• The disintermediation process, the shift from intermediaries to markets
• The role of technology, in transforming the microstructure of our markets and trading platforms
• The globalisation of markets

The Disintermediation process (Shift from Intermediaries to Markets)
The pivotal role of the capital markets in intermediating between users and providers of capital within a market economy in the decade of the 90s and beyond is well-known and well-accepted, both domestically and internationally. The increasingly important role that capital markets play in the growth and development of most market economies has resulted in drastic changes to the financial services landscape in most countries. Two decades ago, for instance, the financial market revolved around banks and banking institutions where, to the average citizen, whether individual or corporate, the concept of investing was almost synonymous with placing money in savings accounts or fixed deposits. Over the last two decades the disintermediation process has changed this cosy relationship and transformed both the banking sector and the financial markets.

Disintermediation refers to the process whereby borrowers bypass balance sheet intermediaries and obtain finance direct from the capital markets. In Malaysia we have experienced disintermediation through the development of the corporate debt (PDS) market, securitisation of housing loans through Cagamas and the growth in the unit trust industry. These changes have been driven by market forces and facilitated by government regulations. The cheaper cost of financing through the capital markets for both institutional and retail borrowers was the main driving force. A second factor is the change in investor behaviour arising from wealth accumulation and higher levels of education. Investors no longer accept the low returns from savings accounts, prefering instead to make their own investment decisions and demand greater flexibility in investing for the long term. The process of disintermediation in Malaysia is still at an early stage. By comparison, in America, disintermediation has proceeded apace such that the total value of funds managed has exceeded bank deposits.

Technology and our financial markets
Disintermediation is one major contributor to change, the second is technology. The stock market has evolved from one that involves a floor with a noisy pit where individuals shout to one another to a screen linked to a centralised exchange. The old days of scrip handling have now been replaced with the book entry system in the Malaysian Central Depository, eliminating the risks of lost certificates, forgery and delays in processing. The derivatives market, both exchange-traded and OTC market have made significant progress through the use of both software and information technology. Risks are more easily identified, allowing the level of risk to be determined more accurately and managed more effectively, resulting in a wide range of applications by a clearing house in its margining systems, and brokers in their pricing and own internal risk management systems.

But the biggest challenge today of information technology is the Internet. The Internet promises to be the true global marketspace in a truly borderless world. But challenges and opportunities on the Net are intertwined so delicately, that those who see and seize the opportunities will emerge with great success.

Let me share with you a success story. How do you get on to the Internet ? Through a net browser. A net browser called Mosaic was the catalyst that got the World Wide Web going. In February 1993, Mosaic was unleashed by a student from the University of Illinois. This simple invention was the catalyst to the information exchange explosion now occuring globally. Mosaic was transformed to a commercial product called Netscape and went public in the American market in August 1995.

Why is the Net so intriguing? First, we have to understand the paradigm of doing business on the Net. No one owns the Net. In a sense, every participant owns it. It breaks down the old fashion idea of time and space in terms of geographical location. That has many implications for the capital markets, changing the ways that securities are offered and traded. In many countries prospectuses are already available on the Internet, reducing the costs of distribution and widening distribution channels across national boundaries. Outside the Net, trading in many exchanges is now global, reflecting the ability of technology to break dependence on physical location as well. New platforms may also influence the future structure of markets. Indeed, the future may evolve into one with computers linked to an intangible network with no central exchange.

Technology will not only affect the conduct of markets and exchanges in the future. It will have a great impact on the retail payments and financial services distribution channels. Consumers are getting comfortable with purchasing small ticket items such as hotel bookings, book ordering and other forms of catalogue shopping. Once SETS ( Security Electronic Transaction System ) is established, there will be greater security and authenticity regarding payments. It will be possible to deal with the big ticket items such as securities trading.

The Net also allows the convergence of different industries into one market place. Imagine what happens when nascent networks are transformed into a robust information highway. It will bring in a fresh breed of market players from outside the financial services industry, with an even greater permutation of financial services that one can dare to imagine.

