Boosting the Ringgit Bond Market at the Ringgit Bond Market Thrust: Institutional Investors' Role & Perspective Conference
1 October 1996 |   By : Dato' Dr. Mohd. Munir Abdul Majid, Chairman, Securities Commission, Malaysia

Good afternoon
Ladies and gentlemen,

Today, as we all know, is a special occasion for the Employees Provident Fund. It is their 45th Birthday and I am indeed glad that they have chosen the subject of the Ringgit Bond Market as a theme for this conference to celebrate this grand occassion.

My special address this afternoon has been appropriately entitled, " Boosting the ringgit bond market". Malaysia has one of the most promising domestic debt markets in Asia, with many of the essential building blocks already in place, namely :

  • positive economic fundamentals,
  • sound regulatory environment,
  • reliable and established financial system,
  • fast-growing debt-hungry economy evidenced by the yearly increase in the supply of corporate debt issues,
  • adequate infrastructure for custody and settlement, and
  • a developing institutional investor base.

With these ingredients the bond market and the wider capital market must grow, and grow fast, to meet the financing needs of our fast expanding economy. The process of capital raising must be facilitated with greater efficiency and prices determined by prevailing market forces with minimal regulatory intervention. Growth must however be balanced by adequate measures for investor protection which discourages unfair market practices. This can be achieved by emphasising greater professionalism, good corporate governance, high standards of due diligence among company directors, advisors and market intermediaries, with clear legal provisions against any misconduct.
The measures which the Securities Commission has undertaken to develop the capital market including listing of infrastructure project companies, securities lending and borrowing, introduction of call warrants, trading of financial futures, have, therefore been carefully framed within a regulatory framework that fosters growth without undermining public confidence in our capital market. This same regulatory philosophy will prevail in our efforts to boost the Ringgit bond market.

Despite the success achieved todate, the bond market in Malaysia, and most of Asia, continues to be overshadowed by the equity market. Several reasons have been cited for this. Firstly, most governments in the region have been down-sizing their borrowing programmes due to healthy fiscal surpluses. Second, where government paper is issued, it tends to be illiquid and is, more often than not, held by banks and national savings funds to satisfy statutory or liquidity reserve requirements. And last but not least, the retail investors in the region tend to invest their money in the local stock market for quick capital gains or, for the more risk averse, are content to leave it in bank deposits. As a result there is an acute shortage of domestic institutional investors specialising in Asian fixed income; hence the theme for the conference today.

It is, however, heartening to note that governments in the region are slowly becoming aware of the positive benefits of a fully operational debt market. When operating efficiently, it will lower the cost of public and private borrowing as well as provide an instrument for the government to implement monetary policy. More importantly, a solid, fundamentally-based domestic capital market would reduce the reliance of any emerging economy on off-shore funding, thereby making them less vulnerable to changes in the global economic environment.

Measures to boost the Ringgit bond market were clearly spelt out in the Commission's three-year business plan announced in the first half of 1995. The development of the corporate bond market has been identified as a key and urgent programme, and the activities already in progress during the plan period are as follows:

  • promoting the issue of benchmark securities,
  • enhancing liquidity and secondary market trading of bonds,
  • streamlining the issuing process,
  • providing risk management facilities, and
  • improving the market infrastructure, including clearing and settlement systems and trading procedures.

Allow me to elaborate on each of these initiatives.

Issuing benchmark securities
The supply-demand imbalance of Malaysian Government Securities (MGS) has prevented a liquid default-risk free benchmark yield curve from developing in the Ringgit bond market. It has been noted that without such a benchmark, the pricing of bonds in both the primary and secondary market will be difficult and complicated; creating a situation which is not conducive to the growth of the local bond market. The Commission had initiated a study to develop a framework, drawing from the experiences of the Hong Kong government, to implement a programme of issuing benchmark sovereign-rated bonds even though the government has no need for such funds.

How successful is Hong Kong's managed yield curve development programme?

In 1990 the Hong Kong Monetary Authority (HKMA) launched the Exchange Fund Bills and Notes Programme with a two-fold objective of managing liquidity in the domestic financial system and providing the local capital market with a benchmark yield curve. Currently, the maturities of Exchange Fund Notes are up to seven years. The proceeds of the bills and notes offerings are not used to fund government spending, but is reinvested prudently by the HKMA. As a result of the Monetary Authority's facilitation, Hong Kong's bond market has grown swiftly. The secondary market for Exchange Fund issues is the most liquid public-sector bond market in the region - around one third of Exchange Fund paper outstanding is traded daily - while the primary market for private issues has more than doubled over the last five years.

