Keynote Address at the conferment of the Fellowship of the Malaysian Institute of Directors
12 November 1997 |   By : Dato' Dr. Mohd. Munir Abdul Majid, Chairman, Securities Commission, Malaysia

I am touched and honoured by the conferment of this Fellowship by the Malaysian Institute of Directors, which I consider also as a recognition of the contribution of the Securities Commission and the members of its staff. I would like to place on record my deep appreciation for the support I have received from the members and staff of the Commission which has been indispensable in achieving whatever we may have achieved in just under five years.

In one of my very first speeches as Chairman of the Securities Commission, on 26 May 1993, I had said: "We should constantly be reminded the process of capital formation in the financial markets and by whatever fashion has the larger objective of funding real economic development. Gucci-shoed, white-stockinged and Porsche-driving financiers and dealers have been known, particularly in the more developed markets, to want to run away with it. This may immediately be taken to be a conservative statement but I wish to emphasise it is a call to realism and away from excesses which, to use Drucker's term, 'uncouple' the real from the financial economy."

I have quoted at some length from that early speech not to claim any degree of prescience, but to reflect on how much water has flowed under the bridge since then and to review capital market development against the needs of the real economy.

Traditionally banks have financed economic activity and growth. Latterly, and incrementally, capital market products have come to play a more significant role. This would not have happened if these products had not been more efficient and cheaper for capital-raising than bank finance. The cheaper cost of finance was made possible by liquid and efficient markets in which these products were traded after the initial capital raising, for in no way can the corporate financiers and dealers be said to earn any less than the sometimes stodgy bankers. Perhaps capital raising could be made even cheaper if cost structures were brought down, but that is a matter I do not wish to get into right now.

With financial markets coming to play an increasing role in capital formation, both the users of capital and the providers of capital had to be governed by a framework of laws and regulations to define their rights and obligations, just as banking laws define the rights and obligations of deposit-takers and depositors. In the early stages, these laws and regulations were very protective of the providers of capital, through a benevolent merit system, but in time the cost of regulation to capital users became a concern and the upshot of this cost-benefit analysis was a move towards a full disclosure environment, which is also taking place in our country.

In such an environment, certain assumptions are made about the responsibilities of governance of users of capital, that is of companies about which the Malaysian Institute of Directors should be most concerned, about the responsibilities of ensuring timely and accurate disclosure of information by the regulators, advisers and market intermediaries; and, finally, about a level of knowledge and understanding on the part of capital providers, most often captured in that reverberating expression "Caveat Emptor," investor beware.

Should all conditions be fully satisfied before we move on? Ideally, yes. Practically, that might be difficult, as complete fulfilment of the conditions itself would be a matter of opinion and disputation, whereas the needs of developing the real economy at the fastest rate and cheapest cost possible are of importance as well. Thus the facilitative approach is to ensure there is a system of laws and capital market regulation that supports those assumptions and is credible enough to demonstrate serious intent. Additionally, there has also to be a programme of education for users of capital, regulators, advisers and intermediaries, and investors as providers of capital, so that their responsibilities in a new regime are better understood. In Malaysia, we are moving in the right direction but there is a lot of work still to be done and I, for one, would not recommend we move into the full disclosure and frontline regulation environment we targeted for January 2001 unless the legal and regulatory framework can fully support it, which would include additional investor protection provisions not now present.

But we digress. I'm not down this evening to go into the details of regulation as into markets. Capital markets, having assumed increasing importance in capital formation, grew and grew on the back not just of economic growth, but also of hard and soft tools to manage the growing industry, institutionalisation of investment, diversification of products, including derivatives of the original underlying, technology which has not only brought speed and efficiency in the execution of trades but also in risk management techniques and, of course, liberalisation and globalisation of markets, driven both by public policy and, increasingly, by information technology.

Actually, the much vaunted "globalisation" of financial flows is not absolutely a recent phenomenon, even if its sweeping and overwhelming nature is. Unfortunately, there are not too many of us nowadays who remember or, at least, relate to official flows of bank finance in the sixties when, both in the context of the "Cold War" and of "flag following aid," there were any number of problems, including fund flows drying up. In those days, when the notion of the sovereignty of nation states was very much on the ascendant with the rise of newly independent Asian and African countries and when the Cold War conflict was a disconcerting feature of international life, the ebb and flow of funds often did not follow economic and financial logic alone.

