RE-ENERGISING THE PRIVATE SECTOR (SRI 1), CREATING A COMPETITIVE DOMESTIC ECONOMY (SRI 3), ENHANCING THE SOURCES

OF GROWTH (SRI 7) & ENSURING SUSTAINABILITY OF GROWTH (SRI 8)

RE-ENGINEERING THE GOVERNMENTS ROLE IN BUSINESS1

I.

Introduction

Re-engineering the Governments role in business is one of the key policy measures to reenergise the private sector to drive economic growth under the NEM. Government-linked companies (GLCs) and their shareholders, the Government-linked Investment Companies (GLICs), constitute a significant part of the Malaysian economy. Listed GLCs account for more than 37% of total market capitalisation in Bursa Malaysia2 and contribute to 17% of fixed capital formation and 10% of GDP.3 If non-listed GLCs, such as Petronas, Felda, KTMB and State-level companies were included, their contribution to GDP would be substantially larger. The Governments presence in the national economy dated back to the pre-Independence period and peaked in the 1980s, when State-owned enterprises numbered more than 1100, out of which many were found to be persistently loss making.4 After the first oil shock, a major round of privatisation and corporatisation of these public enterprises was undertaken, but some of the privatised entities subsequently failed due to poor management and excess debt. In early 2004, under the leadership of the Putrajaya Committee on GLC High-Performance (PCG) and Khazanah Nasional Berhad, a major effort was initiated to improve the corporate governance of the listed GLCs in order to revive growth and performance in the domestic economy.5 Even with privatisation and active divestment, GLCs remain the main service providers in key strategic utilities and services, including electricity, telecommunications, postal services, airlines, airports, public transport, water and sewerage, banking and financial services. In the real sector, GLCs play a role in the automotive and semi-conductor sectors. More recently, GLCs are actively pushing forward the objective of gradual regionalisation of the Malaysian economy to align with globalisation of markets. The verdict on heavy Government intervention in businesses has been mixed. With investments in selected and strategic companies, Malaysia has managed to engineer economic diversification and industrialisation in new sectors not ventured into by the private sector due to heavy capital outlays and perceived low immediate returns. On the socio-economic front, Government
1

This paper is one of many papers prepared by Group A of the National Economic Advisory Council (NEAC) under the guidance of Tan Sri Andrew Sheng. The paper was reviewed by the NEAC and its recommendations summarised into NEM Concluding Part Report. 2 Securities Commission (SC) data as at 29 January 2010 3 Khazanah Nasional Berhad (Khazanah) data 4 Central Information Collection Unit (CICU) data from 1987 5 An overview of the PCG http://www.pcg.gov.my/about_us_overview.asp last accessed 1 July 2010

intervention in businesses helped to decrease identification of ethnic groups along occupational lines, enabled the creation of a large Malaysian middle class and trained a pool of Bumiputera CEOs, as well as contributing to a higher Bumiputera share of capital ownership (21.9% in 2008 from 2.4% in 1970)6. At the same time, increasing Government interests in business have created a growing conflict with its traditional roles as a regulator and provider of public goods. Regulatory impact is significant in determining economic efficiency and competitiveness. International surveys frequently cite regulatory shortcomings as negatively affecting Malaysias competitiveness ranking. Regulation has an overriding impact on the ability of Malaysian enterprises to innovate and deliver quality products and services to consumers along the supply chain. The conflict between GLCs roles as operator and regulator, as well as between social objectives and profit maximisation have a significant influence on the viability of the GLC supply chain, and ultimately on Malaysias ability to progress into becoming an advanced economy. Given their large size and significant impact on the economy, Government intervention through GLCs and the economic behaviour of GLCs can either be a major positive driver of economic growth or a negative drag due to impediments or breakdowns in the 1Malaysia supply chain. Examples of negative drag occur when listed GLCs make substantial losses that not only impact upon the stock market but also investor confidence. This Chapter provides a diagnosis of GLCs in the Malaysian economy and their impact on the 1Malaysia supply chain, and makes a series of recommendations for the transformation of the GLCs to play a major supporting role in achieving the goals of the NEM. These recommendations build on current initiatives by Khazanah to transform GLCs. These recommendations include: a privatisation model for GLCs which draw up major lessons from past experience; further measures to enhance performance of existing GLCs, and a more prudent oversight of GLCs, both at the financial and institutional levels (not covering the regulatory oversight at sector levels). It is also recognised that GLCs can play a catalytic role to achieve the goals of the NEM, as well as help build the Bumiputera Commercial Industrial Community (BCIC). However, this will require a re-engineering of the Governments role in business and a transformation of GLCs that can support these roles. These aspects of the recommendations have built on the Putrajaya Committee on GLC High Performance (PCG) GLC Transformation Programme and recent proposals presented by Khazanah and other GLCs during NEAC discussions with the Transformation Programme participants. II. GLCs Within the 1Malaysia Supply Chain

Most GLCs were incorporated as companies limited by shares or are legal corporations by legislation (public authority), thus imbuing them with separate legal identities from the Government. Entrenched within the domain of the private sector but with direct ownership ties to the Government (see Figure 1 below), GLCs were established to:
6

EPU data

provide key public services, especially utilities and infrastructure; catalyse economic transformation by investing in industries with low private sector participation with a view of lowering barriers to entry; maintain Government interest in strategic sectors; achieve redistributive socioeconomic goals, and; safeguard national wealth, while securing reasonable returns for the Government.

Figure 1: The GLC sub-sector within the 1Malaysia Supply Chain

However, direct Government participation in business is a blunt policy instrument. When not well managed and operating in contravention of the principles of sound public sector and corporate governance, GLCs can contribute to the breakdowns in the 1Malaysia supply chain. As GLCs hold controlling stakes in utilities and other services, their effective functioning to ensure competitive prices and efficiency of services is critical in influencing productivity and private sector output. GLC performance is critical to Malaysias competitiveness and the ultimate riskbearers of GLC failures are usually the taxpayers. The performance of listed GLCs is a critical determinant of foreign and domestic investor confidence and private investment decisions, because they are the largest channels through which the foreign sector invests in Malaysian equities. Foreign investors tend to shun stocks in GLCs where there is perceived to be political interference in governance and operations. Thus far, the Khazanah-led GLC Transformation Programme has shown progress in improving that perception, but overall GLC performance is still impeded due to the legacy of either excess capacity (e.g. motor industry), price controls on their services or the burdens of excess labour and uneconomical activities as a result of social objectives.
3

Moreover, as some GLCs also act as both operators and de facto industry regulators, there has emerged conflict of interests, which result in uncompetitive and flawed pricing structures for services, thus creating market distortions. Figure 1 above illustrates linkages in the 1Malaysia supply chain and breakdowns in the GLC supply chain at both the upstream and downstream levels. These breakdowns have affected competitiveness, and interfered with both the Governments and the private sector delivery systems, with repercussions on capital market development and the growth of the Bumiputera Business and Commercial Community (see Table 1 below). In some sectors, GLCs already play a role in connecting small-to-medium enterprises (SMEs) to the 1Malaysia supply chain through vendor development programmes. However, there are no clear directions for GLCs, and many are seen as competing with SMEs, rather than catalysing SME growth and supporting their integration into the global supply chain. An example where GLCs have not emerged to create new economic space is the agri-food business. Even though Malaysia is a major food and oilseeds producer, and GLCs and State and Federal agencies dominate ownership of agricultural land, Malaysia has not produced a single regional or global agri-food champion compared with the likes of CP Charoen and Union Foods in Thailand and Indofood in Indonesia. Agri-food is an example where a leading company with a global distribution channel can nurture a whole supply chain of SMEs and small farmers/producers that are able to access global markets through branding and high quality standards. Table 1: Impact of Breakdowns in the GLC Supply Chain Areas Breakdowns GLCs face multiple and conflicting objectives with no clear priority. Some GLC debt obligations are underwritten by the Government. Efficiency Perception of Government backing could result in better credit terms. Government ownership of major financial institutions could lead to nonarms-length transactions. Performance-based awards are nonexistent/ weakly enforced; hiring and
4

Impacts Performance evaluation and chain of accountability are complex; could inculcate management ineptitude. Induces moral hazard; privatises economic benefits and nationalizes risks. Distorts financing costs against private sector players, particularly start-ups. Gives rise to excessive risk-taking in credit provision. GLCs have difficulties retrenching unproductive employees, hence

firing rules are restrictive.

dampening overall wages.

