Malaysia's Development as a Capital Market Centre in Asia

6 January 1996 | By : Dato' Dr. Mohd. Munir Abdul Majid, Chairman, Securities Commission, Malaysia

1. Introduction
While the stock market in Malaysia has come to be the largest in ASEAN and the fourth most highly capitalised in the Asia-Pacific, there are still a number of large steps to be taken towards Malaysia's development as a capital market centre in Asia. We shall be taking those steps. We believe we have a good foundation to build upon.

2. Basic requirements
Malaysia has a sound domestic investor base. With a savings rate of 34% of GNP, we are putting our money where our mouth is. Subscribers' balance in the Employees Provident Fund (EPF) alone now total about US$36 billion. With the mandatory contribution recently increased by 1% on the employees' side, taking the total amount from 1996 to 23%, and sustained economic growth which has exceeded 8% in the last eight years, some projections expect EPF contributions to total US$130 billion by the year 2010. With voluntary savings also strong, mobilised by the banking system and increasingly through the capital markets, there is critical mass to develop both the economy and the financial system.

Of course Malaysian economic growth has been far in excess of that that can be funded by domestic savings alone. However this savings - investment gap has so far been comfortably filled by foreign investment. Malaysia attracts foreign investment because of sound macro-economic policies that have delivered good returns, financial stability and order. I believe the fact the savings rate is high gives credibility to the prospect of the sustenance of economic growth, and draws in foreign capital. It distinguishes many East Asian economies from most Latin American ones, although the distinction is not always remembered in more excitable moments. It is nevertheless a good reminder that savings must be kept high and consumption kept under control if we are to exhibit a seriousness about sustaining high economic growth rates.

The other preliminary point about good foundation I wish to make is political stability. While it may seem self-evident, political stability and a set of consistent policies are precious to those who are being asked to look to the gains of the future. In this regard, Malaysia does remarkably well, not just in this region but elsewhere as well. Confidence in the continued political stability of the country and in the expectation of consistent policies, therefore, plays a critical role in the organising and expansion of any financial system to promote domestic and, by extension, regional economic growth.

3. Announcement of June 1995
Since the announcement in June by the Minister of Finance, Deputy Prime Minister Dato' Sri Anwar Ibrahim, of certain capital market initiatives, there has been considerable interest in the prospect of development of Kuala Lumpur as a capital market centre, an objective that was given explicit expression by the Deputy Prime Minister. There has also been some excitement, a bit of misunderstanding and a bit of expectation. Most, however, are waiting to see what would come of it.

Most of the attention has been focussed on the fund management industry, given the emphasis in the Deputy Prime Minister's announcement on developing Kuala Lumpur as a regional fund management centre. Such development, of course, presupposes the growth of diverse and deep capital markets in Malaysia itself and beyond. Before coming back to fund management specifically, let me describe what has been happening and is being planned in the development of Malaysian capital markets.

4. The Stock Market
With a market capitalisation in excess of US$200 billion and well over 500 listed counters, the KLSE is big and growing. It is a liquid market with a diversity of stocks across a range of sectors. The Malaysian Government's privatisation policy, which began to take effect in earnest in 1985, without doubt contributed to the growth of the exchange; it brought to the exchange a depth and diversity that has thrust it to the forefront among world exchanges. At the same time, medium and small industries are coming out thick and fast to be listed on KLSE. Last year the Securities Commission approved 77 new listings, after 36 in 1993 and this year the figure is likely to be close to 60. All this is happening in the context of quantitative and qualitative requirements which are comparable to international standards which will be further upgraded this month. A study has been initiated to allow the listing of foreign companies on the KLSE. Already companies whose assets are substantially located abroad are listed on the exchange and can expand their international asset base through a capital raising on the exchange. At the same time, the introduction by the Securities Commission earlier this year of guidelines on the listing of infrastructure project companies will give an added dimension to the KLSE. We are organising a seminar on 11 January 1996 in Kuala Lumpur to go deeper into these guidelines as a result of industry requests.

The management of KLSE has a plan to make the exchange fully world class. The scripless programme to be completed by the end of next year will complete the circle of making KLSE a fully electronic exchange. Some of the benchmarks in the plan will ensure efficient and fair trading, delivery and settlement, and also address custodial and registration arrangements which have sometimes been found to be unsatisfactory.

