Asialaw - Clarity for Corporate Counsel

Asia's regulatory structures are diverse, varying both in extent and development across the region (see box: Capital markets across Asia). Lawyers must work within a variety of frameworks and be concerned with the laws of multiple jurisdictions. Do these diverse structures provide a good foundation for innovative transactions?

JG: They're less defined. In some ways it can be more difficult, because if you're thinking about doing an innovative transaction in an Asian jurisdiction, sometimes there won't be regulations or rules in place to cover the newly-devised structure.

In addition, there is less certainty. For example, there may be rules and laws governing a specific type of transaction but there's no history of court cases so you don't know how a court's going to decide on an issue should it become litigious. A perfect example is derivatives in India. Derivatives have been sold for quite some time in India and people have now lost significant amounts of money and lawsuits have been filed all over the country. At the moment there is a significant amount of uncertainty as to how the courts are going to decide these cases.

PM: One general perspective on the regulators in Asia is that in some jurisdictions, where you don't have a history of litigation and an efficient way for investors to go to court, the regulators take the place of the private litigants. So, when things go wrong you are dealing with the government and the government has political needs to address. In many countries, there is very significant public interest in the securities markets ... and that can cause a regulator to take on a populist bent when things go wrong. There's always been a traditional view that the absence of litigation is a good thing for innovation - in general it probably is, but on the other hand a lack of clear regulatory guidance combined with an aggressive regulator can be a hindrance to innovation.

DB: We feel in the more developed Asian markets, the regulators are receptive to ideas, and you can engage in a confidential constructive dialogue with them. If you look at what Singapore has done in a number of areas, that's all been driven by the regulators seeing a niche and banks presenting ideas; I think the Securities and Futures Commission in Hong Kong is also very receptive and helpful.

DP: But even in some of the more developed jurisdictions, both the regulators and the courts can still be unpredictable, particularly where there are political sensitivities - that kind of protectionism is something that can deter foreign players who might otherwise introduce innovation in a market.

Although Asian regulators might seem receptive in many cases, do you as lawyers feel constrained by them in other situations or jurisdictions? And can regulatory pressure actually drive demand for innovation?

PM: At times the uncertainty of a regulatory regime can limit certain product offerings; however I don't get the sense that we're significantly constrained by regulatory restrictions in Asia. I think it's a fairly commercial market. Of course we also evaluate whether we think new products are suitable and appropriate for the relevant client sector in addition to the regulatory analysis. There are circumstances where regulation drives the market in certain directions such as access products.

SP: I think it's the sophistication of investors that drives innovation more than anything else. The reason why perhaps London and New York lead sometimes in the development of new products is not because of, in my view, the regulatory framework - it's the investor demand. It's traditionally been the case - and it may change - that US and European investors are a bit more sophisticated, more willing to understand complex derivatives and other products, and those tend to follow and end up [in Asia] perhaps, but that's not because of the regulatory framework limiting the development of those products here or putting up barriers to them, it's just the investor demand that drives a lot of the innovation.

PS: There's a lot of products I know [where] it's not [that] we can't get them done because of regulatory restraints, it's because sometimes we just don't feel that they're appropriate for our investor base.

AM: Innovation doesn't necessarily mean something that's completely new. For me a good definition of whether the product's innovative is, do I get a call from our guys in the London office saying: "So how did that particular feature work?" If it's new to them in Europe, then I think that would be a good example of something that's innovative.

Although regulatory restraints do not seem to play a large part in driving innovation and the development of products, how would you react if regulation was scaled back further?

PM: I think if there was one ask it would probably be to have explicit permission to offer the full range of derivative transactions that you would have in Europe or the US - and that varies widely by country.

DP: I'm sure we'd like to sell as many products as possible but I don't think we would change our business and all of a sudden be out selling everything and anything. You need to be conscious of the investor base and its capacity to understand the products.

Aside from the regulators, what are the issues that drive innovation? Asia has seen its fair share of destabilizing events over the past few years: September 11, Sars, regime changes, the sub-prime mortgage crisis ... But is the way deals are structured related simply to the market reaction at times like these, or is there more to it than that?

DB: I think it's driven by corporate objectives - speed, certainty, cost, and so on - what the investors are demanding and creativity of the capital market intermediaries within the regulatory framework. At this point in time the investors at the bargaining table have the upper hand as opposed to the issuers. To test out an innovative structure, banks will go to hedge funds and private equity funds and the long funds to ascertain where their appetite is.