Inefficient/uncompetitive industries are Consumers are penalized through supported via tariffs, monopoly higher prices and availability of a license, etc. limited range of output. GLCs are subject to political interference, preventing decisionmaking from being subjected to objective cost-benefit analyses. Corporate governance Absence of central monitoring understates size of GLC sector; performance is not scrutinized. Previous privatization exercises lacked transparency & were perceived to be based on patronage rather than merit. Dominant shareholding in GLCs by Capital Government investment agencies. market Share trading and ownership development concentrated among Governmentlinked institutions. Some decisions are opaque and are not necessarily in the best interests of all stakeholders (e.g. minority shareholders, the greater public). There is no accountability mechanism to ensure that Government funds are utilized efficiently. Not all GLCs were transferred to the most efficient operators; some failed and had to be re-nationalized. The patronage system favours the wellconnected & worsens income inequity. Results in an illiquid capital market with limited scope for private sector participation.

III.

Background and Diagnosis of GLCs in Malaysia7 (a) A brief history of GLCs and analysis of the GLC universe

Government direct participation in the economy started as a means to: Provide major utilities and infrastructure; Address development goals: long-term development required investment in a range of physical and human capabilities, hence, the Government intervened to set up institutions to provide goods and services which the private sector, for various reasons, was not able to do; and Apply social justice in terms of wealth redistribution and social restructuring that sustainable development requires. The public enterprise sector boomed in the 1970s into early 1980s as new entities were formed to act as conduits for the implementation of the New Economic Policy (NEP).
7

Details are available in Appendix 1

In 1985, the Central Information Collection Unit (CICU) was set up to track the performance of public enterprises. Housed within Permodalan Nasional Bhd (PNB), the unit collected a comprehensive set of performance data on more than 1000 State-owned enterprises under its purview. In 1986, the Government initiated a large-scale privatisation drive with the issuance of the Guidelines to Privatisation, followed by the release of the Privatisation Masterplan in 1991. While the policies aimed to increase private sector role in the economy, they invited much criticism as most of these privatisations turned out to be exercises in partial divestiture with the Government still holding significant equity stakes, leading to limited efficiency gains. Hence, despite the implementation of the Privatisation Masterplan, the Government, both at Federal and State levels, is still the dominant shareholder in many listed and unlisted companies. The CICU database on Government-owned enterprises initially provided some means of tracking the performance of these entities. However, CICU was decommissioned in the late 1990s, resulting in the cessation of comprehensive public enterprise monitoring and the absence of a comprehensive database on the whole universe of Government-owned enterprises. An NEAC compilation of entities with Government equity ownership resulted in a list of 445 entities which have a distinct legal entity, operate in commercial affairs (i.e. trade marketable goods and services), are controlled by the Federal or State Governments and are directly funded by the Government or expose the Government to contingent liabilities via capital, debt or income guarantees. The entities covered those managed by KWAP, EPF, LTAT, LTH, MKD, Kelantan, Penang, Perak, Sabah, Sarawak, Selangor, and Terengganu. Information on GLCs under PNB and Khazanah was retrieved from their websites. Figure 2: The GLC Universe

Figure 3: Distribution of GLC ownership

As shown in Table 2 below, eight of the biggest 20 companies listed on Bursa Malaysia are GLCs. In total, there are 53 listed GLCs which account for more than one-third of aggregate market capitalisation on Bursa. The profit performance of GLCs hence would have a huge impact on overall investor confidence and the general perception of Malaysian listed company performance.
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Moreover, GLCs account for more than 53% of both the listed Finance and Trading and Services sectors as well as over 28% of the listed Industrial Products sector. Although listed GLCs account for only 7.8% of the listed Plantation sector, the dominance of unlisted GLCs, including FELDA, FELCRA, the plantation arms of conglomerates such as Sime Darby and Boustead, and State-owned oil palm estates such as those owned by the Sabah Land Development Board, would be very large relative to private sector estates. Consequently, GLC presence in the infrastructure, manufacturing and agriculture sectors are preeminent in these supply chains, whereas GLC presence in the technology area is limited. Since services and technology, especially high-tech knowledge-based products and services are at the forefront of the high-value new economy, it could be argued that GLCs are not optimally positioned in the right industries to play their catalytic economic development roles. Table 2: Top 20 biggest companies on Bursa Malaysia as at 29 January 2010
Rank Company 1 Sime Darby Bhd 2 Malayan Banking Bhd 3 CIMB Group Holdings 4 Public Bank Bhd 5 Maxis Bhd 6 MISC Bhd 7 Tenaga Nasional Bhd 8 IOI Corporation Bhd 9 Axiata Group Bhd 10 Genting Bhd 11 Petronas Gas Bhd 12 PPB Group Bhd 13 Kuala Lumpur Kepong Bhd 14 DiGi.com Bhd GLC Market capitalisation (RM bn) 51.26 48.06 44.71 42.09 40.35 35.15 34.65 34.36 27.62 26.12 19.33 18.94 17.68 17.00

15 PLUS Expressways Bhd 16 Genting Malaysia Bhd 17 YTL Power International Bhd 18 AmBank Holdings Bhd 19 YTL Corporation Bhd 20 Hong Leong Bank Bhd

16.55 16.42 14.93 14.65 14.02 12.88

(Source: Bursa Malaysia)

Table 3: Sectoral presence of selected GLCs as at 29 January 2010

Sector Listed GLCs Market capitalisation (RM bn) 48.06 44.71 11.35 19.33 2.23 2.01 51.26 35.15 34.65 27.62 16.55 11.16 8.64 As a percentage of sector size (%) 22.40% 20.84% 5.30% 21.45% 2.47% 2.23% 13.42% 9.20% 9.07% 7.23% 4.33% 2.92% 2.26%

Malayan Banking Bhd Banking & CIMB Group Holdings Bhd finance RHB Capital Bhd Industrial products Petronas Gas Bhd Titan Chemicals Corp Bhd DRB Hicom Bhd Sime Darby Bhd MISC Bhd Tenaga Nasional Bhd Trading & services Axiata Group Bhd PLUS Expressways Bhd Telekom Malaysia Bhd Petronas Dagangan Bhd

(Source: Bursa Malaysia) Although GLCs under the PCG Transformation Programme8 recorded strong aggregate earnings of RM11.7 billion for FY2009, the picture loses its lustre once the analysis is expanded to the
8

An overview of the PCG http://www.pcg.gov.my/about_us_overview.asp last accessed 1 July 2010

entire spectrum of Government-controlled companies. NEAC-compiled data on 445 GLCs show that 79 of these companies recorded losses in their most recent financial year, while 31 have negative shareholders funds. These ailing firms are a cause for concern as the Government underwrites some GLC debts through formal guarantees and letters of support. As at 31 December 2008, Federal Government contingent liabilities stemming from GLC debt guarantees amounted to RM62.9 billion (or 11.9% of 2008 GDP). Furthermore, the 2008 Auditor-Generals Report also highlighted that the accumulated surpluses of the Government-owned companies reviewed would shrink dramatically should Petroliam Nasional Bhds FY2007 profit be excluded from the tabulation of 48 MKD companies (Petronas: RM76.9 billion vs. remaining 47 GLCs: RM0.23 billion). The contrast between the earnings trajectory of the Transformation Programme participants (commonly referred to as the G20) and the MKD companies could be partially explained by the fact that the G20 comprises of the biggest GLCs listed on Bursa Malaysia, while MKD companies have a greater public policy focus. (b) Lack of a standardised and comprehensive definition of GLCs There is general confusion on what constitutes a GLC. In the past, the common term has been State-owned enterprises (SOEs). Later, the common term used was Non-financial Public Enterprises (NFPEs), and in the more recent period, Government-linked companies (GLCs) and Government-linked investment companies (GLICs). For policy design and analysis as well as public accountability purposes, it is important that there is general agreement on the nomenclature as well as the definition of a Government-owned company. A GLC is broadly understood to be any commercially oriented company with Government ownership. However, in practice, defining GLCs requires some qualitative judgement as many firms, despite not being majority-owned by the State, are still under its de facto control or influence. Prevailing terminology on GLCs is sourced from two authorities, namely: the Putrajaya Committee on GLC Transformation (PCG) and Bank Negara Malaysia (BNM) (see Appendix 2). PCG dichotomises Government businesses into GLCs and Government-linked investment companies (GLICs). GLCs are defined as companies in which the Malaysian Government has a controlling stake, while GLICs are Federal Government-linked entities that invest in GLCs. BNM, on the other hand, deploys a quantitative set of criteria in defining Non-Financial Public Enterprises (NFPEs). NFPEs encompass Government-owned business entities involved in the sale of goods and commercial services or manufacturing activities, and: have at least 51% of their equity owned by the Government; record at least RM100 million in sales turnover, and; have a significant impact on the Malaysian economy. However, the PCG coverage does not capture the entire universe of Government-linked businesses, chiefly by not including companies owned by State Governments (see Figure 4). It is

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also unclear whether PNB and EPF ownership would constitute either public or Government ownership, as PNB ownership is classified as Bumiputera-held, whereas EPF ownership is not.

