17th Annual Assembly
International Investment Funds Association
YBhg Datuk Ali Abdul Kadir
Chairman, Securities Commission
20th October 2003
Mandarin Oriental Hotel
YBhg Dato’ Azim Mohd Zabidi, President of the Federation of Malaysian Unit Trust Managers,
Ladies and gentlemen.
A very good evening to everyone and may I bid a warm welcome or selamat datang to all foreign guests to Malaysia.
Allow me to firstly convey my appreciation to the Federation of Malaysian Unit Trust Managers (FMUTM) for giving me this opportunity to address this very distinguished audience tonight. May I also congratulate both FMUTM and the International Investment Funds Association (IIFA) for successfully bringing the 17th Annual Assembly of the IIFA to Malaysia. I have no doubt that it can only add to the good work that has resulted from past conferences, including the 16th Conference held in Berlin.
Holding the conference in Malaysia this year is particularly timely, for we are in the process of moving into the second phase of our Capital Market Masterplan, which we formulated in close consultation with the capital market industry, to guide the long term development and growth of Malaysia’s capital market. The collective investment industry is an important component of the Malaysian capital market, and the unit trust industry in particular has a significant role to play in the Masterplan’s strategies to develop more effective investment management services for Malaysia and to promote a more conducive environment for investors.
However, as with many other globalised financial services industries, the domestic collective investment industry has not escaped many of the issues faced by the global industry as a whole. Of late, international fund management businesses have been affected by global market performance as well as confidence in the industry. There is not much that we can do directly about the performance of global markets. So let me turn to the issue of confidence.
A crisis of confidence?
The world over, financial services are finding themselves under much closer scrutiny, and the business of investment funds is no exception. While the collective investment industry has seen relatively little in the way of fraud and other shenanigans-compared to investment banking and auditors for instance-there is nevertheless a growing perception that some of the industry’s practices are compromising the interests of investors. Issues such as “softing” arrangements, as well as the recent uncovering of apparent improprieties such as market-timing and late-trading in some developed markets have lowered confidence in the industry as a whole and have drawn attention to the issue of investor protection and the governance of investment management businesses.
To be fair, the industry has responded with admirable swiftness to these developments. I note in particular the position of the Investment Company Institute, with which the IIFA is closely affiliated, in denouncing any alleged misconduct and in undertaking to take whatever steps necessary to reinforce shareholder confidence. To paraphrase the statement by the institute’s president, shareholder confidence is indeed every mutual fund’s most precious asset, and the more the industry upholds the public trust and meets high standards of conduct, the more likely it will be able to navigate successfully what is fast becoming a more dynamic and challenging business environment. What I would like to do, therefore, is to look at the relationship between market performance and investor confidence a bit closer.
It’s been said that underlying the whole scheme of civilization is the confidence people have in each other-confidence in their integrity, confidence in their honesty and confidence in their future. To me, the financial services industry is no different and if I may begin with the future, I believe there are good reasons for us to be confident.
Hope for the future
From where we stand today, markets are on the up, supported by an increasingly positive global economic outlook. The Dow Jones Industrial Average has risen nearly 17% since the beginning of the year, while a recovery by the technology multimedia and telecommunications sector has pushed the Nasdaq Composite up more than 43% during the same period. The regional picture is even more buoyant, led by Thailand, which has seen a jump of 58% this year from a low base. Other markets such as Japan, Taiwan and China have experienced a rise of about 30%. Here in Malaysia, equities are up 20.8% for the year amid growing interest in several major public offerings forthcoming and the recent upgrade of the country’s sovereign rating to that of Korea.
Market cycles aside, there are also strong structural reasons to be more optimistic than not about the future of the global industry. For one, populations in the developed world are getting older and living longer, meaning that more people will need to live on invested capital. Moreover, governments are trying to shift the burden of paying for pensions off the state and on to individuals, which should boost demand for savings products. Pay-as-you-go retirement systems, in which contributions from younger workers pay for the pensions of older ones, are under severe strain in many industrialised economies. Many are considering fully-funded private accounts, and these reforms, when they eventually come, ought to prove a boost to investment management.
Trends in many developing countries also provide cause for hope for the industry. There appears to be growing confidence by investors in the use of collective investment schemes-specifically unit trust funds-to fulfil their investment objectives. In Malaysia, for instance, the unit trust industry has grown significantly from 1993 (which incidentally was the year the Securities Commission (SC) was formed). Over the last 10 years, the number of management companies has grown by 131% from 16 to 37 companies. The number of approved funds has grown 389%, from 44 to 215 funds and total net asset value for the unit trust industry has grown 139% from RM28.1 billion (US$7.4 billion) to RM67.2 billion (US$17.7 billion). These statistics show the growing confidence of Malaysian investors in using collective investment schemes, specifically the unit trust funds, as a way of fulfilling their investment objectives.
