The Future of Capital Markets in Asia Andrew Sheng Chairman - - PowerPoint PPT Presentation

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29 April 2005 Association of Merchant Banks, Malaysia PJ Hilton

The Future of Capital Markets in Asia

Andrew Sheng Chairman Securities and Futures Commission, Hong Kong

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Contents of Lecture

• Capital Market trends in major markets and

Asia - overview

• Why does the Asian market not work

better?

• New Financial Structures and Investor

Demands

• Recent Regulatory Trends
• Challenges for the future

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• Finance is a derivative of the real sector – a financial

system is part of the market that delineates, transfers and protects property rights over the whole demographic cycle

• Historical total equity return swap with London and

New York – Asia runs current account surplus with West, places US$2 trillion official reserves (of which US$1 trillion in US Treasuries at 4% pa), and flows return in FDI and FPI, leveraged to earn 10-15% pa.

• Asian capital markets remain bank-dominated, with

limited growth in capital market skills

Asian Capital Markets – where are we now?

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Asia still Dependent on Bank Financing (% of GDP)

Remark: * 2001 figure Sources: World Bank, IMF, WFE, FIBV, CEIC, Bloomberg, BIS, Inte rnational Financial Statistics, various central banks and government websites

Bank Assets Equity Market Bond Market 1998 2002 1998 2003 1998 2002 China 139 140 25 36 12 33 Hong Kong 214 149 206 451 32 27 India 69 36 24 42 21 33 Japan 145 107 64 68 101 169 Korea 233 115 35 49 53 81 Singapore 220 112 112 144 20 66 Taiwan 226 125 97 133 41 33 Thailand 176 82 30 83 23 38 Germany 273 155* 51 58* 97 90* US 65 78 158 130 141 156

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Financial Structure remains broadly unchanged

100 1,564.0 100 446.6 Total 33.1 22.2 14.1 2.9 4.1 1.1 5.1 5.8 517.3 347.7 220.2 46.2 64.1 17.2 79.1 90.5 30.5 18.9 13.9 1.9 2.2 0.9 4.3 7.3 136.4 84.2 62.2 8.3 9.7 4.0 19.5 32.7 Non-bank financial intermediaries Provident, pension and insurance fund Employees Provident Fund Other provident & pension funds Life insurance funds General insurance funds Development financial institutions Other financial intermediaries 66.9 12.8 40.3 9.1 2.8 1.9 1,046.7 200.8 629.6 142.0 44.1 30.2 69.5 13.3 39.3 12.3 3.3 1.3 310.3 59.6 175.5 54.9 14.6 5.6 Banking system Bank Negara Malaysia Commercial banks Finance companies Merchant banks Discount houses

% RM billion % RM billion As at end 2003 As at end 1992

Source: Bank Negara Malaysia

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• Price discovery – high liquidity and low risk

spreads not reflecting underlying risks

• Resource allocation – why is Asia still bank

dominated?

• Risk management – has risk management

really improved? Why do we still have substantial NPLs?

• Corporate governance – are the banks and

capital markets sufficient checks and balances on borrowers and corporate sector?

Asian Capital Markets remain problematic

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44.2% 1,063.2 13.9% 335.0 55.6% 1,338.2 339.6% 8,172.7 Germany n.a. n.a. 70.4% 1,266.0 n.a. n.a. 346.8% 6,235.0 UK 67.4% 7,414.1 67.6% 7,438.0 82.5% 9,075.3 67.1% 7,380.6 US n.a. n.a. 57.3% 2,463.0 45.2% 1,941.0 159.9% 6,862.2 Japan 2.4% 14.1 n.a. n.a. n.a. n.a. 74.7% 433.1 India 19.2% 19.9 56.4% 58.5 19.5% 20.2 207.0% 214.7 Malaysia 8.3% 11.9 7.1% 10.2 10.2% 14.5 126.5% 181.1 Thailand 28.5% 81.5 n.a. n.a. 47.5% 136.0 322.7% 923.4 Taiwan 221.3% 202.1 66.6% 60.9 48.0% 43.9 270.8% 247.4 Singapore 20.1% 121.6 n.a. n.a. 25.6% 154.8 151.2% 915.4 Korea 28.4% 144.3 83.8% 426.0 37.5% 191.0 177.5% 902.6 Australia 1.5% 20.5 1.1% 16.0 7.8% 110.2 217.6% 3,073.8 China 341.1% 534.3 17.7% 27.7 6.0% 9.3 533.7% 836.1 HK % of GDP US$ bn % of GDP US$ bn % of GDP US$ bn % of GDP US$ bn Mutual Funds Pension Funds Insurance Companies Banks Assets of Banks, Insurance Companies, Pension Funds and Mutual Funds (end 2003)

Sources: CEIC, EFRP, OECD, various central banks and government websites.

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• Free Entry of Participants and Products;
• High degree of transparency/low information

asymmetry

• Efficient Operations by solvent participants under

international rules of the game at low transaction costs;

• Absence of incentive distortions or bias that moves

markets in unhealthy direction e.g. moral hazard or subsidies;

• Efficient regulation at low regulatory costs;
• Orderly exit of insolvent participants [obsolete

products and insolvent operators create huge dead costs on market]

•  Accountability [feedback and exit for bad players]

Efficient Markets require:

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Hierarchical Order of Domestic Financial Markets

Asset-backed securities and derivatives Corporate bond and equity markets Government bond market Treasury bill market and foreign exchange markets Money market

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Changing Structure of Banking & Finance

Banking Insurance Brokerage Trust Customer

Traditionally, each intermediary operates as a silo they approach the customer independently.

