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10th SEC Thailand Anniversary Seminar: How Can NBFIs Play a Greater Role in a Bankbased Economy


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Title: 10th SEC Thailand Anniversary Seminar: How Can NBFIs Play a Greater Role in a Bankbased Economy

10th SEC Thailand Anniversary Seminar How Can
NBFIs Play a Greater Role in a Bank-based Economy
  • The Future of Capital Market Development In East
    and South East Asia
  • Andrew Sheng
  • Chairman
  • Securities and Futures Commission
  • Hong Kong

  • Where are our capital markets today?
  • How has Asian growth strategy shaped our
    financial systems?
  • How have our financial markets performed their
    four key functions of resource allocation, price
    discovery, risk management corporate
  • What are implications of global financial
    landscape changes on Asian financial markets?
  • What conditions are required for regional

Asian Contrasts
  • Asia - More than half of global population, but
    only 1/3 of global GDP and 1/4 of world exports ,
    but only 16 of global market cap 7 ex-Japan
  • High savings - FX reserves exceed US1 trillion,
    but still importing capital
  • Asia accounts for 25 of global FX trading US
    19 and EU 53
  • Insufficient internal growth engines, still
    awaiting growth from US and Europe

Asia in Global Economy (GDP, of world, 2001)

PPP-GDP Exports Population Weighting
Japan 7.3 6.0 2.1 9.38 4 Tigers 3.3 9.4 1.3 1
.82 China 12.1 4.0 21.0 0.26
India 4.7 0.9 16.7 0.12 Other
Asia 5.4 4.5 14.5 1.57 Total ASIA 32.8 24.8 55.6
13.15 US 21.4 13.6 4.6 55.30 EU 19.9 37.7 6.2 17
.14 Others 25.9 23.9 33.6 14.41 TOTAL 100.0 100.0
100.0 100.00 Excluding Australia and New
Zealand Source IMF, World Economic Outlook,
April 2002
Asia still Dependent on Bank Financing ( of

Bank Assets Equity
Market Bond Market 1998 2001 1998 2001
1998 2001 China 139 160 25 45 12 28 Hong
Kong 214 215 206 313 32 28 India 69 133 24 26 21 2
8 Japan 145 139 64 55 101 153 Korea 233 233 35 46
53 67 Singapore 220 243 112 135 20 41 Taiwan 226 2
62 97 104 41 20 Thailand 176 134 30 32 23 39 Germa
ny 273 155 51 58 97 90 US 65 63 158 136 141 148
Remark 1999 figure Sources FIBV, CEIC,
Bloomberg, various central banks and government
Asias Financial Structure
  • The financial system is a derivative of the real
  • Dualist mercantilist model drove Asian
  • Development led by highly efficient export
    sector open to international competition
  • Financed by protection of domestic natural
    resources, services and financial sectors
  • Banking system protected from foreign
    competition, mobilised bulk of savings and was
    guided in lending
  • Fish-trap mentality welcomed FDI, and delayed
    capital account opening, resulting in periodic
    asset bubbles
  • Stock markets were short-term speculative and
    also restricted foreign listings
  • Corporate sector was state- or family-dominated,
    so corporate governance reflected ownership

Key Resource Allocation Issues
  • Too much savings in Asian banking systems 80
    140 of GDP, compared with 60 in US
  • Lack of credit culture, and collateral-based
    lending behaviour, coupled with excess liquidity
    caused by fish-trap policies fuelled property
    and stock bubbles
  • Huge NPLs represent waste of savings NPL
    resolution cost up to 50 of GDP in Asian crisis
  • Development of bond, equity and derivative
    markets would help to diversify risk away from
    banking system and impose greater market
    discipline in the intermediation of savings

Poor Price Discovery
  • Openness to trade meant that traded consumer
    prices were stable at competitive global prices
  • But capital controls and supply distortions, eg
    lending/listing guidelines led to distortion in
    key financial prices, eg excessively low domestic
    interest rates relative to risks and high PE
  • Bank herding with cheap loans fuelled property
    asset bubble, and small free float fuelled stock
  • Credit risk not properly priced with bank spreads
    of 1.5 2 points with NPLs at between 1050
    of total assets
  • Bond spreads have recovered close to pre-crisis
    levels, although NPLs have not been cleaned up
  • PE ratios remained around 80 in Japan, as the
    Nikkei 225 plunged from 38,000 to 10,000. China
    peaked around 60 in 2001, now down to 30
  • Mispricing meant that large Asian savings wasted
    in inefficient investments

