The new millennium promises a tidal wave of changes, not just to the Malaysian financial services sector, but also to the global economy. The decisions which we make now, as we are poised on the brink of those changes, will determine whether we will ride the crest of that wave of changes or be swept aside in its wake.
The trends of the changes that drive the world economy are clear enough to see. The difficulty lies in anticipating the import and impact of those changes and formulating a coherent plan of action, not just to temporarily deal with those changes or to stem the tide, but to turn those changes into opportunities for Malaysia and Malaysian companies. While precise prediction of the future is fraught with hazard and should not be expected, we can, nevertheless, identify 3 major drivers of change: technology, the internationalisation of markets and economies, and regulatory policies.
Technology
In the last decade or so, financial services, in particular the risk management industry, have been greatly influenced by technological advancements. Technology has allowed the decomposition of financial instruments, even a portfolio of financial instruments, into its constituent risk factors, and for these risk factors to be then independently managed. Technology has also paved the way for advanced proprietary trading systems, for electronic funds transfer, and for faster and more secure settlement of transactions. Technology has aided the immobilisation of securities traded on the stock exchange and sets the stage for the decertification or dematerialisation of all securities.
Growth of networks and expansion of telecommunications capacity
The emergence of the Internet and private or restricted networks into the mainstream of urban lifestyles in Malaysia is not a fact lost on financial institutions. Already we have seen aggressive inroads made into banking and related services which have transformed the traditional bank-customer relationship and which have made 24-hour banking a reality. The city indeed never sleeps. The accessibility and availability of networks will continue to increase, in tandem with the capacity of the communications infrastructure which supports it. Once network security problems are resolved, the effect of these changes will be likely to further accelerate. The provision of on-line trading services, direct to the offices or homes of clients, will no longer be hampered by technological obstacles.
Continuing reduction of technology costs
The escalation of technology-driven change is matched by the downward-spiralling cost of that technology. A 286 pc not very long ago cost almost rm 12,000. Today even Pentium-equipped pcs can be got at one quarter that price. The ubiquity and pervasiveness of technology has the capacity for rendering certain rules and regulations obsolete: consider the case of the Paris Bourse which operates some 4000 user devices, a significant proportion of which is in fact placed in the offices of institutional clients. In such a situation, the role of a broker may be viewed as being relegated to a service provider with credit enhancement facilities! Indeed, looking farther down the road, the disintermediation of markets appears to be the next logical step.
The globalisation of economies...
The fact of increasing international economic integration is undeniable: according to the World Trade Organisation, world trade in goods in 1995 grew at a rate of 8%, four times the growth of world gdp. In the 1990s, growth in international trade has pretty much outpaced the increase in world output. For Malaysia, a member of the wto and a signatory to the interim accord of the General Agreement on Trade in Services (GATS), the question relating to the liberalisation of the financial services sector is not one of "if" but "when".
In addition to the wto, Malaysia is also party to regional trade agreements, such as the Asean Framework Agreement on Services, where liberalisation between member states is to be implemented on a gats-plus basis.
...dictates regulatory policies
However, liberalisation of financial services is untenable if not preceded by deregulation policies. For the Malaysian financial services companies to compete on a level footing with foreign companies which are used to operating in open and competitive markets, then the Malaysian economic environment too must be competitive before the tsunami of liberalisation is upon us.
Deregulate only if it promotes competition
Deregulation is aimed at reducing or removing the barriers to entry for market participants and dismantling rules or regulations which serve to insulate participants from market and competitive forces. Competitiveness in turn predicates the like treatment of like activities, or a level playing field. Deregulation, apart from creating a more competitive economic environment, also focusses the resources of companies away from the need to innovate around outmoded regulation, to the actual provision of financial services.
But what does this mean to the Malaysian derivatives industry and how does it stand to gain from deregulation? The financial futures industry itself is relatively new in Malaysia and is perhaps most open to competitive forces. As such the effects of deregulation would probably be more felt indirectly through the deregulation of other parts of the financial services sector.
More specifically, deregulatory policies will seek to dismantle non-competitive rules and regulations. The process will, of course, be conducted in consultation with brokers, exchanges and clearing houses and can be anticipated to cover matters such as:
- the negotiability of commission and other fee structures;
- a re-examination of limits (if any) on numbers of licences or memberships;
- the provision of full financial services, including the dual-licensing of brokers;
- a re-examination of the traditional distinction between securities, derivatives and futures contracts, and the
- promotion of competition between spot and derivative markets.
Deregulation masterplan
It is important to appreciate that deregulation cannot be implemented on a piece-meal basis but must be undertaken cohesively and systematically as part of the larger aim of the positioning of Kuala Lumpur as a regional capital markets centre. In this regard, the efforts of liberalisation by regional trade agreements such as afas must be seen by market participants not as a threat to their existing market share but as an opportunity for regional penetration and growth.
