Re-evaluating investment opportunities, risks and challenges
Special Address by
Datuk Ali Abdul Kadir
Chairman, Securities Commission
At the Malaysian Capital Market Summit 2003
28 October 2003
Nikko Hotel, Kuala Lumpur
Thank you for inviting me to speak today. The summit has become an important annual event in the capital market’s calendar and I am especially glad to have the opportunity to address you at this year’s summit.
I say this because it is an exciting time for the market. Of course those of you investing in the market will immediately think of the Kuala Lumpur Stock Exchange’s recent stellar performance. And indeed, we have good reason to be optimistic about the near-term outlook for the Malaysian stockmarket, especially in light of growing interest among global investors and a positive re-rating of the country’s fundamentals.
But as those of you who took part in the recent Securities Commission Dialogue 2003 will know, it is the process of moving into the second phase of the Capital Market Masterplan by next year that I am particularly excited about.
The right honourable minister has spoken of the important successes achieved by the Malaysian capital market in a relatively short period of time, primarily in addressing many weaknesses that emerged from Asian crisis and in strengthening the foundation for future expansion. He also outlined several opportunities in the wider economic environment that could support to the growth and development of Malaysia’s capital market.
In formulating the masterplan’s second phase of implementation, a key challenge is to ensure that strategies keep pace and remain relevant to the needs of the market, the strengths of its players and with the opportunities that arise. What I’d like to do this morning is to touch on several ways through which the capital market can ensure closer alignment between strategy and opportunity going forward.
Aligning strategy with opportunity through value creation
The first involves value creation. In a world where markets are arguably more volatile, the business environment more dynamic and many traditional businesses are increasingly more commoditised, the capital market must be geared to deliver greater value to its stakeholders.
It is interesting to see that some of the challenges facing our market players are being shared by many globally-active players as well. Take investment banks in the United States and Europe, for instance. Prices and margin have fallen sharply in activities once considered to be generators of core revenue. In issuance and trading, for instance, prices are said to have barely held up because too many firms are offering products and services that are barely distinguishable. Reports suggest that issuance margins have fallen by around 20% since the late 1990s, while in the area of corporate finance, customers have become more savvier over more straightforward deals and have demanded lower prices.
But global players are good at re-inventing themselves and at producing different types of products and services to suit the needs of different customers. It is likely therefore that they will weather these trends-as they had the dot-com crash as well as other major shocks to their business-and emerge stronger than before.
Our market players must do the same. We cannot afford to get into a situation of stalemate, where profits are cyclical, low on average with few doing better than the rest. Having been in the industry before, I can empathise: this is harder to do that to preach, and it may mean confronting some deep rooted patterns in our mind-sets and behaviour.
A fundamental response in value-creation must be to lower costs, increase efficiency and, importantly, pass cost-savings to consumers. Wall Street for example is outsourcing more and more of its equity research to India, where it can be done at a fraction of the cost.
On top of that we must be able to enhance our competitive advantage. We must be able to rethink our strategies, not wait for demand to catch up with supply. Instead of simply waiting for prices to return to “realistic” levels, we ought to be looking to create new business opportunities by developing or exploiting our edge, be they Islamic products and services or a more effective or efficient distribution system. Hence, in the face of liberalising and impending foreign competition, Malaysian players must be able to “out-local the global players”!
This means we also have to innovate more. For one thing, consumers are crying out for a wider and more diverse range of capital market products and services to meet their needs. Where such a high products are more commoditised, and therefore no longer command a price premium, it is crucial that we move to a more service-based approach-uncovering the special needs of customers, tailoring services and its delivery and pricing in (fair) value. I am glad to hear that the industry has already recognised this.
In this regard, information management is key because, in reality, every business today is an information business. When we talk of the value of customer relationships, what we really mean is the proprietary information that we have about customers and that they have about the companies we run and the products and services we offer.