5. Futures and Options Market
I had implied at the start of this address, the large and liquid stock market alone is a necessary but not sufficient condition of a developed and credible capital market centre. There have to be other markets to meet the risk-reward profiles of different types of investors, and indeed of the same investor at different times. This includes the availability of exchange-traded futures and options contracts for risk management purposes. While there will be speculative activity of course, it is the prime intention of the Kuala Lumpur Options and Futures Exchange (KLOFFE)) which will start trading later this month and of the Malaysia Monetary Exchange (MME) which will begin its activities early next year, to afford investors with hedging instruments against underlying risks so that they are better able to manage their asset exposures. All trading done on KLOFFE and MME will be cleared by a single clearing house (MDCH), which will impose strict risk management standards and use a risk-based margining system, TIMS, designed by the Options and Clearing Corporation. The membership and trading rules of the exchanges have also been designed with a view to ensuring capital adequacy, professional management, active risk management and internal controls.

Some of you will recollect the length of time we have taken to get this market going since approval in principle was given at the end of 1990 for the establishment of KLOFFE. There has been a tremendous amount of training and education that has gone on although, as with all education, it is never enough. The Futures Industry Act, which came into force in March 1993, was thoroughly reviewed in the light of regulatory concerns thrown up by high profile incidents in the derivatives industry in the last couple of years, and also because of certain definitional inadequacies and other rigidities felt by the Securities Commission, also established in March 1993, to be constraints on the development of the futures and options market. Thus, I believe for the first time in Malaysian legal history, an Act was amended before it had time to be tested in a live situation, and the Futures Industry (Amendment) Act 1995 just came into force last month. We have been that careful and thorough. This has given us the confidence that the regulatory environment for the start up of trading in futures and options is well prepared.

KLOFFE will begin trading in the middle of the month in a futures contract on the composite index. We want to see trading start in a small way, and are looking to see its growth in 1996. Options products will next come, starting with options on the index. MME, meanwhile, is preparing to start trading early next year in a futures contract on three-month KLIBOR (Kuala Lumpur Inter-Bank Offered Rate).

As the futures and options market begins, guidelines will also be announced this month on Stock Borrowing and Lending Arrangements to allow market participants to hedge their short positions. Section 100 of the Futures Industry Act, already enables short selling activities for the purpose of arbitrage and the execution of futures strategies. Subsection 41(1) of the Securities Industry Act is being amended to ensure consistency of legal provision and market practice.

While opening up and allowing new trading strategies, the introduction of stock borrowing and lending also brings to the Malaysian capital market a new business activity well developed only in a few major capital markets. It therefore further marks the further growth and development of Malaysian capital markets.

6. Ringgit Bond Market
Development of the Ringgit bond market would be the next challenge. We recognise the difficulties of rapid take-off, which are common to Asian capital markets, but watch this space next year as the Malaysian authorities take a crack at it.

The primary private bond market is large, its issue in 1994 for instance of RM20.7 billion (this includes RM4.3 billion Eurobond issues) constituting the overwhelming part of RM35.2 billion of funds approved to be raised by the Securities Commission. In the first nine months of this year, Ringgit bond issues approved by the Securities Commission, which this time does not include any Eurobond issues, total RM12.2 billion of RM21.9 billion of funds approved to be raised in the Malaysian capital market. One wonders what its size, ceteris paribus, would have been, both absolute and relative, if the regulatory approval process is not admittedly multi-layered and prolonged, and if the secondary market was efficient and liquid. By addressing these drags on the development of the Ringgit bond market, Malaysia hopes to provide issuers and investors with an important component which gives diversity and choice -- and will take Kuala Lumpur a long way towards its development as a capital market centre.

We recognise some of the problems will take time to resolve. Bond markets have typically been OTC (over-the-counter) markets, institutional and quote-driven, when the largely retail Asian markets are order-driven. The individual investors are of course accustomed to investing in stocks and shares where quick capital gains can be reaped, whereas bonds are usually long-term investment products. While the individual investors have to adopt a longer-term investment attitude, bonds have also to be packaged right, with attractive rates of return, and marketed well.

I do not have the time to go into the various issues that have been identified in detail. I only wish to state they have been identified, from the legal and regulatory right to the availability of benchmarks and the need for a deep and liquid secondary market. In the process the particular needs of securitisation are also being looked into, with special factors such as accounting treatment and stamp duty and tax issues identified. While looking ahead, it may also be useful to look back to see how, in recognising the important role of the private debt securities market, the Malaysian Government consciously planned its development to the present stage, still unsatisfactory though it may be. Starting in 1986, when Cagamas (the national mortgage corporation) was established, to 1990 when the first credit rating agency (Rating Agency of Malaysia or RAM), and to 1993 when the Securities Commission was established, one of whose major functions is developmental, to waiver of stamp duties on all instruments related to the issuance and trading of debt instruments, to tax exemption on interest earned on bonds by individuals, there has been a clear line indicating a seriousness about developing the private bond market.

