Conference on Central Banking and Sustainable Development in the 21st Century
28 August 2000 |   By : Ali Abdul Kadir, Chairman, Securities Commission
"Issues and Challenges Emerging from the New Economy from the Perspective of Capital Markets"

Ali Abdul Kadir
Chairman, Securities Commission

Conference on Central Banking and Sustainable Development in the 21st Century

Kuala Lumpur, August 28th-30th 2000

Distinguished guests, ladies and gentlemen:

1 It is an honour for me to participate in this conference, especially in a session with my esteemed fellow regulator, Andrew Sheng. In this last session, Andrew and I have been asked to present our views on capital markets and the New Economy. Let me first take you through what I see as the more important aspects of the New Economy revolution on capital markets before turning to some of the challenges that this new reality poses for capital market activity and regulation.

The Dynamics of the New Economy

Ladies and gentlemen,  

2 We are experiencing what many are calling the Technology Revolution, a term that describes the current proliferation of information and communication technology, and resultant acceleration in communication that many are saying will revolutionise every facet of society. And it is the Technology Revolution that drives the notion of the New Economy. While the concept of the New Economy may mean different things to different people, let me briefly highlight what I believe characterises the essence of the New Economy:
The first thing that characterises the New Economy, as I have just indicated, is clearly new technology. A key issue here is that the strength of this new technology lies not in the creation of a new product or process relevant to only a specific segment of society. Rather, the profundity of recent innovations lies in the fact that their impact is pervasive, giving rise to changes across a wide range of economic activity. This is due in no small part to the multimedia-based, high level of connectivity they afford, which allow linkages between what once would have been distinct spheres of business activity.
The second thing that characterises the New Economy concerns information. Put simply, there's just more of it about: technology has meant better access to information (although this does not necessarily imply access to better information). This is not to say that more information is necessarily being generated either. Information remains costly to produce. What network technology has allowed is for information to be reproduced-and distributed-much more cheaply than ever before. In other words, information has become "commoditised".
3 The advent of the New Economy has generated several dynamics that are beginning to have a significant impact on the nature of capital market structure and activities.
One dynamic is the increase in cross-border transactions. Through improved communication, traditional boundaries between markets and their locations are less relevant in many aspects of capital market activity. Previously, this phenomenon was limited largely to institutional investors and a handful of high net-worth individuals. Now, however, the ability to undertake international transactions is being increasingly offered to retail investors. Moreover, the range of investment products available is also steadily expanding to include not only equity but also bonds, forex, derivatives and mutual funds. What this means is that small investors now have the scope to diversify their wealth portfolio never before seen in the past.
A second dynamic is the increasing disintermediation of market institutions and intermediaries. Traditional hubs of capital market activity, such as exchanges, and "gate-keepers", like brokers, are being side-stepped by net-savvy market participants, who are finding alternative low-cost mechanisms and routes through which to interact. So far the main impact of this trend has been on the trading process. For instance, we are all aware of the rise of on-line broking and alternative trading platforms founded on electronic communication networks. But the possibilities offered by the New Economy go beyond simply trading, and we are already beginning to see the potential benefits of on-line securities issuance being tapped, not only for equities but increasingly for corporate bonds.
A third dynamic concerns changing structure of the capital market, driven by the shifting balance of power away from exchanges and intermediaries towards the investor partly. Market institutions and intermediaries are being forced to confront greater competition by seeking new opportunities to add value for their traditional customer base. Hence, in trying to achieve the critical mass of activity that has become so essential in the network economy, exchanges are adopting new governance structures to facilitate the pursuit of strategic alliances. In a similar vein, market intermediaries are extending their reach beyond traditional geographical and market boundaries through the pursuit of mergers and other strategic partnerships.
A fourth dynamic concerns the blurring of traditional classifications of products. This has arisen in part by the trend of tailoring integrated financial solutions for clients, which in turn is being driven by a variety of pressures including other dynamics, as well as by an increasing focus on explicitly managing the different types of financial risk. While markets-particularly exchanges-in traditional asset classes such as equity, bonds and commodities continue to flourish, the ability to craft and, more importantly, to sell specific hybrids of these assets has improved with the advent of greater computing power and networking technology. But far from replacing each others, these two aspects of the capital market serve to complement each other. The success of providing cost-effective financial engineering solutions requires the existence of deep markets in the underlying products; in turn, explicit risk-management through customised products drives market liquidity.
4 Together, these facets of the New Economy have several weighty implications for capital market participants to consider. Indeed, it has been appropriately noted that
"in today's new economy, all markets and all market participants must respond to new rules and reinvent their roles, not just to compete but to survive."

