Gs Asset Management

GS ASSET MANAGEMENT

Introduction

“Hello……”

“Sawadee[1]”

“Hello. This Peter Lim[2]’s from BEB[3]. May I speak to Mr Kaaampool Adsasahfdkj”

Silence.

“Kaaampoool Adsavlikaii…”

“Ring!Ring!”

“Sawadee”

“Kammpul Adsav….?”

Click.

Not being able to pronounce Thai names and not being able to get hold of the person he needed to speak with were the least of Peter Lim’s problems. He had other more pressing issues that needed to be resolved quickly. A week ago, his boss Hans Schmidt had handed him a disorganized folder with financial information on an asset management company called GS Asset Management (GSAM) in Thailand. He had asked Peter to get in touch with the CFO and the CEO of the company to get more information and prepare a proposal recommending if BEB should buy a 25% stake in the company and how much they should pay for it. The proposal would be sent to the bank's head office in Europe and a decision would be made on the basis of his analysis.

The task would have been relatively easy was it not mid-January 1998. The Asian Financial Crisis that started about 6 months earlier had created and environment of uncertainty, volatility, panic and risk. It appeared to be a good time to buy, the markets had crashed, the Thai Baht was "cheap" and regulators in East Asian countries were opening their once closed or partially opened doors to foreign investors in a bid to save their ailing companies. But what if the markets had not bottomed out? What if BEB bought a stake and in 3 years Thailand decided it did not like foreign ownership of local assets? What if the Baht depreciated further? What if this was just a "bad" company up for sale? Was there "value" here?

The Asian Crisis

South East Asian countries experienced tremendous growth during the last two decades. This progress has positioned these countries as the example for other emerging markets. Moreover, the world community calls them the “Asian Tigers” for the success they have achieved. After all this, most of South East Asian countries have transformed their economies into a powerhouse of exporting products, most of them in the technology arena. Consequently, they have accomplished great result in terms of reducing poverty, education and growth.

Despite all this incredible remarks, the region suffered one of the most difficult crises in mid 1997. The financial crisis impacted the whole region and all the currencies in the region were devalued as investors started pulling out money from the region. At the beginning, Central Banks handled most of the demand by reducing their level of international currencies in order to maintain the exchange rate, which was pegged to the US dollar and some other currencies. However, they could not sustain this policy and allowed their currencies to fluctuate. This environment generated uncertainty among international investors not only in South East Asia, but also in other emerging markets. In addition, it created a tremendous concern about the real potential of those economies and questioned the prestige obtained in previous years in the investment community. The “Asian Miracle” was over.

In the middle of this storm, Thailand was severely affected (Refer to Exhibit 1 for Thailand’s Economic Indicators after the Crisis). In January 1997, The Central Bank of Thailand started to see the first signs of pressure on the currency as Thailand released poor fiscal and export numbers. In addition, a downturn in the real estate affected many developers as well as the manufacturing sector and both sectors began to default on interest payments as they carried large amount of US dollar debt.

This situation started to affect the financial stability of the banking system and the government announced a plan to buy real estate loans from finance companies (USD 3.9 billion). After that, the government continued applying restrictions in order to defend their currency. However, the level of international reserves diminished - the Bank of Thailand sold forward almost the same amount of the actual reserves. By July 2, the government allowed the Baht to float, losing 15% of its value. In the beginning, people reacted positively; for example, the stock market went up. However, this optimism vanished as the investment community realized that the Bank of Thailand did not have enough reserves to provide any support to the currency. Consequently, the Baht continued to lose ground as did the stock market.

This entire situation created a difficult situation for the banking system and the government, which had to apply for IMF support. The government also created a new organization, Financial Restructuring Authority (FRA) to take care of the financial institutions with liquidity and solvency problems. By August, 58 financial institutions were taken over by the FRA. In addition, the Bank of Thailand strengthened the rules governing the financial sector in order to revitalize the trust in the remaining institutions. It is important to mention that the crisis was partially explained by the lack of regulations to restrict banks exposure to highly leveraged companies as well as concentrated lending in any specific industry (e.g. most of the loans were given to the real estate sector leading to a “property bubble”).

IMF Intervention

The IMF’s most important objective is to safeguard the stability of the international monetary system and to help restore confidence in the economies affected by a crisis. The Mexican Crisis taught that the speed in which the help is provided is as important as the help itself. Hence, the Asian countries were given hope not to bankrupt during the crisis thanks to the quick IMF help. Among the objectives to help the most affected Asian countries, the IMF would provide financial resources and spearheading the mobilization of additional funds from other multilateral and bilateral support of these reforms.

