The Regulation of VIP Room Contractors in Macau

Macau’s casino gaming revenue under the monopoly concessionaire the Sociedade de Turismo e Diversões de Macau S.A. (STDM) was U.S. $2.26 billion; gaming revenues subsequently grew to U.S. $13.57 billion in 2008. Throughout this period, the VIP segment has constituted about 70 percent of Macau’s total casino gaming revenue, as illustrated in Table 1. The economic significance of the VIP segment in Macau has naturally led to concern for the regulation of VIP room contractors there.

Source: Macau Gaming Inspection and Coordination Bureau (DICJ)

Note: All figures are in U.S.D. The exchange rate from Macau currency to U.S.D. is 8.0134-to-1.

This article will analyze the profitability of Macau’s VIP room contractors and provide an introduction to the existing regulations that govern the financial stability of VIP room contractors. It will also explore relevant regulations in Nevada, in the hope of identifying what lessons Macau might learn from this veteran gaming jurisdiction.

The History of VIP Rooms in Macau
The modern system of Macau’s VIP rooms can be dated to around 1984, when the monopoly concessionaire STDM informally outsourced some of its private VIP rooms to certain third parties who had social networks that allowed them to entice high-betting gamblers to an STDM casino premises. Different people were involved in bringing customers into the casino premises, including contractors who operated a VIP room in the casino premises and entered into agreements directly with the monopoly concessionaire; junket operators who worked for VIP contractors; and collaborators who worked with junket operators to bring high-betting gamblers to the VIP rooms. In fact, junket operators and their collaborators have also always offered many types of “value-added” services, including credit arrangement and collection, entertainment, and other recreational activities, and they earn commissions on their services offered.

Given that a significant number of premium players in Macau wish to remain anonymous or keep a low profile, they prefer private VIP rooms with just a few tables, where they can play without being seen. Historically, this meant that the VIP room contractors and junket operators could operate their businesses in a barely regulated market under a set of informal rules developed from the interactions between the VIP room contractors, the monopoly concessionaire and the casino patrons; this system prevailed in a relatively stable manner for two decades.

VIP Tables and Foreign Operators
With the passage of new gaming laws in 2001, the Macau Special Administrative Region (MSAR) government ultimately awarded six gaming concessions or sub-concessions between 2002 and 2005. These were awarded to Wynn Resorts (Macau) S.A., Galaxy Waldo, Sociedade de Jogos de Macau (SJM), Las Vegas Sands, MGM Grand Macau and Melco-PBL.

While the mass market in Macau would need some time to develop, all of the licensees would focus on the VIP segment, because it would ensure certain amounts of gaming revenues—as long as the operators had the extensive social networks needed to mobilize premium players to their property. This has led the Nevada-based licensees to target more VIP business and junket operators to ask for more commissions. Unlike separate private VIP rooms, like those found in the casino premises of local gaming operators, the VIP segment of foreign gaming licensees has been operated in reserved areas with a number of VIP tables.

Since this type of self-directed (non-junket) VIP table business deals directly with gaming patrons, it offers casinos much stronger margins because the win does not have to be shared with intermediaries, and because patrons cannot be easily channelled to another property by junket operators or their collaborators. Although casinos incur extra expenses in this type of business model, such as more marketing dollars spent on self-directed patrons, the expenses are much less than those required by junket operators and their collaborators. Therefore, the profitability of this type of self-directed (non-junket) VIP table business operated by foreign gaming licensees is be much higher in the absence of intermediaries. However, the crucial issue is whether casinos can develop the extensive social networks needed to mobilize premium players to generate cash flows in their property.

A close look at Table 2 reveals that the gross gaming revenue of VIP tables constitutes about 58 percent of total gross gaming revenue from the VIP segment for the six months ending June 30, 2009, in Macau. However, there has been extremely limited data to identify the extent of self-directed VIP table business, as opposed to the VIP tables operated by private contractors in foreign gaming franchisees in Macau.

Source: Macau Gaming Inspection and Coordination Bureau (DICJ)

Most of the VIP room contractors in Macau are associated with local gaming operators, such as SJM and Galaxy. The keen competition for premium players over the great number of VIP rooms, coupled with the economic downturn triggered by the global financial tsunami, has resulted in a sharp reduction in the number of VIP rooms—a drop of 51.75 percent over a two-year period, as displayed in Table 3.

