Keynote Address at Ernst & Young/ASLI Management Seminar on "The Speed of Change in a Connected Economy: How to Stay Ahead of the Curve"
5 April 2000 |   By : Encik Ali Abdul Kadir, Chairman, Securities Commission
Challenges in the Network Economy: A Capital Markets Perspective

Keynote address

Encik Ali Abdul Kadir
Chairman, Securities Commission

Ernst & Young/ASLI Management Seminar on
"The Speed of Change in a Connected Economy:
How to Stay Ahead of the Curve"

5 April 2000
Sheraton Imperial Hotel, Kuala Lumpur

Ladies and gentlemen, allow me first of all to thank the organisers of this management seminar for inviting me to speak to you this morning. When I found out the topic of today's seminar, with its references to speed and to curves, my thoughts immediately turned to motor-racing. As any of you who follow motor-sport or have driven a sports car around a racing circuit must know, taking corners and sharp bends at Formula One speeds is an extremely difficult exercise. But imagine what it would be like if, at the same time that you were trying to manoeuvre those curves, the race organisers were changing the slope, camber and course of the track each time you accelerated into or out of a curve.

This, to me, seems to be the kind of challenge that managers all over the world are facing as they size up their opportunities in the fast-changing and increasingly interconnected business environment we call the network economy. The parameters on which business decisions are made are changing rapidly; the conditions in which businesses operate are now more dynamic; and the boundaries that used to define the nature of business and markets are shifting or disappearing altogether. As Christopher Myers and his associates have trendily put it, the forces of "Blur" are producing substantial economic changes.

These forces have made the process of management - that is, the planning, organising, motivation, control of corporate resources at your disposal - much more difficult to undertake. In addition, amid this new and sometimes confusing environment, the concept of value has become much more difficult to ascertain - and a lot easier to overlook.

During this period of innovation - referred to by some as a Technological Revolution - entrepreneurial and investment opportunities seem endless, and the potential value of such enterprises appear to have no bounds - at least none that fall within the range that we have been used to all this while. And yet we are only just beginning to get to grips with a number of very significant issues. Exactly how much value does one place on this new economy? What is the appropriate yardstick with which we should measure it? How do we fully capitalise on what value we potentially have, and how do get more of it?

What I would like to do this morning, ladies and gentlemen, is focus on some of these issues as they pertain to the capital markets, where I believe some of biggest and fastest changes are taking place. But before I do so, it might be useful to highlight some of the broader forces at work in driving these changes.

Challenges of the brave new world

Advancements in communication and information technology - in particular, the development of faster and more powerful networks of computers that form the Internet - has meant that more information can now be sent over a further distance at greater speed. The advent of an open multimedia environment for the Internet has meant that widespread and instantaneous communication has been coupled with greater interactivity and interconnection, thus resulting in a low-cost, flexible, decentralised and, to a large extent, anonymous environment.

The growth of such technology has clearly been phenomenal. According to some estimates, the number of Internet users in the world has increased ten-fold over the last five years, and is expected to amount to around 350 million users in the next five. In Malaysia, projections suggest that the number is likely to double to around 1.4 million users in the next two years alone. Moreover, the penetration rate of the Internet has been the most rapid among the major technological innovations. It has taken only four years for 10 million households to achieve Internet access, compared to just under a decade for mobile telephones, over 20 years for the fax machine, and nearly 40 years for fixed-line telephones.

The impact of the network economy has been nothing short of radical. Distance is clearly no longer as significant to business transactions as it was before. Just as important is that producers and consumers enjoy greater interactivity. And let us not forget that we are now more deluged with information than ever before. Hence, as our business environment shrinks, becomes more pro-active and increasingly transparent, it is critical that we understand what implications these developments have for the markets in which we operate, participate or regulate.

It is clear that the scope for competition - and hence, for lower costs and greater efficiency - has increased. Markets are more "contestable" from sources within as well as from outside the industry. Non-traditional firms are exploiting any information advantage they may have to enter a particular market, while smaller and more nimble upstarts are chipping away at market share by providing more cost-efficient alternatives.

