Corporate restructuring in East Asia

Corporate restructuring in East Asia:
what has been achieved in the years
following the 1997 financial crisis?

Koji Hayashi
Partner
Abe Ikubo & Katayama

In the summer of 1997, the financial crisis that had been triggered by the steep fall of the Thai baht swiftly and uncontrollably spilt over into other East Asian countries, most seriously Indonesia, the Republic of Korea and Malaysia, and thereafter into other regions further afield (including Russia and some Latin American countries). Up until this time, East Asian companies had raised large amounts of money by borrowing, putting this funding into low-margin or loss-making business activities and markets. Against such a backdrop, the currency crisis almost automatically ran into an economic crisis when these highly-leveraged companies found themselves unable to make repayments – in turn deteriorating their lenders' own financial standing.

While the Asian financial crisis had limited direct impact on Japan, it came at a time when Japan was facing its own financial crisis following the sudden collapse of a number of major financial firms. Therefore, instead of being able to play any major part in defusing the wider economic situation, it was tied up in maintaining confidence in the yen and its own financial system. The People's Republic of China was, at that stage, still under the protectionist control of its government and this ensured that it was, to a substantial degree, protected from the escalating turbulence experienced elsewhere in the region. Indeed, in some quarters this was deemed ample for the country’s trademark economic isolationism.

Responses to the crisis
The initial reaction in most of the crisis-affected countries was to attempt to fix problems in the corporate sector by providing strong government support to the domestic banks (through recapitalisation, the purchase of non-performing loans (NPLs) and other support measures). As a matter of course, however, these countries soon understood that they needed not only banking industry reform, but also the introduction of more fundamental measures designed to revitalise the corporate sector. Thus, corporate restructuring was justifiably recognised as key to the recovery process and long-term corporate viability and stability of each country. Although it is not easy to abstract one common trend from the various frameworks that the East Asian countries actually implemented for their corporate restructurings after the 1997 crisis, it is probably accurate to categorise them into the following basic types:

• out-of-court workouts;

• judicial regimes (court-supervised restructuring and bankruptcy); and

• government-led restructuring processes with the involvement of public asset management companies (AMCs), state-owned banks, or other public institutions.

In most countries, official institutions were often closely involved in whatever process was adopted in a bid to ensure that any adverse outcomes did not risk destabilising what were already vulnerable state-level economies and social systems.

Judicial regimes (court-supervised restructuring and bankruptcy)
The adaptability of each country’s legal system proved to be an important determining factor in establishing an effective framework for out-of-court restructuring. The fact that the frameworks for out-of-court workouts have been more effective in the Republic of Korea and Malaysia than in Indonesia and Thailand is closely linked to differences in their respective positions on creditors’ rights and bankruptcy regimes.

In the Republic of Korea, where a credible bankruptcy regime was already in place, major shareholders were willing to cooperate in the restructuring process by accepting severe dilutions of their shareholdings. This mindset helped to promote an acceptance of wide-scale corporate restructurings which played a crucial role in reshaping the Korean economy. Instead of the large companies (or chaebol) being protected from restructuring (for fear of introducing social ferment or systemic risk), creditors were prepared to force many of the largest conglomerates (including Daewoo) into bankruptcy – proving that no company should be considered ‘too big to fail’. The same scenario played out in Malaysia, where the bankruptcy system also proved to be an effective driving force in promoting corporate restructurings.

In other crisis-affected countries, like Thailand and Indonesia, for example, where creditors were traditionally constrained from ousting the incumbent owners of troubled companies, the bankruptcy system proved to be a less effective tool for corporate restructuring (at one stage NPLs reportedly accounted for 50 per cent of all loans in Thailand). However, steps have been taken towards improving these countries’ judicial systems – and with some success. Thailand has now introduced a reorganisation procedure into its bankruptcy law, and in 1998 Indonesia reformed its own bankruptcy law setting up special commercial courts to accommodate corporate restructuring cases.

Out-of-court workouts
For most countries in the region the basic model for corporate restructuring has been an out-of-court workout process modelled on the London approach, or a derivation of it (as codified by INSOL) – the Principles for a Global Approach to Multi-Creditor Workouts. The Republic of Korea, Indonesia, Thailand and Malaysia all adopted this approach, with some local variations (often tested out on a trial-and-error basis), and all have been turning their attention to the same key factors (eg introducing powers compelling the parties – both creditors and debtors – to participate in the process, rules and penalties ensuring speedy, rational and effective procedures for consensus-building, capability to enforce agreements among the majority of creditors over the dissentient minority creditors and effective sanctions where debtors fail to fulfil their agreements).