Source: Macau Gaming Inspection and Coordination Bureau (DICJ)
*Through June 30. The author was unable to obtain data for the whole year.

* According to Article 11 (2b) of Law No.10/86/M of Boletim Oficial dated 22/09/1986.
** Wang, W. (2009). The junket system in Macau’s gaming industry.
*** Based on the model developed by Wang (2009) and that the commission paid to junket operators was 0.7 percent.
**** Based on the assumption that the revenue-sharing ratio between gaming licensees and VIP-room contractors has been 7:3 from 1986 to 2009.
***** What remains out of 100 percent goes to junket operators.

Table 4 reveals that since the introduction of the VIP segment in 1984, the percentage shares of both the Macau government and junket operators have increased remarkably, at the expense of gaming licensees and VIP room contractors. In 1986, the VIP room contractors could get about 15 percent of the gross gaming revenue, but in 2009 they could only get about 5 percent, a reduction of about two-thirds. With this narrow margin, the financial stability of VIP room contractors is likely to raise concerns, especially in the event that the contractors experience significant negative financial events that render them unable to pay patrons’ claims.

Current Regulations
Based upon the set of informal rules developed from the interactions between concessionaire, VIP room contractors, junket operators and patrons, from a legal viewpoint, VIP room contractors historically had private contractual obligations primarily to the monopoly concessionaire. For better regulation of the VIP room contractors and junket operators, the MSAR government issued Administrative Regulation No.6/2002 on April 1, 2002, and its annex on Aug. 10, 2009. The regulation has given the Macau Gaming Inspection and Coordination Bureau (DICJ) the authority to examine the qualifications of and grant licenses to applicants who can satisfy the findings of suitability in accordance with Article 14.

The MSAR government may request a risk assessment report on the licensee of the VIP room or shareholders or directors who hold 5 percent or more of the capital stock of the company. Such risk assessment reports must be ratified by Macau’s Secretary for Economy and Finance (the supervising authority of DICJ) in accordance with the provisions of Article 13. If there are changes in the organizational structure, the board of directors or the management board of the VIP rooms, the licensee should comply with the provisions of Article 19. The licensee needs to ensure that all of the above changes are reported to the DICJ for ratification.

Gaming licensees are legally required to help monitor VIP room contractors in Macau. The licensees must comply with Article 24 and submit their original contract with the VIP room contractors to the DICJ. Should the contractors owe debts of MOP $1 million or more to the gaming licensees, the licensees should notify the DICJ. The gaming licensees are also legally required to notify the DICJ of anything that might affect the solvency of the contractors. The licensees are also required to monitor the activities of contractors in the fulfillment of their legal, statutory or contractual obligations. In the event of non-compliance, the licensees must comply with Article 30 and report to the DICJ.

So it appears that the MSAR government has been adopting a rather passive approach to its regulation of the VIP room contractors. Only in the event of changes in the organizational structure, board of directors or management board of the VIP room contractors are the contractors required to report to the DICJ. Although the DICJ can request risk assessment reports at any time to better evaluate the financial stability of the VIP room contractors, it would probably only request such reports when there is strong suspicion that something has gone haywire. These kinds of reactive measures may result in a closer supervision and regulation of the contractors only when the interests of certain parties, including gaming patrons, have already been infringed.

Other than requiring the VIP room contractors to deal directly with the DICJ for the application of licenses and notification of changes in their organizational structure, the DICJ appears to depend on the gaming licensees to notify them whatever necessary with regard to the contractors. Although the VIP rooms are on the casino premises and gaming licensees can keep close track of the amount of chips sold to the contractors for patrons to wage their bets with, the licensees may not clearly know about the daily operations of the VIP rooms, including the uncollectibility of gambling debts or the exploitation of weaknesses in the internal control environment by corrupt employees. Viewed from this perspective, with Macau’s gaming liberalization since 2001, the approach adopted by the DICJ still appears to be reminiscent of its previous regulatory mechanism targeted at the monopoly concessionaire for effective regulation of the VIP room contractors and junket operators, despite the fact that the end of the gaming monopoly system has been accompanied by growing numbers of junket operators and increasing complexity in the VIP segment.

