The scandal of S-chips

A couple of years after The Edge Singapore came into existence in 2002, the darlings of the market were stocks of China-based companies that listed in Singapore, otherwise known as S-chips. Actively pursued by the Singapore Exchange to revive interest in the stock market, S-chips allowed investors the partake in China’s rapid economic growth during the lead-up to the Beijing Olympic Games in 2008.

At one point, up to more than a hundred S-chips were listed. In 2004 alone, there were 40 such listings. However, these tended to be small issues, raising a total of just around $900 million among them.

By any measure, the S-chips were a colourful and diverse bunch. Not only did they come from every corner in China, they also came from diverse industries, living up to China’s reputation as Factory of the World. There were textile and apparel makers like China Gaoxian Fibre Fabric Holdings and Great Group which manufactured lingerie.

A handful focused on sports shoes and apparel like China Hongxing Sports, China Eratat and China Sports. There were foodstuff producers like Youcan Foods International which specialised in ice creams and potato starch maker China Essence Group and snack maker China Star Food Group.

Then there were those from the heavy industries such as pulp and paper manufacturer Guangzhao Industrial Forest Biotechnology, steel miller FerroChina and Fabchem China, the manufacturer of explosives for the mining industry. There was even China Milk the producer of bull semen that recorded net margins of up to a whopping 90%.

Typically, the holding company of S-chips was structured as an offshore entity based in Bermuda, the British Virgin Islands or the Cayman Islands. This holding company, in turn, held the operating subsidiaries and its assets in China.

To burnish their image, auditors were poached by some of these S-chip companies to fill the roles of financial controllers or even CFOs to lend them an air of legitimacy. While most S-chips cited the need to raise capital for expansion as a reason for listing in Singapore, some readily admitted they did not lack funds but instead coveted the status of listing on “an international financial centre”.

For quite a few years, the whole S-chip party was in full swing. IPO managers flew up to China to attract prospective new listings, assess the suitability of listing applicants and lead them through the IPO process.

Many other local market professionals hitched a ride too, including lawyers, auditors and consultants. Site visits and plant tours were also organised for analysts of research houses, dealers and remisiers of brokerage houses and financial journalists where the highlight of the trips often took place in the after-dinner parties.

Fresh from the junkets, the remisiers would promote S-chips to their clients while the media would report on their bright prospects. When the stock went up after its IPO, many more investors jumped on the bandwagon.

Many of these S-chips were keen to be seen and heard. For example, The Edge Singapore (Issue 320, May 26, 2008) featured five S-chip stories. Three of the headlines captured the bullish prospects that were all too typical of these listings. China Paper looks to M&As to rapidly expand manufacturing capacity, China Merchants on the hunt for more toll roads and China furniture maker banks on strong domestic demand, referring to Cacola Furniture International.

However, two of the stories in Issue 320 also indicated that things were not always rosy in the S-chip universe and that investors had begun to wise up: These were China Oilfield clarifies seasonal losses, seeks recurrent revenue streams and Reyphon takes action to stem falling margins of essential plant hormone.

Of stolen trucks and office fires

By the end of the decade, cracks had started to appear in the whitewashed facade of some of these S-chips with sub-par corporate governance. Reports of accounting irregularities, loan defaults and missing cash began to surface with increasing frequency.

Retail investors went quickly into denial as one regulatory filing after another described all sorts of corporate malfeasances ranging from long-overdue receivables to significant overpayments to suppliers only to have these amounts written-off later.

Often, bosses of these beleaguered S-chip became uncontactable or went missing in action. Shareholders would only discover the existence of unauthorised loans taken up by local operating subsidiaries when the company announced it had received a letter of demand for payment from creditors.

Another common problem was the unauthorised flow of funds from a local subsidiary to a third-party company linked to the same boss. Independent directors blindsided by the rapid turn of negative events scrambled to appoint special auditors and set up committees to investigate the matter.

However, when the audit committees asked to look at the company’s books, many were stonewalled. In one infamous 2009 episode, the account books of China Sun Bio-Chem Technology were lost after the truck ferrying the accounts was stolen.

When auditors from KPMG went to an office to start their investigations, power to the finance department was cut. When the power was restored, the hard disk in one of the four computers could not be detected. For Sino Techfibre in 2011 and China Paper Holdings in 2012, office or factory fires were cited as reasons for incomplete accounts.

In or around 2010, the endgame for S-chip was clearly in sight. Many retail investors got burned by S-chips. It was widely believed that the ownership structure of the S-chip companies where the listed vehicle is typically just an oversaes-incorporated shell, significantly insulated the majority shareholders and business owners from Singapore regulatory actions and accountability.

In late 2013, regulators put in place new rules. These included the so-called direct listing framework where China-incorporated companies could only list on the SGX with approval from the China Securities Regulatory Commission (CSRC).

