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 1
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 2
Asian Capital Markets – where are we now? 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 3
Asia still Dependent on Bank Financing (% of GDP) 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 Remark: * 2001 figure Sources: World Bank, IMF, WFE, FIBV, CEIC, Bloomberg, BIS, Inte rnational Financial Statistics, various central banks and government websites 4
Financial Structure remains broadly unchanged As at end 1992 As at end 2003 RM billion % RM billion % Banking system 310.3 69.5 1,046.7 66.9 Bank Negara Malaysia 59.6 13.3 200.8 12.8 Commercial banks 175.5 39.3 629.6 40.3 Finance companies 54.9 12.3 142.0 9.1 Merchant banks 14.6 3.3 44.1 2.8 Discount houses 5.6 1.3 30.2 1.9 Non-bank financial intermediaries 136.4 30.5 517.3 33.1 Provident, pension and insurance fund 84.2 18.9 347.7 22.2 Employees Provident Fund 62.2 13.9 220.2 14.1 Other provident & pension funds 8.3 1.9 46.2 2.9 Life insurance funds 9.7 2.2 64.1 4.1 General insurance funds 4.0 0.9 17.2 1.1 Development financial institutions 19.5 4.3 79.1 5.1 Other financial intermediaries 32.7 7.3 90.5 5.8 Total 446.6 100 1,564.0 100 5 Source: Bank Negara Malaysia
Asian Capital Markets remain problematic 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? 6
Assets of Banks, Insurance Companies, Pension Funds and Mutual Funds (end 2003) Banks Insurance Companies Pension Funds Mutual Funds US$ bn % of GDP US$ bn % of GDP US$ bn % of GDP US$ bn % of GDP HK 836.1 533.7% 9.3 6.0% 27.7 17.7% 534.3 341.1% China 3,073.8 217.6% 110.2 7.8% 16.0 1.1% 20.5 1.5% Australia 902.6 177.5% 191.0 37.5% 426.0 83.8% 144.3 28.4% Korea 915.4 151.2% 154.8 25.6% n.a. n.a. 121.6 20.1% Singapore 247.4 270.8% 43.9 48.0% 60.9 66.6% 202.1 221.3% Taiwan 923.4 322.7% 136.0 47.5% n.a. n.a. 81.5 28.5% Thailand 181.1 126.5% 14.5 10.2% 10.2 7.1% 11.9 8.3% Malaysia 214.7 207.0% 20.2 19.5% 58.5 56.4% 19.9 19.2% India 433.1 74.7% n.a. n.a. n.a. n.a. 14.1 2.4% Japan 6,862.2 159.9% 1,941.0 45.2% 2,463.0 57.3% n.a. n.a. US 7,380.6 67.1% 9,075.3 82.5% 7,438.0 67.6% 7,414.1 67.4% UK 6,235.0 346.8% n.a. n.a. 1,266.0 70.4% n.a. n.a. Germany 8,172.7 339.6% 1,338.2 55.6% 335.0 13.9% 1,063.2 44.2% 7 Sources: CEIC, EFRP, OECD, various central banks and government websites.
Efficient Markets require: 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] • 8
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 9
Changing Structure of Banking & Finance Traditionally, each intermediary operates as a silo they approach the customer independently. Banking Insurance Brokerage Trust Customer 10
Delivering Service Through One Agent Another strategic option is to approach customer through a single financial adviser - acting as a hub: Banking Insurance Brokerage Trust personal financial adviser Customer 11
Multi-Tier Financial System Bank loans Risk transfer Securities markets Individuals Companies Funds Personal investment accounts Product Sales creation Source: Nomura Institute Capital Markets Research 12
Classification of NBFIs* 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 * Jeffrey Carmichael and Michael Pomerleano, “The Development and Regulation of Non-Bank Financial Institutions”, World 13 Bank, 2002
Recent Key Market Trends in Asia 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 14
China IPO market as big as Japan, 12% of the Global IPO Market in 2004 $142B $48B Europe/ 41 Rest of Asia- Middle East 6 Pacific 3 India 6 Australia Asia-Pacific 48 15 Japan Americas 53 China 17 Note: Chinese IPOs include Chinese domestic A-share issues. China includes Hong Kong. 15 Source: Dealogic
Key Capital Market Trends 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? * 16
Hedge Funds are driving the business 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) * 17
Private Equity Funds are the reborn merchant banks without regulation 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 18
Recent Regulatory Trends 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 * 19
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