Speech at Launch of "Guide Book on the Malaysian Bond Market"
19 October 2000 |   By : Encik Ali Abdul Kadir, Chairman, Securities Commission
Speech by

Encik Ali Abdul Kadir
Chairman, Securities Commission

at the
Launch of "Guide Book on the Malaysian Bond Market"

19 October 2000
The Regent, Kuala Lumpur

YBhg Tan Sri Dato' Dr Abdul Khalid bin Sahan, Chairman, Rating Agency of Malaysia, distinguished guests, ladies and gentlemen. Good afternoon.

I would like first of all to thank the Rating Agency Malaysia for inviting me to launch the "Guide to the Malaysian Bond Market".

Three years have passed since the Asian crisis struck in 1997, hurting many economies around this region, including Malaysia. As in many other emerging economies in this region, source of financing of the private sectors which formed the backbone of the economies, were through loans from financial institutions. And as we all know, indirect financing is an inefficient system of resource allocation. Bond markets are important because they economise on risk capital. Unlike banks which typically intermediate credit, term and currency risk on leveraged balance sheets, bond markets link borrowers directly with savings pools that can more easily bear risks because they are unleveraged, have a longer term investment horizon, and are able to diversify among many tradable investments.

Recognising that the development of a viable and efficient corporate bond market is such a key step to economic recovery, the Government has announced its commitment to develop the bond market in Malaysia specifically to redress the funding and use-of-funds mismatches and to diversify risks away from the banking sector.

It has sometimes been suggested that bond market development will pose a challenge to the banking sector, and in some instances, a threat to liquidity of the equity market. I believe this is too narrow a view. When the banking system and equity market are fairly well developed, which is the case in Malaysia, the bond market complements, rather than, competes with banks and the equity market. In channelling long term savings to long term projects, the bond market reduces the risks arising from the maturity mismatch. Furthermore, an active bond market would encourage securitisation of illiquid bank assets, and provide an avenue for banks to offload assets to capital market investors, thereby enhancing their overall liquidity position. A vibrant and efficient bond market is thus a source of stability for the banking system.

Recent developmental initiatives for the corporate bond market

Over the past few months, the Malaysian bond market has witnessed some important developments specifically in the regulatory landscape that governs this market. The Securities Commission (Amendment) Act 2000 makes some far reaching changes to fund-raising activities in Malaysia, broadly resulting in the positioning of the SC as the sole regulator for all fund raising activities in Malaysia. More importantly, the issuance of corporate bonds has seen some radical changes, with a number of issuance requirements liberalised and the issuance process has become facilitative, market driven and efficient. For example, the SC's Guidelines on Private Debt Securities no longer imposes mandatory underwriting requirements nor a minimum investment grade for all bond issues. The capital structure of an issuer is also left entirely to be determined by the issuer and its underwriters. The SC conducts a post vetting system of approval, whereby the issuer and the lead manager need only to file a declaration of compliance with the SC's Private Debt Securities Guidelines in order to secure an approval from the SC within 14 days. I am happy to say that the SC has been able to live up to its commitment to grant approval within 14 days in regard to all applications for new issues of bonds since 1 July 2000.

These changes are timely particularly in a climate where economic recovery is taking place and where there is increasing global competition for scarce resources. In this regard, one of the many strategic reforms emphasised by the SC is the transition from a merit-based system of regulation to that of a disclosure-based regime. We believe that the disclosure-based approach to regulation is fundamental and critical to further developing an efficient capital market.

Efficient capital market

Often, the question is asked: what makes an efficient capital market? Let me begin with a definition of market efficiency. In theory, an efficient market is one in which market prices reflect the economic values of assets being bought or sold. Put another way, market prices reflect the present value of expected future returns on an asset. These market prices are available to all market participants and is reflected in the market price of the asset. With no reliable information, market prices may become volatile, leading to a negative impact on the economy, or buyers and sellers may simply withdraw from the market due to their inability to determine future expectations and thus appropriate price levels for an asset.

does not share the good fortune of the company. The bond investor simply receives the principal and interest or principal and profits in the case of Islamic bonds that are specified in the debenture instrument. The focus on fixed income investments is thus on risks, specifically the risk of default. Default takes place when an issuer fails to pay interest or principal on the bond. The investor must also ensure that he receives a return that is commensurate with the risk he is being asked to take. In order to do this, the fixed income investor needs to have access to information in order to evaluate the level of default risk on a particular bond investment.

