YBhg Tan Sri Zarinah Anwar

Chairman, Securities Commission Malaysia

at the

Kuala Lumpur International Venture Capital Symposium 2011

11 October 2011

Kuala Lumpur

“Strengthening the Venture Capital Eco-system in Emerging Markets”

Yang Berhormat Senator Dato’ Dr Awang Adek Hussin, Deputy Finance Minister
Distinguished guests, ladies and gentlemen



I would like to thank the MTDC for inviting me to speak at this symposium today.


The venture capital industry has played a key role in providing risk capital to nurture dynamic and innovative global firms. This includes the likes of Intel and Federal Express in the early days and, more recently, internet phenomena such as Facebook and Twitter.


But the contribution of the VC industry extends well beyond these success stories. The VC industry has generally acted as an enabler to innovation and its commercialization, and promoted a more rapid pace of commercial start-ups, contributing to the building of several emergent industry clusters.


The Venture Impact Report 2011 highlighted that while investments in venture-backed companies accounted for less than 0.2% of US GDP, venture-backed companies employed 11% of the private sector workforce and generated revenue equal to 21% of GDP 1.


The macroeconomic contribution of the VC industry is certainly very attractive and this has inspired many governments to emulate initiatives to create VC breeding grounds to spawn technology-based start-ups in their backyards.


As Malaysia embarks on its economic transformation from a middle-income to become a developed economy, we hope that the venture capital industry can play a similar catalytic role as an “essential funding apparatus for innovation” in our economic transformation process. The success of innovation clusters worldwide has largely been driven by a robust VC eco-system that has facilitated the pro-active supply of risk capital.


Our long-term strategic blueprint for the development of the Malaysian capital market, the Capital Market Masterplan 2 (CMP2), places emphasis on enhancing the role of markets in promoting capital formation. A key strategy in this regard is to enhance the role of the private sector in the venture capital industry, reflecting the strategic significance with which we regard the VC industry as a catalyst for innovation and transformation.


Today, I would like to share with you my perspective on some of the challenges of creating a thriving VC industry within the context of emerging markets in the region, our regulatory initiatives to strengthen the VC eco-system and issues relating to the development of Islamic venture capital.


I hope that with the presence of leading industry practitioners and global experts at this Symposium, you will have the opportunity to discuss and debate these issues in the following sessions. We would welcome any feedback that you can offer in our efforts to build a vibrant VC industry in Malaysia.

Ladies and Gentlemen

Challenges for the VC industry in the region’s emerging markets


While the VC industry has been in the limelight with its spectacular achievements, success is typically limited to clusters such as the Silicon Valley in the US, some clusters in Europe, in Tel Aviv, and in centres like Bangalore, and the Guangdong and Zhejiang provinces in Asia. Generally, Asia has yet to evolve the VC firms that can match the capabilities of their counterparts in US and Europe. Nor has the region attained critical mass in funding a sufficiently large number of start-ups to make a significant contribution to economic growth.


This disparity can, of course, be explained by the fact that it is still early days for Asia which is currently building the economic infrastructure that is conducive for innovation and commercialization of research. But this does suggest that many of the critical pre-conditions that gave rise to VC technology-based innovation may not yet exist across the region and that it is not merely a matter of replicating successful strategies elsewhere since prevailing conditions differ widely from country to country.


There are many challenges ahead in building a vibrant regional VC industry and I would like to identify a few key ones for your consideration. The first and perhaps most important is the availability of large investment opportunities. There needs to be sufficient and sizeable deal-flows, to justify the existence of a community of VC firms. As a recent study of the European VC industry postulated, the relative under- performance of the European VC industry compared to the US, could simply be due to less quality entrepreneurial ideas generated in Europe 2.


In the context of emerging markets, this suggests that efforts to build a venture capital industry need to take on a global mindset. An innovative product or service that is oriented towards a global marketplace would clearly offer scale and implicitly better prospects of sizeable returns to compensate for the risks. In addition, in many of the successful venture capital clusters, the presence of immigrant participants is highly visible and they add value either in terms of technological or market knowledge from their own countries, to complement capabilities in the host country.


Another factor that can shape the size of investment opportunities is the emergence of a new industry. In relation to this, the VC industry boom over the past few decades had been driven largely by the IT sector which generated sufficient opportunities first in the hardware and software segments, and currently in the internet space. However, as the IT sector becomes increasingly crowded, there may be a need to identify the next wave of innovation that will capture imagination and be the next future source of deal-flow.


The second major challenge relates to the mindset for managing risk. In this context, many emerging Asian economies are still evolving from bank-centric financing systems where the mindset is more on managing the probability of failure rather than participating in the potential returns of successful outcomes. The development of a thriving VC industry is not dependent merely on financing. Equally important is what VC firms bring to the table in terms of the specialised industry knowledge of VC partners, their network and their ability to assist the entrepreneur to turn innovation into a successful business venture. Indeed, specialised industry expertise is an essential skill that will enable VCs to identify high potential investments.