Meanwhile, incumbents are responding by forming strategic alliances, cultivating partners. Collaboration and co-operative arrangements are being seen as crucial business strategies for tapping the potential economies of scale that come with achieving common standards and systems compatibility. This has become all the more important for capturing the loyalty of customers, whose behaviour has become increasingly fickle.

This is because the network economy has imbued the customer with relatively more strength. The interaction facilitated by the network economy has meant that customers are becoming more pro-active in their purchasing decisions, preferring to search for products, assess their quality and make transactions without the presence of an intermediary. As a result, goods and services are becoming increasingly customised to suit customers' requirements.

Hence, not only is the network economy making the game harder to play; it is also forcing a change in the rules. Underlying assumptions of the way businesses ought to be conducted no longer fully apply. Sources of competitive advantage and value propositions apply less and less to market leaders. This has been none more apparent than in the financial sector - in particular, capital markets.

Challenges for the capital market

In general, innovation within the financial services industry is taking place at an accelerating pace, thanks to technology. Storage costs are declining, the capacity for data processing continues to increase, and accessibility is improving through lower-costing communications technology. These developments are occurring across the spectrum of financial services and markets, albeit at different rates. Major participants in most sectors seem to have identified some kind of network-economy strategy, and have made some progress in proffering on-line advice.

The biggest impact has clearly been seen in the equity market. Among brokers, the emergence of on-line brokers has raised competition for retail investors, and this has led to lower costs of transaction for that segment of the client base. There has been an increased disintermediation of market makers, brokers and - to a certain extent, underwriters - as investors and issuers have been able to obtain more direct access to the market through on-line channels.

With the benefit of lower fees and more convenient and wider access to the stockmarket, it is not surprising that there is now more demand for customised financial services. More fundamentally, the client-broker relationship is changing. An increasing number of retail investors around the world are getting directly involved in the managing of their assets, conducting investment research and executing - or near enough, given the advent of straight-through-processing - their own trades over the Internet.

The on-line broking phenomenon in the United States is well known. What you may be interested to know, however, that the second-largest on-line broking market in the world, outside the US, is Korea, which is reported to enjoy trading volume of some US$1 billion a day over the Internet. Indeed, the value of on-line trades is expected to account for around half of monthly turnover this year. Other than Korea, Taiwan is another major market, with at least a five-fold increase in trading volume during 1999, while the market in Japan is expected to grow significantly over the next few years.

Competition for liquidity in the secondary trading of stocks has also grown tremendously, especially in the US, where electronic communications network, otherwise known as ECNs, are breaking the traditional monopoly of the exchanges, and provide alternative trading platforms for retail and institutional investors alike. Their growth in the US market has been rapid. From only one in 1997, there are now 10 ECNs. But for now, they remain largely a US phenomenon, although there are signs that Europe will be the next big market for intense competition between national-based stock exchanges and cross-border trading platforms that cater to increased demand for pan-European sectoral investments.

In Malaysia, capital market participants have been keen to explore the benefits of technology, in particular, the opportunities offered by the Internet. The SC has and continues to encourage the industry to take up technology solutions, and has tried to facilitate wherever possible the development and implementation of such solutions. These have included the introduction by the Kuala Lumpur Stock Exchange of the Electronic Client-Ordering System (ECOS) in 1995 as an electronic means for stockbroking companies to route order to the exchange, as well as the introduction by several brokers of proprietary and, more recently, Internet-based electronic links with their clients. Last year saw the launch of facilities for investor to check their central depository accounts remotely as well as what it is believed to be the region's first posting of an electronic share prospectus on the Internet (for a listing on the Malaysian Exchange of Securities Dealing and Automated Quotation [MESDAQ]).

Lessons going forward

Clearly, our capital markets have some way to go in truly embracing the network economy. Received wisdom suggests that there is no single way to achieving success. The experience of other markets points to a wide variety of different strategies. These include international expansion to promote a global brand name, or concentrating on domestic markets, either in a niche market or across the spectrum of financial markets and services. However, there are some valuable lessons which I believe we can draw from what is happening elsewhere.