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Banking Insurance Brokerage Trust

personal financial adviser

Customer

Delivering Service Through One Agent

Another strategic option is to approach customer through a single financial adviser - acting as a hub:

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Multi-Tier Financial System

Individuals Companies Personal investment accounts Funds Securities markets Risk transfer Bank loans Sales Product creation

Source: Nomura Institute Capital Markets Research

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• Deposit-taking Institutions
• Risk-pooling Institutions, i.e. insurance

companies

• Contractual Savings Institutions, e.g.

provident and pension schemes

• Market makers, such as securities dealers,

money brokers

• Specialized Sectoral Financiers, e.g. leasing

companies

• Financial Service Providers, e.g. investment

advisers and management consultants

Classification of NBFIs*

* Jeffrey Carmichael and Michael Pomerleano, “The Development and Regulation of Non-Bank Financial Institutions”, World Bank, 2002

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Deposit-taking Institutions – demographics changing customer pattern – growth of consumer banking, credit cards, demand for structured products Risk-pooling Institutions - still foreign dominated, but demand growing Contractual Savings Institutions - huge liquidity pools, but shortage of professional fund management skills Market Makers - key investment banking skills still dominated by large foreign players, with foreign fund managers as key clients Specialized Sectoral Financiers - policy-based banks shrinking in market size; venture capital and private equity becoming more important Financial Service Providers – exchanges demutualizing

Recent Key Market Trends in Asia

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China IPO market as big as Japan, 12% of the Global IPO Market in 2004

Note: Chinese IPOs include Chinese domestic A-share issues. China includes Hong Kong. Source: Dealogic

53 41 48 17 6 15 3 6 Europe/ Middle East Asia-Pacific Americas Rest of Asia- Pacific India Australia Japan China

$142B $48B

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Demographics – around 300 million Asians earn US$5,000 or more annually; by 2020, discretionary spenders will grow to 1.4 billion. Huge demand for asset management and consumer banking needs Wealth management - private banking spreading from those with US$1 million or more to middle income professionals Mutual Funds - in US already US$7.5 trillion market, but becoming more leveraged – no longer just long-only funds; line between mutual funds and hedge funds blurred Market makers - domestic investment banks still small by any standard Outsourcing - over 100,000 jobs moved to India from US, worth US$136 bn in wages – what is SE Asia doing about this?

Key Capital Market Trends

*

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8,000 hedge funds with US$1 trillion in assets under management – leveraged around 2-3 times Trading velocity much higher than mutual funds - currently account for 40-50% of turnover in US and EU Fees around 1-2% of AUM + 20% of profits Larger funds around US$10-15 bn in AUM Depend upon prime brokerage for transactions and funding - if we do not allow in prime brokers, how can emerging markets benefit from hedge fund activities? Highly skilled business - talents drawn from fund managers and investment banks (ie difficult to home grow)

Hedge Funds are driving the business

*

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3,000 private equity funds with unknown total assets under management – leveraged levels also unknown More involved in direct equity investments rather than trading Fees around 1-2% of AUM + 20% of profits Longer lock-ups Larger funds of around US$5-10 bn in AUM In 1H2004, Asia raised US$5 bn, compared with US$3.3 for 2003 and US$3 bn for 2002 (compared with US$17.9 bn in 2000 and US$9 bn in 2001) – overall private equity investments in Asia estimated at US$8.6 bn Roughly 10% of UK pension funds invested in private equity - still early days for Asian pension funds

Private Equity Funds are the reborn merchant banks without regulation

*

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Greatest change in global standards and regulation since 1930s – Convergence in IAS and US GAAP Oversight of auditors, analysts, CRAs Massive changes in corporate governance standards and disclosure Sarbanes-Oxley European Directives, Higgs etc International rules – Basle Capital II IOSCO standards Massive civil litigation if financial firms do not get it right

Recent Regulatory Trends

*

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• “The central lesson that emerges from this story of

the boom and bust – that there needs to be a balance between the role of government and of markets – is one which evidently the world has to learn over and over again.”

• “When countries got that balance wrong, veering

either towards too much or too little government, disaster happened.”

• “Today, the challenge is to get the balance right,

between the state and the market, between collective action at the local, national, and global levels, and between government and non-governmental action.”

Nobel Laureate Joe Stiglitz: Roaring Nineties Allen Lane, 2003

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Opening Up to Foreign Participation

Parameters of the liberalization strategy for the securities industry Where foreign participation is needed to promote the development of core and value-added segments within the securities industry When the nature of the business requires global linkages and international exposure Where expertise is needed to upgrade efficiency and such expertise is not available locally Where external capital is needed to further develop and expand the local securities industry

Source: Singh, Emam, and Tang. 2001. “Foreign participation in emerging securities industries”

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Concluding Thoughts

• Asian capital markets are integrating, as Asian savings seek

regional placement, but it will integrate according to global standards.

• In Asian time zone, stock markets have to change from

“national” markets selling only national products to Pan- Asian product distributors

• Globalization has benchmarked all domestic financial
• systems. You need to compete according to global

performance, otherwise you become marginalized.

• Getting foreign skills involved in building domestic strength

is inevitable. Closed systems cannot compete against open

• systems. Importing skills can come in different packages, eg

building outsourcing base [ie Penang electronics assembly model in financial services]

• Corporate strength cannot be built without strong financial

services sector

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Thank you very much