There is no doubt that technology will continue to be the major driving force to change and liberalisation and challenge the framework within which business in financial services is currently conducted. We, at the Securities Commission are not sitting back, with the hope, that some unfortunately have that this will somehow go away. We are currently embarking on a paper on electronic commerce to grapple with the issues from a regulator's perspective. This we will release as a preliminary study at a conference on 2 September, inviting comments from industry. On a similar theme we are working on guidelines to deal with electronic branching.

Liberalisation and Globalisation
Coupled with the forces of disintermediation and technology is the globalisation of world economies. As a result of liberalisation of trade and capital flows, the Malaysian financial markets are now closely linked to global markets. Foreign direct investments have grown dramatically in the past decade, and in recent years, outward investments, or reverse investments, by Malaysians have grown significantly too. This was in response to the government's call for Malaysian conglomerates to diversify into overseas ventures. Fundraising by these companies is getting more international than before, with a number of bonds and equity issues placed successfully at very competitive rates in the international financial markets. Recognising the need for such funding from home and abroad, we have formulated our own foreign listing guidelines.

On the secondary market KLSE has attracted significant international participation with clear demand from foreign investors in Malaysian equities and bonds. We strongly believe that the nascent derivatives exchanges, KLOFFE and MME will be significant players in the future as well. I am particularly pleased, too, that our local unit trusts funds have been pressing at our doors to allow them to invest part of their funds overseas. Initially, we limited it to 10 per cent of their funds managed. Now we have lifted the ceiling with confidence that our fund managers have matured to venture abroad intelligently to seek better returns for their investors. All these activities will truly move us forward to become a regional financial centre.

Liberalisation, however will also mean opening our doors to foreign competition. As I said earlier, it remains a concern to our local players that liberalisation, at too fast a pace, will bring in the Barbarians, waiting at our Gates. However, if executed properly, it should make our markets fairer, more efficient, more secure and more transparent. Liberalisation starts within Malaysia for the benefit of Malaysian business. Malaysian stockbrokers are now able to undertake activities beyond the traditional scope of business, as announced in the 1997 Budget speech, and other financial institutions are similarly encroaching into stockbroking business. In the recent amendments to the unit trust guidelines, we have further opened up internal competition allowing any financial services company to set up unit trust management companies. This, I believe, is the way forward.

We must not be paralysed by the fear of foreign competition. I would call on our local players to rise up and turn challenges into opportunities, beat swords into plowshares. Exposure to global competition is a powerful force that drives improved efficiency, lowers costs, promotes innovation and professionalism within our markets. More importantly, whilst we continue our internal deliberations on when to do it, why we should do it, and what are the first steps, let us not be blind to the international markets. Call Warrants on Malaysian stocks were already traded in Luxembourg before we even started work on our own guidelines. FINEX has just announced that they will be launching Ringgit futures in New York on July 11, this coming Friday.

We have to get going, not slowly, but quickly, and into high gear. If you remember, the theme of last year's conference was "Making Kuala Lumpur a Regional Capital Market Centre". If you recall further, the first steps were taken since the announcements by the Acting Prime Minister and Minister Of Finance on 22 June 1995. Let me therefore move from the rhetoric to the specifics of our liberalisation programme. Two of the topics, the fund management industry, and the move from merit to disclosure based regulation, will be further deliberated upon during both the morning and afternoon session of today's conference. The third is the concept of front line self regulation, an important aspect of the regulatory aspect of liberalisation, which, until this year's annual dialogue, has not been well addressed.

The fund management industry is a big item in our agenda as the development of the capital market hinges on the effective mobilisation of savings to productive capital formation. Let me share some statistics with you to put our focus in perspective. The number of approved funds has increased from 39 in 1992 to 79 in April 1997, with total net asset value of the funds growing from RM15.7 billion to RM56.7 billion during that period. At RM56.7 billion, it represents 7.5 per cent of the market capitalisation which is still small by international standards. I must further qualify that this figure is camouflaged by the size and success of PNB. Within the composition of figures I have just mentioned, there are 52 approved private schemes with a NAV of only RM7.1 billion, or 0.94 per cent of the market capitalisation.