What of the man in the street? Clients and consumers can rejoice; increased competition is a sure means to ensure benefits or savings by companies are passed directly to the consumer.
Increased competition does not necessarily result in consolidation of businesses
The effects of increased competition can be to consolidate businesses into a few, strong institutions better placed to take advantage of scale economies and to compete with large foreign institutions. This appears to be the premise upon which the recent and on-going consolidation efforts in the banking industry are based. In the broking industry, small businesses too can survive strategic rethinking allows room for niche, value-added, services such as trade execution and advisory services.
Other regulatory pressures
Compliance with bis and iosco standardsFinancial innovation and globalisation have increased the linkages between markets both within a jurisdiction and without. The need to reduce systemic risks and the increased exposure to cross-market risks drive the need for harmonisation in regulatory requirements between different jurisdictions, particularly in the area of prudential requirements. In this respect, Malaysia can justifiably be said to be well placed in the region.
Common clearing
The need to reduce risks of a systemic nature has also to a large extent driven the government's pursuit of the policy for there to be a single independent clearing house for the financial futures markets. The consolidation of the regulatory framework of the commodity futures and financial futures industry in mid-April has paved the way for the voluntary merger of the Malaysian Derivatives Clearing House, which provides clearing facilities to the two financial futures exchanges, and the Malaysian Futures Clearing Corporation, the clearing house for the Kuala Lumpur Commodity Exchange. Indeed, I am pleased to announce that a memorandum of understanding will be signed in a few minutes' time between the two clearing houses to signify their intention to merge operations. To this merged entity the Securities Commission will be making a grant of rm 8 million, intended to be applied for developmental purposes. A significant proportion of this sum will be used, we hope, for the development of a front-end clearing system on a platform which will see to the clearing needs of the derivatives markets well into the first decade of the next millennium.
The desirability for a common clearing house is readily apparent, from both a risk and efficiency perspective. Thus we see that in January this year the Chicago Board of Trade and the Chicago Mercantile Exchange, the two largest futures markets in the world, have established a Joint Strategic Initiatives Committee, headed by Nobel Laureate Professor Merton Millar to devise a plan for the consolidation of the clearing functions of the two exchanges. Congratulations are in order for the two Malaysian clearing houses for being world leaders in this respect.
Merger of exchanges?
The case for a merger of exchanges is no less compelling, at least in the case of the Malaysia Monetary Exchange and the Kuala Lumpur Commodity Exchange which share common ownership, and soon, a common clearing house. A single exchange for all futures markets in Malaysia would make eminent sense too, as there will be significant economies of scale to be achieved from pooled resources and operations. The fact of the use of differing trading environments will not pose a problem; in fact, if anything, it may even prove to be an advantage products can now be brought to the screens of a more diverse group of market participants which would in turn aid liquidity in their markets. A product may even be traded both in the pits and on the screens at the same time, provided price discovery between trading environments is efficient and the trade matching algorithm fair.
For brokers, savings can be more directly felt from the reduced costs of compliance as there will be only one set of exchange business rules with which to comply.
Prospects
The prospect for the Malaysian derivatives industry in the face of this sea of change is one that is abound with opportunities which must be seized with both hands. Educating the potential market participants, in particular local institutions, has until now been a slow, drawn-out process. This process will quickly accelerate with the deregulation of financial services which must occur before the inevitable liberalisation as local institutions are forced to be more competitive and efficient. Institutions will have to learn and innovate ways in which savings can be made and profits locked in through the use of risk-management tools. Liberalisation will further provide the impetus for growth of the derivative markets. As markets and the economy become more efficient, we can expect the use of derivative instruments the tools of efficient/semi-efficient markets to be more prevalent. The liberalisation of regional markets ahead of gats obligations must also been seen as a prospect for Malaysian companies to widen the geographical scope of operations and for the diversification of risks.
Financial innovation will be supported by the march of technology. As costs of technology are further reduced, the capacity of telecommunications systems expands, and the spread of networks widens across society, access to financial services by customers will be increased. Notions of geographical restrictions will appear more and more outdated. The operations within a financial institution, and the links between financial institutions, will also likely be improved. The planned use of a new technological platform by the derivatives clearing houses is a clear example in which structural risks may be reduced by the use of technology.
The role of regulation is key in order to ensure that the incentive structures in the financial system promotes competition and efficiency. Government regulation is also crucial where market forces alone cannot achieve that desired efficiency. The nature of regulation in an uncertain environment must be flexible and accommodative to cope with paradigm shifts in the financial landscape.
The time frame within which these changes will occur is unclear. What is clear, though, is that the speed with which we act today will determine whether the clouds we see on the horizon will bring opportunities for growth and renewal, or a flood to punish our ill-preparedness.