Among the new reforms the IMF supported a temporary tightening of the monetary policy to stem exchange rate depreciation, correct the failures and weaknesses of the financial system by implement new regulations and remove failures of the economy such as monopolies and trade barriers. One of the major IMF objectives was to find a balance between the tightness and protection of the social sector safety net. The IMF helped was deeply criticized, since they hurt the whole growth of the economies creating social and political problems.

With regards to the financial sector, the IMF supported the closure of unviable financial institutions, with associated write down of shareholders’ capital, capitalization of viable institutions, close supervision of weak institutions and increased foreign participation in the domestic financial system.

Additional measures taken by the IMF in response to the crises were the acceleration of procedures in terms of approval time and access, the creation of the supplemental Reserve Facility (SRF), increase coordination among other international financial institutions such as the World Bank, Asian development Bank etc. Another important objective was to recover the confidence of the international community by making public letters of intent on the IMF website so that details of the programs were available to all interested parties.

After all, the IMF involvement helped the countries to promote the return of international investment, since they knew that the IMF had enough funds to support the economies as well as they would not let the "tigers" go down again. For this reason, the IMF promoted and demanded from the countries that they implement big structural reforms. Part of the reforms were to change the ownership restrictions that did not allow foreign banks to own more than 25% of a financial institution.

Thailand

Thailand is unique in Southeast Asia in that the country has never been a dependency of another nation. Another notable difference is that Thai women, unlike women of some other East Asian countries, are active in business affairs, the professions, and the arts.[4]

Thai, a member of the Tai language family, is the chief language. Four regional dialects are in use. Lao, Chinese, Malay, and Mon-Khmer are also spoken in Thailand. English is taught in secondary schools and colleges and is also used in commerce and government.[5]

A revolution in 1932 transformed Thailand into a constitutional monarchy after centuries of rule by absolute monarchs, but until recently the country was largely controlled by the military. Although King Phumiphon Adunyadet has little direct power, he exercises considerable influence on political leaders. The nation’s 15th constitution took effect in 1991, although it has since been amended significantly, notably in 1995.[6]

After elections in July 1988, Chatichai Choonhavan became Prime Minister. A military junta ousted him in February 1991 and installed an interim civilian government. After pro-military parties won the elections of March 1992, demonstrations in Bangkok calling for democratic reforms were violently suppressed. New elections in September resulted in another coalition government, with a veteran politician, Chuan Leekpai, as Prime Minister. In February 1995 the government passed a sweeping package that amended almost all the articles of the 1991 constitution. The pro-democracy changes included lowering the voting age from 20 to 18 years and changing the number of representatives from a fixed number to one based on population. In addition, Thai citizens were guaranteed due process and equal justice under the law.

In May 1995 the Chuan Leekpai government collapsed amid accusations of wrongdoing in a government land reform project. In July 1995, after new elections, the leader of Chart Thai (Thai Nation Party), Banharn Silpa-archa, became Prime Minister. Less than a year into Silpa-archa’s government, accusations emerged of corruption among his appointees, prompting investigation into bribes, abuse of authority, and questionable bank loans. In 1996, after a no confidence debate in parliament, Silpa-archa resigned as Prime Minister. New elections secured a slim victory for the New Aspiration Party (NAP); its leader Chavalit Yongchaiyudh became the next Thai Prime Minister.[7] After the crisis, Democrat Party leader Chuan Leekpai was nominated on 9/11/1997 as the next prime minister by Parliament President Wan Mohammad Noor Matha on the strength of support he received from 210 MPs, a clear majority in the House of Representatives.

Financial Services Restructuring Authority

As part of the plan to face the crisis, the Thai government established the Financial Services Restructuring Authority (FRA) which main objective was to manage and eventually sell the assets from those institutions that were unable to continue operations. In October 1997, the FRA decided to close 56 from 58 finance companies and started a review of their assets in order to form a package and analyze the best way to bring them to the market.

“We are looking at what assets to bring to the market and how we should package them and how we can organize the bidding process” said Mr. Vicharat Vichit Vadakan secretary general of the FRA

This was a situation that the BEB had to consider given the fact that other stakes of the GSAM may be sold. A 40% stake in GSAM was “frozen” due to the operations of GCN Finance and GF Finance being suspended. This situation could generate two possible outcomes. On one hand, the BEB would be able to compete for this stake of the company if regulations that limited the foreign investment stake were modified. On the other hand, BEB participation in the capital of GSAM would be minor if the government decided to keep the regulations unchanged or if they were unable to purchase that stake. If they failed, a mere 25% stake would not give them control of the company.