Nevada Regulations
Major leading jurisdictions with legalized casino gambling have incorporated criteria for assessing the financial viability of both new casino applicants and existing licensees. Nevada, the largest casino market in the United States, was the initial jurisdiction that established such criteria for financial stability. Other newer gaming jurisdictions in the U.S. have adopted regulations similar to those in Nevada. In fact, Nevada is widely looked upon as one of the benchmark models for successful gaming regulation.

The Nevada Revised Statutes (NRS 463) give the Nevada Gaming Control Board fairly broad authority in monitoring the financial practices of licensees (NRS 463.156 to NRS 463.1592), and casino licensees are legally required to present their audited financial statements. The statutes provide for the appointment of a supervisor to manage and control a gaming establishment when the licensees are determined to be unsuitable or financially unstable.

The Nevada Gaming Control Board undertakes financial statement analysis primarily on an annual basis, using the audited/reviewed financial statements. Regulation 6.080 specifies which licensees are required to have audited or reviewed financial statements. For statistical purposes, licensees are also required to present their standard financial statements, as required by Regulation 6.070.

The Nevada Gaming Control Board looks for such indicators as net income, cash flows and current ratios. Net losses or a poor current ratio are factors that play into the risk assessment for each licensee. Should the board have concerns over a given licensee, it may require that licensee to supply monthly (unaudited) statements and bankroll computations weekly or monthly. Should a licensee offer a payout where the payments to the patrons are made over time, the licensee must comply with the provisions of Regulation 5.115, which ensures that the patron’s ability to collect winnings is not adversely affected if the licensee should fail financially or go out of business. Moreover, the board may also telephone or visit company officials to discuss their recent developments.

Lessons for Macau
Given that financial statement analysis is one of the major criteria for assessing financial stability of casinos in Nevada, the Gaming Control Board requires all casino licensees to prepare financial statements of the licensee’s establishment for each business year. Depending on the amount of gross gaming revenue, casino licensees with annual gross gaming revenue of U.S. $5.639 million (approx. MOP $45.2 million) or more must engage an independent accountant to review their financial statements in accordance with the statements on standards for accounting and review services, while licensees with annual gross revenue of U.S. $11.277 million (approx. MOP $90.4 million) must engage an independent accountant to audit the financial statements in accordance with the generally accepted auditing standards (Regulation 6.080).

Table 5 indicates that the financial statement requirements are applicable to casinos in Nevada that have average annual gross gaming revenue in excess of MOP $300 million. Although it may be argued that the financial statement requirement applies to casino licensees instead of VIP room contractors, a close look at Table 6 reveals that the estimated average annual gross gaming revenue per VIP room in Macau as a result of the consolidation and integration of VIP rooms in recent years is close to MOP $300 million, a level comparable to that of an average casino in Nevada.

Source: Nevada Gaming Abstract
* Refers to casinos with gross gaming revenues in excess of U.S. $1 million.
** The exchange rate for Macau currency to U.S.D. is 8.0134-to-1.
*** Net Income as a percentage of total revenue of casinos with gross gaming revenue in excess of U.S. $1 million.

Given that VIP room contractors in Macau need junket operators and their collaborators to bring in high-betting gamblers to their VIP rooms, their major expenses are commissions paid to junket operators and their collaborators. Compared to an average casino in Nevada, which requires high capital outlays, payroll expenses and equipment rentals or leases, the expenditure items and amounts of VIP room contractors is fewer and less, apart from the commissions currently capped at 1.25 percent paid to junket operators. Following this line of thought, the appointment of auditors or accountants to prepare financial statements should not be very financially onerous for VIP room contractors in Macau, unless their net income percentage lags far behind that of casinos in Nevada as indicated in Table 5.

Lessons from Nevada’s experience indicate that a financial statement analysis, such as the evaluation of income statement for positive earnings, the current ratio from the balance sheet for liquidity, and the evaluation of cash flows to meet current operating commitments and bank loans, can provide relevant information for additional assurances of the financial stability of gaming companies. With such a self-reporting mechanism to complement the information provided by gaming licensees, the DICJ would have a better understanding of the operations of the VIP rooms. By attaining a more informed, continuous assessment of the financial stability of the VIP rooms, it could offer better protection to gaming patrons in Macau.

