YBhg Dato’ Zarinah Anwar
Chairman, Securities Commission
MIBA Regional Capital Market Conference
20 June 2007
‘Future Direction of the Legal and Regulatory Framework
for Malaysia’s Capital Markets’
YBhg Tan Sri Azman Hashim
Ladies and gentlemen
A very good morning
1. First of all, let me thank the organizers, the Malaysian Investment Banking Association and Pinnacle Group International for inviting me to share my thoughts on the “Future Direction of the Legal and Regulatory Framework for Malaysia’s Capital Markets”.
2. This invitation is timely as we are about to implement the new Capital Markets and Services Act 2007 or “CMSA” which introduces some significant changes in the regulation of the capital market. The CMSA, which consolidates the existing Securities Industry Act 1983 and the Futures Industry Act 1993 as well as the fund raising provisions in the Securities Commission Act 1993, seeks to increase business efficiency in the capital market particularly through a single licensing framework for capital market intermediaries and more facilitative rules on fund raising activities.
3. It is not surprising that in two recent studies commissioned by the City of London and New York City on their competitiveness as financial centers, the existence of an appropriate regulatory regime has been identified as a key factor in competitiveness. The imperatives of staying competitive are skilled workers, the legal environment and the need to strike a proper balance between regulating markets effectively and allowing them to develop in line with market needs. I believe that the CMSA lays the foundation for the SC to be able to fulfill its core mission: to provide a regulatory environment that is conducive to market regulation and market development.
4. Ladies and gentlemen, remarkable challenges and opportunities lie ahead for the Malaysian capital market. But any analysis of what the future holds must be assessed against developments and trends in the past and present. In so doing, this gives us useful and necessary perspectives to position the capital market strategically going forward.
Trends over the past decade
5. Three main trends can be observed over this past decade:
- First, increasing innovation and the growth in cross-border finance has led to greater integration and complexity within financial markets with significant demands on regulation;
- Second, the diversification of risk profiles which have provided other alternatives to investment; and
- Third, rapid information, communication and technological innovation in the financial and capital markets
6. Together, these developments have a striking impact on the competitiveness of capital markets around the world, compelling securities regulators to reassess the traditional basis of regulation.
i) Increasing innovation and complexity of financial markets
7. The role of financial institutions has expanded dramatically in recent years. Financial institutions are now engaged in a broad range of complex financial transactions and operate in various markets – banking, insurance and capital markets. From being straightforward intermediaries, they now play the role of ‘risk managers’ – taking on and laying off risks on behalf of their customers. They underwrite complex financial transactions, provide specialized over the counter hedging and risk management products, and take on many advisory roles.
8. In Malaysia, while some restrictions remain, for the large part, the regulatory framework has been pragmatic in enabling financial institutions to participate in the capital market. Merchant banks were accorded ‘exempt dealer’ status as far back as the 1970’s thus allowing these intermediaries to participate in the capital market, particularly in underwriting, arranging, placements and corporate advisory activities. The imperatives of better pricing, higher quality and greater availability of products have led to merchant banks evolving over time into full service investment banks with the capacity to carry out a range of activities spanning the entire spectrum of services in the capital market.
9. The creation of investment banks in Malaysia serves to emphasise the increasing trend for integration of the various segments of the financial markets with the resultant blurring of boundaries between once-separate institutions, products and market sectors, challenging the traditional parameters of regulatory and supervisory roles and functions.
10. The challenge is for regulators to be able to respond to these changes and to optimize and streamline the regulatory approach to ensure seamless regulation. In Malaysia, this development has augmented a framework of co-regulation between the Securities Commission and Bank Negara Malaysia. The objective is clear – to ensure a robust framework that will allow the supervision of investment banks as a single conglomerate dealing in securities and corporate finance. This approach of functional regulation allows for prudential and market conduct regulation to be applied as appropriate.
ii) Product innovation
11. The second major trend which we have observed in the past decade is the diversification in the risk appetite of consumers. The proliferation of new products is testament to the innovative capabilities of market intermediaries in customizing products according to the risk/return appetite of customers.
12. This means that regulators need to be even more responsive to the needs and demands of the market. The recent changes in the “Guidelines for Structured Warrants”, for example, which allow for term sheets to be issued on the basis of a base or shelf prospectus has led to a more speedy issuance process and shorter time to market. In this respect, the partnership between the SC and industry is vital in allowing the SC to adopt a more proactive role in fine tuning the regulatory framework to cater to the needs of issuers and investors.
13. With new products however come new risks. Therefore, the push for innovation must be matched with equally robust disclosure standards. The underlying basis of a well functioning market is ensuring that investors are able to base their investment decisions on sound disclosures, both of the prospects as well as the attendant risks to the venture. As Lois Loss, one of the most revered securities law professors said of the US securities laws: “The federal securities laws do not deprive a man of his God given right to make a fool of himself. They merely prohibit others from making a fool of him.”