5 But in the New Economy, it is not just the survival of the fittest but also the fastest. Those that survive the evolution into the New Economy will be those that are able to adapt both effectively and efficiently to the fast-paced changes taking place: Market intermediaries must source for new opportunities, new market niches and new markets altogether; firms and markets must seek out new ways to respond to a more informed and more savvy investor base; market participants must explore new possibilities of reaping the full benefits of technology into the organisation of their business and response to their customers. Those that do not, stand to be archived by the technology that surrounds them.

Whilst we can, to a certain extent, manage the advent of globalisation into our countries to give domestic players time to prepare themselves, technology knows no boundaries and will come to our shores whether we are ready or not. Technology will cause liberalisation of our markets and we need to manage this phenomenon in Malaysia, the SC has issued a paper entitled "Framework for E-Commerce in the Capital Market" so that any player is clear as to the timing and phasing in of E-Commerce into our markets, in order to give us time to amend our laws and regulations and for our institutions and intermediaries to get their systems ready.

New Economy Regulators

Ladies and Gentlemen,

6 I have just outlined to you some of the major trends that are taking place in capital markets-trends that are principally driven by technology and that are resulting in the faster globalisation of financial services, new financial products that require new valuation methods, and heightened competition among incumbent as well as new market participants. These trends undoubtedly pose significant challenges to market participants, as I have just briefly outlined to you. However, given the presence of my central-banking counterparts in the audience today, allow me to focus the rest of my talk on what I see as some of the key New Economy issues for all of us as financial market regulators.

7 As has been pointed out by other commentators before, it is important to realise that financial regulation is primarily about the regulation of information. This is not surprising, since financial markets are essentially mechanisms for generating and processing information. Unfortunately, information is markedly different from many commodities and it is well recognised that this tends to make financial markets susceptible to certain "market failures", such as moral hazard and adverse selection, which can lower the efficiency with which they operate. Hence, regulators are already faced with challenges arising from information under the conventional market environment.