In the European study I mentioned earlier, one of the arguments advanced for the relative under-performance of European VCs compared to the US is the fact that European venture capitalists more commonly have a finance background unlike US VCs who tend to be scientists and ex-entrepreneurs who are better able to understand and advise their investee companies.


While the VC industry needs to operate in a culture of calculated risk-taking, this has to be balanced by the confidence of investors that the rewards are fairly shared to ensure that the flow of investment dollars is sustained. These are elements in the eco-system that need to be further developed in the Asian environment.

Ladies and Gentlemen


Governments around the world, including Malaysia, have been highly committed and supportive of the VC industry. However, the government role in the VC industry has come under active scrutiny as to whether governments can succeed in an area that typically requires a high level of entrepreneurial savvy. In this regard, the role of government needs to be carefully shaped such that they act as a catalyst or provide risk mitigation to attract credible domestic and international private sector players to participate in the VC industry. But clearly it is not the role of government to act as on-going providers of funding.


We have certainly taken these observations on board while developing our long-term strategies for the development of the VC industry and, arising from this, our initiatives are aimed at raising the levels of private sector participation to complement the supportive measures of the government to enhance overall policy effectiveness.


Overall, the Asian VC industry has a critical role to play in promoting innovation and capital formation throughout the region. In the context of the current global economic slowdown, it is necessary to accelerate the pace of technological development in Asia to generate new sources of growth, investment capital and job creation so that Asia can grow more rapidly to take up the slack in global aggregate demand. The Asian VC industry therefore needs to formulate appropriate approaches that can most effectively combine the commitment of their governments to promote innovation, with private sector entrepreneurial capability and the vast pools of savings of their citizens.

Ladies and Gentlemen,

Strengthening the VC eco-system in Malaysia – a regulatory perspective


The VC industry in Malaysia has enjoyed rapid growth with committed funds growing by 16% annually from RM2.1 billion in 2003 to RM6.0 billion in 2010, with about roughly half of the funds disbursed to investments. Reflecting this, Malaysia currently ranks 18th in the “The Global VC and PE Country Attractiveness Index of 2011″ 3.


However, this growth has been driven by substantial public sector involvement with the government accounting for 51.4% of total fund commitments as at the end of 2010. We therefore see a need to further strengthen the eco-system through addressing gaps in the venture creation process. This ranges from the innovation process, the availability of specialist skill sets and networks, funding, exit mechanisms as well as the liquidity of VC investments.


From a broad perspective, the Malaysian policy initiatives to strengthen the VC eco-system may be viewed as being two-pronged. First, within the public sector, there are broad initiatives underway to propel the levels of innovation. The government funding – whether through grants or funding commitments to the VC industry – are also being streamlined to ensure greater effectiveness – particularly in relation to anchoring critical aspects of the innovation process.


The second prong is to expand the role of the private sector in the VC industry as well as the complementary development of the private equity (PE) industry. Higher private sector involvement is critical to increasing VC deal-flows to build critical mass so that the VC industry can generate self-sustaining growth momentum.

Private sector participation however can be hindered by the absence of flexible risk pooling structures such as limited liability partnerships or other schemes which facilitate risk sharing for pooled investments in a wide range of asset classes. Therefore there is a need to introduce flexible pooling vehicles which can facilitate the participation of institutional and high net-worth investors into VC funds.


On another note, the long-held belief was that the VC industry should not be subject to regulation given the hands-on nature of their management, the low leverage, the fact that their main source of funding is from institutional and high net-worth investors, and given its significant role in financing innovative companies and industries.


In recent years however, starting with the bursting of the internet bubble and in the aftermath of the global financial crisis, regulators are starting to lean towards the view that some form of oversight is required. As is well-known, the VC industry can be prone to aggravated boom-bust cycles. As more retail investors and pension funds increasingly diversify into VC and PE assets either directly or indirectly, the need for oversight becomes more evident as grave consequences can arise for example from redemption pressures requiring the disposal of illiquid VC assets and information asymmetry due to complex terms and conditions or inadequate disclosures.


Another factor that triggered the interest of regulators was how technological changes have caused organized risk-taking at the primary investment stage (such as crowd-funding and angel funding) to increasingly spill over into the traditional boundaries of securities regulation – such as the act of offering and trading of securities, the management of funds and the provision of investment advisory services.


Recently, the Dodd-Frank Wall Street Reform mandated the US Securities and Exchange Commission (SEC) to register hedge funds and private funds as investment advisors, but exempted venture capital funds advisors from registration requirements. However they are subject to reporting and recordkeeping obligations. In addition, the SEC developed a strict definition of “venture capital fund”, focussing on the lack of leverage and the non-public, start-up nature of the companies that they invest in.


From our perspective, the lack of formal regulatory oversight actually hinders the orderly development of a highly professional VC industry in Malaysia. In the more developed markets, the higher levels of industry reputational capital and capabilities provide a basis for relying on market discipline. But this approach may not be suitable for attracting private sector investment when the industry is still in relative infancy.