PS: I strongly believe that necessity drives innovation; therefore, investor appetite is only part of the solution. The key is to look to the needs of the clients. After all, new products are devised to address the needs and concerns of the clients. Whether these products are successful depends on whether there is investor interest.

SP: If you look back to the period when the markets were coming out of Sars [in late 2003] - there had been a period where there wasn't a whole lot of capital markets activity, and when we came out of that there was a huge number of convertible bond offerings in Taiwan, in Korea, in India. Each one had a slightly different modification compared to the one that preceded it, and that sort of led us out of a fairly dark period in capital markets ... We're wondering whether or not you'll see a significant increase in the number of convertible bond issues towards the end of 2008, as the way we move towards a more solid equity market.

JG: One distinguishing aspect of the Asian market is the real focus on controlling shareholders retaining control. So, you spend more time in Asia structuring issues around shareholder control, and companies with a public float that would be lower as comparing to a US company or sometimes a European company. That's a unique feature. And that in turn drives certain structures, or certainly is a consideration as to the type of deals we might do. So families that own companies might be less likely to do private equity than a more later stage company elsewhere.

Authorities in the United States seem to be making efforts to encourage more Asian listings on the New York markets (see box: Regulators and courts move to make US markets more attractive). But, despite a possible resurgence of competition from the US after the relaxation of certain requirements and attempts to decrease the prevalence of class-action lawsuits, there are some areas in which Asia may have a natural advantage. The use of Islamic instruments is one ...

AM: That is going to be an interesting area, particularly in Hong Kong with the government's stated policy to promote Hong Kong as an Islamic finance hub ... together with the rumoured tightening up of Islamic structures by the Islamic scholars, that's probably going to drive innovation in a way that may make it more difficult to do these deals - moving away from fairly loose asset-based structures to something which is more closely related to the assets, and I guess closer to securitization.

DB: Other than Indonesia and Malaysia where the state is influential in driving some of the large corporates to raise money in the form of sukuk instruments [Islamic securities] which helps to develop the Islamic market, we have not seen the publicly listed Hong Kong or PRC corporate issuers issue sukuk instruments. This may change going forward if the pricing is attractive.

JG: I think that we will see an increasing number of deals using Islamic structures. There is obviously a very large investor base who require that an investment be Shariah-law compliant. If that's the structure that is required for a company to raise capital, those are the structures you will see.

It's clear that lawyers and in-house counsel need to take advantage of Asia's strengths, and be ready to come up with innovative ways to structure deals, whether this is inspired by market conditions, investor appetite, or client needs. What evidence of innovation are lawyers seeing at the moment?

AM: I think convertible bonds are a good example of where we've seen quite a steady trend of improvements and innovations. Certainly going back to before the crisis, Asian convertible bonds tend to be very tailored to specific jurisdictions. Taiwanese deals were formatted for specific Taiwanese problems; going back a bit further, there was a specific Thai format which dealt with specific Thai problems.

What I think we're seeing more recently is the Asian format first of all catching up with the trends in the European markets and really starting to be seen to become more of an international product than an Asian jurisdiction-specific product. I think now, and over the past year or two, we're in the position where the Asian convertible bond product is in some ways leading the international product.

SP: I think in a market like this is the time you're going to see innovation occur actually, because there's been a lot of Chinese companies going public over the past two years and a lot more are in the process but obviously the market isn't there to help them. If these are companies that are going public not just to go public but because they need the funds, we're going to need to find ways to help them get the funds until the market turns to where they can actually raise equity IPO financing.

JG: There's a lot of pre-IPO structuring going on right now, to help these companies meet short-term capital needs and I think if this continues for another four or five months, there probably will be a lot more of that kind of activity.

PM: The interesting dynamic is that innovation is not solely a product of a bank's creativity. Investors present their unique needs and, in the iterative process of negotiating a structure that satisfies the company's need for capital and flexibility, the result is innovation. In Asia there is less standardization of transactions and company structures, in particular for pre-IPO companies, and the result is a greater opportunity to end up with a structure that is different from the original expectations.

DP: One of the issues with innovation is that, although there's been a huge regional increase in expertise and resources within banks and law firms, many issuers or borrowers in the market aren't used to the level of fees associated with developing and executing innovative capital markets structures. They've traditionally been able to tap the bank market very cheaply ... That dampens the ability to do innovative deals in the region.