Figure 4: Universal set of Government-owned businesses

For the purposes of this paper, the term GLC refers to a company which: has a distinct legal entity operates in commercial affairs (i.e. trade marketable goods and services) can be controlled by the Federal or State Government (directly via shareholdings or indirectly via interposing holding companies) is directly funded by the Government or exposes it to contingent liabilities via capital, debt or income guarantees The term GLIC refers to any agency that either receives funding or guarantees from the Government and is directly designated to invest in GLCs on the Governments behalf. This includes the following entities covered under the PCG definition: Khazanah Nasional Berhad, Kumpulan Wang Persaraan (KWAP), Kumpulan Wang Simpanan Pekerja (EPF), Lembaga Tabung Angkatan Tentera (LTAT), Lembaga Tabung Haji (LTH), Minister of Finance Incorporated (MKD) and Permodalan Nasional Berhad (PNB). For the purpose of discussion, it is also expanded to include State Government-owned investment entities as well as new Federallevel agencies such as Ekuiti Nasional Bhd (Ekuinas) and 1Malaysia Development Bhd (1MDB). (c) Past Experiences in Privatisation of the GLCs In 1985, the Malaysian Government reversed its stance on State interventionism and set out to privatise public enterprises by releasing the Guidelines to Privatisation, followed by the Privatisation Masterplan in 1991. The official objectives of privatisation, as outlined in the 1984 Mid-term Review of the Fourth Malaysia Plan, were: To increase the role of the private sector in economic development; To reduce the burden on the Governments fiscal budget, and; To improve the productivity and efficiency of State enterprises.

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Since the inception of the policy, 474 projects and entities have been privatized, including Sistem Telekom Malaysia (STM, now Telekom Malaysia Berhad), Lembaga Letrik Negara (LLN, now Tenaga Nasional Berhad) and Klang Container Terminal (KCT). Capital expenditure savings from privatization were estimated to be RM123.2 billion, which helped to turn a public sector deficit of 21.8% of GNP in 1981 to a surplus of 6.5% of GDP by 1997, prior to the Asian financial crisis. However, efficiency gains from privatization have been limited due to several pitfalls in policy execution, some of which are: Many GLCs remained under de facto Government control, despite having part of their equity divested to private investors; The first-come-first-served approach to private sector-initiated privatisation was perceived as opaque and potentially biased towards well-connected promoters; Privatisation was not accompanied by greater competition, thus effectively converting public monopolists into private monopolists; Sweeteners to encourage employees to migrate to the privatised entities (e.g.: job security, minimum wage requirements) restricted the entities ability to right-size its workforce; Initial public offerings were underpriced, resulting in forgone Government income and encouraging stagging (the practice of buying and selling shares to make quick profits); Privatisation of successful companies reduced the potential to cross-subsidise unprofitable but socially important business lines. (d) Roles of Khazanah in GLC management Khazanah Nasional Berhad, the Governments strategic investment arm, was incorporated in 1993. Having received a significant number of equity stakes in companies via transfers from other Government-linked institutional investors, Khazanah initially acted as a passive holding company before the scope of its mandate was greatly expanded in 2004. It was repositioned as an active investor and strategic value creator, with the objectives of nation building and developing national competitiveness. The key thrusts of Khazanahs re-modeled mandate include four strategic pillars, namely: 1. Streamlining, repairing and restructuring its legacy investment portfolio; 2. Transforming GLCs to increase strategic and shareholder value; 3. Investing in new strategic sectors and geographies, and; 4. Engaging in active human capital development for the nation. Khazanahs foray into new strategic sectors are funded not only by the RM1 billion plus annual income generated by its investments but also through gradual divestments of its equity stakes which are recycled into new acquisitions. The drive to transform GLCs into regional champions gained impetus with the launch of the GLC Transformation Programme in 2004 under the auspices of the PCG. As the secretariat to the Programme, the Transformation Management Office (TMO) housed in Khazanah coordinates the various efficiency-driving initiatives and publishes regular progress updates on the participating GLCs (G20) for public scrutiny. At the time of writing, there is no plan on the horizon to include
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either more GLCs into the G20 or new Government-linked investors such as Ekuinas and 1Malaysia Development Bhd under the purview of the PCG. (d) GLC recommendations in NEM Part 1 and the 10th Malaysia Plan The 10th Malaysia Plan (10MP) has adopted the NEM Part 1 recommendations in principle although few details were outlined. Of interest is the proposal to fund Ekuinas to acquire, amongst others, non-core assets of GLCs. Further study is required to determine the congruence of this proposal within the broader strategy of reducing Government participation in business. Figure 5: Overlaps and divergences between NEM & 10th Malaysia Plan recommendations

IV. Policy Review and Recommendations As we progress towards the NEM, it is important to leverage on the role of GLCs to catalyse the development of high value-added economic activities to achieve high income, while also assisting in the growth of BCIC as the prime mover for Bumiputera to become more active participants and contributors to the economy. In this regard, a comprehensive policy on the governance of GLCs is required. PCG has made significant strides in its Transformation Programme, but emphasis currently is placed only on listed GLCs. A comprehensive policy must build upon the favourable PCG experience and expand its scope to cover all GLCs. The policy governing GLCs would also require clear demarcation of GLCs roles in the NEM and the role of Government. To become a high-income, inclusive and sustainable nation, it is imperative for Government involvement in business activities to be clearly defined. The Governments overarching role must shift from being a direct participant in business towards focussing primarily on its role as a regulator and facilitator. Achievement of socioeconomic goals such as the development of SMEs and the Bumiputera Entrepreneurial Community (BEC)

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must be done by nurturing a business ecosystem where optimal distribution of the economic cake could be achieved endogenously without the Government micro-managing the allocation. To move forward, in implementing a comprehensive and holistic policy on the role of the GLCs in the NEM, recommendations are categorised into 4 components: A. An oversight mechanism for GLCs B. A model for the Government to divest non-strategic companies and re-engineer the roles of remaining GLCs by improving governance and adopting the service competition model C. Creation of a Fund from divestment proceeds to finance GLCs catalytic role to grow new private sector activities D. A re-engineered role for GLC in the economy one that supports and does not compete with the private sector. This holistic 4-pronged GLC policy framework comprises both defensive and offensive strategies as well as an over-arching policy framework governing GLC activities, supported by a monitoring mechanism to ensure GLCs remain focussed in order to achieve the new objectives which are aligned to support the NEM goals.

Figure 6: Strategies to re-engineer the roles of the Government and GLCs

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The 4-pronged approach aims to achieve the following policy objectives: Increase efficiency in resource allocation and elevate competitive positions of both Government and private sector companies; Reduce the Governments level of business ownership to enable it to focus on its facilitative and regulatory roles; Improve public sector governance by separating regulatory and participatory functions; Improve private sector confidence and trust in the public sector to build new private sector dynamism in the Malaysian economy; Enhance the Governments fiscal position by reducing contingent liabilities. A. An oversight mechanism for GLCs Following the decommissioning of the CICU in 2001, there has not been a single institution charged with overall GLC oversight and coordination, with the task currently fragmented across the various GLICs. The annual Auditor-Generals Report provides aggregate GLC performance reviews but covers only MKD companies and a selection of State Government-owned entities, while PCG and Bank Negara only report on companies that fall within their respective working definitions (see Section II on universe of GLCs). MKD monitors 100 GLCs in which it holds equity
(including golden shares). Khazanah has a stable of companies it manages under its own policies that are not applicable to GLCs held by other GLICs. Furthermore, GLCs also are held by PNB, EPF and other Government entities, each managing GLCs based on their own internal policy guidelines. In addition, listed GLCs must comply with governance rules set by the capital market regulators, while banking and insurance GLCs are regulated by BNM. The issue, however, is that there is no aggregated information on GLCs, and no macro-level analysis is possible as data on GLCs are not easily available. For many GLCs, data are not even compiled, and when compiled are not shared. 15