7. Fund Management
The initiative of the Minister of Finance in June on fund management has to be seen in the context of the Malaysian Government's wider development of the capital market to make Kuala Lumpur a regional financial centre. I do not treat in this presentation the development of Labuan as an off-shore financial centre, because I am conscious of the time constraint and therefore of the need to focus on Kuala Lumpur, although I shall be glad to take any questions on Labuan.

We want to develop efficient capital markets because of their critical role in real development. At the same time, the capital market in itself becomes an important part of that economic growth and activity. We recognise the challenges and the competition, but we take the attitude it is a positive, not a zero sum game.

I have related the steps that have and are being taken to develop Kuala Lumpur as a regional capital market centre. At this stage, I wish to focus on the promotion of the fund management industry which serves the purpose of market liquidity, while bringing greater institutionalisation and professionalism to the market. The prospects for the industry are enormous based as I have stated at the start of this address, on the continuous increase in the national savings level. Witness, not only the fast-growing EPF contributions but also the booming unit trust industry which, even so, constitutes only 8% of stock exchange market capitalisation.

In support of the Minister's objective to develop Kuala Lumpur as a fund management centre, five vital aspects of the industry have been identified to be addressed:

the efficient utilisation of existing funds
the mobilisation of new funds
enhancing the skills, capabilities and professionalism of local fund managers
the provision of fiscal incentives
streamlining the regulatory framework

Investment restrictions on statutory funds are now no longer tenable given the continuing decline in the number of government securities issued due to the realignment of the roles of the public and private sectors, and the massive financing needs for privatisation of infrastructure and other projects. Government agencies and institutions have also to have their funds managed by professional fund managers. The big one is the liberalisation of EPF. The Minister has already allowed a significant portion of the fund to be professionally managed. I expect more will come. The Securities Commission has proposed that eligible EPF accountholders be allowed to transfer part of their funds in their old age account to special purpose unit trust funds.

New funds are also being mobilised through the promotion of the unit trust/property trust industries, guidelines on which have been liberalised by the Securities Commission and will continue to be liberalised to meet market needs, New vehicles of collective investment schemes are being looked into to be introduced. A bond fund has recently been launched, managed jointly by a Malaysian and Singapore bank. The Securities Commission has also issued guidelines this year to facilitate the listing of investment funds on the KLSE.

All this requires enhanced skills, capabilities and professionalism of local fund managers. The exposure that will come with the opening up of the market will be a great help. not to mention specific joint ventures and training arrangements. The Securities Commission's own Securities Industry Development Centre (SIDC) will also be mobilised to help. The convergence of and interaction among fund managers in Kuala Lumpur will have a catalytic effect on efforts to develop it as a regional fund management centre. It would also jump-start the development of the local fund management industry.

Numerous tax incentives are being looked into to be improved upon. Approved foreign fund management companies will be accorded a tax rate of 10% on income earned from the management of foreign funds, but we believe tax incentives on the savings contributions side can be further improved upon. As indeed can the regulatory framework, which needs to be streamlined by distinguishing asset management as a separate activity in the capital market. Amendments to the Securities Industry Act for a distinct licence for such activities are already in the works.

The foreign fund managers are being asked to look at the prospect of Malaysian fund management against the context of these development plans and opportunities.

8. Investor Protection
The development effort at establishing Kuala Lumpur as a regional capital market centre very necessarily includes emphasis on investor protection, disclosure standards and market conduct. The Securities Commission Act, which came into force only in March 1993, was recently amended to clarify and enhance the Commission's powers, and to clearly place the onus of responsibility on issuers and their advisers to make accurate disclosures and representations. Section 32B of the Act very clearly makes it an offence to make false, misleading or deceptive statements, an offence liable, on conviction, to a fine not exceeding three million ringgit or to imprisonment for a term not exceeding ten years or to both. The Commission also has extensive powers of investigation and prosecution in the securities and futures market. We will not tolerate those who try to pull down the edifice of our capital market system. We view lawful conduct in the capital market a matter not only of integrity but of national interest.

9. Conclusion
In conclusion, I hope I have been able to give you an appreciation of efforts that have and are being made towards the development of Kuala Lumpur as a regional capital market centre. It is a huge task, but we are fully committed to it. Certain dimensions are already in place. More is to come.