To be clear, the majority of S-chips listed here are properly governed and law-abiding. Unfortunately, most investors here have had enough and their attention soon turned elsewhere. Among the surviving S-chips, a few delisted from Singapore and relisted on Hong Kong like China New Town Development while others delisted on their own or on the orders of SGX RegCo, which embarked on a deliberate “clean-up” exercise.

Quite a handful remains suspended, leaving their long-suffering shareholders in limbo. A few, like Hu An Cable, tried to string together a business so that it could resume trading, but to varying degrees of success.

To be sure, the future isn’t completely bleak for China listings here. With SGX becoming a favoured hub for REITs, a couple of these trusts holding China-based property assets have listed in recent years, like EC World REIT and Dasin Retail Trust.

And to their credit, some wayward S-chips have even managed to reverse their fortunes. Most notable was China Aviation Oil whose management lost US$550 million betting on jet fuel derivatives the wrong way back in 2004. Following a high-profile restructuring exercise, the company is firmly back on track and remains listed here.

Not quite over

Unfortunately, even after these years, reports of S-chips getting into trouble still crop up occasionally — including that of aluminum parts maker China Haida just last April. Similar to some previous cases, the company’s subsidiaries in China received court orders freezing their bank accounts because of unpaid loans, which the Singapore-listed entity only became aware of recently. The CEO Xu Youcai also become uncontactable and its Singapore-based independent directors were left scrambling to appoint lawyers and forensic accountants to help shed more light on what had happened.

On Aug 3, as directed by the SGX RegCo via a notice of compliance issued on June 28, FTI Consulting has been appointed the special auditor to investigate the circumstances leading to the loans taken out by Xu, assess the “recoverability” of the company’s receivables and verify the bank balances.

To be sure, S-chips aren’t the only companies falling short of corporate governance standards or running afoul of the law. Still, each new case is one too many and to the credit of the regulators of the markets, they have taken numerous steps to address them.

Broadly, there is an underlying need to raise standards across the board. Regulators can be armed to the teeth but there will always be some motivated players who will find ways and means to get away with fraud or “creative accounting”. The whole ecosystem, including directors and auditors, have to commit to meeting certain minimum standards in the respective roles they play.

Also, given how the overall market environment is always changing, there will be new industries with their own attendant set of circumstances. Each new development or situation is in a way, a precedence. If regulatory frameworks are made absolutely watertight, they might suffocate rather than stimulate growth and a balance has to be achieved.

But that is not to say regulators and authorities prefer a more hands-off approach. One way to minimise the deliberate flouting of corporate governance standards is to build up a credible deterrent with various bodies ranging from the SGX, the Monetary Authority of Singapore, the Accounting and Corporate Regulatory Authority, the Commercial Affairs Department and even professional associations such as the Law Society of Singapore, Association of Banks in Singapore, Institute of Valuers and Appraisers Singapore (IVAS) and Singapore Institute of Surveyors and Valuers (SISV). While these measures may have arrive too late for investors who were burnt by S-chips, the least this ecosystem can do is to minimise future damage.

We highlight three notable S-chip episodes covered by The Edge Singapore over the years.

Midas turns from golden touch to train wreck

In a very visible way, Midas Holdings was different from most S-chips. While its single largest shareholder and chairman Chen Wei Ping was based in China, CEO Patrick Chew, the poster boy of the company, was a Singaporean.

Making aluminum parts for China’s rapidly expanding high-speed rail system, Midas regularly announced it had bagged another new delivery order worth hundreds of millions of RMB. Soon, it became a darling of the investment community and the media and even had won a slew of corporate transparency awards to show off.

In 2011, a fatal railway accident near Wenzhou threw open questions regarding the safety of China’s high-speed rail system and doused overall enthusiasm for all rail-related stocks. Yet, a few analysts remained bullish on Midas even as it remained stubbornly undervalued.

In an interview with The Edge Singapore (Issue 776, April 24, 2017) Chew even expressed optimism that Midas could get a piece of the action of the KL-Singapore high-speed rail project. “We work with all these global giants, and hopefully this contract will come soon,” Chew said then, referring to the likes of Alstom and Siemens.

Within a year, things began to unravel for Midas though. On Jan 3, 2018, the company announced an RMB2.7 billion contract, seemingly signalling that all was well with the company. But on Feb 3, Midas shocked the market with disclosures that its China-based operating subsidiaries had taken out loans that the Singapore-listed holding company was not aware of.

The same subsidiaries had also acted as guarantors for loans taken out by chairman Chen’s nephew. Only after creditors in China went to court to try and claim back some RMB452.2 million and the assets belonging to the subsidiaries that were frozen by the courts, was it revealed that CEO Chew was also one of the guarantors for the loans. He denied and resigned straight after.