Ladies and gentlemen, this is where Disclosure-Based Regulation plays its role in promoting an informed market because it restores the onus of capital allocation and decision making back to the market. Disclosure-based regulation focuses on information that an investor and his professional adviser would require in evaluating the risks and rewards of investment. I believe we are now at the stage of market development where the magnitude and quality of information available to the market for primary offerings needs to be much improved. Of course, a balance would need to be maintained so that costs does not become prohibitive for both issuers and investors. If the cost is prohibitive, it may have a damaging effect on the market. If the information cannot be obtained either because the cost is excessive or because the information is simply unavailable, the investor will be left with a high degree of uncertainty about the future default risk of the issuer. A lack of information or high information costs would lead to higher financing cost for the issuer.

As you may be aware, the National Bond Market Committee has identified various key issues for further development of the corporate bond market such as the need to widen the issuer and investor base, the need to improve liquidity in the secondary market and the introduction of risk management instruments. In addressing these issues, it was found that the dissemination of quality information to the market is critical for the benefit of promoting confidence among market participants in the bond market. We should note that a mere increase in information without an equal commitment towards inculcating knowledge through education, especially in the case of investors, would not help in achieving the desired goals with respect to the bond market.

On its part, the SC has undertaken specific programmes to increase the market's understanding of the current regulatory framework, specifically that of the bond market, investors' rights and obligations of borrowers, intermediaries and trustees. It has also held programmes for members of the public on capital structuring, asset valuation and other aspects of investing. The Securities Industry Development Centre of the SC is committed to enhance investors' awareness and educate them on various aspects of investments including fixed income investments in order to raise sophistication of analysis and understanding.

Role of ratings as a means of dissemination of information to investors

The critical role played by credit ratings in an efficient bond market is conventional wisdom. By providing information on default risk, and therefore, on the likely future performance of an issuer, ratings contribute to the efficiency of the capital markets. Ratings can help establish a more balanced information system in a market. With ratings, investors have an additional source of information that they can use to establish benchmarks for comparing risks and returns. Rating agencies can also play a key role in educating investors about credit risk. Through its research and opinions, rating agencies can contribute to the development of a pool of sophisticated investors who are knowledgeable about credit risk and the tools of credit analysis. At the issuers' end, a good rating can result in lower costs to the issuer and potential access to a wider investor pool. Indirectly, the rating process serves as a useful marketing tool for the issuer as it generates publicity and accords status for highly rated companies.

With a shift towards a disclosure-based system of regulation, the transparency and accountability of the rating process becomes even more critical. I wish therefore to call upon rating agencies to continue to strive towards attaining high standards in performing their functions pertaining to due diligence, fairness and impartiality. As they continue to enhance their credibility and reliability, rating agencies in Malaysia will play an integral part in the creation of higher levels of knowledge and sophistication in the bond market. Acceptance in the international arena of Malaysian domestic papers will also continue to grow. However, as a continuous process of nurturing a more market-driven environment for fund raising, the Securities Commission envisages that a mandatory requirement for rating of domestic bond issues would be removed upon the development of a critical mass of risk management capabilities in the capital market.

While rating does to some extent serve as a gate-keeper to fend off sub-standard issues, it is not a guarantee against credit loss. The investors themselves must bear the credit risk. Rating is, therefore, not a substitute for investor protection. Because of this, investors need a regular flow of information from a broad range of sources in order to make informed investment decisions of their own. They would need credit ratings, but they would also need greater financial disclosure and strong accounting standards. To this end, the SC is committed to seeing through a process of improving the adequacy regarding disclosure of financial information through its surveillance activities in financial reporting of public listed companies. The SC also works closely with the Malaysian Accounting Standards Board to enhance accounting standards especially with regard to transactions in the capital market.

Whilst much has been spoken about what measures need to be taken on a broad range of areas in order to develop the corporate bond market in Malaysia, today, I wish to just focus on two areas, namely, broadening the issuer and investor base for corporate bonds.

Broadening the issuer base

Let me first deal with the question of supply of bonds.

Since the beginning of this year, there has been a remarkable improvement on the level of activities in the primary market for corporate bonds. Favorable interest rate environment, strong economic growth coupled with low current and expected inflation levels has created an encouraging environment for bond issuance.