While these developments may offer hope for the industry going forward, the industry must exercise caution while waiting for structural changes in savings behaviour to take place. In so far as pension reform is concerned, this is not an easy process to undertake anywhere. Systems will certainly not be transformed overnight. Significant risks remain regardless of the approach being adopted. The move towards private funds can be affected by the same demographic risks that make pay-as-you-go systems insolvent. Moreover, reform can face significant hurdles in obtaining popular support.
Similarly, the industry should be cautious of clinging to the idea that all the industry’s troubles are cyclical, and that markets will revert to the mean. For one thing, markets have arguably become more volatile. And while in the past stocks have outperformed bonds in the long run, it has been argued that investors must consider the potential severity of stockmarket underperformance in the short run. As the experiences of the Asian crisis and the aftermath of the dot-com bubble have shown, when stockmarkets fall, they may fall so steeply that they wipe out a huge chunk of funds’ values. These may recover in due course, but the danger is that they take a terrible toll on investors’ savings, leaving insufficient time to build them up again for retirement.
A need to deliver greater value
So prospects for the external environment provide scope for optimism-albeit cautious optimism-and the investment management industry can draw comfort and confidence that its assets will indeed grow with the changes that are likely to take place going forward. But what of that most precious of every mutual fund’s asset, the confidence of your stakeholders? What changes need to happen if the industry is to sustain stakeholder confidence in the long run? The question is not a trivial one, for I believe that in the face of a more challenging and dynamic business environment, the investment management industry’s long term success and growth will depend on how well it sustains confidence among its stakeholders. In other words, regardless of market vicissitudes and structural changes to savings behaviour, the industry must be geared to deliver greater value to its stakeholders.
There are three areas in particular in which I would like to see further improvements made by the industry:
First, greater professionalism. The relationship between trustees and their investment managers needs to be better managed. And investment management companies must adopt stronger risk management and governance practices to improve investor protection.
Second, more transparency. Investment funds must provide better performance disclosure. And they must be more open about the derivation of charges and fees.
Third, higher efficiency and innovation. Margins are falling amid more frequent shift in and out of asset classes as well as more volatile returns. There is therefore a need to manage operational costs better, and to exploit economies of scale and scope.
I do not intend to cover every aspect of these three areas but allow me to say a few words on each.
Higher levels of professionalism and integrity would certainly boost investor confidence in the market, while augmenting the laws and regulations. In order to meet higher standards of professionalism and integrity, industry players will have to practise a greater degree of self-compliance than they do currently. Regulatory discipline alone to ensure compliance is not enough. Breaches may be discovered long after they have occurred. Pro-active self-compliance, through effective internal controls and procedures, is more immediate, and would contain risks posed to the system, the credibility of the industry or to the investor before they can escalate.
Just how much control should be incorporated into the policies and procedures will depend on your own respective risk assessments. There may not be a single method to monitor and address breaches. But the advantage of formulating and imposing higher standards yourselves, compared to those that are externally imposed by the regulator, is that they can cater specifically for your particular risk profile.
In Malaysia, the SC has been encouraging the industry to establish a full-fledged self regulatory organisation (SRO) to carry out self-regulation over the industry and to encourage and enhance the level of professionalism. For instance, the Commission issued a consultation paper titled “The Self-Regulation Framework For The Malaysian Capital Market” which highlights the need for SROs to enhance public trust and confidence in the industry. In this way, we hope to meet the challenge of achieving the twin objectives of enhancing market integrity and investor confidence without unduly raising the regulatory burden on the industry.
The development of a pool of competent professionals is also important in enhancing professionalism within the industry. In many developing markets, regulators are involved in playing an active role in the development of human resources for the capital market. But this must not be done as a substitute for the industry’s own efforts. The industry must be at the forefront of developing human capital, not only to avoid any duplication of resources, but simply to take greater responsibility for meeting their own specific needs in the long run.
On the matter of transparency, the relevancy and quality of information conveyed to investors must be acceptable to enable them to make the appropriate decisions. In this regard, I should like to draw attention to the issue of fees and charges. Investors have raised concerns about the entitlement to discounts and varying practices in giving discounts. The industry needs to look much more closely at this issue and learn from developments in other jurisdictions on ways in which to enhance further the disclosure of fee and charges to the public.