14. In a framework of disclosure based regulation, the adviser plays a critical role in the gate keeping function involved in the issuance of securities. The quality of the companies on our stock market and of the products offered to investors have much to do with the level of due diligence that is invested in the pre-offering stage. While the SC has and will continue to reduce our time for approval of corporate proposals, this must be matched with high quality submissions based on a stringent verification process. A system of diffused responsibility will necessarily result in weaker structures giving rise to legal and ethical abuses and very expensive corporate failures. In this regard, I wish to applaud MIBA for taking the lead in developing a code which would serve as a benchmark in assessing the adequacy and quality of due diligence for the industry. I believe this would pave the way for more rigorous due diligence standards and clearer understanding of the roles and responsibilities and the accountability of all professionals and experts who are involved in the corporate advisory process.
iii) Technological advances
15. This brings me to the third major trend I wish to discuss. The past decade has heralded significant changes in the financial and capital markets due to rapid information, communication and technological innovation. The large cost reductions in ICT over the past decade have had a major impact on our markets. Technology allows for cheaper production and better mainstream financial services for households and smaller size firms. In turn, cost advantages can be passed on to consumers in the form of lower margins and better quality services. Technology also makes cross border provision of financial services easier and cheaper. In addition to this, telecommunications and internet service providers with their wide distribution networks and superior knowledge of customer behavior and preferences are already acting as portals to a wide array of financial services.
16. The effects of technology are many and sometimes complex. Cost reduction, greater choices of products, transactional ease and efficiency, to name a few, demonstrate the upside to technology. But perhaps the most important aspect of change brought about by technological advancement is the improved availability and dissemination of information that has re-shaped the expectations of investors and society. Transparency and trust have become acutely critical to the operation of corporations. In a world of instant communication, people can be easily informed and public opinion speedily mobilized against any company.
17. Directors and management of companies would do well to realize that the capital market is a place where “investors pay enormous amounts of money for intangible rights, whose value depends entirely on the quality of information that investors receive and on the honesty of people about whom investors know almost nothing about.” (Prof Bernard Black, “Remarks on the Preconditions for Strong Securities Markets). The relationship therefore needs to be built on the critical element of trust; and that trust, once squandered by misbehaviour, will lead to investors voting with their feet. Investor’s trust, once lost, will not be easily re-captured.
Future Direction Of The Legal And Regulatory Framework
18. The formal structures and rules in any marketplace do not exist in a vacuum. The regulatory framework of the Malaysian capital market, as in many other jurisdictions, is in many ways responsive to the issues and forces at play in the domestic and external environment.
19. It has been 10 years since the Asian financial crisis. Over the last decade, the Malaysian capital market has not only recovered, but has grown significantly, anchored on a strong regulatory foundation based on international standards and best practices. The total value of the capital market stands at RM1.55 trillion (end April 2007), with an equity market that is RM 1.05 trillion and a bond market at close to RM500 billion; one of the largest in the Asia-Pacific on a GDP adjusted basis. We have a growing investment management industry with over RM 164 billion under management and a leading position internationally in the Islamic capital market.
20. The market now exists in an environment where a range of market intermediaries from investments banks to financial planners operate. We have significant foreign investments in our market as well as foreign firms operating as brokers and fund managers. We have a liberal capital account regime that allows foreign issuers to raise funds from the domestic capital market as well as a more liberal environment for domestic residents to invest in foreign markets. A variety of investment products have been introduced, from exchange traded funds, real estate investment trusts to a range of structured products, providing investors with even more investment choices.
21. Continuous efforts are being made to enhance the competitiveness of the market including initiatives to enhance the vibrancy and liquidity in the market across all asset classes. At the same time the SC has invested much effort at ensuring that our regulatory infrastructure remains competitive in providing the right value propositions that both investors and issuers are seeking when making investment or capital raising decisions.
Imperatives to ensure regulatory competitiveness
22. Enhancing and sustaining competitive advantage in the capital market by managing regulatory costs and burden while maintaining the confidence of investors is a major focus for us. The SC has articulated our regulatory philosophy in the Capital Market Master Plan, “that there should be no more regulation than necessary”. But there will be the appropriate level of regulation in place to ensure that our market provides the right degree of investor protection, standards of disclosure and market integrity.
23. In order to achieve this objective, the SC has over the years introduced a series of reforms and enhancements on our approach to regulating the market place with the CMSA being the latest effort. Our approach to regulation is principles based which essentially means that we will remove where necessary prescriptive rules and focus on broad principles related to areas, such as, conduct, standards of due diligence, internal compliance and risk management among others. Our objective is to focus on key regulatory outcomes that we want to achieve related to investor protection, market integrity and systemic stability. In doing so, we will allow firms that demonstrate high standards of conduct, a level of flexibility to design their own internal controls and compliance processes to achieve the regulatory outcomes desired. These firms will also benefit by having less intrusive regulation being imposed on them.
