Repositioning East-Asian Exchanges

Speech by
Datuk Ali Abdul Kadir
Chairman, Securities Commission
at the
Regional Seminar on Non-Bank Financial Institutions in the East-Asian Region

5 September 2002
Securities and Exchange Commission of Thailand, Bangkok

1. It is my great pleasure to be with you here this morning, and I am especially delighted to be part of the celebrations commemorating the 10th anniversary of the Securities and Exchange Commission of Thailand. The Thai capital market has indeed achieved a decade of progress and growth under the watchful eye of the SEC, and I would like to take this opportunity to extend a warm congratulations for all the SEC’s good work. The celebrations have also allowed us to be in this room together today to share our experiences on this well-timed topic and I am honoured to be in the presence of such distinguished and expert speakers from the region.
Globalisation and its impact on exchanges
2. Today we seem to be catapulting into a world where many market participants, and indeed regulators, have acceded to the fact that change is a constant in this era of innovative and fast-moving markets. If you ask the question of why such dramatic processes such as demutualisation and listing are suddenly seen as necessary for exchanges, the answer would be clear-cut – it is simply that the rules of the game have changed.
3. Indeed the game is now dictated by those perennial twin forces responsible for altering the landscape of much of the modern world – technology and globalization. Few have been spared from their potency including East Asian financial markets. Greater electronic connectivity and the resulting integration of markets have forced exchanges to address new possibilities of greater cross-border capital flows through the availability of instantaneous information streams and the removal of traditional obstacles to trade. Hand in hand, these forces work together to revolutionize the structure and shape of financial markets, including exchanges, not only in developed markets but also in developing and emerging markets.
4. Many exchanges have thus adopted new and radical ideas for repositioning through different business structures such as demutualisation and listing, with the objective of creating new strategies and services for its future development and expansion, as well as to remain relevant domestically as well as globally. These new structures require new business perspectives, cultures and philosophies that may significantly alter the outlook and role of the exchange in the capital market.
The Malaysian Experience
(a) The Capital Market Masterplan – motivation for demutualisation
5. In response to the impending change brought upon by technology and globalisation, the Malaysian Securities Commission had embarked upon a project of a 10-year national development blueprint called the Capital Market Masterplan, where we had worked and consulted with industry and market participants to produce 152 recommendations in all sectors to develop and position the Malaysian capital market.
6. A section in the Masterplan has been dedicated to repositioning market institutions, where it contains recommendations that include the consolidation of all Malaysian exchanges into a single exchange, the demutualisation and listing of the consolidated exchange, and the pursuit of strategic exchange alliances internationally. In essence, the Masterplan underscores the need for the single Malaysian exchange to ensure that its business model and organizational structures is fully aligned with the evolution of markets.
7. It becomes important to highlight at this point that demutualisation must be viewed as a means to an end, and not an end in itself. The thrust of the recommendations in the Masterplan is therefore to create a flexible and responsive structure through the demutualisation and listing process. These processes should enable the exchange to compete more effectively by being in a position to respond not only to direct and immediate challenges, but also to future and unforeseen challenges, given the speed and exponential growth of market innovation.
8. Thus when we launched the Capital Market Masterplan in February 2001, we had drawn attention to the need for the Malaysian capital market to constantly meet the evolving and increasingly sophisticated needs of market participants. This, we had stressed, should be done through continuous efforts to enhance the value proposition of the market. The dynamic nature of the industry requires all capital market participants, including the Commission, to work together towards a shared solution, taking into account commercial and regulatory needs to ensure that the capital market not only meets international benchmarks and standards of excellence in providing financial services, but that it also remains relevant to the needs of all its users.
(b) Issues that arise in the process of demutualisation and listing
9. The process of repositioning Malaysian market institutions began with the consolidation of the Kuala Lumpur Stock Exchange (KLSE) group. This included first of all consolidation of three derivative exchanges into one and the merger of the KLSE with MESDAQ, which was Malaysia’s exchange for high-growth companies. The Masterplan contained recommendations for these mergers to ensure that there was no fragmentation of liquidity, and to widen access for investments and products through a single marketplace.
10. This has already proven to be the right recommendation – we have seen significant increases in liquidity and trading volumes on MESDAQ since the day of its merger on 18 March 2002, where the pre-merger daily trading volume was 64,000 units compared to 3.2 million units post-merger. Similarly, market capitalisation has increased by five-fold from January to August this year. In addition, the total number of listed companies on MESDAQ have more than doubled.
11. With the consolidation completed in 2002, the KLSE group and the Commission are now focusing on the demutualisation and listing process. In the process of demutualisation, we are presently tackling many issues that I am sure is common to most exchanges that underwent or are undergoing this process, as well as other issues that are unique to the Malaysian capital market. As the oversight regulator, our focus is necessarily to ensure an appropriate framework for the protection of investor interests, preservation of market integrity and management of systemic risks.