Big European Bank

Big European Bank ("BEB") is one of the largest and most global banks in the world. In the early 1990s, they bought European Investment Bank ("EIB") to complement their commercial banking business. BEB hoped to establish itself as universal bank, a "one-stop" shop bank providing an array of financial services. Following the trend of other major global players like Chase Manhattan, BEB was moving from being a commercial bank to a universal bank. BEB was hence growing businesses such as equity underwriting, advisory services, asset management among others.

BEB had a presence in Asia since for over a hundred years though they grew their presence as a commercial bank mostly in the last three decades. In order to grow their fee-based businesses, BEB was hoping to expand it asset management business in Asia by growing internally and by buying local asset management companies. Though BEB was one of Europe's largest asset managers[8], their presence in Asia was nominal - with one office based in Singapore and less than 1 billion USD under management. The Asian Financial Crisis presented the perfect opportunity to buy some “good” companies at discounted prices and expand asset management retail business.

BEB was given the chance to exclusively consider buying a 25% stake in GSAM by EIB. Though EIB was owned by BEB, their asset management divisions were run separately. The management of BEB and EIB decided to rationalize the two businesses and reduce the overlap and unnecessary competition between the two divisions. As a result, BEB would concentrate on the retail aspect of the business and EIB’s asset management division would serve the institutional clients. According to the EIB asset management division head in Singapore, Citicapital, one of the investors in GSAM with a 10% stake in GSAM had offered to pay 1 million USD for their 25% stake. However, before EIB offered its 25% in GSAM to other potential buyers, they gave BEB’s asset management division based in Singapore a chance to purchase the stake for 1 million USD.

The Asset Management Industry in Thailand[9]

In most Asian countries, the asset management business is still in its infancy. A common feature before the crisis was that very few countries in Asia allowed majority or 100% ownership by foreigners of asset management businesses. Hence, foreigners have small stakes and hence influence in this industry. In the early 1990s as the Asian population became wealthier it was perceived that this business was set to grow dramatically.

Thailand experienced rapid growth in its asset management business between 1992 and 1995. Before 1992, there was one state-owned company that offered investment funds in Thailand. In 1992, the Bank of Thailand decided to grow the industry and awarded several licenses. The licenses stipulated that a Thai commercial bank had to be the senior partner, but they also required international expertise as a requirement to get the license.

By April 1992, 8 licenses had been awarded and that resulted in the phenomenal growth that resulted in the funds managed to rise from 1.5 billion USD to 8 billion USD in two years. Over that 2-year period, the number of funds rose from 12 to more than 70. See Exhibit 2 on the asset management business in Thailand.

A large part of the funds offered in Thailand have been close ended[10]. Though towards the end of 1994, some companies offered a few opened-ended funds. By 1996, the Securities and Exchange Commission (SEC) of Thailand allowed insurance companies, and not just commercial banks to distribute mutual funds. They continued to increase the degree of foreign participation, as the industry required foreign expertise in technology and investment management to continue to grow.

However, according to current Thai law, a foreign stake in shareholding cannot exceed 25% of capital of the fund management company which has been established for less than 5 years. GSAM was established more than 5 years ago, so the foreign stake can be increased to 49%. However, major reconstruction is expected in the financial sector and the government is expected to lift the foreign ownership limits for banks and financial companies. Foreign shareholders will be allowed to invest in financial companies and have ownership of more than fifty percent for up to ten years. After the ten years an increase of fund must be sold out to Thai shareholders until the foreign shareholders are reduced to less than 50%[11]

In spite of new companies being formed and the business growing, at the end of 1996, against a backdrop of a worsening economic climate, the outlook for owners of Thai-equity funds was regarded as bleak in the coming year.

That outlook was probably too “optimistic” considering what happened in July 1997. The asset management industry was critically affected by the financial crisis. Panic redemptions were rampant for open ended funds due to poor economic fundamentals, the market crash and poor liquidity. Several fixed income funds were liquidated. Only six new funds were launched from the beginning of the third quarter of the year till September 1997, showing only a 6.89% success rate based on projected size. The market for new products had “disappeared”. Exhibit 3 shows the Thai mutual fund industry during the economic crisis and an article from The Nation, a local newspaper. The marketing director of GSAM admitted in local Thai newspaper that fund management was becoming more difficult.