Therefore, Malaysia is taking the approach to formalize regulatory oversight with the objective of promoting greater investor confidence in the VC industry. The framework will take into account the unique characteristics of these industries and will be aimed at ensuring higher standards of professional management and providing greater clarity and safeguards in relation to the availability of information, and the maintenance of valuations and records. In addition, a formal framework can also facilitate the shaping of a more effective tax regime where greater incentives can be provided because more precise scoping reduces the room for abuse of these incentives.


The increase in investor protection safeguards will then provide a foundation from which to expand the participation of the public and private sector institutional investors in the VC and PE industry.


Currently, pension and insurance funds account for less than 3% of funds committed to the VC industry in Malaysia4. In this context, it is worth noting that institutional investors in the US were initially discouraged from making private equity investments which were deemed too risky within the context of “prudent man rule” pursuant to the Employment Retirement Income Security Act (ERISA).


However, in the late 1970s and early 1980s, the rule was amended to suggest that a risky investment, that may be imprudent in isolation, may be acceptable in a portfolio. The easing of restrictions was viewed as a critical catalyst for the growth of the VC industry. Pension and insurance funds now account for more than 30% of VC funding in the US.


On the basis of US benchmarks, if 5% of the almost RM1 trillion managed collectively by the private sector fund management industry, GLICs and insurance companies in Malaysia were allocated to alternative investments, this would translate into roughly RM50 billion that would be available for investment in alternative assets including VC and PE.


From a macroeconomic viewpoint, increasing the proportion of national savings managed by these institutions into primary investments will strengthen the intermediation linkages between savings and capital formation and reduce systemic risks through reducing the level of correlation between investment portfolios and market risks.


Apart from strengthening regulatory oversight to address information asymmetry issues, facilitating the entry of institutional investors into alternative assets such as VC and PE unlisted securities also require initiatives to improve the liquidity of these assets. This we will tackle by assessing the viability of mitigating illiquidity risks including facilitating the establishment of “trading” venues for unlisted securities. In the US and Europe, the emergence of venues such as SecondMarket5, SharePost6 and DealMarket7 have helped to reduce search costs for angel investors as well as finance the development of innovative growth companies.


In addition to tapping institutional investors, efforts also need to be made to promote greater PLC participation in seeding the formation of innovation-based companies and to provide greater support to VC investee companies via vendor schemes, co-investment arrangements or through their participation in an angel network.

In fact the involvement of corporates is important as shown in the US where the strong ties between corporates and the VC community account for much greater amounts realised in trade sales.


Lastly, the development of the VC industry will also benefit from greater stakeholder collaboration to increase the talent pool by providing education, raising professional standards as well as connecting domestic and international talent with global industry knowledge and track records with the opportunities available.

Ladies and Gentlemen,

The development of Islamic venture capital


The development of the Islamic venture capital industry is a major objective in our plans. There are many aspects of venture capital that are consistent with Islamic finance – most particularly the provision of capital without leverage, the sharing of risks in a fair manner among partners and the impact of the VC industry in promoting growth for economic and societal development. There can be no greater motivation to grow a business practice than one that is crafted by deeply-held religious and ethical beliefs.


The SC has already launched a regulatory framework to provide guidance on Shariah-compliant practices for the VC industry. Many of the building blocks are already in place to provide a strong foundation for the emergence of a distinctive Islamic VC and PE industry. There are two more missing pieces of the puzzle. The first is a familiar challenge to the Islamic finance industry – namely the need to bridge vast oceans of knowledge. The Islamic VC and PE industry require the fusing of talents well versed with Shariah as well as finance knowledge and a third additional element – a deep working knowledge of industries and markets. It will take time to accumulate and organize the skill sets.


The second is to seed the orchard. As outlined in the CMP2, a seeding strategy will be developed to increase the range of Islamic investment strategies. Priority will be placed on nurturing Islamic fund management services with high value add such as the VC industry, investing on the basis of the principles of active partnership and risk-taking in accordance with Shariah principles.


It is our vision to position the Islamic fund management industry to play a key role in developing products and services that generate economic returns while complying with universal ethical standards to strengthen the distinctive value proposition of Malaysia’s Islamic Capital Market and establish Malaysia’s position as an international centre for Islamic asset management.

Ladies and gentlemen,

Concluding remarks


On that note, let me conclude by thanking the organizers once again for inviting me to speak, and I wish all participants a very productive and successful programme.

Thank you.


The Venture Impact Report 2011, National Venture Capital Association (NVCA)


The Performance and prospects of European Venture Capital; Roger Kelly


The Global Venture Capital and Private Equity Country Attractiveness Index 2011; IESE Business School, Ernst &Young, EMLYON Business School


SC Annual Report 2010


SecondMarket; United States


SharePost; United States


DealMarket; Zurich Switzerland