8 However, when you add to this the impact of rapid changes in information technology and the dynamics of the new economy as well, it becomes obvious why the job of a regulator is not an easy one. Traditional regulatory structures are becoming hard to reconcile with certain aspects of the new economy, thus complicating the pursuit of regulatory goals even further. Broadly speaking, the main challenge confronting regulators is that of adapting themselves and the regulations they discharge to this dynamic environment in a manner that facilitates market innovation while ensuring that key regulatory objective and principles are upheld. What additional issues and implications then must regulators consider in the exercising their functions?
Facilitating the financing process for the New Economy. An issue that has attracted much discussion and debate recently is financing New Economy enterprises. Given their higher risk-profiles, such ventures typically find it difficult to secure suitable financing. A critical factor in the development of the New Economy is clearly access to venture capital. The success of venture capital in nurturing the growth of US New Economy companies have led to efforts in other countries to stimulate venture finance. Venture capital investment has expanded rapidly in most European countries while several East Asian countries such as Hong Kong and Singapore are actively implementing policies and reforms to ease access to venture capital.
But in order to attract VC, the investing environment must facilitate their participation. In this regard, cost-effective exit mechanisms, for instance, through a stock market listing, is crucial. Stockmarkets are taking pro-active measures to cater for high growth companies of the New Economy. Around the region, Singapore's Sesdaq and Hong Kong's Growth Enterprise Market (GEM) are two such examples. The Stock Exchange of Thailand has revised its listing requirements in a move to stimulate a still nascent venture capital market for its New Economy companies. On its part, the SC is well aware of these issues, which is why it supported the establishment of MESDAQ in 1997. While there is clearly scope to achieve critical mass, we believe that the exchange represents a significant development in facilitating the shift towards the New Economy in Malaysia.
Going forward, the development of a thriving domestic venture capital industry will further bridge the funding gap that currently exists in relation to New Economy ventures. The SC will be pursuing this aim to spur the proliferation of both local and foreign venture capital funds. The Commission has already initiated discussions with key industry players in both the technology and venture capital industries in a move towards better understanding the challenges faced by these industries.
Promoting investor education. The Internet is providing investors with access to more financial news and reports, real time prices and analytical tools. However, increased access to information by investors does not necessarily mean the quality of information has improved. Internet fraud and information hype can easily eschew an investor's investment decision. Furthermore, access to a large pool of information does not increase an investor's ability to act upon it. Often, investors who act upon their own analytical and investment research, find they accumulate sizeable losses from ignoring the basic fundamentals of investing. While the ultimate responsibility for investment decisions ultimately rest with investors themselves, the social responsibility for ensuring that they are adequately prepared to do so-especially amid the uncertain environment of the New Economy-must lie, at least in part, with the regulator.
On its part, the SC has undertaken specific programmes to spread better understanding of the regulatory framework in which Malaysia's capital market operates, investors' rights and obligations, as well as public technical programmes on market structure, asset valuations and other aspects of investing. Our web-site even provides the investing public with an opportunity to practice their skills with no risk to their wallets through our "Wise Investor" market simulations. Going forward, more resources in the form of technology and personnel will undoubtedly be required, especially in light of the shift the Malaysian capital market is undertaking towards disclosure-based regulation. I believe that the Internet holds tremendous potential for the widespread dissemination of timely and relevant material, as well as of the necessary tools with which to undertake safe, sound and appropriate investing. In this regard I also believe that there is further scope for firms and market intermediaries and institutions themselves to participate in investor education.
Facilitating innovation in the market-place. Current trends are prompting changes in the financial landscape that render traditional product and institutional categories redundant or hard to reconcile with current regulatory structures. Unfortunately, what this means is that competition and innovation-in the form of hybrid products, new market entrants and alternative market processes and new technology, and which may have strong added-value or social benefits-can be stymied by regulations drawn up along familiar product/institutional lines. The approach to regulation must therefore be open to different technology and industry outcomes through a technology-neutral approach. Similarly, regulatory structure should also be seamless with respect to different approaches of conducting market activity as well as to different types of market activity that carry comparable risks, so long as the relevant regulatory principle and objectives are met.
This approach of "seamless regulation" must refer to a strong set of regulatory objectives and principles. For instance, in the case of e-commerce in the capital market, our proposed framework-which was released for public consultation earlier this year-makes reference to
- Applying fundamental principles of regulation of the capital market regardless of the operating medium
- Providing transparency and consistency regarding how the regulatory framework applies in an electronic environment
- Regulating and facilitating capital formation without undue impediments
- Co-operating and sharing information with other capital market regulators, particularly in the areas of surveillance and training
- Ensuring that investors without access to electronic information are not unduly disadvantaged
- The SC taking the lead in promoting and facilitating the adoption of electronic transactions in the capital market.
In this regard, it has also been recognised, not only by the SC but also by counterparts in several other jurisdictions, that it may also be necessary to facilitate innovation further by leading the establishment of appropriate regulatory and physical infrastructures-in the form of enabling technology to support technology-based capital market activities, and clear and proper policies and regulations to allow the conduct of such activities.
Developing appropriate regulatory capacity. Developing the appropriate capacity-in terms of skills, powers, resources-is now critical in ensuring that regulators are fully in a position to tackle the issues I have just described. For one thing, it means having the necessary resources to undertake the effective monitoring of wide range of activities that are being conducted through an ever-increasing variety of media. In this regard, there have been tremendous improvements in monitoring and data analysis techniques-including the introduction of smart systems and neural networks-that regulators ought to be prepared to exploit in their conduct of market supervision, surveillance and enforcement.
The advent of cross-border and cross-asset transactions adds a great deal to this particular challenge and it is therefore critical that financial market regulators have explicit arrangements with each other to undertake explicit international co-operation in supervision and monitoring, and the effective co-ordination of regulatory policies. There are opportunities to exploit new technology even here: recently, Australia's securities regulator launched Global Enforce. Net, a discussion forum for regulators around the world to discuss matters relating to enforcement in an electronic environment. I do not anticipate a switch to a veritable supra-national regulatory framework-replete with global capital market enforcers-anytime soon, which makes the pursuit of these goals all the more vital in ensuring that markets remain fair, efficient, liquid, transparent-and robust.
But the need to raise capacity extends beyond that needed to ensure effective monitoring, regulation and supervision of capital markets. It includes the having a workable and responsive legal framework, consistent with international best practices and standards. Ideally, the regulatory framework should be governed by consistent principles that lead to predictable results regardless of the jurisdiction in which a particular buyer or seller resides. Last, but by no means least, the need for enhanced capacity extends to the abilities of regulators themselves. There must be an awareness and capability to anticipate the critical issues that will undoubtedly arise as the landscape continues to change-for it is far from likely that we have seen the definitive shape of things to come. Above all, regulators must afford to adopt a flexible mind set-savvy, if you like-that simultaneously appreciates and is responsive to the changes that are afoot, and yet is appropriately wary of the risks they may entail. This, then, is what I believe characterises the New Economy regulator.

Ladies and Gentlemen,

9 The Securities Commission is taking pro-active steps in preparing the Malaysian capital market for the New Economy. Needless to say, a lot must be done to prepare the capital market so that it can face and fully partake in Technological Revolution. But while we need to ensure that it is market innovation that leads and not the regulators, it is also important that the appropriate safeguards are in place to deal with the challenges that are emerging from the New Economy. Perhaps the most important of these is the need to have sufficient awareness of the issues and challenges that lie ahead and to develop the appropriate capacity with which to respond to them.
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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