It was only in the seventies, especially after the first oil price crisis in 1973-74, that private capital flows supplanted official ones, courtesy of the mobilisation of Arab Petrodollars through the Western banking system. These funds came out as largely "Western" bank loans to Latin American and other Third World destinations. The surplus funds were sometimes thrown at economies with less concern for the projects and activities they were financing than for the margins the banks were looking to enjoy. There is always this human trait of excess, going over the top. When the crunch came, there were any number of recriminations about "economic mismanagement" during "banking crises."

And then came the tremendous development of capital markets, the diversion of savings from bank deposits to mutual funds and other collective investment schemes, the supplanting of Citibank by Fidelity in the US as the institution with the largest assets. The era of the capital markets had begun and picked up globally with liberalisation and the privatisation of economies worldwide, including those formerly centrally-planned ones after 1989. There has been great competition for these funds. Capital market development proceeded apace to attract these funds, quite apart from the real economic development plans. Capital deficient countries sought both foreign direct investment and foreign portfolio investment to make up for the shortfall between their savings and investments. Malaysia, too, welcomed foreign investments because of the resource gap, although we are perhaps in the enviable position that our high savings rate of 40% of GNP is only 5% short of our rate of investment. Nevertheless the gap has to be covered if we wish to continue to grow at the rate we desire.

What has become apparent, however, is that foreign portfolio flows cause market volatility, especially in relatively illiquid markets in which they predominate but also markets in which local investors follow the foreign lead. In Malaysia we have both benefited and suffered from foreign portfolio capital flows. In 1993, they led the surge that broke so many stock market records resulting in so many happy faces and, more importantly, allowed Malaysian companies to leverage their growth to an extraordinary extent. Even after the early 1994 correction, prices remained relatively high to support healthy corporate activity. This year, however, the foreign portfolio capital has flowed out, causing an extremely sharp decline of the stock market. Even more seriously, there has been a selldown of the Ringgit, leaving our incomes diminished and overall economic strength threatened. The financial markets and the flows they generate between and within them have become a blight.

We, of course, do not want to throw the baby out with the bath water. We do appreciate and understand the discipline of the market. We are a market economy after all. But there are some aspects of the discipline of the market of the financial markets we are having a problem understanding, and there are some concerns about the discipline of the market practitioners themselves.

To me, the most important issues arising pertain to governance, both in a very large macro sense and in very many micro dimensions. The biggest issue is how the world and the nation states within it is to be governed. It may be an issue as old as the hills, but it has come back with a vengeance. With globalisation, interdependence and transnational capital flows, which can wreak havoc particularly in currency markets, what is the meaning and place of the sovereign state? Then again, in a unipolar world it is proving extremely difficult to ensure what is being touted as universal principles and practices is something established by the community of nations comprising the international system. This issue of high politics is equally relevant in specific functional contexts, such as financial markets. Relatedly, there is the issue of governance relating to the management of the economy, about what needs to be done to address macro-economic problems. With respect to Malaysia's 1998 Budget proposals, for instance, foreign fund managers are dissatisfied with the measures proposed although they concede they are in the right direction. So, what is enough? And who says what is enough? Elected leaders contend they will decide and, convincingly, they are the best judge of how to balance the different interests and to achieve political and socio-economic stability. And in Malaysia we have the track record to prove the point.

However, there is no gainsaying that when you take or use other people's money, be they foreign or otherwise, there are certain reasonable expectations that must be fulfilled. This discipline of the market is best exercised by selling out. And we have seen plenty of that just recently. But fund manager's judgment and activities should also be subject to scrutiny, as they are scrutinising everyone else's. How well and how they manage the funds can be better measured and assessed. Performance ratings are not as accurate as they could be. At the same time, there should not be churning and unnecessary switching of assets in the fund. Of course, it can be disputed what is unnecessary, but one measure must surely be performance of the fund, as against the financial return to the fund manager. I am yet to verify this, but I have been told that redemptions from emerging markets funds during the period 1991-96 were miniscule. What then accounted for the buying and selling by the funds? This, obviously, is something worth examining further.

Whatever, whether the investor is institutional or individual, shareholders have rights which have to be protected and respected. The level of corporate governance, therefore, is a matter which must be given the most serious consideration and bodies such as the Malaysian Institute of Directors should play their role to ensure good corporate governance. Unhealthy practices such as the shifting of assets, conflict of interest situations and lack of transparency only serve to lower the attractiveness of companies for investment, or to occasion a selling down. The directors of companies are not doing a sufficiently good job of ensuring good corporate governance.