For instance, our market in particular has a strong retail investor base. We mustn’t ignore them and we must know more about them. Even in the United States, a wide range of companies vie for retail business, including traditional banks, securities firms and mutual fund and insurance companies. And within any single one of those industries there is a wide range of strategies and business models that can be adopted.
Therefore, for some of you, it may be worthwhile targeting high-net-worth individuals. For others, it may be more crucial to know whether consumers are going for “comprehensiveness” in services and products or are they more discerning. (In any event, variety-whether from one provider or from the market as a whole-is one thing that investors will continue to be seeking more of.) The challenge would then be to provide the kind and range of services those clients seek while finding ways to attract and keep a base of other investors at a minimal cost. For this, having and making use of good quality information about your market segments would be key.
One particular area where I think we have much to do is in leveraging our key strengths through global networks. We need to enhance our international competitiveness further by focusing on areas of comparative and competitive advantage, especially in area of Islamic products and services, and enlarge our markets beyond their current scope. To do so, we must position ourselves to exploit the benefits of global networks. Whether at the level of the individual firm or collectively at the level of industry, we must identify the kind of network that best fits our particular process or business profile.
Aligning strategy with opportunity through strong reputation management
A second way of aligning strategy with opportunity is to gain the confidence of our stakeholders and to achieve a strong reputation for our market. I have already spoken on many occasions about the need for greater professionalism-to establish and self-comply with higher industry standards of business conduct. At the same time, the market must also raise its standards of ethical behaviour. In particular, we must find a way to “operationalise” such standards of behaviour.
This is vitally important. It has been said that you only know the worth of reputation when it lies in tatters. I hope that the market need not wait until such an eventuality before it does so. A high level of integrity by individuals and organisations would go a long way to improve confidence in the market overall. This would make the capital market more resilient to “shocks” arising from isolated cases of misconduct or simply from changes in investor sentiment towards the market as a whole.
Ethical behaviour and standards of professionalism are also forms of competitive advantage. In time, sustained levels of such behaviour and standards of business conduct will also allow for a lighter touch to regulation. Allow me to elaborate on this in terms of a framework originally developed by the United Kingdom’s Financial Services Authority.
In the last 10 years since the commission was established, we have developed a relatively strong compliance culture. Market players are typically reliant on guidance and go by the book. Consequently our relationship with the market has been one of supervising, educating and developing ethics and competence. We are chiefly in the business of looking for early warning signs of risk escalation, in order to take early action to get firms back on track and in ensuring strong enforcement.
What we want to do is to move beyond compliance. We want industry to be risk focused and self policing. Senior management must “buy in” the professional and ethical ethos. This must be integrated into business processes and be seen as assisting business not hindering it. Hence we would like to evolve our regulatory relationship to be more educating, consulting and to facilitate the development of competence, culture and values. In short, pursue a lighter regulatory touch with an emphasis on strong enforcement when necessary.
Ultimately, business must be values-led. Core values must be internalised and regulation pursued to the spirit, not just the letter. Players will have a strong sense of individual responsibility, with a focus on prevention, continued reassessment and improvement in benchmarking to the highest standards. Among things, this will require a strong learning culture.
Is this an idealised view? Hardly. Many firms-and a number of markets-do operate in this manner. But change in culture cannot happen overnight. Neither can behaviour, which needs to change if culture is to change. Awareness of these issues is therefore a key first step.
Aligning strategy with opportunity through strong risk management practices
A third key approach for aligning strategy with opportunity is in managing risks actively-risks to the business environment as well as to reputation.
As far as the business environment is concerned, clinging to the idea that all the market’s troubles are cyclical, and that markets will revert to the mean will not ensure sustainable value and growth for capital market industry. That internationally-active investment banks have been able to maintain profits despite the pricking of the dot-com bubble, geopolitical shocks (including of course the September 11th impact), the global economic downturn and bond market correction is a testament to their resilience.
