Introduction

Good morning. I should like to begin by thanking the ADB Institute and the Organisation for Economic Co-operation and Development (OECD) and their collaborators, IOSCO, the World Bank, the IMF and the ADB for giving me this opportunity to speak at this roundtable on securities market reforms, and in particular on the causes and impact on securities markets of the Asian financial crisis.

For the next 15 minutes or so, I will present an account of Malaysia's experience of triggering events that prompted certain policy initiatives for the securities market, the nature and current status of those initiatives, and some of the early indications of how those initiatives appear to be affecting the situation concerning Malaysia's securities market and industry.

For the purpose of the presentation this morning, I will keep my comments mainly to securities markets, although where relevant and appropriate I may extend them to the wider economy.

Triggering events for policy initiatives

For Malaysia, as for many crisis-affected countries within the Asia-Pacific region, the triggering events for policy initiatives involved a series of developments that arguably began with a deterioration of investor confidence, which rapidly grew into an irrational panic.

In Malaysia's case, this was reflected in a widening of the benchmark international yield spread-in this case, the difference between the Petronas 2006 bond yield and equivalent US treasury security yield-from around 66 basis points at the end of May 1997 to 230 basis points five months later to over 1,000 basis points in September 1998.

This was accompanied by rapid downgrading of Malaysia's sovereign credit rating by international rating agencies to just above so-called junk bond status in the last quarter of 1998 and a marked rise in sell recommendations by international market analysts.

Panic eventually translated into capital flight which led to a severe deterioration of Malaysia's reserves position and a sharp weakening in the ringgit. Foreign reserves, which fell from US$18.4 billion in 1996 to US$15.6 billion at the end of 1997. The ringgit dropped by nearly 60% in the year to July 1998.

Eventually, this took its toll on the economy, which contracted by -6.7% in 1998 after having grown at a rate of 7.7% the year before.

These developments had a significant impact on Malaysia's securities markets, in particular the stockmarket. The market from its peak of about 1,200 fell very sharply to about 800 and bottomed out at levels of 250 in the second half of 1998. The Kuala Lumpur Stock Exchange's benchmark Composite index declined by over 70% during July 1997-August 1998. The size of the Malaysian stockmarket shrank dramatically as did share trading activity, although it is interesting to note that the market in Composite index futures expanded as the index's daily volatility grew to way beyond historical norms.

The sharp and prolonged decline in asset prices began to realise many problems among market intermediaries and among the corporate sector. Falling share prices eroded the value of securities pledged as collateral for margin loans and led to a higher frequency of margin-calls and, in some instances, forced-sales; they also aggravated the maturity-mismatch of their balance sheets.

As a result, a number of market intermediaries, among them several stockbrokers, began to find difficulty in meeting prudential requirements and in financing their daily operations and short-term obligations.

Certain listed companies faced similar difficulties, where higher operating and financing costs, as well as bad debts, increased as a result of some of their market exposures. In some cases, financial problems were aggravated by various links between securities markets, the corporate sector and the wider economy.

To a certain extent, these developments placed a substantial amount of pressure on the stability of the financial system and arguably increased the risk of systemic disruption. Besides intermediaries, systemic stress also rose at the level of market institutions, in particular within the stockmarket's clearance and settlement system. However, I should like to emphasise that at no point was systemic risk ever realised.

Common experiences among many emerging markets: the IOSCO EMC report

The triggering events that I have just outlined were not unique to Malaysia. Many of these experiences were shared, to a greater or lesser extent, by emerging markets around the world-not just those in Asia-and have been documented in an interim report released last September by the Emerging Markets Committee (EMC) of the International Organisation of Securities Commissions (IOSCO). The report, entitled "Causes, Effects and Regulatory Implications of Financial and Economic Turbulence in Emerging Markets", was prepared by a working group of the EMC led by Malaysia.

A survey of 17 emerging market jurisdictions [countries included Malaysia, China, Chinese Taipei, Brazil, South Africa and Thailand] conducted for the purpose of the report suggested that causes of the crisis lay in an interaction of macroeconomic factors, a host of structural issues, and several financial market issues, which included currency and OTC market activity. The report noted that major effects on securities markets included a worsening of international perception towards emerging markets regardless of whether or not fundamental weaknesses were apparent at the time in those markets.

Policy initiatives

I think that it is fair to say that external factors contributed significantly to the increasing difficulty that authorities had in managing the economy and regulating the financial system.