Among the crisis-affected countries, the Republic of Korea has established probably the most well-equipped framework, including the introduction of a set of codified rules that meet all of the above standards. Although most countries seem to be aware of the key factors underpinning effective corporate restructurings, not all of them have finished off the task of establishing strong frameworks for out-of-court workouts. The general view so far is that the systems in Thailand and Malaysia for out-of-court restructurings are relatively strong and reliable, while Indonesia’s remains comparatively weak and unreliable (in Indonesia, it is still difficult to avoid a creditor’s unreasonable refusal to sign a restructuring agreement, along with any unjust delays in advancing the process).

Overall, however, when compared to the out-of-court workout practices in the United States or the United Kingdom, the levels of actual implementation in the Republic of Korea, Malaysia, Indonesia and Thailand do not appear to be satisfactory – regardless of their well-drafted schemes. One of the characteristics of these Asian versions of the London approach is a greater focus on the government’s role (which is much more substantial and formalised than what the Bank of England did in the early years of the London approach). This means that the effectiveness of each of these frameworks is ultimately dependent on the government’s enthusiasm for resolving the country’s corporate restructuring problems. As long as most of the cases with which they have to deal involve foreign parties from America, Western Europe or Japan as creditors, investors or other parties, it will be necessary to inject more practicality, effectiveness, predictability and visibility into the process.

For the most part, out-of-court workouts are a time-consuming and laborious process, in which the parties must arrive at a settlement through a series of negotiations, so this approach tends to be used only for large-scale corporate restructurings. Nevertheless, in Thailand and Indonesia, the large number of corporate restructurings for small and medium-sized companies are still handled through the out-of-court workout process in spite of their recent efforts to improve bankruptcy regimes and court systems.

Government-led restructuring processes
The Republic of Korea, Indonesia, Malaysia and Thailand now all have publicly-owned asset management companies (AMCs), which have so far purchased more than half of all the NPLS in these countries. Such buy-up of bad loans was made with the primary aim of rehabilitating the banking sectors. As a result of this necessary step, governments have often become one of the biggest creditors in restructuring cases, thereby putting themselves in a position where they inevitably have had to play a decisive role in restructuring their respective corporate sectors. This is even more the case when governments give additional powers to AMCs to propel the restructuring process more vigorously.

Practical examples from many countries, however, show that AMCs are often incapable of making full use of their powers to carry out their duties. They frequently become a cause of delay in the process, obstructing optimal outcomes for various reasons, including poor skillsets and political factors. To remedy this situation, governments should be directing AMCs to concentrate on quick disposals of companies or viable businesses to the private sector (where there is typically wider experience of complex financial and operational restructuring).

Lack of operational restructuring
Recent statistics indicate that the speed with which NPLs are getting resolved has been rapidly decreasing in individual countries, particularly in Thailand and Malaysia, over the last few years as compared with the first few years following the crisis. One reason for this could be that recent economic conditions in the region have afforded countries, and their inhabitants, some breathing space. However, a more fundamental reason is, once they are resolved through out-of-court workouts or other restructuring measures, a substantial proportion of NPLs have reverted to their non-performing status, and that new non-performing loans have been generated.

It is now clear that, in addition to financial restructuring, more operational restructuring is needed. The bulk of the restructuring measures intended to downsize excessively leveraged companies were completed in the early days of the crisis. These were achieved by disposing of excess facilities and other non-core assets, cutting back work forces, labour cost savings and other streamlining efforts. It is clear, however, that the profitability of East Asian companies has not improved that much, aside from the short-term improvements that followed what were often knee-jerk cost reduction initiatives. And while profitability can, of course, also be affected by a range of external factors (including market trends and the global and/or regional economic environment), it is essential for sustainable growth across the region that East Asian companies persevere with their efforts to boost performance. In this regard, all these countries might usefully be encouraged to seek more advice from international turnaround specialists who specialise in the operational restructuring of troubled companies. Experience has shown that the capabilities of financial institutions and governmental bodies in this area are, on their own, insufficient in this respect.