Lack of all-encompassing and reliable data on GLCs has constrained a wholesome approach to the design of a comprehensive strategy for improving the management of GLCs and to determine GLC role in supporting Government policies. Problems in GLCs are therefore resolved on a case-by-case basis, and there is no consistency in public policy towards GLCs as a whole. It should be noted that monitoring of GLC financial and operating performance would be subject to overall public sector fiscal standards that will be monitored internationally according to IMF Core standards. Recommendations (i) Set up a central oversight authority Without a central authority, the GLC sector is under-monitored and uncoordinated, which allows potentially problematic entities to remain under the radar and impedes any comprehensive transformation initiatives. To overcome this, a GLC Oversight Authority (GOA) should be established to regularly collect financial data on all GLCs and monitor their performance. As many of the GLCs incur financial liabilities to the Government, the GOA should be subjected to a governance framework similar to that adopted by BNM and the SC. However, the GOA will not duplicate sector regulatory oversight that is the responsibility of sector regulatory authorities. In fact, regulatory authorities should leverage on GOA to create pressures for better performance of the GLC. As the oversight authority, the GOA is responsible for policies on GLCs, monitoring their performance and accountable for budgetary expenses incurred by GLCs. The GOA will coordinate with GLICs that are already tasked with operations of selected GLCs, and design a monitoring framework for GLCs as a whole. As the coordinating authority, GOA will aim to avoid duplication of functions and inconsistency in policy implementation among GLCs. Coordination is also required between Federal and State authorities, which have regulatory oversight on activities of GLCs. The GOA will also be the authority to pursue the policies being recommended by the NEAC to implement the GLC-related policy changes in the economic transformation programme (ETP). Ideally, the GOA should report to the Prime Ministers Department. It is conceivable that the PCG and TMO be formally institutionalised into the GOA to carry out this oversight function. The GOA will adopt best international practices with respect to governance and preserving the public sector financial investments in GLCs. When embarking on a privatisation exercise, GOA will observe principles of transparency to build private sector confidence and also to constantly engage with the private sector on the transformation of a given GLC and its eventual transfer to the private sector. In this respect, the GOA will publish an annual report, which would provide an analysis of the performance of all GLCs, their contributions to the economy, fulfilment of the GLC mandate and

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other necessary information.9 The report should include summaries10 of the following information: Objectives (financial and social) and the extent of their fulfilment; Key financial indicators and total Government portfolio value as at year end; Any trade-off between commercial and public policy objectives and an imputation of their impacts on GLC resources and performance; Any material risk factors and steps taken to mitigate them; Financial assistance from the Government, including direct funds and guarantees, and; Transactions with related parties/entities For greater accessibility, aggregate interim reports on GLCs also should be published on the GOA website and be updated regularly. The oversight functions performed by this authority will improve overall GLC transparency and disclosure levels to its ultimate owners, i.e. the taxpaying public. Maintenance of comprehensive data also will form a sound basis for further studies into GLCs and allow trouble spots (e.g. perpetually loss-making firms) to be identified promptly. (ii) GOA to design policies for the Governments role in GLCs, taking into account the following: GLCs lack a clear mandate and are often required to undertake conflicting operations that have dire consequences on their financial viability; they are expected to act as profitmaking entities and pursue the Governments socio-economic objectives at the same time. They are required to implement vendor development programmes, provide lossmaking services to rural areas and are restricted from downsizing their workforce. The pursuit of these conflicting objectives not only compromises the GLC performance, but could also provide an excuse to mask inefficiency and poor performance. Government interference in terms of micro-managing GLCs through specific directives pertaining to investment decisions and corporate social responsibilities (CSR) has often undermined efficacy of GLC operations. These practices affect GLC bottom lines, particularly when such directives make little economic sense. The Government continues to support uncompetitive GLCs that would have been dissolved if privately owned. While GLCs providing essential services such as transportation should be supported, supporting non-essential GLCs have had a severe burden on public sector expenditure. The holding of significant blocks of equity by Government constrains private sector participation in successful Malaysian companies, dampening enthusiasm in the Malaysian equity market. GLC staff remuneration is performance-linked on paper only. In practice, bonuses and salary increments still depend on subjective decisions, and performance tends to take a lower weight than seniority, if not overlooked altogether. Front-line employees also avoid escalating problems to their superiors to create a perception of being in control, resulting in delayed problem resolution, ultimately requiring some form of Government bailout.

10

Adapted from the OECD Guidelines on Corporate Governance of State-owned Enterprises Aggregate reports for small GLCs and individual reports for larger GLCs

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The Governments presence as an investor in the private sector companies conflicts with its mandate as a regulator and facilitator of business. Views held by the private sector that GLCs receive preferential treatment, such as more favourable credit terms due to perceived Government backing and opaque selection mechanisms in awarding contracts influence their decisions to expand operations in Malaysia. Implicit capital and income guarantee for GLICs induces moral hazard risks by privatising benefits and nationalising risks. It also prevents certain financial products from being certified shariah-compliant which hinders Malaysian efforts to become the global Islamic financial hub.

B. A model for the Government to divest non-strategic companies and re-engineer the roles of the remaining GLCs by adopting the service competition model and improving their governance. The omnipresence of GLCs in the Malaysian economy resulted in some of them encroaching into sectors where they are in direct competition with the private sector. This phenomenon deters private investment, particularly in industries where GLCs are perceived to receive special treatment via monopoly licenses, preferential procurement policies and tariffs. Such concessions often were granted to compensate for public policy obligations that GLCs are required to fulfil, for example universal access requirements, usually to the detriment of their bottom lines. However, the public has no access to information that would enable it to verify whether the adverse impact of public policy obligations on GLC performance had been quantified objectively and whether the compensating concessions are fair or excessive. Long-term holding of significant blocks of shares in listed GLCs by Government-linked institutional investors also reduces the proportion of freely tradable equity. Private investor interest in Bursa Malaysia has remained lacklustre compared to that in other Southeast Asian bourses due to the illiquidity of the capital market. The Government already has directed GLICs to reduce their holdings in major listed companies. However, while gradual progress has been recorded over recent months, as evidenced by the gradual divestment of Pos Malaysia Bhd and Telekom Malaysia Bhd by Khazanah, divestment has been through private placements. In line with its ambition to reach high-income status by 2020, Malaysia needs an investment climate that is transparent, meritocratic and well regulated. It requires an incentive structure that promotes competition and private sector involvement, as well as strong institutions and minimal red tape. Malaysia currently ranks 23rd on the 2010 World Banks Cost of Doing Business index, which is lower than its regional neighbours Singapore (1st), Hong Kong (3rd) and Thailand (12th).11 Improving investor perception would require significant economic liberalisation, particularly better implementation of ethnic-based business participation targets and restrictions on foreign ownerships, as well as the introduction of competition into previously monopolistic markets.
11

World Bank, Doing Business 2010 last accessed 9 May 2010 http://www.doingbusiness.org/economyrankings/

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In moving forward, the Government needs to divest all non-strategic holdings and concentrate on being the economys regulator and facilitator, not a participant. It needs to assess its list of strategic holdings and streamline it to contain only firms that are vital to Malaysias broader development strategy and national security, rather than pander to the whims of rent-seekers. Even so, strategic control need not be retained through majority ownership but rather the holding of a golden share which allows the Government to have a say in major decisions while freeing up equity to private investors. To date, the Federal Government (via MKD) holds a golden share in 30 corporations, including Malaysia Airport Holdings Bhd, MISC Bhd and Telekom Malaysia Bhd.12 GLCs and GLICs need to be issued with a clear mandate and specific terms of engagement to clarify their goals and minimise confusion over their roles in the economy. Each GLC mandate should unequivocally outline the responsibilities and objectives of the given entity, which would improve transparency in performance assessment and reduce the opportunity for the Government to persuade GLCs to engage in excessive CSR. The Government also ideally must allow the investment strategy committees of Governmentlinked trust agencies to be fully independent and make investment decisions in the best interests of their beneficiaries (e.g.. trust unit-holders or savers), which may not necessarily coincide with the Governments wishes. Lifting restrictions on overseas investments by GLICs also will enable them to diversify risks and reduce the level of inter-GLIC trading on Bursa Malaysia. Instituting a more arms-length relationship will make threats of sanctions for non-compliance more credible, thus sending out a signal to private investors that the Government is taking the issue seriously. The dominant presence of Government nominees on the boards of GLCs also is a poor corporate governance practice, as regulatory bodies are expected to regulate what essentially are related entities, hence creating a conflict of interest within the Government itself. The GLCs will benefit from better economic performance and public accountability by having more private sector practitioners with ample business experience and wider perspectives than former civil servants. All that is required is a right balance of public and private sector representatives to ensure that the boards of directors optimally reflect investor interests. Recommendations (i) Reduce excessive Government participation in business Government equity stakes must be reduced and GLCs that engage in purely private sector activities should be privatised. A privatisation model is recommended in order that the exercise will yield benefits to the economy. This model entails developing a comprehensive programme that classifies all GLCs into various categories based on a set of criteria and identifies an appropriate divestment strategy for each class, including where possible a recommended timeframe. Furthermore, it is recommended that the Service Competition model should be adopted for industries where Government ownership of natural monopolists is socially efficient, such as telecommunication, utilities and aviation.