Weak Risk Management
  • Asian Crisis showed lack of risk diversification
    avenues as savings were concentrated in banking
    system and residents were not allowed to hold
    foreign assets
  • Bank-dominated systems with high NPLs and
    relatively low capital carried high moral hazard
    risks through explicit/implicit deposit insurance
  • Lack of specialist and derivative markets, such
    as venture capital, futures and options markets,
    point to need to develop a wide range of
    financial instruments and markets, and allow
    participation of different types of specialist
    market intermediaries
  • Choice of financial instruments improves asset
    allocation, and allows the hedging of market
    risks that in turn increases the risk-bearing
    capacity of the economy and, hence, growth

Weak Corporate Governance
  • Structure of Asian markets reflect failure of
    financial markets to check against poor corporate
  • Need to upgrade accounting, auditing and
    disclosure standards to improve checks and
    balances on corporate governance
  • Dominance of SOEs or close corporate-bank
    relationships marginalised minority shareholder
  • Domestic institutional investors have close links
    with corporations, while foreign investors not
    inclined to impose governance
  • Entry barriers to foreign strategic investments
    protected domestic companies from
  • Preference for merger of failing institutions
    than liquidation or opening up to foreign

Self-discipline, Regulatory Discipline and Market
  • Corporate governance requires all three
    disciplines to provide checks and balances for
    healthy companies
  • Self-discipline works if controlling shareholders
    have high integrity and treat minority
    shareholder fairly
  • Regulatory discipline acts as backstop when
    management and board lack integrity and ethics,
    by setting out clear rules and through effective
  • Market discipline works best because global
    competition demands management professionalism
    and observance of global standards of quality,
    code of conduct and accounting and disclosure
  • Markets buy or sell stocks based on company
    performance benchmarked against transparent
    global standards.
  • Enhance management accountability to

Globalization means Dualistic Domestic Sectors
are also Marked to Market
  • Consolidation of Financial Intermediaries
  • Advances in technology, de-regulation, and WTO
    opening of domestic markets means huge
    competition to domestic financial institutions
    from large complex financial institutions
    offering banking, insurance, asset management
    derivative services
  • Ability of domestic policies to protect domestic
    financial sectors limited as-
  • WTO and IMF rules push for market opening
  • Sophisticated domestic investors seek global risk
  • Liquidity begets Liquidity
  • Smaller domestic players do not have same capital
    base, technology and market reach as global
  • Improvements in accounting and disclosure means
    domestic inefficiencies are revealed as NPL etc
  • Smaller players are marginalized

Trends in Domestic Exchanges
  • Vertical Consolidation - Exchanges are
    demutualizing to align interests with market
  • They are also merging or cooperating with
    Clearing Houses to optimize fixed investment
    economies of scale
  • Horizontal Consolidation Exchange merge or ally
    with each other to optimize geographical and
    product reach
  • Accenture estimates that merger of trading,
    clearing and settlement in Europe may
    concentrate liquidity and reduce clearing and
    settlement costs by US1 bn annually

Global Three Time Zone Market
  • New York (US12.8 trn or 50 of global market
    cap) now services global Latin American capital
  • European financial markets consolidating under EU
    and euro
  • Asia has tremendous savings, but fragmented
    financial markets
  • Asias capital markets still retail driven -
    insufficient local institutional investors
  • Liquidity begets liquidity in a virtuous circle
    that benefits issuers, investors, intermediaries

East Asian Miracle is Demographically Driven
Source Jeffrey G. Williamson, Demographic Shocks
and Global Factor Flows
Aging Population requires efficient Pension and
Retirement Fund Management
  • North Asia aging, slowing growth and requiring
    more retirement funding
  • South-east Asia still young, but must avoid North
    Asian retirement funding mistakes time to
    develop deep and well diversified retirement
    institutional funds
  • If retirement funds have over-priced bonds and
    equity, the retiring generation pay for this
    generations funding mistakes
  • Deep and well-diversified retirement funds will
    develop institutional savings, improve liquidity
    of bond and equity markets, and play role in
    corporate governance
  • Existing retirement funds allow policy makers
    option to cover up mistakes e.g. retirement
    funds helping in corporate rescue

Relationship between Third World OECD
  • The Third World OECD in two different
    demographic cycles former has labour surplus
    capital shortage, while latter has scarce labour
    capital surplus.
  • However, Asia has both labour surplus capital
    excess, but excess is funding OECD markets
  • Would policy makers allow labour and capital
    markets to make intergenerational transfers?
  • How can Asia institutionalise savings within Asia
    for better resource allocation?
  • Source Jeffrey G. Williamson, Demographic Shocks
    and Global Factor Flows