In a rare move, SGX RegCo stripped chairman Chen and another Midas director Ma Ming Zhang from their board appointments, citing immediate and serious concerns about the suitability of the two individuals to continue in their appointments. The remaining members of the board, including former cabinet minister Chan Soo Sen, tried to salvage the situation but eventually, the company was put in liquidation.

In a Sept 1 joint response, the Accounting and Corporate Regulatory Authority, the Commercial Affairs Department and the Monetary Authority of Singapore said the joint investigations into Midas are at an advanced stage. They noted that the transactions under scrutiny occurred in China and many of the suspects and witnesses are based overseas. “We have reached out to the relevant overseas authorities for assistance. We are currently working closely with the Attorney-General’s Chambers to review the available evidence,” the agencies say.

Shoemaker China Hongxing kicks shareholders in the face

Sports shoemaker China Hongxing, which was listed in 2005, played well into the consumption story of China’s increasingly affluent middle class, attracting even Western fund houses to take up substantial positions.

However, as the years went by, investors began to lose patience with the inaction of the company on its cash position, which as at Sept 2009, purportedly stood at nearly RMB 3 billion, equivalent to 30% of the company’s then market value of $462 million. It did not undertake buybacks and distributed only a pittance of an interim dividend of one RMB cent per share, which works out to RMB28 million in total.

Evidently, the issue over the idle cash pile had been gnawing at the investment community for months. In April 2009, when the cash pile was already at RMB1.9 billion, The Edge Singapore posed the same question to then CEO Wu Rongzhao. “I think it is necessary to keep large cash reserves so that the company can deal with any economic situation,” says Wu.

In The Edge Singapore (Issue 411, March 8, 2010), Wu had seemingly decided to do something to address the issue. He announced plans to spend RMB1.1 billion to expand its distribution channels and to ramp up its apparels business — adjacent to its core footwear business. An unnamed analyst told The Edge Singapore then that this RMB1.1 billion coincided with the jump in the company’s reported cash holdings a year ago in early 2009 when questions over the cash pile were raised. “It’s a little bit suspicious,” says the analyst.

Within a year, in February 2011, the company disclosed that EY, its newly-appointed auditor, had discovered discrepancies in the accounts of its subsidiaries. For seven years, minority shareholders were left in a lurch.

In September 2017, the family of former CEO Wu offered to acquire China Hongxing’s operating assets for RMB100 million. The assets were carried in the company’s books at RMB470.7 million. The bulk of the RMB100 million offer consisted of a waiver of debt owed to the Wu family. The actual cash to be given to other shareholders was just RMB28 million. This means a minority investor holding 1,000 shares in China Hongxing will get a grand total of $2.99 in cash.

The hapless trio of independent directors left to hold the fort for the past seven years had the thankless task of fronting a special general meeting held on March 28, 2018, to seek approval from upset shareholders.

They pointed out that if shareholders accepted the offer, they could still find a new business to inject into the empty shell. “Take whatever small money you have, treat it as a dividend. Your shares are still intact,” says Charles Chan Wai Meng. The proposal was approved narrowly.

Chan spoke too soon. Throughout 2019, China Hongxing tried to RTO with a gold miner but the deal fell through. The stock was finally delisted in October 2020.

‘Confessions’ from Oriental Century’s ex-CEO

Private education company Oriental Century was listed on June 1, 2006, at an IPO price of 35 cents. Riding on the presumption that education was a big business in China, the stock ran up to as high as $1.64 by February 2007, valuing the company at $272.5 million.

For two full years after its IPO, Oriental Century reported better earnings and cash holdings. However, in March 2009, the company announced that executive chairman and CEO Wang Yuean had “substantially inflated” its FY2008 balance sheet and that the former prosecutor in China’s navy had resigned.

As The Edge Singapore (Issue 381, Aug 3, 2009) had reported, Wang had siphoned off money to a privately-held company Baisheng Investment that actually operated the school. Oriental Century, the Singapore-listed entity, owns the physical premises of the school and the land and generates its revenue from the management fees from the school.

As Wang told our former associate editor Leu Siew Ying, he did so to help Baisheng Investment reduce its debt and not for personal gain. “I do not deny that I have wronged investors and shareholders and caused them losses but I didn’t take a cent for myself,” Wang said then. “That is why I called the special board meeting in March and I volunteered a report on the situation. I take responsibility and will do my best to make up for their losses.”

The company was delisted in May 2011. Wang’s name remains on SGX’s Directors’ and Executive Officers’ Watchlist, a public list of individuals “who have been reprimanded by SGX or who in the exchange’s opinion did not extend the necessary cooperation to the exchange.” Those on the list cannot be given new appointments in Singapore-listed entities before SGX’s “views and guidance” are sought.