12

Minister of Finance Incorporated (MKD) data

19

Instead of being a direct market participant, the Government could attain its goals via legislative reform and strengthening the regulatory environment. It should encourage private investment by simplifying the process of doing business and introducing competition-friendly policies, while empowering regulators to enforce the relevant legislations. The passage of the Competition Bill 2010 and the Competition Commission Bill 2010 to legislate against anticompetitive behaviour13 marks a promising start. WHAT THE GOVERNMENT SHOULD DO 1) Focus on being the facilitator and regulator of businesses, not their competitor 2) Review and streamline list of strategic holdings; divest all non-core and noncompetitive investments 3) Issue GLICs and GLCs with a clear mandate and specific terms of engagement 4) Allow the investment committees of GLICs to be independent and make decisions in the best interest of their beneficial owners 5) Institute an arms length relationship with GLCs and make them compete on a level playing field 6) Reform the legislative framework and strengthen the regulatory environment WHAT THE GOVERNMENT SHOULD NOT DO 1) Attempt to micro-manage GLCs 2) Use the GLCs as vehicles to indiscriminately achieve the Governments socioeconomic objectives while comparing their performance to solely profitorientated private sector entities 3) Support uncompetitive GLCs although it does not make economic sense

13

Includes cartels, predatory pricing, withholding of supply or information to the detriment of consumers, pricefixing and bid-rigging

20

The recommended approach to the privatisation exercise is sequenced as follows: Figure 6: Recommended approach to formulation of divestment programme

a. Proposed objectives of the divestment programme The divestment program aims to rationalise the large number of Government entities with a view to transfer qualified GLCs to the private sector, nurture those which have potential and undertake appropriate measures, as well as decide on non-viable or problematic GLCs. This privatisation model will also encompass a process to build capacity in the Bumiputera Commercial Industry Community (BCIC). The objectives of the privatisation model should include, among others, the following: To revive private sector participation in the economy; To downsize Government role in business in order that the conflict with its regulatory role is removed, and restore public sector governance; Alleviate drain on fiscal resources; Improve efficiency in resource allocation and elevate competitive position of companies, and; Give priority to privatisation methods that will stimulate capital market development.

b. Proposed principles for divestment The NEM is envisaged to take Malaysia into a new paradigm of market-based and transparent policy implementation. It is also desired that policies under the NEM will improve competitiveness. Hence, it is important that we maintain the course and not succumb to temptations to revert to past undesirable practices, even for a few cases. This is particularly important in the privatisation model. This time around, there should not be any backtracking or policy reversals. This can happen through the adoption of a set of principles to guide the implementation of the privatisation model. This set of principles should be determined upfront
21

and made transparent. Any change in the principles requires explanation to the public and should be proposed only after acceptance through a public-private sector consultative process. The Principles proposed are as follows: The Government should divest companies which are deemed non-strategic and in which the private sector has greater scope for value-creation; Divestments must be transparent, market-based and meritocratic, using transparent procurement procedures and adequate safeguards to prevent exploitation or abuse; Divestments should be made to the private sector (not other GLICs); Divestment cannot be reversed; Implementation of any divestment exercise must follow internationally-benchmarked procedures and adopt proper governance principles;14 As a priority, divestments should be conducted via the capital market to enable greater public participation and market development; Divestment proceeds must be capitalised into a reserve and not treated as general revenue; In addition to the above, the following practices must essentially be observed to build confidence and public trust in the implementation of the privatisation model: When privatising publicly owned assets, the Government must ensure that majority ownership is indeed in private hands, so that privatisation does not happen in name only. This applies to both listed and non-listed companies. In addition, if companies and assets are transferred into private hands via the capital market, the Government cap the potion of equity held by GLICs and other GLCs (See c. below on strategic holdings). Divestment will also create opportunities for new Bumiputera entrepreneurs. Use of divestments to enhance Bumiputera participation in business must ensure that privatised GLCs are spread across a pool of new Bumiputera entrepreneurs. Eligibility could be determined by excluding Bumiputera individuals or companies who already own stakes in privatised GLCs or are already mature in the industrial community. Companies in which GLICs hold significant equity interests will be accorded the same treatment as private sector-controlled companies (no preferential nor discriminatory treatment). This equal treatment will cover aspects related to legal compliance as well as access to business opportunities and facilities, such as loans. Companies in which GLICs hold equity interests must be given clear mandates and specific terms of engagement. Their responsibilities must be spelled out to minimise confusion and misinterpretation. A process must be in place to ensure that all parts of Government will not be able to persuade such companies to engage in socio-political activities that may contradict their commercial objectives (see recommendations on public sector governance in the 1Malaysia supply chain chapter). Professional managers must be allowed to manage GLCs with neither interference nor micro-management by Government, whether in day-to-day issues or in decision-making.

14

Suggested standards include the OECD Guidelines on the Governance of State-owned Enterprises

22

They should be given clear terms of reference and be hired or fired based on their performance against such KPIs. Pursuit of withdrawal of State participation through the capital market is important for two reasons: 1) GLCs were built using public money. It is only right that the public should be given the an opportunity to invest in them and benefit from their future growth; and 2) integration into the capital market will automatically allow greater transparency of operations of the entities, while also making entities subject to international practices of corporate governance. Other benefits of divestment through the capital market include: the ability to fetch the highest value through a competitive market system; signals the Governments commitment to subject GLCs to market discipline; and creates wellcapitalised stocks to attract investors into the equity markets. The mechanism for divestment must accommodate the different characteristics of the GLCs, but conducted within the parameters of the proposed model for divestment. However, in the privatisation model shown in Figure 7 below, GLICs and strategic companies are not recommended for complete privatisation. c. Addressing the issue of strategic GLCs What constitutes a strategic company? The standard definition would be an entity whose functions are of national importance, i.e. critical for the day to day running of the countrys econom y and civil society. Strategic companies often include energy, utilities, finance, telecommunications and transportation. Characteristics of a strategic company include: Generation of significant positive externalities Economies of scale through the provision of physical or intangible infrastructure/knowhow to other firms in the same or related industries Important upstream and downstream linkages15 It is acknowledged that some form of Government control over strategic industries is vital to ensure their sustained operations, particularly in times of crisis. However, ownership is not the pre-requisite for strategic control. Some countries use ownership rules for companies that are deemed strategic, but in most instances, they are not to protect Government ownership but to differentiate between domestic and foreign interests. For example, France has a tradition of blocking foreign ownership in 10 strategic industries, including defence, military-related technologies, biotechnology, information security and the casino business. Canada and Australia designated certain financial institutions as strategic to the domestic economy and limit foreign participation in those institutions. In the privatisation model, a clearer definition of strategic sectors is needed and it is not necessary that all companies within the stipulated sector are also strategic. At the moment, there is no authoritative list of sectors deemed strategic. Based on Government control of entities, it appears that strategic sectors cover automotive, financial services, airline and airports, railways, seaports, energy, utilities and telecommunications. Often, certain sectors are designated as strategic because the regulatory capacity in the sector is weak. Instead of enhancing regulatory
15

Strategic Industries in A Global Economy: Policy Issues for the 1990s OECD International Futures Programme