Source: Macau Gaming Inspection and Coordination Bureau (DICJ)
* The author was unable to obtain data for the second half of the years 2007 to 2009.
** Obtained by multiplying the average monthly revenue per VIP room by 12.

Given that the number of VIP rooms has been reduced by about one-half in recent years, the VIP room contractors that have survived in the market are likely to have strong capabilities and rich resources. Based upon these factors, the remaining contractors are better equipped to deal with change, such as the appointment of auditors to prepare financial statements that incorporate information from the gaming licensees to provide regulators additional assurances about the financial stability of VIP rooms.

Apart from this, given that fraud and scams can come in all shapes and sizes in the VIP rooms, the appointment of independent auditors may also be used to report on the effectiveness and adequacy of the contractor’s internal control systems, especially when fraud is committed by insiders. Not only can this rectify any inadequacies in the contractor’s control systems and ensure that the financial reporting process produces more reliable information, but it can also strengthen the balance between the VIP room’s expenses and income.

Given that the VIP business is mobile by nature and that the emergence of multiple gaming jurisdictions in Asia may pose expansion opportunities, VIP room contractors in Macau need to meet the requirements of the jurisdictions concerned to be licensable there. In this respect, the experience gained from the preparation of financial statements may also assist the VIP room contractors to better meet the statutory requirements of other gaming jurisdictions.

Although the financial statement analysis serving Nevada may not perfectly serve Macau, it is crucial for Macau regulators to consider the adoption of appropriate self-reporting measures to complement the information reported by the gaming licensees and to better monitor the financial stability of VIP rooms. Such measures might not only offer greater protection to patrons, but also help convert the industry’s somewhat seedy image to one that is more socially acceptable. In this way, the VIP room contractors will be able to better meet the requirements of other gaming jurisdictions and be better prepared to tap new markets for the sustainable development of the industry.

Final Thoughts
Macau’s existing regulatory mechanism for the VIP rooms, which is reminiscent of its previous regulatory measures targeted at the monopoly concessionaire, is insufficient. There exists a strong need for a systems perspective for more effective gaming regulation. Given the economic significance and increasing complexity of the VIP segment, the current heavy reliance on the gaming licensees to provide information about the contractors and junket operators is inadequate. There lacks a self-reporting mechanism to proactively monitor the financial stability of VIP rooms.

Lessons from Nevada demonstrate the use of financial statement analysis to monitor and continuously assess the financial conditions of casinos. Given that the gross gaming revenue of an average VIP room in Macau is comparable to that of an average casino in Nevada, the appointment of auditors or accountants to prepare financial statement should be affordable and can provide incremental information for additional assurances of the financial stability of the VIP rooms. Moreover, such auditors can help rectify any inadequacies in the internal control system.

Although the financial statement analysis serving Nevada may not perfectly serve Macau, it is crucial that Macau regulators consider appropriate self-reporting measures to complement the information from the gaming licensees and to better monitor the financial stability of the VIP rooms. In this way, the VIP room contractors will be in better alignment with the requirements of other gaming jurisdictions to tap the emerging markets in the future.

Footnotes
1 Wang, W. and Eadington, W. R. (2008). The VIP-Room contractual system and Macau’s traditional casino industry. China: An International Journal, 6-2, 1-24.
2 Siu Lam, C. and Eadington, W.R. (2009). Lessons from the Nevada model on Macau’s junket operations. Gaming Law Review and Economics, 13(1): 6-22.
3 Eadington W. R. and Siu, R. C. S. (2007). Between law and custom — Examining the interaction between legislative change and the evolution of Macau’s industry. International Gambling Studies, 7(1), 1-28.
4 Bible, L. and Mills, J. (2001). Incorporating cash flow analysis with traditional analysis for evaluating casino financial stability. International Gambling Studies, 1(1), 150-173.
5 Bible and Mills, 2001
6 Based on an interview with the head of the Audit Division of the Nevada Gaming Control Board, May 2009.
7 UBS (2008). Macau Gaming: Trips to the Strip.

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