24. Under the principles based approach, we will enhance our oversight over firms through periodic risk assessments that will rank the firms based on their conduct and compliance levels. We have enhanced our supervision efforts across all segments of the capital market and extended our direct examination of market intermediaries on both a firm and integrated group wide basis. We will work with market players to instill best practices and strengthen internal controls and compliance structures. However, where we observe breaches or shortfalls in standards of compliance or conduct, the appropriate enforcement action will be taken.
25. The SC has also continuously re-engineered our processes to ensure that we are able to deliver quality regulatory services to the market place by removing or streamlining regulation where necessary as well as enhancing the efficiencies with which we are able to discharge our responsibilities through shorter approval timelines. Our corporate and licensing approvals are subject to very clear and transparent time-charters and our performance scorecard are published at regular intervals. As I have indicated earlier, with the introduction of the CMSA, we expect even greater efficiencies to be achieved.
Market and self discipline must complement regulatory efforts
26. In order to achieve our overall objectives it is imperative that there is self and market discipline to support the regulatory efforts and discipline that authorities like the SC enforce on the market.
27. Fortunately, the majority of company directors, market professionals like auditors and advisors and management at companies understand their obligations and responsibilities and discharge their fiduciary duties with the right standards and levels of care that is expected of them.
28. Unfortunately, there will always be the few that will attempt to abuse the markets either through manipulation of share prices or through perpetrating corporate fraud and transgressions, such as, manipulating the financial accounts of companies. This happens across countries and across time. It is apparent that even in the most developed and highly regulated markets, corporate shenanigans will unfortunately rear its ugly head periodically.
29. We have seen this happen here over the last few years with the likes of Energro, Pasaraya Hiong Kong, GP Ocean and Nasioncom and now more recently Transmile and Megan Media. Our response to these developments is very clear – the SC will take swift and firm enforcement actions against the perpetrators. As evidenced by our enforcement record, we have instituted actions against company directors, auditors, corporate advisors and management. There is a range of enforcement powers available to the SC and I will be very clear – we will use all these powers and leave no stone unturned in our investigative and enforcement efforts, to come down hard on any one that abuses our market.
30. I am heartened to note that many aspects of our existing framework for corporate governance and financial reporting has played a key role in maintaining high overall standards that have been acknowledged internationally. Our whistle blowing provision, for instance, has played a key role in assisting the SC’s enforcement efforts. We also have in place a mandatory requirement in law for compliance with accounting standards that, coupled with a robust corporate surveillance program in the SC, has helped identify instances of corporate financial irregularities and is even being replicated in other jurisdictions in the region.
31. However, I am firmly of the view that a lot more can be done by company directors, audit committees and auditors among others to instill the right level of self discipline that will reduce the occurrence of the types of corporate transgressions that we have been seeing.
32. Company directors are under a fiduciary duty to act in the best interest of the company, to protect the company’s assets and safeguard the interest of all shareholders. They must exercise the requisite duty of care; there must be heightened awareness of the need to be vigilant and to oversee management, foster integrity and prevent transgressions. Independent directors must not only be independent in their decisions and protect the interest of shareholders but must have the necessary levels of experience, knowledge, diligence and skills to be able to question and challenge and review the adequacy of the company’s internal control systems.
33. Where some of these responsibilities are delegated to board committees like the audit committee it is incumbent on members of the audit committee to ensure that they effectively discharge their responsibilities. Audit committees have a key role to play in ensuring the integrity of the financial statements that are approved by the company for release to the investing public. Members of the audit committee must evaluate the quality of the external and internal auditors. They must probe and assess the extent of issues that management and auditors pay attention to. They must be able to assess the quality and competence of the company’s financial management. An effective audit committee can play a key role in enhancing the reliability of financial statements of public companies.
34. Over the last few years, company auditors have come under intense focus world wide in the light of some spectacular corporate failures and I fully share the sentiments of my colleagues globally on the role of the audit and accounting profession in maintaining the integrity of the financial reporting process.
35. Investors rely on financial statements as a key medium to evaluate their decisions and therefore we will always be concerned about the quality of information provided in these financial statements. If auditors fail to deliver a quality audit, investor vulnerability to misstated financial statements and fraudulent financial reporting will continue to remain.
36. As regulators our ultimate focus is to protect investors and ensure the integrity of the capital market. However I cannot but emphasise yet again that accountability is not limited to regulator- led prosecution under securities laws. A diligent and responsible Board, honest and ethical management led by the CEO, pro-active and responsible professionals all play an important role in complementing the efforts of the regulator to prevent wrong doing and to identify and assist us to prosecute wrong-doers.
37. In conclusion, let me reiterate – the legal and regulatory framework for the Malaysian capital market must provide the basis to:
- Increase efficiencies in the conduct of business by minimizing regulatory friction and enabling capital market intermediaries to respond to changing investor needs in a timely manner;
- Promote greater reliance on self regulation and market based discipline to foster and institutionalise good behavior, with strong oversight by the SC;
- Facilitate swift and effective enforcement against those responsible for misconduct and breaches of securities laws; and
- Ensure that risks to investor protection, a fair and orderly market and financial soundness are minimized.
Ladies and gentlemen, thank you for your attention.