23

and policy-making capacity, the Government chose to govern and guide the industry through the relevant GLICs and GLCs. More work is required to determine strategic sectors. This, however, must be clearly defined as critical to national survival. Second, once the strategic sector is defined, ownership in companies within the sector is not the only means to exercise control. Examples of controls are shown in Table 4 below. Table 4: Alternative methods for exercising control over strategic companies Method Countries Description A golden share allows the holder a say in major decisions pertaining to a strategic company; it affords the Government control while freeing up ordinary shares for private investors To reduce scope for political interference, the powers of a golden share must be clearly defined and time-limited Industry policy The Japanese Government holds only 0.05% of equity in Japan Airlines (JAL) but maintains strategic control via an aviation policy which requires all airlines to service regional airports as a form of CSR initiative The Australian Government does not use post-privatisation ownership controls but imposes foreign ownership limits of 49% on strategic entities such as Qantas Russian strategic industries law requires foreign investors seeking a majority stake in any strategic company to obtain Government approval, while State-controlled foreign investors would require permission to hold stakes > 25%

Golden share

Great Britain & Poland

Japan

Foreign ownership restrictions

Australia & Russia

The NEAC recommends the following: Only GLCs that perform a public sector function should be deemed as strategic and should not be privatised; Companies in sectors deemed strategic should continue to be divested, and Government aggregate holdings in such companies should be capped at 20% in line with international norms. Ownership restrictions in these companies at the private sector level should be limited to foreign holdings. Government control can be exercised through its regulatory oversight of the sector and companies in the sector. In non-strategic companies, Government equity holdings should be capped at 10% The above limits apply to equity held for long-term strategic purposes. It is not recommended to cap the number of shares purchased for short-term trading purposes, but

24

GLICs should be required to trade the shares within a stipulated period after purchase to create market liquidity. d. Factors to be considered in designing a market-based and transparent divestment exercise16 Below are factors or the pre-requisite considerations for the design of the modalities for the divestment exercise: Existing market structure (competitive vs. monopolistic; will regulatory amendments be required prior to divestment); Method of privatisation (e.g. IPO, private placement, management buyout, etc) Transparency of privatisation method; Valuation/pricing of assets to be divested; Market saturation and absorptive capacity; an ill-timed investment into a weak market may result in poor proceeds; Pre-sale preparation in terms of due diligence and disposal terms; Short-term revenue forgone vs. long-term gains in economic efficiency and taxes; Selection of a financially and reputationally sound buyer (in the case of a private placement/trade sale); and Potential buyers development strategies for the divested entities. e. Proposed classification method of GLCs Government-linked ownership entities may classify GLCs based on characteristics such as financial performance, strategic importance and turnaround potential. Figure 7 illustrates the recommended GLC classification process. However, the formulation of specific thresholds remains at the discretion of the respective holding entities. Figure 7: Decision Tree for GLC Classification

16

Adapted from non-core asset management best practices in the GLC Transformation Programme Yellow Book

25

f. Recommended action plan for companies that should remain under Government control In the initial stage of implementing the model, it is recommended that GLICs and State-level holding companies should not be privatised. Privatisation should focus on their investee companies. However, it is necessary that these GLICs are better governed and there is disclosure on their operations. Their corporate strategy and deliverables should also be made known. Appropriate oversight by GOA is required. The Government (through the GOA) can undertake the following: Issue an ownership policy that outlines, amongst others, the Governments investment objectives; Macro-manage GLCs instead of being involved in day-to-day management and afford them operational autonomy; Issue each GLC clear terms of reference, including their commercial and public policy goals; Make investment decisions based on objective cost-benefit analyses, not political expedience; Build risk-management capacity as a lead-up for diversification into overseas investments; Collaborate with the GLC central monitoring authority to provide timely aggregate reports on GLC performance; GLCs must comply with best practices in corporate governance and there must be a mechanism to assess their compliance and sanction non-compliance.

g. Recommended action plan for companies which should be divested by the Government: Non-strategic companies, defined as GLCs that perform purely private-sector activities, should be divested on a staggered timeline based on their characteristics. It must also be noted that not all GLCs are wholly owned by the Government. In large, listed conglomerates, a subsidiary that is classified as non-strategic from the Governments point of view may be deemed strategic for the conglomerate by minority shareholders. In these instances, corporate governance best practices must be adopted to ensure that all shareholders are treated equitably. Non-strategic listed companies Cap aggregate Government holdings to 10% of issued shares to increase liquidity Non-strategic unlisted high performers Strategies: Companies with good track record that meet Bursa Malaysia listing requirements should be privatised via the capital market where possible; Upon privatisation, aggregate Government long-term shareholding should be capped at 10% of issued shares;
26

However, in some instances, trade sales and management buyouts may secure a higher valuation; hence, privatisation methods will be considered on a case-by-case basis using a cost-benefit analysis Rationale: Initial public offerings (IPOs) allow greater scope for participation by the private sector and retail investors; Greater liquidity contributes to capital market development and improves foreign investors perception; and GLCs were forged out of tax revenue and listing enable taxpayers to obtain direct share ownership and participate in their success Non-strategic unlisted low performers with potential for turnaround Strategies: Appoint a team of professional managers and provide incentives to managers to want to turnaround the company (e.g. management or employee buyout opportunities). Incentives will entice them to revive the companies to graduate into the high-performing category; Selection of professional managers has to be meritocratic and transparent, not politically-driven. Public sector officials with no business expertise and experience should not be allowed to take over companies; Management of these GLCs must follow private sector best practices and adhere to each firms respective terms of reference (see Defensive Strategy iv.a. above); Government support, especially financial, must be limited to development cost with a view to sell out or withdrawal within specified period; Select some companies for inclusion in the BCIC to be run by Bumiputera entrepreneurs with potential. The Government will provide support, especially skills and coaching to ensure companies can turn around. Rationale: Appointment of professional managers enables the companies to be run by experts; Adherence to each GLCs terms of reference and decision-making independence are vital to minimise arbitrary political interference that could jeopardise company performance. Non-strategic unlisted low performers with no turnaround potential Strategies: Offer these low performers to the private sector for sale in an open tender, failing which; Liquidate these entities and establish an asset-management company to dispose of their assets in a transparent and market-based manner. Rationale: The private sector may generate synergies by integrating these companies into their existing corporate structure; Should there be no takers, these GLCs should be liquidated to avoid further drain on fiscal resources. Table 5: Summary of strategies in applying the privatisation model

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Category

High-performing unlisted companies

Unlisted low performers with turnaround potential

Unlisted low performers without turnaround potential Offer to the private sector for sale, failing which; Liquidate entities and establish an assetmanagement company to dispose of assets in a transparent and marketbased manner

Strategy

Companies with a Appoint good track record that professional managers meet Bursa Malaysia and provide incentives listing criteria should be for them (e.g. divested via the capital management/employee market where possible buyout opportunities) to revive the companies in Aggregate order to graduate into Government the high performance shareholding is capped category at 10% of issued shares IPOs allow greater scope for private sector & retail investor participation Contributes to capital market development GLCs were forged out of tax revenue and listing would enable taxpayers to obtain share ownership and partake in their success

Appointment of professional managers enable the companies to be run by experts Decision-making independence is crucial to minimize political interference that could jeopardize company performance

Rationale

The private sector may generate synergies by integrating these companies into their existing corporate structure Should there be no takers, these SOEs should be liquidated to avoid further drain on fiscal resources

C. Creation of a Fund from divestment proceeds to finance GLC catalytic role to grow new private sector activities. In the past, the Government has failed to capitalise proceeds from previous privatisations. Since 1983, 474 projects and entities have been privatised, netting the Government capital expenditure savings of approximately RM123.2 billion. However, direct receipts from previous privatisations were not explicitly capitalised into a special reserve, but were used to fund Government expenditure. It is vital for divestment proceeds NOT to be treated as operating revenue (i.e. flow), for they arose from disposal of assets and hence should be recognised as capital (i.e. stock) in Government accounts.