The strategic significance and potential growth of the fund management industry prompted the Securities Commission to submit to the government a comprehensive plan to liberalise the fund management industry in early 1995. The activities since has included the opening of the fund management industry to foreign fund managers and also allowing a wider group of new players into the market. The EPF liberalisation scheme, known as the EPF members Saving Investment Scheme also provides contributors investment alternatives within an umbrella of funds professionally managed.

On top of these measures taken, a comprehensive review of the unit trust guidelines was announced on 6 May 1997. The thrust of the new guidelines reflects fully the SC's views on liberalisation creating a regulatory framework which is in line with international standards. Restrictions on the size of the fund have been lifted. There is no longer the prescribed ten percent limit on unit trust fund's investment in foreign securities which I mentioned earlier. Unit trust were further allowed to invest in unlisted securities, other collective investment schemes, financial futures and options and participate in securities lending.

These liberalisation measures will broaden the scope of investible assets, allow better management of risks and cash flows of portfolios and increase the level of professionalism and expertise of our fund managers. However, it also comes with concomitant increase in the responsibilities of management companies and trustees. Consonant with the move towards disclosure based regulation, the new guidelines imposed greater standards of relevant disclosures in the prospectus, annual and interim reports of the funds, including the disclosures of fees, charges and other expenses. New entrants are only allowed if they have sufficient capital and expertise. And in line with the concept of front line regulation, it also necessitates the setting up of a compliance unit and internal audit to oversee the operations of the management company.

Change in philosophy of regulation
I have touched on regulation so far in the context of specific matters. Let me now elaborate on the principles and philosophies of regulation, moving on to the subject of functional, frontline and disclosure based regulation.

The buzz words in regulatory circles these days are regulation, deregulation and reregulation. The London financial markets deregulated with a Big Bang in 1986 with the introduction of the Financial Services Act, creating the Securities and Investment Board to oversee the regulation of the financial market. Ten years later they are now reregulating and reorganising themselves to address problems of regulatory overlap and underlap, duplicate rulebooks, and coordination between regulators. This, we all know are not problems peculiar to the UK markets alone. The Australians are also going down a similar path of reorganising and rightsizing, and on 18 March this year released their Financial System Inquiry Final Report, a 745 page thick book. This report proposes the establishment of a Prudential Regulation Commission, (which will bring all the different institutions, deposit taking, insurance and superannuation under one regulator), Corporations Financial Services Commission (responsible for market integrity and consumer protection) and a Payments Services Board within the Reserve Bank.

Why the need for reregulation, one might ask? The answer is simple. A modern and effective regulatory system cannot make clear separation between the activities of banking, merchant banking, stockbroking, insurance and fund management as these distinctions are getting increasingly irrelevant. Let me illustrate within our own domestic context;

• The application of capital adequacy standards between banking institutions, stockbroking firms and fund management companies vary significantly raising issues of competitive equality between them. On this score, the SC has asked the KLSE to introduce a new capital adequacy framework that will replace the current minimum liquid funds and reflect more fully the activities its member companies engage in.
• A risk based framework will level the playing field between different types of institutions. It will also subject stockbroking firms which take on higher risks to greater prudential requirements.
• The emergence of new markets, such as KLOFFE and MME will link financial institutions and markets in new ways that redefine the boundaries of systemic risk
• The appearance of new retail financial products such as equity linked insurance products which do not readily fit into the current regulatory structure

The SC recognises the disappearance of such traditional distinctions between financial activities calls for the need to look at functional regulation as the current regulatory boundaries no longer reflect the economic reality of the industry.

