Merger of the clearing houses
We have always maintained that there must be a sound regulatory framework which addresses issues of market and financial integrity, as well as systemic stability and investor protection. Steps have been taken to rationalise the regulatory framework and in April of this year, the Commodities Trading Act 1985 was consolidated with the Futures Industry Act 1993. This merged the functions of the Securities Commission and the Commodities Trading Commission and placed the financial futures and commodities futures exchanges under the supervision of a single regulator. This consolidation brings obvious cost advantages to those involved in the commodity and financial futures markets, as well as greater legal certainty. Having the same regulator, also presented the opportunity for a single clearing house to be formed.
In fact, today's event gives me the opportunity to mark another step forward for the derivatives industry. As of today, the Malaysian Futures Clearing Corporation ("MFCC") and the Malaysian Derivatives Clearing House ("MDCH"), have been merged into a single entity. The Commission has always considered that the merger should be effected within the shortest period of time so as to minimise uncertainty and to channel resources to other developmental activities. This merger has, indeed, been achieved within a short span of one year, well ahead of schedule. As such, I consider this achievement worthy of praise.
I have little doubt that this merger will bring about the expected benefits, not merely to the members of the clearing house by way of economies of scale, but also, in terms of minimisation of systemic risks to the industry as a whole. The Commission is aware that this merger has come about after a great deal of hard work and compromise on the part of all parties involved, in particular, the management of MDCH and MFCC, the Kuala Lumpur Commodity Exchange ("KLCE"), KLOFFE, MME and their respective members - I congratulate you all for a task well done.
Liquidity
In terms of activity on the markets since October 1996, the futures exchanges have experienced a mixture of fortunes. A snapshot of the figures for the month of October shows the average daily trading volume on KLOFFE at a figure of about 2,337 contracts, while MME averaged around 237 contracts a day. KLCE, on its part, achieved an average daily turnover for the month of October of 2,018 contracts. While there may have been some increase in trading activity, particularly on KLOFFE, much still remains to be done to increase liquidity levels on the futures exchanges. Liquidity has more often than not been used as an indicator of the success of any market, be it equities, bonds or derivatives. Various measures have in fact been taken by the industry and the Commission towards developing liquidity on the futures exchanges.
KLOFFE's proposal to introduce market making has more or less been finalised, and will be implemented together with the introduction of the options contract. It is envisaged that the introduction of market making on KLOFFE will have a positive effect on the liquidity of futures contracts as well. Market making is expected not only to improve liquidity, but also to make for greater efficiency in the market. Competitive and committed market making, as well as the introduction of options, will provide institutions added confidence to enter the market to carry out their trading, investment and risk management strategies.
The Commission has also liberalised the dual licensing scheme for dealer's representatives to perform the role and function of a futures broker's representative at the premises of the stockbroking firm to which he is attached as a dealer's representative. The dual licence holder is now allowed to receive and execute orders to trade futures contracts on behalf of his clients. To date, the Commission has issued a total of 190 representatives with dual licences and approved 16 companies which employ such representatives. The Commission has, therefore, cleared the path for industry to provide greater access to investors to obtain information and trade in the futures market. It is now up to industry to utilise this opportunity to generate further participation on the exchanges.
Participation in futures market and education
Greater participation by local investors on our exchanges will serve to attract the interest of pension funds, mutual funds and insurance funds, both local and foreign, into our futures market. On KLOFFE, the percentage of local participation in the market as of 31st October 1997 is constituted by 30.85% domestic retail participation and only 2.46% domestic institutional participation. There is certainly a need to promote a better spread of participation in the market, in particular, participation by domestic institutional investors.
Measures are being taken to encourage institutional investors to utilise these instruments for their portfolio management activities. Unit trusts, for example, are now permitted to invest 10% of their scheme's net asset value in futures contracts for hedging purposes, subject to the appropriate licensing requirements being fulfilled. The Commission is currently drawing up guidelines for the licensing of futures fund managers. In drawing up these guidelines, the Commission is also considering the means by which the licensing of managers of unit trusts and representatives can be best accommodated within the existing regulatory framework.
Also in order to draw greater participation in this industry, the Commission continues to encourage the education of intermediaries and investors of derivatives instruments. Educational and training programmes organised by the Securities Industry Development Centre ("SIDC") are well on their way and extend to our universities, institutions of higher learning as well as those involved in the profession. ITM, for instance, has recently incorporated the "Malaysia Futures and Options" module into its Bachelor of Business (Finance) Honours degree programme. A few other local universities plan to do the same in the near future. Over the next few years, the Commission also proposes to place emphasis on the education of retail investors on the securities and derivatives industry as part of our plan to increase the awareness and knowledge of our general investing public.
In this connection, the SC applauds the efforts of members of industry, which have conducted public seminars and exhibitions such as this. These exhibitions, conferences and workshops provide opportunities for investors to educate themselves on the nature of risk and use of futures products and have the full support of the Commission.
New products and developments for risk management instruments
In his budget speech, YAB the Minister of Finance has announced that an appropriate time is being considered for the introduction of futures contracts on the ringgit. The "in principle" endorsement by the Government of futures contracts on the ringgit is consonant with the commitment of the Government to the development of new financial products to augment our capital market.