Implications for Asian Market Models
  • Asian market distortions and barriers hindered
    its ability to intermediate its own savings and
    manage risk
  • Yen/ swings caused huge revaluation gains/losses
  • Surpluses flow to US and Europe which return as
    FDI or portfolio flows
  • Risks remain concentrated in domestic economies
  • Japan is largest market, but financial market is
    relatively inward looking
  • China has law of large numbers and demand
    economies of scale, but banking and enterprise
    reform still at a global selective opening
  • ASEAN markets are small, and face huge external
    entry pressure, with concerns about
  • AU/NZ have sophisticated systems but not
    integrated with rest of Asia
  • Non-integration is not an option unless one
    wishes to be disconnected from global markets

Conditions for Regional Cooperation
  • Bank Reforms must go on - NPLs remain a drag
  • Raise Corporate Governance standards - with focus
    on market discipline
  • Higher standards of Transparency Disclosure
    move to IAS, IAuS, IDS
  • People - higher skills for investment banking,
    asset management and risk management
  • Pricing - spreads have to reflect risk
  • Products - wider choice for better risk
  • Platform - better inter-connectivity,
    inter-operability and common standards
  • Political Will willingness to open up to
    regional cooperation

Improving Market Liquidity a Priority
  • Asias segmented markets fragment liquidity
  • Negative feedback effects of declining liquidity
    bad for capital markets
  • Liquidity depends on common products, common
    rules and common markets
  • Can we afford marginalization?
  • Are we ready to adopt international best
    practices, codes, and standards?
  • We have common competitive threats, but do we
    have common goals?

Global Markets and Standards
  • If one wants to be part of global market, one has
    to play by global rules and standards
  • Africa and Latin America have fallen behind, as
    inward looking strategies retard their
    competitiveness in trade and financial services
  • Global financial markets are a network of local
    markets, and are as strong as the weakest link
  • For successful integration, equivalent standards
    are needed to ensure stable, orderly and fair
  • US and EU today set standards for global markets.
  • Asia can be free riders on these standards, as
    long as we can meet all the pre-conditions.
  • Can we work toward common Asian standards?

Which Asian Standard?
  • Asia has no common voice to influence these
    standards. To have a say, we first need to have
    critical mass to do proper research and lobby.
  • Current forums not conducive to common voice
  • ASEAN 3 not representative of Asia as long as
    major players such as Australia and HKSAR not
  • We should recognize that domestic interests
    out-weigh regional interests
  • But we must have common forum to debate these
    issues, not political but technical
  • Standardize for liquidity, differentiate for
    value added

Phased Approach?
  • There is suggestion that four markets -
    Australia, HKSAR, Japan and Singapore - work at
    free trade in services first, before integrating
    with others
  • Not sure that phased approach will work, because
    it causes greater market differences and tensions
  • More realistic to have common forum for technical
    discussion first
  • Asian BIS or AMF probably too politically charged
  • Probably Asian Financial Institute more likely to
    be the common forum for debate of issues,
    standards, goals and processes
  • EU integration indicates that it was not possible
    to cooperate unless there there are not only
    common goals, but also common channels of
    discussion at operational level. Asia lack

Conditions for Increasing Liquidity
  • Common Products
  • Are Asian exchanges willing to cross-list?
  • Inter-operability
  • Common trading and clearing rules
  • Are they willing to share technology and
  • Low transaction cost
  • Standard tax rates, services and operations
    through common networks and infrastructure
  • Inter-connectivity
  • Willingness to allow connections through common
    custodians, common participants and
  • Free flow of capital by residents and

First Steps in a Long Journey
  • While direction ahead may seem obvious, getting
    there is dependent on sovereign decisions which
    are not easy to make
  • Requires recognition that it is win-win and not
    win-lose, or Nash equilibrium for our markets.
  • AFI will make journey easier if Asia has an
    independent and non-profit making research
    institute that studies Asian issues from an Asian
    rather than a national perspective.
  • The conduct of research on issues with strategic
    significance for Asia would deepen our
    understanding of the implications of global
    developments and provide a basis for objective
    debate on win-win solutions for us.
  • Such cooperation would help in capacity building
    for the region and in building trust, which is
    essential if we are to be able to work together
    for the good of our markets.

Concluding Thoughts
  • Asian dualist model must be re-written to
    globally efficient and regionally fitting
    model, where markets perform their functions
    well, inherent risks are reduced
  • Priority is to improve corporate governance,
    where trust is rewarded, and fraudulent behaviour
    is punished
  • The quality of all players has to be enhanced to
    improve the quality of our markets
  • Non-integration is not an option, but we have to
    play by global standards and rules
  • We can cooperate to set our own standards, have a
    say in international standards, and work together
    to improve the liquidity of our markets
  • Or we can continue with our own individual agenda
    and see continued marginalization of our markets
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