This proposal to build a benchmark yield curve has already been submitted by the Commission to the Minister of Finance for his consideration. The successful implementation of this proposal would, we hope in time, remove one of the hurdles in the development of the Ringgit bond market; viz. the absence of a credible liquid benchmark.

Enhancing liquidity and secondary market trading
One trademark of any successful market, be it equity or debt, is the high level of liquidity in the secondary market; and the lack of trading activity in the Ringgit bond market has been acknowledged as an urgent item in our agenda. A simple way to compare the trading volume in Hong Kong and Malaysia is the use of the ratio of daily turnover to outstanding paper. Hong Kong, in 1995, has a ratio of 1000 times higher than Malaysia.

How then should we go about to seek a viable solution to address this problem of an illiquid secondary market for Ringgit bonds?

In the more successful and mature bond markets, there always exists alongside, a well-developed repo market in government bonds. Traditionally, repos are used by Central Banks as a tool for conducting open market operations, that is, to inject or remove money supply from the financial system. Today, repos are also used mainly by institutional investors to take short bond positions, reduce funding costs for long bond positions and earn incremental income by lending bonds that are in demand.

If I may, let me now take you on a quick tour of some repo markets around the world to give you some idea of its size as well as the close link between the repo market and the overall fixed income market.

The American market which has been growing since the 1960s is currently seeing close to USD1 trillion of daily repo transactions. Over in continental Europe where the repo markets are much younger, the development has been just as rapid. In France, the volume of repo transactions has exploded from a daily average of FFr 300 million in 1990 to one of more than FFr 45 billion in 1994. In Germany, repos account for almost two-thirds of the turnover in government bonds, more than any other European country. And in Italy, the concept has even filtered down to the streets, where close to 80% of the repo transactions involve retail investors.

Across the English Channel, the Bank of England at the start of this year fully opened the repo market in government bonds or gilts. This new reform measure is intended to increase the efficiency and liquidity of the UK gilts market, in addition to bringing market practices into line with those of other large government bond markets like the United States and France. After an initial sluggish start, the gilt repo market is now set for continued growth.

Closer to home, the repo market in Taiwan accounts for about 90% of the total trading volume in the secondary bond market, and institutional investors generally use repos to finance their long-term bond holdings. Flexibility in market practices, where the transaction period can range from overnight to several months and where early termination is acceptable, has brought about greater liquidity in the secondary market.

In Malaysia, the repo market has been in existence since 1979. While the use of repos to borrow cash against the collateral of securities is well-developed, the use of reverse repos to borrow securities against cash is less common. Currently, all financial institutions are allowed to engage in repos with a non-interbank participant if the transaction period exceeds 30 days; the reverse, however, is not allowed. This means that a corporate body cannot borrow against its holdings of securities from a licenced financial institution via a repo. Such restrictions present difficulties to non-financial institutional investors who seek to maximise returns on their investments in debt securities. Furthermore, under the present regulatory framework, only securities listed on the Kuala Lumpur Stock Exchange (KLSE) are eligible for borrowing and lending.

In view of the relative benefits of a well functioning repo market to the bond market as a whole, the Commission is in the process of studying the state of the domestic repo market with the aim of identifying measures that need to be taken to facilitate its growth.

At the start of this address, I noted that one of the problems faced by the bond market is the lack of fund managers specialising in fixed income securities. The introduction of bond funds into the unit trust industry, in addition to providing an additional means to promote savings amongst the retail investors as well as giving them a choice to invest in an asset class that will yield higher returns than fixed deposit in the medium to long term, would also infuse some liquidity into the inactive secondary bond market. We have todate approved the launch of four bond funds, the most recent being the Kuala Lumpur Bond Fund and Mayban Income Trust Fund on the 11th and 19th of June,1996 respectively. Investor response so far has been encouraging with the net asset value of the earlier 2 funds standing at RM125 million as at 30th June.

Streamlining the issuing process
The process of issuing corporate debt paper currently involves the approval of no less than three regulatory authorities - the Commission, Bank Negara Malaysia and Registrar of Companies, - the rating agency, and if the issue is to be publicly listed, the KLSE. It has been observed that the entire process of obtaining the approvals of all the relevant authorities could easily take six to nine months. During this period, the issuer will be exposed to interest rate movements and the risk of the issue becoming less attractive to investors.

