YBhg Tan Sri Zarinah Anwar
Chairman of the Securities Commission Malaysia
IOSCO APRC Seminar Training Programme
29th November 2011
Kuala Lumpur, Malaysia
Ladies and gentlemen,
On behalf of the Securities Commission Malaysia, l would like to extend a warm welcome to all participants to the IOSCO’s Asia Pacific Regional Committee (APRC) Seminar Training Programme (STP). To those who have travelled from abroad, welcome to Malaysia.
The Seminar Training Programme is part of IOSCO’s efforts to build technical and regulatory capacity and expertise amongst securities regulators across various regions. Similar programmes have been successfully held in Costa Rica and Marrakesh in March and June this year respectively. The Securities Commission Malaysia is therefore very pleased to be able to host the Seminar for the Asia-Pacific region, and to contribute to IOSCO’s capacity building agenda.
The theme “Understanding New Financial Products and the Regulatory Implications of Those Products” is one that is critical to securities regulators; and over the next one and a half days, a panel of distinguished speakers will be sharing their expertise and experiences with you on the subject matter.
New Financial Products and their Impacts on the Global Financial Markets
Global financial markets have seen significant changes through innovation, leading to the introduction of a multitude of new products and the reshaping of trading practices and market structures. Such innovation has been primarily driven by deregulation, new information and technologies, and increased investor demand. Financial innovation is said to be the hallmark of a vibrant financial system. It has the potential to provide for a more efficient allocation of resources and higher levels of economic growth.
But as the global financial crisis has shown, such financial innovation and exuberance can be exploited through poor governance and unethical behaviors, leading to the mis-selling and misuse of products, poor disclosures, disregard of risks, and the undermining of the integrity of markets. The creation and sale of high risk, opaque and complex products such as collateralized debt obligations, asset backed mortgages and credit default swaps were identified as among the key causes of the crisis.
The crisis has required policy-makers, regulators and the industry alike to review the way in which financial markets operate, and from the perspective of securities regulators, how we regulate and supervise securities markets. Firstly, it is evident that a number of the financial products including structured products, derivatives, hedge funds and asset-backed products that have complex and unique features were not fully understood by investors who had difficulties evaluating the quality of these products and related information. Some jurisdictions are now re-evaluating the definition of sophisticated and high-net worth investors as it was clear during the crisis that even, so-called sophisticated investors did not necessarily understand the risks inherent in the products they were buying.
Second, in the pursuit of profits, financial intermediaries often promoted high-risk products to maximise gains and compensation for themselves. Many regulators are now requiring intermediaries to ensure that the product being sold is suitable for the financial requirements and the risk profile of the investor. Enhanced know your client requirements and suitability assessments are particularly relevant for investors who do not possess adequate skill sets to make the appropriate assessment. To minimise conflicts of interests and misaligned incentives, some regulators are also requiring intermediaries to have “skin in the game”, and to retain some portion of the products that they originate.
Ensuring the quality, adequacy and reliability of information disclosed is a key element of investor protection. Strengthening transparency is therefore a critical aspect of regulation. Investors must have timely and adequate information to enable them to accurately assess the risks inherent in the products and to price their investments appropriately. In this regard, many jurisdictions are increasing the level of disclosure required of financial intermediaries, including requiring them to provide more qualitative information, standardizing key product features to promote comparability and enhancing ongoing reporting of performance over the life of the product.
IOSCO, as the international standard setter for securities regulation has been at the forefront in the development of regulatory standards for capital markets. Based on the lessons learned from the global financial crisis, IOSCO has revised its Objectives and Principles of Securities Regulation to incorporate eight new principles designed to strengthen the global regulatory system against future crises. These new principles cover specific policy areas such as hedge funds, credit rating agencies, and auditor independence and oversight, in addition to broader areas that include the need to monitor, mitigate and manage systemic risk, and to regularly review the perimeter of regulation.
Earlier this year, IOSCO released a discussion paper on “Mitigating Systemic Risk – A Role for Securities Regulators”, which outlines five key areas in mitigating systemic risk:
Emphasis on disclosure and transparency in markets and products. This is not just to equip regulators with information but is aimed at allowing market participants to better price risk;
Managing conflicts of interest and the buildup of undesirable incentive structures within the financial system. This is addressed via the presence of robust regulatory supervision of business conduct;
Making financial innovation a regulatory focus. Aside from encouraging innovation from a market efficiency and product variety standpoint, the emphasis on risk management is equally encouraged;
Enhancing regulatory understanding on systemic risk and development of relevant key risk measurements; and
Regulatory cooperation to improve overall understanding of markets, particularly its vulnerabilities and interconnectedness.
The emphasis on systemic risk reflect the recognition that financial markets regulated, or exempted from regulation, by IOSCO members can be the mechanism by which risk is transferred within the financial system, and securities regulators must therefore possess regulatory processes to adequately monitor, mitigate and manage such risks.
IOSCO had also released a report in September 2009 on “Unregulated Financial Markets and Products” which examined ways to introduce greater transparency and oversight over these markets and products,, and to improve investor confidence. The Report made recommendations on regulatory approaches to be considered by regulators with respect to securitisation and credit default swap markets, and the broader unregulated financial markets.
Globally, we observe regulatory reforms being undertaken by policy-makers in response to the shortcomings surfaced by the global financial crisis. For example, the US in 2010 introduced the Dodd-Frank Wall Street Reform and Consumer Protection Act which among others, aims to increase transparency and accountability for exotic instruments by eliminating loopholes that allow risky and abusive practices to go unnoticed and unregulated.
Regulatory Implications for the Asia-Pacific Region
While the markets for complex products may be less well‐developed in most of the Asia-Pacific region, there is no denying the fact that complex products and activities are today becoming integral features of modern financial systems. As our markets develop, these products and services will become more relevant to us, carrying with them the associated risks. Furthermore, as the global financial crisis demonstrated, our markets have become integrated with the global financial system and increasingly exposed to systemic risks.
A key challenge for regulators is to ensure that regulatory gaps and weaknesses are addressed and unregulated or poorly regulated activities are brought within the purview of regulation. It is important however that whilst optimizing regulatory coverage, and reducing opportunities for regulatory arbitrage, we ensure proportionality and regulation that is consistent and fit for purpose.
Particularly important for our region, as capital market integration in the region deepens, is to have high quality regulation consistent with international best practices and standards., This will ensure greater regulatory certainty in cross-border transactions and provide for more consistent treatment of market participants, thus reducing the cost of compliance and other friction costs associated with greater cross-border activities.
But above all, we need to ensure regulation that continues to provide high levels of investor protection, and enables us to ensure fair, efficient and transparent markets.
Ladies and gentlemen
In conclusion, I would like to express my appreciation to all the speakers who have agreed to take time from their very busy schedules to be with us this next one and a half days. This Seminar will not be successful if not for your participation and contribution. I would also like to thank the IOSCO General Secretariat, who have worked very hard in putting the programme together.
I hope you will find the Seminar instructive, and I wish you all a very productive and enjoyable program.