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Recommendations: Recent Citigroup calculations have estimated that the Government could gain approximately RM40-50 billion from reducing its shareholding in key GLCs to 30%. This sum and any further proceeds from GLC divestments should be capitalised into a special reserve. Suggestions for their utilisation include the following: To fund GLC Transformation initiatives under the auspices of the GOA, including ventures into new strategic sectors (e.g. business development services). GOA could allocate funds to PCG, given its track record in driving new growth initiatives among its holdings GLCs. The Fund to be managed as a sovereign wealth fund (SWF) that invests in various asset classes (e.g. securities, foreign exchanges and derivatives) to maintain a sustainable income stream. It is recommended for governance of this SWF to follow the Sovereign Wealth Funds Generally Accepted Principles and Practices (Santiago Principles)17 which require, amongst others: public disclosure of the funds investment policy; financial statements and risk management approach; and for the fund not to take advantage of privileged information or inappropriate influence by the broader Government in competing with private entities. To finance ventures into technologies with a Technology Readiness Level18 rating that is lower than nine. Malaysias tendency to import complete technologies that have been fully tested and proven to be operational (i.e. TRL 9) saw local engineers having limited exposure to the process of incubating successfully commercialised applications. GLCs should partner with private companies that develop applications with a TRL rating that is lower than nine to catalyse a transfer of semi-complete technologies to Malaysia. This will expose the workforce to the process of developing a mature application that involves, among others, the formulation of technical manuals and procedures.

D. A re-engineered role for GLCs in the NEM in a manner that is supportive of, rather than competing with, the private sector. There is on-going work at Khazanah to constantly refresh its programme of supporting private sector growth and attracting investments across all sectors. Examples include deepening the advantages from the global presence of electronic firms, building liveable cities, adopting new approaches to tourism ventures, reforming the commercialisation of agriculture into a sustainable industry and bringing in new technologies from abroad. While GLC transformation continues to remain on track, a consolidated and coordinated approach to operations of GLICs and large GLCs is necessary for them to become agents of change for economic transformation under the NEM. The roles of the GLCs that remain after the privatisation model has been executed can be summarised in the 6 key roles proposed by the PCG below: Figure 8: Modalities for GLC support in the NEM

17 18

http://www.iwg-swf.org/pubs/gapplist.htm last accessed 8 July 2010 http://esto.nasa.gov/files/TRL_definitions.pdf last accessed 8 July 2010

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1
Stay the course in executing the 10 year GLCT Programme

6
Other roles under NEM [e.g. market liquidity and labour market issues ]

2
Relentless execution to become regional champions

ROLES

Continue focus on core operations on a level playing field and exiting non-core and noncompetitive assets
Collaborate and co-invest with non-GLC private sector

Pursue new economy investments in line with the NEM

4
KKU 2 Oct 2007

(i) Confluence of infrastructure ownership and operating rights In certain industries, particularly in telecommunication and utilities, a monopoly market at passive infrastructure level is the most efficient structure as economies of scale only could be optimally exploited over a very large range of output. However, in Malaysia, GLCs dominate not only the infrastructure but also the content provision markets and in some cases, they prevent private sector competition and innovation in these areas. This affords their content provision arms lower costs to access both passive and active infrastructure relative to private sector content providers. These areas are usually the most dynamic sectors of value creation in the global markets and an area where private sector (or joint ventures with GLCs) could transform the competitive landscape. Absence of industry regulators also forces some GLCs to exercise some form of regulatory functions, which could give rise to conflict of interests. Recommendations

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Industries where the natural monopoly market structure is socially efficient should adopt the service competition model which will allow network ownership to be separated from regulatory functions and operating rights (see Table 6). Under this model, GLCs will retain ownership of passive infrastructure (e.g. optical fibre networks, power generators) while the second tier of infrastructure, known as active infrastructure (e.g. access node switches) will adopt an oligopoly structure.19 Private sector players will populate the active infrastructure market; the existing arm of GLCs, which operate on this tier, should be privatised. Most importantly, the content and service provision market will be fully liberalised. This requires existing content provision arms of GLCs (e.g. BlueHyppo) to be severed from ownership of both passive and active infrastructure. Liberalisation of this market tier is expected to induce competition and result in increased efficiency and consumer choice. Table 6: The Service Competition Model Level Upstream Market Passive infrastructure Active infrastructure Content & service provision Structure Monopoly Players GLCs (e.g. TM, TNB and MAHB) Private operational companies (OpCos) including privatised arms of GLCs which operate on this tier; access is license-based Private content and service providers (ServeCos) including privatised arms of GLCs which operate on this tier; minimal barriers to entry and exit

Mid-stream

Oligopoly

Downstream

Fully liberalised

Implementing agencies: GLC Oversight Authority, Competition Commission, industry regulators and all GLICs (iii) Lack of a facilitative legal and regulatory framework In some industries, GLCs were established to achieve public policy objectives due to weak regulatory capacity or the absence of an industry policy (e.g. aviation). However, in transitioning towards a more laissez-faire approach, it is important for the Government to strengthen the legal and regulatory framework to level the playing field between GLCs and private businesses and alleviate private investor uncertainty (see papers on regulatory standards for NEM and recommendations on implementing the Competition Law.) A robust, well-enforced governance framework, which defines what falls within GLCs mandates, will also reduce the opportunity for political interference in their day-to-day operations, hence contributing towards more transparent and efficient companies.
19

Full liberalization of the active infrastructure market tends to lead to resource duplication, subscale operations and coordination issues

31

Recommendations: Include GLCs under the provisions of the Competition Act to ensure that their trade practices refrain from being anti-competitive it is essential that GLCs are not exempted; Mandate via laws and legislation any public policy obligations that have to be undertaken by GLCs (e.g. universal access requirements). Information on these obligations, the resulting costs and impacts upon GLC performance and resources should be disclosed to the public; Refrain from providing automatic Government guarantees for GLC liabilities; Grant credit to GLCs on the same terms and conditions as those for private sector firms; Remove both written and unwritten barriers in the Government procurement supply chain which affords GLCs special treatment; Legislate against interference in the day-to-day management of GLCs by political entities and other Government agencies to curb ministerial discretion; Prohibit officers and directors in GLCs from being involved in formulating or enforcing regulations that directly affect their companies. This precludes, amongst others, GLC Board members from concurrently serving as members of regulatory bodies. (iv) High barriers to entry into new strategic industries Efforts to develop new strategic industries often are thwarted due to risk aversion by the private sector or the lack of adequate infrastructure and venture capital availability. 3.7.1 Recommendations GLICs such as Khazanah and Ekuinas already are investing in new industries at various stages of development (e.g. start-up and growth). The Tenth Malaysia Plan (10MP) has highlighted that GLCs will continue to play a catalytic facilitator role by venturing into new industries with a view of lowering barriers to entry. The NEAC concurs with this approach and also recommends that GLCs should be trailblazers in adopting sustainable practices. The following are recommended: A clear exit strategy is required to ensure that GLCs do not linger in mature industries; GLCs should establish Corporate Venture Capital (CVC) arms. Through CVC, GLCs will invest directly in start-up firms and SMEs to which they may provide funds, management services and technical expertise. CVC investments are be motivated by the potential competitive advantage afforded by the investees upon their maturity; GLCs can partner with non-profit organisations to venture into social enterprises, which are businesses where social and environmental goals, rather than profits, are central to their mission. Operating surpluses are not distributed but re-invested to fund business expansion. Examples of social enterprise objectives include employment of the disadvantaged or people with disabilities and recycling by using industrial waste as product inputs. A social enterprise GLC also could be established specifically to provide labour training and up-skilling programmes for the 40% lowest-earning households in line with the Governments ambition of alleviating poverty; Adopt the triple-bottom-line (TBL) reporting method, which highlights not only a companys financial, but also social and environmental performance. TBL reporting currently is recommended but not mandated in Malaysia.
32