The objective of introducing futures on the ringgit is to provide domestic companies or firms with diversified risk management instruments with which to manage their foreign exchange risks. This would also encourage trading activity on the ringgit onshore, with the added advantage of pricing efficiency and transparency both to the underlying and futures market. Prior to the introduction of currency futures, matters such as the trading, surveillance, clearing and settlement mechanisms must be properly put in place. As indicated by YAB the Minister of Finance, the primary challenge to the successful introduction of futures on the ringgit will be timing; against the backdrop of current market conditions and perceptions.
As you well know, KLOFFE has been planning to introduce index options for some time, and has been working with the Commission to finalise the contract specifications and introduce the market making scheme in relation to these options. I am aware that some members of industry are fairly anxious to see this product get off the ground. The Commission has no objections in principle to the development of index options. However, the success of these options, as with most new financial products, will be dictated by the readiness of the market and market participants. Prevailing market conditions and the confidence of the investors must of necessity be considered before these products are launched; KLOFFE must be able to garner a sufficient number of market makers, having regard to their importance in relation to the liquidity of the product. It can be anticipated that the successful introduction of index options will pave the way for the introduction of other products, such as stock options, provided that the appropriate clearing, settlement and other trading mechanisms are put in place.
Other areas of progress in the development of risk management instruments include the serial month KLIBOR futures contracts which are being provided by MME. This is significant, in particular, for the investors in the ringgit-based money market, providing institutional users an alternative to similar products on the OTC market. The advantages over the OTC market include the reduction of counterparty risk, transparency and a more open and competitive trading environment. The existence of market makers, who are required to provide bid/offer spreads, will also add to liquidity. With these advantages, and the participation of traders, hedgers and OTC product providers, it is hoped that the depth and liquidity of the MME market will be increased.
In relation to the KLCE, it is understood that steps towards the introduction of plywood futures have been initiated, but were put on hold pending the finalisation of the merger between MFCC and MDCH. I believe the merger of the clearing houses today will make way for such plans to continue.
Competition
Technology, the internationalisation of markets and economies and liberalisation of regulatory policies make it inevitable that there will be changes in the financial services industry. For Malaysian financial service providers to be able to compete with foreign companies, they must be competitive and come up to par. Studies are under way to permit local traders to trade on specified exchanges outside Malaysia. Any decision to permit trading on particular exchanges is likely to be on the basis of reciprocity with that exchange, and with the consideration as to whether it will provide competition as well as opportunities for international penetration by our financial intermediaries.
Integrity of the market
Thus far, I have referred to matters which relate to the growth and development of the futures markets. Growth however, should take place with adequate measures to protect the integrity of the market, in particular, to ensure transparency as well to provide adequate protection to investors. These are the issues which I would now like to address.
The maintenance of an efficient, transparent and secure marketplace makes it vital that the development of the market be supported by the development of institutions and intermediaries within the market. Institutions and intermediaries that play pivotal roles in the development of the market must themselves be conscious of the need to constantly enhance skills and professionalism as well as operational, financial and other capabilities. It is only in this way that a market can continue to remain competitive and cost-efficient in the face of increasing competition.
The development of the futures market also hinges on the capacity, efficiency and professionalism of institutions, intermediaries and infrastructure that support the market. These include, among others, improving systems to ensure security, efficiency and lower costs to all capital market participants. In particular, markets should be transparent to ensure that there is no information asymmetry to the advantage of any particular group.
In this connection, I would mention one other matter which has remained unresolved since the launch of KLOFFE. The original target at the inception of KLOFFE was to have 40 members, all of whom would have been properly licensed and trading on the exchange as futures brokers under the Futures Industry Act 1993. At the request of some of these members, the requirement for licensing was postponed to 31st March of last year and the Commission and KLOFFE made accommodations for this request. It is with some disappointment that the Commission has noted, that to date, not all members have been licensed, and some brokers, although licensed, have not been actively trading. Some indeed, have been licensed and have asked for voluntary suspension. All these matters, as you are aware, have consequences for other participants of KLOFFE and the degree of confidence which investors have in this market. The Commission takes the view that some degree of professionalism is expected from amongst those involved and I would ask that these deficiencies be resolved as soon as possible.
Further developments towards front line regulation
In line with the global trend towards deregulation and liberalisation, the Commission is also looking at the roles and responsibilities of exchanges, clearing houses and other market institutions as front line regulators. For the development of the futures industry, the Commission sees the front line regulator putting in place more sophisticated and stringent enforcement and surveillance procedures over the market, as well as inculcating the discipline of internal compliance and controls in their intermediaries. The front line regulator should place emphasis on increasing the efficiency of systems, lowering costs for the market participants and enhancing systemic risk management. Issues such as inter market surveillance, institutional information-sharing, modes of handling emergency situations, capital adequacy as well as consumer protection would also need to be addressed. Not least of all, front line regulators should, together with the Commission consider the opportunities that technology presents for the efficient fulfilment of their role as regulators.
Conclusion
My personal view, having taken you through the developments in the futures industry over the past year, is that a lot more remains to be done to reinforce, solidify and improve on the basic foundations that we have established to ensure the success of our futures industry, namely, market and financial integrity, and investor protection.
At this moment, I believe that the futures industry is still at the infant stage. However, in the light of the challenges posed to the financial services sector, in a time of technological advancements, globalisation and increased competition, we cannot afford to linger at this state of infancy. All efforts must be made by industry to climb up the learning curve exponentially, and ensure that our futures market reaches the levels of sophistication and resilience necessary to compete and succeed.
Thank you.