I should also like to highlight in particular the issue of advertising. While information in prospectuses and annual reports can be regulated through prescribed disclosure requirements, there is more scope given for creativity in advertising. Advertisements are potential powerful marketing tools for reaching out to investors. However, they can also be easily abused, and the industry must ensure that the quality of information through advertising does not compromise the integrity of the product being sold.
Transparency is not a trivial issue. Around the world, it is receiving much closer attention from regulators and investors alike. In the United States for instance, securities regulators are considering, among other things, additional disclosures on fund advertising, on breakpoint discounts so that investors avoid losing out on discounts entitlement, on operating expenses to encourage cost competition among funds and on broker incentives in order to highlight better any possible conflicts of interest in investment transactions by funds.
In a similar vein, the International Organisation of Securities Commissions (IOSCO), of which Malaysia is an active member, issued a report in February this year outlining best practices for performance presentation standards for collective investment schemes. Among other things it focuses on standardising formulae, time period, disclosure of fees and charges, use of performance benchmark and rankings in advertising have been advocated.
Efficiency and innovation
On the subject of efficiency and innovation, I should like to turn briefly to the issue of fees and charges once more, and make the point that the level of fees and charges has a direct bearing on the rate of returns to investments. I would therefore strongly urge the industry to reconsider whether fees and charges currently being imposed on investors are competitive against other investment alternatives on the basis of cost. As far as our domestic market is concerned, perhaps the industry might consider introducing performance-based fees. Whatever the approach, passing on any economies of scale to the investor in the form of lower fees would go far in engendering greater trust and confidence in the market.
The role of the regulator
Before I conclude my address, allow me to say a few words about the role of the regulator in improving market performance and investor confidence in the collective investment industry. A thriving industry needs to operate in regulatory environment that supports the promotion of the industry’s growth and development, while at the same time ensuring a high degree of investor protection. Decisions based on commercial considerations should not be unduly inhibited; competition should be allowed to thrive. At the same time it is necessary to impose strong regulatory discipline, and to promote even stronger self-discipline by the industry to enhance greater integrity of individual players as well as of the industry as a whole.
Achieving the right balance is never easy. I am confident however that in pursuing a more market-based system of regulation, this can be achieved. This means that we should place much greater emphasis on supervision and enforcement, as well as on enhanced disclosure and transparency over products and services being offered. Indeed the approach should not be confined just to collective investments, but to various aspects of regulation throughout the capital market. The adoption of a market-based regulatory approach involves, among other things, a shift from a merit-based review of new investment products to a disclosure-based process of regulatory approval. We should also make more use of appropriate incentive structures and easing-or in some cases, removing entirely-restrictions that impose unnecessary constraints and costs on the industry. And I have already mentioned the need to identify, subject to appropriate criteria, suitable self regulatory organisations to complement the regulator’s lead regulatory function.
Regulators in developing economies typically have an additional role-that of facilitating market development. This requires taking a “total picture” view of the market, often with the long run in mind, as well as a highly-consultative approach to policy-making. In Malaysia for example, the Commission has taken steps to increase the number of industry participants and allow greater access to larger pools of funds. We are also working towards the streamlining of the licensing requirements for the investment management industry. And in consultation with industry, we are formulating a regulatory framework for financial planners with a view to increasing their professional standards. We see financial planning as an important aspect of investor protection, as good financial advice will allow the investor to appreciate the various investment tools available to achieve their financial goal. And certainly, a more informed investor will be in a better position to assess risks relative to returns.
A strong in-house compliance infrastructure is therefore needed to ensure that investor interest is safeguarded, particularly since retail investors form the bulk of unit trust investors. Earlier this year the Commission, in consultation with industry, issued guide for operational controls for unit trust operations for both the management companies and trustees, in recognition of the crucial role played by the trustees in ensuring investors interest are protected. A framework for compliance and internal control were also drawn up.
The importance of partnership between the industry and regulator cannot be overestimated. However strong our laws and effective our regulations, they by themselves cannot ensure market performance and investor confidence. Self-discipline by the industry itself is critical in complementing the role of the regulator.
There is clearly much work to be done in achieving sustainable market performance and enhancing investor confidence in the collective investment industry globally. I hope that the 17th annual assembly of the IIFA can contribute towards a better collective investment industry both in Malaysia and in the rest of the world, and I hope that you will have a productive session tomorrow. But do not also forget to enjoy the many attractions that Malaysia has to offer, so that when you return to your own countries, it will not only be to bring back lessons and ideas relating to the collective investment industry, but also fond memories of your stay in Malaysia.