The other pillar of ensuring good corporate governance are the company shareholders. While directors are to represent shareholder interests through insisting on good company management and direction, active involvement of shareholders and investors in the affairs of the company will make them more conscious of their responsibility and accountability. Alas, even shareholder participation at general meeting, infrequent enough as it is, has been unsatisfactory. Indeed, general meetings are often over at the speed of light, the directors rushing them through as if the process is a chore and a bit of a nuisance that has to be got through, and the shareholders largely allowing the directors to get away with it. Only afterwards does one hear isolated expression of disgruntlement and dissatisfaction which is like a drop in the ocean. There no doubt has to be more effective director accountability and shareholder representation.

Malaysian investors also have to start to understand the businesses and activities of the companies they invest in better. Now I may have erred by using the word "invest," as there is a strong speculative tendency in the market. While speculation will always be part and parcel of the marketplace, it cannot be its leitmotif. There has to be the driving force of steady investment for steady income and long-term growth. Companies' futures, furthermore, are not determined by transient factors but by good solid business plans and management. There is insufficient weight given to a company's fundamentals, too much to rumour and association. While I hope the individual investor will mature, it is also our intention to expand local institutional activity and share of the market so as to give the necessary ballast to the market. Then again, would it, given the mixed record thus far of fund management activity. Quite obviously then the point about governance of fund managers is something that has to be worked at by the investors in the funds with the help of the authorities.

Good advice is always useful, and it is never more useful and relied on than when given in the course of professional duty, especially in technical and functional situations. The company auditor has a pivotal role. On his professionalism rests a lot of the conduct of the company including, of course, its financial management. Other professional advisers also have their specific roles, such as the merchant banks. There is no point employing professionals if there is no value added to decision-making and conduct of business. There is no point being called a professional if you are a rubber stamp living a lie. Competition among professionals should not be one leading to the lowest common denominator, but to the highest level of achievement and standards. On the general point of governance which I am making, all relevant responsible bodies have a duty to discharge to ensure adherence to professional standards. When we face problems, we should first look to see if we have carried out our responsibilities adequately and how we can improve our performance.

There is one particular area which I wish to identify in the context of the responsibility of governance of intermediaries. This has to do with their internal management and controls which must be heightened as the risks mount in a falling market. They must understand their financial management particularly will have to be tight to insure against failure which will carry with it systemic risk. Such discipline should be enhanced and additional measures taken as advised to cap potential problems.

The pressure on regulators are greater of course, when the going gets tough. They, however, will also have to examine if they have discharged their responsibilities adequately. Are the enforcement powers sufficient? Should there be enhancement of the legal and regulatory framework as, for instance, in the context of a full disclosure environment which I mentioned earlier? When the government asked that short-selling be made legal, the Commission limited it to regulated short-selling supported by a stock borrowing and lending (SBL) arrangement, leaving "naked" short-selling still illegal and requiring clear reporting responsibilities to the exchange. While this was prudent on hindsight, the brokers must still take steps to ensure there is no "naked" shortselling through meaningful and effective application of the "Know Your Client" rule, for otherwise the only way to definitively establish there has been "naked" shortselling is when there is a failed trade for which there is no acceptable explanation for failure to deliver. The KLSE must also improve its surveillance of this and other activities, so that a clear level of deterrence is added to the instruction to brokers.

I have used a particular example to illustrate the point, but there are many areas of planning taking place in the Commission just now, as we finalise our Business Plan for 1998 to 2000, at the end of which a full disclosure and frontline regulatory regime is to be introduced from January 2001. As I have said, we will examine critically the level of preparedness as we progress along, although I hope we will achieve the necessary progress in the development of the capital market as planned.

As I have also said at the start, that development is first and foremost intended to mobilise capital for real economic development, and secondarily to enhance the role of the financial services sector in the economy, without arriving at a situation where the tail wags the dog. Quite evidently capital market development can have a salutary effect on the growth of the real economy, and indeed it has done so. On the other hand, there can also be certain dysfunctionalities in the process of that development that call for a review of some of the regulatory principles and market practices on a worldwide basis. This is the agenda of the nation.
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