder, it has no ex-officio representation on our Board. We have someone from the Ministry of Finance but he was asked to come in because of his expertise. Over the years, through careful selection, we have built a Board of respected business leaders from Singapore and abroad. Over time, the civil servants have been replaced by private sector veterans. These Directors have been tasked with guiding the evolution of Temasek and ensuring that the company remains focused on generating long-term sustainable returns.
28. I give you some examples of our Board and Directors – Mr Kwa Chong Seng, our Deputy Chairman, is the Chairman and Managing Director of ExxonMobile in Asia; Mr Goh Yew Lin, is Managing Director of GK Goh Securities; in 2008, Mr Marcus Wallenberg, the former President and CEO of Investor AB from Sweden and currently Chairman of Skandinaviska Enskilda Banken and many other leading Swedish companies, joined our Board.
29. Just as we place a great emphasis on the quality of our own Board, we encourage our TLCs to do the same. As part of our governance framework, we have encouraged and supported our portfolio companies to diversify their Boards and appoint Independent Directors independent of management. Indeed we have made it clear to companies in which we have significant interest that we will not support more than two members of the management on their Boards. We have also built up a data base of business leaders from all over the world with whom we have established contacts. We submit these names to the Boards of the TLCs for them to consider and invite to their Boards. For 90% of the cases, the Board and Nominating Committee will meet the candidates. Close to 25% of the directors of the TLCs are non-Singaporeans. In fact, one of my main jobs is to meet and assess these candidates. In a few cases, the management said that the candidates are not the kind that they want.
30. We have also shepherded the TLCs to separate the position of Chairman and CEO. All our companies have independent non-executive Chairman with a separate CEO. We hold the Boards of the TLCs accountable for the long-term performance of the companies.
31. The second aspect of building a long term institution is the quality of our people, including the very top management. Some 40% of the senior management of Temasek Holdings is non-Singaporean and these men and women come from all over the world, including Malaysia, the U.S., South Africa, India, Lebanon and Africa. Similarly our TLCs source talent from all over the world. We do not insist that the CEO has to be a Singaporean. Get the best man or woman to run the business.
32. The Board also has the responsibility for succession planning and evaluating the CEO. We believe it is crucial for any Board to continually review its CEO succession options.
33. To this end, we have put in place an annual CEO succession review in our Board. This provides the Board with a full view of its options for all contingencies. Our Board has been engaged annually to review potential successors for various time frames; from an immediate interim need, to longer horizons where we deliberately add promising individuals in their 30s for us to track or bring on board over time. We include our internal management as well as external candidates on our list, Singaporeans as well as non-Singaporeans, promising leaders from Temasek-linked companies and non-TLCs. We keep expanding our database so we can identify the right people for ourself and the TLCs. All the boards of our TLCs have similar succession plans.
34. Equally importantly, we make sure that there is alignment between the long-term objectives of Temasek and the compensation paid to our management. Long before the latest debate about executive compensation grabbed international headlines, we have been working on refining a system that nurtures an owner mindset in our management to focus on the long-term, and not the short-term.
35. Compensation philosophy and frameworks are complex subjects which can be emotional. There are no perfect solutions. The trade-off is how to weigh short-term competitive pressures from the market against the long-term goal we have set for ourselves in Temasek.
36. We lean heavily towards having a well-balanced compensation structure which would reinforce a one-team culture, and an incentive philosophy which puts the institution before self, emphasises long-term over short-term, and aligns employee interests with that of the shareholder.
37. Our compensation framework has two dimensions. One dimension is time. This covers short, medium and long-term pay-out horizons. The other dimension is the different levels of difficulty to earn out the incentives. One key principle is for our employees to share in the institution’s performance, both for positive and negative results. This is different from many institutions where employees share only on the positive but not the negative results. The performance of individual business units in particular sector or geography in Temasek determines only a very small part of compensation. The emphasis is on the total performance of the institution. We share gains and pains alongside our shareholder. This is in essence having an owner’s approach to our business and operations.
38. For senior management (we call them Senior Managing Directors and Managing Directors), the bulk of their incentives are deferred between three to 12 years. Some of these deferred components are subject to market risks, and they rise and fall with Temasek’s total shareholder returns. Another very significant component is subject to a “no-floor claw back” – in other words, these deferred components could potentially be totally wiped-out if Temasek delivers returns well below the cost of capital, as happened last year. This claw back feature is tied to the principle of rewarding only sustainable performance and applies from the CEO down to the lowest level. We are in the process of encouraging all the TLCs to adopt a similar system. Some of them are halfway there, but not all the way there like in Temasek.
Nurturing Accountability
39. Aside from attracting the best people and keeping compensation aligned, over the years we have also put in place a set of markers to instil discipline.
40. The first such marker is our engagement with our stakeholders not shareholders. In October of 2004, we published our first Temasek Review, which is our annual report. Under Singapore law, we were not required to submit annual reports as an exempt private company. Our core purpose, in particular the annual report, was not transparency per se, but to instil the discipline, the professionalism and the open willingness to be tested and measured by the market.
41. Such an annual review serves more than one purpose. It provides a public marker of our performance, whether good or bad. Today, the market is generally aware that we have had an annual return of about 16% a year since inception.
42. Our Temasek Review is also meant to introduce us to our friends and potential partners, as well as to our portfolio companies, and other interested parties or stakeholders in the market.
43. All TLCs, whether listed or unlisted (because they are wholly owned by Temasek), produce financial statements audited by international accounting firms. These reports are made widely available to the public together with an Annual Report which describe, among other aspects of the company, the governance, risk management and compensation principles and practices of the company.
44. The second marker was our decision in 2004 to seek a credit rating with both Standard & Poor’s and Moody’s. Based on full confidential disclosure, we were assigned AAA/Aaa ratings by the two ratings agencies.
45. These ratings have established a public marker of our financial position and credit risks. Our strategic actions and commercial choices are bounded by these clear bright tripwires and any move to shift our credit risk stance requires deep and deliberate debate within our Board and senior management.
46. The third public marker we set was raising funds from the international bond market as well as Singapore bond market. In 2005 we raised an international 10-year US$ bond. We have continued to tap both the U.S.-dollar and Singapore dollar- denominated bond markets and have raised almost S$8 billion, with bond maturities ranging from 10 to 30 years. We have a good yield curve.
47. The bond spreads are a real-time live indicator of our credit risks, much like the role of a singing canary in a coal mine. If a canary drops dead, you would know that there is poisonous gas. This was also a deliberate move to create a new group of sophisticated stakeholders for ourselves.
Conclusion
48. As I have shared, we have over the years put in a set of guiding principles and a set of markers to build a sustainable institution.
49. As we gear up for the next phase of our development, we will continue to focus on our core purpose of delivering sustainable long-term value. We continue to anticipate and explore opportunities, not just within Asia, but also in Latin America and elsewhere.
50. As an institution, we build not just for ourselves, but for our shared future with the wider community and also for our next generation, in Singapore, in Asia and around the world. We invest in many countries and we know that the future generations in these countries will benefit. This will guide us and the institution that we in Temasek are working to build in the years ahead.
51. Thank you.
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