Above all, there is no holding back the tide of innovation and its subsequent implications for the capital market industry. Open markets in goods and services necessitate a more open and competitive financial sector in the long run. The facilities offered by technological developments will continue to feed rising consumer expectations and to break down traditional barriers to entry to competition. In this respect, I am not even suggesting that the biggest threat will come from abroad. Traditional market leaders in their various market segments must realise that they more likely to face competition from non-traditional domestic firms who are in the position to provide rival services more cheaply and efficiently.

Turning to more specific sectors, brokers must reduce cost and improve the level of service, or risk losing their share to those who can. All over the world, retail investors are beginning to become a potent driving force for the market. In Malaysia, we enjoy a strong retail base, whose loyalties to any one firm can and should no longer be taken for granted. Customers will increasingly be demanding lower costs, best execution and greater transparency about the manner in which their orders have been handled. Brokers must therefore continue to ask themselves "Where and how do I add value?" However, in expanding their scope of services, brokers must ensure that they pursue active risk management and perform the appropriate due diligence, and the SC will remain vigilant in ensuring that prudential standards are met.

Market institutions must continuously look to improve the trading, clearance and settlement processes and to provide innovative services. As I have already mentioned, the monopoly enjoyed by exchanges over corporate listings and secondary-market liquidity is no longer a given in many jurisdictions, and it is only a matter of time before the same pressures are felt in Malaysia. While we might arguably retain liquidity in the current group of listed companies in the short-term, what of the new listings that are already looking offshore for more cost-effective fund-raising opportunities? In this respect, our market institutions must consider providing greater access to the market, along with cost-effective technological solutions such as STP and the possibility of remote-access terminals.

>From a broader perspective, it is imperative that the various components of the infrastructure underlying the entire financial system be open or at least compatible to afford greater efficiency and lower costs. In other words, if the financial system - including both the capital market and the banking system - is to be effective in the network economy, then it is imperative that the parts fit. Hence, it is imperative that undue barriers to greater connectivity be removed, so that current technology can be used to the fullest extent possible to ensure that order-routing, trading and clearing processes are as efficient as they can be.

The issues that I have described above suggest a need to re-evaluate the business models that have served our industry well in the past. However, I believe that it is also crucial to maintain a sense of perspective as we hurtle forward trying to stay ahead of the curve on the information super-highway. The key point I would like to make is that I would hesitate in saying that every single aspect of the capital market has experienced a significant paradigm shift. While certain aspects of conventional philosophy may have to be re-assessed in light of technological changes, I do not believe that the principles and laws on which markets operate have broken down.

Maximising and recognising value in the new economy

Take for instance the issue of valuing shares of "new economy" companies. Although there has been much talk of the need for new measures to assess their valuation, this ought not detract investors from assessing these companies on its fundamental merits or weaknesses. Unfortunately, amid the kind of sentiment that currently pervades over such stocks, this is not just about assessing the quality of information, but also about gauging the hype from reality. I would urge investors not to go in for superficial fads or be misled by those who might take advantage of the heightened optimism in the market. Remember - creating website or attaching a dot-com label is not enough to attain true value.

Shareholder value must be about fundamental strengths through achieving a strong market position, sound financial management and the active management of business risks, and ensuring high standards of transparency and accountability by management. It is also about safeguarding the interests of shareholders. As I have said in the past, creating shareholder value means establishing an environment where shareholders can be confident that their interests are protected in the company they invest in. This, in turn, makes the company an attractive investment option, which is important if Malaysian companies are to be able to compete effectively for long-term capital.


Ladies and gentlemen, this morning I have discussed where I believe some of the key challenges lie for Malaysia's capital market, bearing in mind the growth of network economy. They include maximising shareholder value, adding value to clients, and recognising value where it is due. These challenges can be met if we maintain an open mind and maintain a sense of perspective, for only then will they turn into opportunities.

Thank you for your attention.
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