The other big ticket item which the SC has undertaken is the strategic shift from merit to disclosure based regulation in both the primary and secondary market. Our stock market is the envy of our neighbours. The Kuala Lumpur Stock Exchange is the largest bourse in the ASEAN region. As at 30 June 1997, it has a total of 657 companies, 431 listed on the main board, and 226 listed on the second board, with a total market capitalisation of RM744 billion. The number of IPOs raised in 1985 was only 4, in 1996 a total of 92 companies were listed, raising a total of RM20.8 billion.

Until January 1996, the primary market has operated under a paternalistic environment. As the market moves from emerging to emerged, a change in approach is necessary. And so our scheduled move away from merit-based regulation to a disclosure-based regime is the most visible evidence of the SC's willingness to discard unnecessary regulation. Does this mean that the SC intends to shirk from its responsibilities? Emphatically no. The SC, for instance, will look towards market institutions and intermediaries to ensure that prospectuses contain all the relevant information necessary to enable the potential investor to make an informed investment decision. Through regular checks and reviews of practices of the market institutions and through punitive action against the recalcitrants, the SC will ensure compliance.

This leads me to the point on front line self regulation. As our market develops, the role of the SROs will take on greater significance. The empowerment of the SRO essentially gives greater rights and responsibilities to market participants who, for their part, must be capable of ensuring effective regulation and must be able to meet these challenges. Failure to regulate effectively will lead to a deterioration of market integrity and stability and, ultimately, the intervention of the SC as supervisory regulator with oversight responsibilities. I also expect that, in time, much of the current developmental role currently played by the SC will be taken over by the SROs. In an environment of growth and expansion, it is the SRO who can best facilitate innovation and adaptation to seize competitive opportunities and meet challenges.

The role of the SC and the SROs should complement each other. Government regulation in tandem with self regulation can and should result in an efficient and effective regulatory system. To achieve this optimal efficiency and effectiveness, it is important that the roles of the supervisory regulator and its SROs are clearly defined and understood. If they are not, the existence of the two-tier system will lead to increased cost through a duplication of resources, and reduced efficiencies which may eventually lead to loss of confidence in the system. To prevent this, the SC intends not only to table relevant amendments to the securities laws and rules of the SROs to ensure that there is no jurisdictional confusion over the scope and responsibilities of each party but also to promote awareness among all parties on the roles of the SRO.

The SC realises that the acceptance of frontline SROs and disclosure based within the stock market will be a slow and gradual process, and we have laid out a programme which will achieve full implementation by the year 2001. To accelerate market acceptance of this change in regulatory philosophy, MESDAQ will incorporate all the ingredients of a frontline regulator, operating in a full disclosure environment from day one. You will hear more about the disclosure programme and MESDAQ in the afternoon, but I wish to underline that we will be watching closely the coming to fruition of this SC initiative -- both its support of real economy objectives, in particular the Multimedia Super Corridor, (MSC), and its adherence to disclosure-based and frontline regulation.

Another piece was fitted into the jigsaw of disclosure regulation with the formation of the Financial Reporting Foundation and the Malaysian Accounting Standards Board, a project driven by the SC. This is yet another milestone to enhance transparency and integrity in the disclosure of financial information to institutional and retail investors

A vision for the future
In closing, what then, is the vision for the future? How will the long term impact of disintermediation affect both the banking system and capital market? How will the impact of new technology, changing investor behaviour and liberalisation change the landscape of our financial market? How will regulation deal with these changes that will take place? The SC has already made known its plan, and indeed has introduced various initiatives, reflecting deregulation and reregulation based on function. At the recent dialogue, we threw the gauntlet at industry participants, saying that we are yet to see a robust response from them to the profound challenges we have outlined. They said, quite rightly, one of the big problems is the multi-layered and sometimes confusing regulatory structure in the country. We have told them to come back to us on this and the other issues of market liberalisation, including training and development needs. I daresay they will come back to us, if not at us. We will work it out from their responses, against national objectives. If we do again meet this time next year, our plan is to give some more weighty answers to the weighty issues which I hope I have been able to concentrate your minds on in this address.