Our players must, if they are to continue to add value, manage the risks of the cyclical component of their businesses through better active risk management, diversification of core activities and capital enhancement. Operational risks must be treated more explicitly as should the causal links between different types of risk and unexpected correlations between them. To this end, a comprehensive and integrated risk management approach, including periodic risk-mapping, is likely to be helpful for this.
Ignoring the risk of poor brand management and marketing, including management of investor relations, is also a source of value erosion. This, too, is an issue of information management. Whether real or imagined, intellectual or emotional, brands constitute information that consumers have in their heads about your product or service. Moreover, the tools used to build brands, including advertising and promotion through various media, are themselves information or at least ways of delivering key information. What will be required for our market therefore is a systematic, pro-active approach to managing the information we have about ourselves and of our stakeholders to maximise brand and reputation value.
The benefits to be gained from better risk management should not be discounted lightly. First, firms will be less likely to fail or to face serious threats to their solvency or market standing that are a major drain on senior management resources. This indirectly upholds systemic integrity. Second, as regulators, we are more likely then to achieve our objectives and save the effort involved in taking more severe enforcement action at a later stage or coping with a failing firm. This means lower regulatory cost to the market and the need for less direct intervention. Third, consumers and other market participants will benefit from a reduced risk of loss and inconvenience, and market disruption that can arise when a firm is in trouble.
The role of the capital market regulator
To conclude, allow me touch upon the role of the regulator in aligning capital market strategies and opportunities. In order to be able to implement these strategies going forward, the capital market will need 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.
We at the commission recognise this explicitly. Decisions based on commercial considerations should not be unduly inhibited; competition must 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. In order to maximise value for the market, we must support those that are competitive, not protect laggards, in a pragmatic manner that manages risks to market integrity and the broader public interest.
One way the commission is trying to achieve a better balance, is by pursuing a more market-based system of regulation. We are placing much greater emphasis on supervision and enforcement, as well as on enhanced disclosure and transparency over products and services being offered. 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 are also making more use of appropriate incentive structures and easing-or in some cases, removing entirely-restrictions that impose unnecessary constraints and costs on the industry.
In order to facilitate the market-based approach, the commission has been encouraging segments of the industry to establish full-fledged self regulatory organisations to carry out self-regulation and to encourage and enhance the level of professionalism among its members. 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 capital market industry. In this way, we are trying 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.
We are also working with industry to develop a pool of competent professionals within the industry. But we are not looking to 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.
That said however, I don’t want to give the impression that the commission is eschewing opportunities for collaboration with the industry, and indeed the market in general. The importance of this consultation between the market and regulator cannot be overestimated. However strong our laws and effective our regulations, they by themselves cannot ensure our objectives, including market performance and investor confidence, are met. Self-discipline by the industry and market discipline by institutions and investors themselves are critical in complementing the role of the regulator.
Lastly, the commission is helping to address areas where the market may not operate as efficiently as it should. In this regard, the commission will be working closely with the industry to ensure that the relevancy and quality of information conveyed to investors is acceptable enough to enable them to make appropriate investment decisions. Some ways to enhance transparency may include: providing comparable product information directly and encouraging consumers to use it; making firms provide certain information in a clear way to help consumers compare among products and services; product regulation, by setting standards for benchmark products that can be relied upon as a reasonable deal; and promote greater public awareness of product choices, fees and charges.
I have spoken at length about some of the ways through which the domestic capital market can ensure closer alignment between strategy and opportunity going forward. I would like to end my address this morning by asking ourselves whether, in a world where financial markets are becoming increasingly integrated, it makes sense to put all this effort into developing our domestic market? Aren’t our institutions, intermediaries and other market players in danger of becoming irrelevant by the sweep of globalisation?
Interestingly enough, the empirical evidence suggests not. Local financial development still matters, for both large and small firms alike, and has positive implications for economic development and growth. The key to tapping value added opportunities successfully at home and abroad, therefore, is to continue with efforts to develop and grow a strong domestic capital market.
Thank you for your kind attention.