The Commission is, therefore, looking at various measures to streamline the regulatory framework for corporate bond approvals to shorten the time taken in the primary issue. One practical solution is the introduction of 'shelf registration' for bond issue. At first glance, the proposal may involve some amendments to the Companies Act and/or the introduction of new guidelines to oversee the shelf registration process. As is the modus operandi in any project undertaken by the Commission, we will work closely with all parties concerned, which would include potential issuers, to get this proposal off the ground.

The practice of shelf registration is not new. Under Rule 415, adopted by the US Securities and Exchange Commission (SEC) in 1982, widely traded leading corporations may file a single S-3 'shelf registration' statement form with the SEC to cover the total of new bond and/or stock financing for the next two years, without the necessity of filing new registration statements and distributing new prospectuses, thus expediting the public offering without the customary 'waiting period'.

Many academic studies have shown that Rule 415 has tended to lower the issuer's net borrowing cost, increased the variety of securities issued by firms, and has been extremely successful. An eligible issuer under Rule 415 does not incur repeated administrative costs of registration and does not bear the time costs of SEC bureaucratic delays. Once a shelf registration statement is approved, the issuer can receive bids from various investment bankers offering to buy the securities at a given set of terms and price. Almost all the firms eligible to use Rule 415, numbering 1,500 of the largest US companies, are using shelf registration for their debt securities.

This system of shelf registration has also caught on outside the United States, particularly in the Eurobond market. In Asia, bond issuance under the shelf registration system was introduced in Japan in 1988. And, in Hong Kong, the rules on the listing of debt securities were revised in 1994 to allow for the quick approval for several bond tranches at different times as part of one programme. These changes were initiated with the objective of making the rules more responsive to market requirements, while at the same time striking a balance between operating efficiency and effective regulation of debt securities. Shelf registration however, does require prompt and stringent filing of accounts and corporate reporting by the issuers for investors to evaluate the risks in the company.

Providing risk management facilities
The lack of a hedging market has been raised time and again by both local and foreign investors in Ringgit paper. Risk management tools need to be in place to enable investors to hedge their positions in the cash market, and manage their risks accordingly. Without an opportunity for hedging, even an investment position can be transformed into a speculative one if a cash crunch forces the investor to liquidate his position prematurely.

Before 28th May of this year, the only market for hedging interest rate risks is the swap market, which is more active off-shore than on-shore. With the launch of the Malaysian Monetary Exchange and the introduction of the 3-month KLIBOR futures contract, this issue has, in part, been addressed. It would be unfair, at this point in time, for anyone to evaluate the success of the 3-month KLIBOR contract. However, while average daily volumes have been maintained below 500 contracts, the average daily open interest has climbed, albeit slowly, from 1,300 contracts in the first month to 1,800 contracts in August. This, I believe, is an encouraging sign.

The next step after interest rate futures, therefore, is bond futures and options. However, it should be stressed that unless the underlying cash market has the requisite liquidity it would be difficult to stimulate market interest in bond futures.

Improving the market infrastructure
At present, there are 2 main clearing and settlement systems for the trading of bonds in Malaysia. One involves listed bonds on the KLSE and the other, SPEEDS, caters mainly for government bonds and Cagamas paper. The missing link, therefore, is an organised and centralised trading, delivery and settlement system for unlisted corporate paper. Furthermore, there is a lack of market information on these unlisted issues.

One option would be to set up a completely new market infrastructure for unlisted paper. This would mean a duplication of resources which would likely translate to higher transaction costs for the investors. A more efficient solution, I believe, would be to enhance SPEEDS in order to handle larger volumes of transactions, and to explore the possibility of opening up the electronic book-entry system to non-Scripless Securities Trading System members. Due to the fact that SPEEDS cannot undertake collateral management functions, it is suggested that the settlement of trades by non-Scripless Securities Trading System members will be through designated settlement banks, as is the existing practice.

Currently, only financial institutions and selected statutory bodies are given direct access to SPEEDS. This leaves the fund managers, securities firms and non-financial institutions having to trade through financial institutions. For the Ringgit bond market to attract greater liquidity, the Commission believes that that the custody and settlement system should be opened to all institutional participants, be they banks or otherwise. This would not only widen the market participant base, but also create a more level playing field for all.

Just as I started by making mention of the Commission's three-year business plan, I would like to close on the same. The objectives of the business plan are to ensure the creation of a credible, fair, efficient, transparent, competitive and stable capital market; and the Commission's efforts to develop the Ringgit bond market would, at all times, embody these elements.

Thank you.
about the SC
The Securities Commission Malaysia (SC) was established on 1 March 1993 under the Securities Commission Act 1993 (SCA). We are a self-funded statutory body entrusted with the responsibility to regulate and develop the Malaysian capital market.

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