Since 1st January 2000, we have seen at least 23 bond issues in the market amounting to RM10.901 billion (excluding bonds that were approved by the SC since 1 July 2000). The average issue size and tenure of RM474 million and 9 years respectively reflects favorably on the stance of the Government in encouraging long term bond issues. Furthermore, these figures also show that some of the risk concentration of the banking industry can be diversified away. Of these bond issues, approximately 13 issues amounting to RM7,436 million or 68% were made to fund infrastructure projects which are relatively long-term in nature. The other categories include three bond issues for utilisation in the property sector amounting to RM1,334 million or 12% and two issues in the telecommunication sector amounting to RM250 million or 2%. Five other bond issues were made to fund diversified projects amounting to RM1.88 billion or 17%.

Since 1st July 2000, the SC has approved ten corporate bond issues of value amounting to RM8.6 billion. Excluding one long term bond issue for infrastructure project, the average approximated issue size and tenure for these bonds are RM400 million and 6 years respectively. Therefore, it can be seen that corporate bond issues in the second half of the year mirrors the robust primary market activity at the beginning of the year. Of these ten bond issues approved by the SC, two bond issues amounting to RM5.4 billion or 63% were made to fund infrastructure projects which are long term in nature. The other categories include two bond issues in the telecommunication sector amounting to RM 1 billion or 12%; one issue in the manufacturing sector amounting to RM 300 million and one issue in the property sector amounting to RM150 million. Three other issues amounting to RM1.73 billion or 20% are to fund diversified projects including the services sector. The SC has also approved 22 applications seeking relief from the form and content of prospectuses for bond issues that were approved by Bank Negara prior to 1 July 2000. In addition, 18 applications were made to the SC for variation of terms and conditions for bond issues that were approved by Bank Negara prior to 1 July 2000. In all these applications, the SC is committed to a facilitative and smooth transition with minimum burden and cost to issuers without compromising investor protection.

The SC believes that one measure to address the "supply" question is to promote asset securitisation as it would provide for a wider range of debt securities in the market as well as to attract more debt issues from a wider range of issuers. Despite its great potential, asset securitisation is virtually non-existent in the domestic bond market due to concerns over legal, regulatory, tax and accounting issues. As an initiative to kick-start the development of asset securitisation market in Malaysia, the SC has set up an Asset Securitisation Consultative Committee comprising market professionals such as legal practitioners, accountants, merchant banks, rating agencies, tax practitioners as well as Cagamas to undertake studies and to make recommendations to the Government on what is required to facilitate asset securitisation in Malaysia. I am happy to say that the deliberations and recommendations of the Consultative Committee in regard to all these issues are at the tail-end of the process and would be finalised in the last quarter of this year. Based on this report, the SC would co-ordinate with the relevant agencies to develop a comprehensive framework encompassing legal, regulatory, tax and accounting aspects which would promote asset securitisation in the country. On its part, the SC would be releasing its Guidelines on Asset Securitisation in the last quarter of this year so as to provide a framework for asset securitisation transactions.

Broadening the investor and intermediary base

To ensure sustainable development of the bond market, the SC has taken efforts to advocate further liberalisation of regulatory restrictions imposed on institutional investors in the bond market, specifically pension funds, provident funds and insurance companies. In this regard, the SC is in active consultation with relevant agencies and industry bodies to identify all the impediments that restrict institutional investors' active participation in the bond market. Various studies are also being conducted to widen the categories of investors in the bond market such as promoting retail participation via bond funds. In cultivating investor interest in fixed income investments, one real challenge is to develop liquidity in the secondary market. We find that even the "buy and hold" type of investors attach great emphasis to liquidity. While broadening the investor base is one necessary step, a pragmatic starting point for improving liquidity in the market is to broaden the range of principal dealers which hitherto is limited to financial institutions and to ensure an effective market making system for the bond market. The SC believes that suitable stockbroking companies and fund managers can play their part in this regard.

In conclusion, I wish to applaud RAM for its contribution and educational efforts in relation to the bond market through this "Guide to the Malaysian Bond Market". May this launching of the "Guide to the Malaysian Bond Market" by Rating Agency Malaysia be a milestone in continuous market driven development initiatives as well as a conduit for disseminating high quality information on the bond market.

Thank you.
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