12. The public policy framework of the new exchange operating in a for-profit environment is consistent with IOSCO’s analysis of demutualisation issues, where in its Issues Paper on Exchange Demutualisation, the Technical Committee had identified the key regulatory issue as:
whether the commercial pressures (or governance structure) of a for-profit entity will undermine the commitment of the exchange’s resources and capabilities to effectively fulfil its regulatory and public interest responsibilities to an appropriate standard
13. The public interest concerns that arise out of demutualisation and listing is necessarily of first-order priority, and relate to issues such as the quality of regulation provided by the exchange working as a for-profit entity, potential conflicts arising from self-listing, potential abuse of ownership by the exchange’s new owners, the quality of corporate governance, potential abuse arising from a monopolistic position and the quality of risk management.
14 In addressing these issues, we are taking into consideration various best practice measures that have been adopted by demutualised exchanges, such as the removal of any self-listing conflict by empowering the Commission to undertake the supervision of the single exchange entity, enhancing the Commission’s oversight and powers over the exchange’s activities and self-regulatory functions and ensuring that the composition of the board of directors on the exchange adequately represent public interests.
15. In designing these measures, the basic challenge lies in providing the a demutualised and listed exchange the necessary checks and balances to the standard required of any public listed company, whilst at the same time recognizing the fact that it is no ordinary public listed company given its key economic role with regard to capital formation and allocation in the capital market. Exchanges perform a critical public utility role and is, at present, much more than a mere service provider for trading securities and commodities. Indeed, it often functions also as a self-regulatory organization, with statutory rights and responsibilities.
16. In this regard, high standards of corporate governance should dictate issues such as exchange board composition, to ensure mechanisms such as the presence of independent directors and appropriately structured board committees relating to nomination, remuneration and audit are taken into account. Apart from such measures, the presence of pure public interest directors on the board is also crucial, to ensure that public interest issues are of first-order priority in matters governing the exchange, and will never be compromised in the pursuit of profit.
The Way Forward
17. It becomes increasingly clear, that in order for exchanges to move up the value chain, they can no longer remain insular and isolated from international developments and competition. The creation of new gateways which allow large movements of cross-border capital have brought markets into direct competition with each other. Exchanges have now become rivals in a bid to attract order flows and create large pools of liquidity through means such as low trading costs and high levels of disclosure and transparency.
18. As a result, strategic alliances and mergers amongst demutualised and listed exchanges have become important commercial strategies, to stave off competition posed by each other. Inter-exchange networks help to remove or reduce barriers that would otherwise limit the growth of individual markets or increase the cost of cross-border investment activity. The formation of explicit linkages between markets also leads to significant cost reductions to investors that take positions across national boundaries.
19. The advantages of co-operation and integration among exchanges are therefore obvious, particularly for the world’s smaller exchanges that seek to build critical mass. Today, Asia-Pacific equity markets, which include markets in Australia, Hong Kong, Indonesia, Korea, Malaysia, New Zealand, Philippines, Singapore, Thailand, Taiwan, China and Japan make up 18.3% of total world market capitalization. In the case of the Asia-Pacific excluding Japan, the total is 8.7%. In comparison, United States markets make up 47.8% of total world market capitalisation, with Western Europe markets taking up 27.2%.
20. In moving forward, it is particularly imperative for East Asian markets to explore the creation of linkages and alliances that will be mutually beneficial. Although the region can boast of exchanges that are of world-class standards and providers of market services par excellence, it is obvious that we still face considerable competition from our much larger counterparts in the United States and Europe.
21. By fragmenting the region’s liquidity pools, East-Asian exchanges have to strive harder to draw the attention of institutional investors and tap into global funds. By combining our strengths, and achieving efficiencies not otherwise possible on individual levels, the region has immense potential to compete head-on with the more established exchanges around the world and for global order flow.
22. The age of a global, interconnected financial world is coming our way, whether we want it or not. To survive in unchartered waters, we must be willing agents of change to embrace new challenges, as part of adapting to the natural process of market evolution. We must resist urges to fight change and preserve the traditional models, that may be comfortable in the short-term, but detrimental to the market development process in the long-term.
23. I am confident that this seminar will play its role in educating each and every one of us on the almost limitless potential and possibilities that lie ahead for exchanges, particularly for East Asian exchanges, as they continue to shed their mutual skins and assume their new and agile shapes alongside their counterparts in developed markets as exchanges for the future.
Thank you.