(v) Ongoing need to develop Bumiputera entrepreneurial participation Socioeconomic restructuring efforts have yielded significant results, as evidenced by the growth of a thriving Bumiputera professional class. However, there is a need to continue stimulating Bumiputera participation in entrepreneurial ventures to achieve the development of a Bumiputera Commercial Industrial Community (BCIC). 3.8.1 Recommendations Expand upon existing vendor development programmes by partnering with Bumiputeracontrolled SMEs and providing them management and technical expertise in order to assist them in making the leap into becoming mature companies; Privatise a selection of GLCs to Bumiputera entrepreneur consortiums through a transparent open tender process, and ensuring that privatisation is accorded to a broad range of new Bumiputera entrepreneurs based on merit and capacity; Require a minimum representation of Bumiputera officers in professional management teams appointed to run GLCs. Selection of these officers from within the Bumiputera candidate pool must be transparent and meritocratic. Performance incentives such as opportunities for management buyout of successfully restructured GLCs also contribute to the achievement of the 30% macro-level Bumiputera equity ownership target; GLCs to develop an apprenticeship and internship system to build a bigger pool of Bumiputera entrepreneurs and technical experts in various fields in both the services and the real sector; the German model offers useful lessons; GLCs to form a conglomerate to develop one-stop business development services (BDS) to SMEs (See recommendations on developing the BCIC SMEs in the SME chapter). Implementation Issues Many agencies will be involved in the implementation of the recommendations above. However, further detailed work is required in implementing these recommendations. Given that Khazanah already has instituted a divestment policy, its input in developing the proposed privatisation model into an implementation action plan will be useful. Managing stakeholders perceptions and understanding of this policy is important for buy-in throughout the process. A review of past privatisation exercises is required to better appreciate the sub-optimal actions and measures. Such lessons also will be useful to manage similar risks, which could also occur in this privatisation model. Equally important is to address the implementation impact on the distribution of income objectives and general consumer welfare. It should be noted that divestments and listing plans are subject to prevailing market conditions. Expected Outcomes In summary, expected outcomes from the recommendations would be as follows: Favourable fiscal results from privatisation model; Greater scope and opportunities for private sector investment; A clear separation of regulation and operations; enhancement of regulatory capacity in the various sectors will improve private sector confidence; Improved efficiency from various measures reinforcing each other into a virtuous cycle of transparency, market discipline, fair practices, leading to removal of monopolies, market-based pricing structures, higher productivity and competitiveness;
33

Divestment through the capital market will improve liquidity, build greater confidence in the equity market, resulting in higher investments by both domestic and foreign investors. Setting up the GOA will ensure coordinated policies on GLCs and that GLCs perform according to new mandates as agents of change in the NEM. Oversight functions will improve overall transparency and disclosure levels to its ultimate owners, the tax-paying public. Maintenance of data will also form a sound basis for further studies on GLCs and allow trouble spots to be identified and corrective measures taken promptly, and avoid loss-making developments. V. CONCLUSION For Malaysia to transform into a high-income, inclusive and sustainable economy, it cannot continue the status quo where the State dominates the market. If the private sector is to drive the economy, the Government has to concentrate on becoming a regulator and facilitator by nurturing an optimal environment for all businesses to grow. Public sector governance requires Malaysia to strengthen its regulatory standards and oversight, and cease to directly participate in the economy to achieve its goals. It is imperative for Malaysia to benchmark against international best practices, particularly in pursuing a separation between its regulatory and participatory functions to avoid skewing the playing field against the private sector. GLC transformation efforts under the oversight of the PCG are already showing results through the sustained improvement in the G20s performance trajectory. Initiatives under the Programme, such as pursuing new economy investments (e.g. green technology) and divestment of non-core assets, are congruent with the recommendations of the NEAC. However, these initiatives should be expanded to all GLCs, including State-owned companies, to ensure that the best practices permeate throughout the entire sector. Adoption of the recommendations of the NEAC to re-engineer the role of the Government in business, in conjunction with other market optimisation initiatives such as deregulation and improved enforcement, will allow Malaysia to re-energise the private sector, create a competitive domestic economy, as well as enhance the sources and sustainability of growth to enable it to become a developed nation by 2020.

Group A of the National Economic Advisory Council September 2010

34

Appendix 1: Overview of Previous Privatisation Drives in Malaysia State enterprises were conceived as a means to achieve economic development and address under-provision of public goods by the private sector. The introduction of the New Economic Policy (NEP) also cast Government enterprises as the main vehicles for reaching wealth redistribution targets. This sector expanded significantly since late 1960s with Government enterprises numbering over 1,100 entities prior to the privatisation drive.20 However, most of the entities were perpetual loss-makers, with an aggregate net loss of RM1.9bn in 1987.21 In the 1980s, as the developed world embraced free market ideals, the Malaysian Government under the then-new Prime Minister, Tun Dr Mahathir Mohamad, reversed its stance on State interventionism and ostentatiously set out to privatise public enterprises. The official objectives of privatisation, as outlined in the 1984 Mid-term Review of the Fourth Malaysia Plan, were: To increase the role of the private sector in economic development
20 21

Jomo & Tan (2002) Privatisation and Renationalisation in Malaysia: A Survey 562 companies recorded aggregate losses of RM7.5bn while another 446 made collective profits of RM5.6bn

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To reduce the burden on the Governments fiscal budget To improve the productivity and efficiency of State enterprises It also became an avenue for achieving increased Bumiputera corporate participation via the requirement for at least 30% of the privatised entitys equity to be held by Bumiputera investors. Shareholdings by foreign investors were capped at 25% of equity. Privatisation was initiated by either the Government or the private sector. In a private sectorinitiated privatisation, the first promoter to submit a detailed feasibility study earned the right to negotiate the proposed privatisation of the studied entity with the Government and no other privately commissioned feasibility study would be accepted. However, should the negotiations fail, the Government may open a public tender or commence negotiations with a single, selected party. Some of the State enterprises that were privatised in this period were Sistem Telekom Malaysia (STM, now Telekom Malaysia Berhad), Lembaga Letrik Negara (LLN, now Tenaga Nasional Berhad) and Klang Container Terminal (KCT). Implementation pitfalls The execution of the privatisation policy, however, was not without its shortcomings, several of which are listed below: Privatisation occurred only in form and not in substance. Many GLCs remained under de facto Government control, despite having part of their equity divested to private investors. This exercise hence failed to resolve most of the governance issues that originally plagued the entities and may have worsened the aggregate public sector balance sheet by the natural selection tendency to privatise only successful enterprises. The first-come-first-served approach to private sector-initiated privatisation was perceived as opaque and potentially biased towards well-connected promoters who could have access to inside information Privatisation was not accompanied by greater competition, hence effectively converting public monopolies into private monopolies Sweeteners to encourage employees to migrate to the privatised entities (e.g.: job security, requirements that emoluments must be at least as much as what the employees received in the public sector) restricted the entities ability to right-size its workforce and trim costs Initial public offerings were underpriced, resulting in forgone Government income and encouraging stagging (the practice of buying and selling shares to make quick profits) Privatisation of successful companies reduced the potential to cross-subsidise unprofitable business lines or companies which were instituted to meet socioeconomic objectives

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Appendix 2: Existing definitions of GLCs in Malaysia Government-linked investment companies (GLICs) Putrajaya Committee on GLC Transformation (PCG) Federal Government linked investment companies that allocate some or all of their funds to GLC investments.

Term

Government-linked companies (GLCs)

Non-financial public enterprises (NFPEs)

Issuing authority

Putrajaya Committee on GLC Transformation (PCG)

Bank Negara Malaysia (BNM) Business entities which are owned by the Government and involved in the sale of goods and commercial services or manufacturing activities,

Companies that have a primary commercial Definition objective and in which the Malaysian Government has a direct controlling stake.

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Defined by the Federal Controlling stake refers to Governments influence the Government's ability in: appointing/approving (not just percentage Board members and ownership) to appoint senior management, and Board members, senior having these individuals management, and/or make report directly to the major decisions (e.g. Government, as well as in contract awards, strategy, providing funds for restructuring and operations and/or financing, acquisitions guaranteeing capital (and and divestments etc.) for some income) placed by GLCs, either directly or unit holders. through GLICs. Currently includes: EPF, Khazanah, KWAP, LTAT, LTH, MKD and PNB.

with: 51% Government equity >RM100 million sales turnover Large impact on the economy

Appendix 3: Summary statistics of GLCs compiled by NEAC* Federal Number of entities Listed Unlisted Public limited companies Private limited companies Statutory bodies 332 53 279 91 241 0 State 113 1 112 9 90 6 Total 445 54 391 100 331 6 Federal (%) 74.61% 97.78% 72.00% 91.00% 72.81% State (%) 25.39% 2.22% 28.00% 9.00% 27.19%

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Unlisted public companies Dormant entities

38 17

0 10

38 27

Public float > 50% Public float 0% < x < 50%

9 25

0 1

9 26

Negative shareholders' funds Loss-makers Public (Bhd) loss-makers Private (Sdn Bhd) loss-makers Statutory body loss-makers

17 41 19 22 0

14 38 2 34 2

31 79 21 56 2

5.12% 12.35% 20.88% 9.13%

12.39% 33.63% 22.22% 37.78%

* GLICs and State Governments which submitted information are: KWAP, KWSP, LTAT, LTH, MKD, Kelantan, Penang, Perak, Sabah, Sarawak, Selangor and Terengganu. Information on GLCs under PNB and Khazanah were retrieved from their websites. Information submitted is based on the latest set of published accounts.

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