Economic deceleration proved difficult to reverse despite various attempts to boost investor and consumer confidence, including the announcement of a stabilisation package for the financial sector and the release of a National Economic Recovery Plan by the National Economic Action Council, a consultative body to the Cabinet that was established to deal with the economic crisis.

Furthermore, there is no doubt that, in hindsight, not all policy measures were appropriate and that some mistakes were made,. For instance, the curb on credit growth when liquidity was in fact needed, the increase in interest rates which further exarcebated the credit crunch, tightening of prudential requirements [NPLs from six- to three-months] when financial institutions were already finding it difficult to meet existing requirements, a cut in government expenditure when aggregate demand was already falling. These measures proved to be wrong principally because of the timing of their introduction. However, these mistakes were recognised and quickly rectified.

As the crisis dragged on, consumer confidence continued to worsen and extremely higher offshore ringgit interest rates hindered the effectiveness in some of the policy changes without an unacceptable increase in the risk of further outflow of capital funds.

A necessary first step towards recovery: exchange controls

Given these circumstances and the policy constraints faced by economic and financial authorities at the time, the government felt that longer-term recovery required a more drastic approach in the short-term.

On September 1st 1998, Malaysia imposed exchange controls to regain a degree of financial independence. Among other things, the measures aimed at preventing manipulation and excessive speculation on the ringgit. As a result, trading in ringgit could no longer be conducted outside of Malaysia and the exchange rate was fixed RM3.80 to the dollar. A twelve-month holding period was also imposed on portfolio capital.

However, it should be noted that these measures were followed by a rapid succession of recovery measures that sought to improve the efficacy of monetary policy, provide the economy with a significant amount of fiscal and monetary stimulus and to stabilise and rehabilitate the financial system, including the securities markets. I will elaborate further on what these latter measures were and what prompted their establishment briefly.

Admittedly, imposing exchange controls did have severe consequences on the market at first. Price volatility, already high by historical standards, leapt to levels previously unseen on heavy buying activity emerged-reportedly on short-covering by foreign investors. However, turnover soon fell as foreign participation diminished on account of several factors, including the removal of Malaysian equity from several major benchmark indices and a change in perception by the foreign investment community in Malaysia.

Nevertheless, the measures allowed authorities to regain some control over the economy and financial system, and provided some "breathing space" to pursue recovery measures which I shall outline in a moment. And it is important to realise that the government has maintained a pro-active approach to the implementation of the controls.

For example, in view of increasing concerns raised by foreign investors over the 12-month holding period requirement as well as to facilitate portfolio investment from abroad, the government revised the exchange controls by replacing that particular rule with a graduated levy on the repatriation of portfolio capital.

Measures towards the recovery of Malaysia's securities industry

I should like now to turn towards the measures that have been taken to promote the recovery and improvement of Malaysia's securities industry. With the onset of the financial crisis, the Securities Commission, and, where relevant, market institutions, have re-doubled efforts to

• maintain systemic stability
• restore market confidence
• improve market transparency and corporate governance
• facilitate the raising of funds
• rehabilitate the securities industry

The Finance Committee submitted its recommendations to the government on 30th June 1998 and a major report containing these recommendations was circulated for consultation among relevant private and public sector organisations. The report was finalised and made public on March 25th this year. The recommendations of the Finance Committee essentially seek to

In connection with the APEC Collaborative Initiative on Corporate Governance, Malaysia is currently leading the APEC Finance Ministers initiative on corporate governance that is being carried out in collaboration with the Asian Development Bank and the World Bank.

In addition KLSE has been asked to make revisions to rule 118 of the KLSE Listing Rules to stop possible abuses by large/controlling shareholders in connection with related party transactions. Among other things, the rule now requires a company to appoint an independent corporate adviser to advise minority shareholders of the company, and prevents directors, substantial shareholders or interested parties from voting on the transaction.

• ensure that they maintain appropriate checks and balances
• practise proper corporate governance
• establish "Chinese Wall" procedures
• establish compliance officers, whose responsibility will be to secure effective internal controls and an active segregation of duties between trading and operational functions within their respective stockbroking firms.

Other measures came about through amendments to five securities laws and regulations effective November 1st, namely in the

• Securities Industry (Central Depositories) Act 1991
• Securities Industry Act 1983
• Securities Commission Act 1993
• Futures Industry Act 1993
• Securities Industry (Substantial Shareholders' Reporting) Regulations 1998