AFR: Why does Singapore want the ASX?

Australian Financial Review, September 27, 2010

Singapore Exchange has a long-standing problem: its home is just too small. An island state that could fit into urban Sydney three times over, its domestic market is inevitably limited and is already mature.

Look what happens when a rare new blue chip hits the markets. Earlier this month the Government of Singapore Investment Corporation, one of Singapore’s two sovereign wealth funds, spun off an unremarkable cluster of logistical properties in China and Japan called GLP. Such was the fervour for exposure to quality local equity – even when the underlying assets were thousands of miles away – that the deal was 12 times oversubscribed, raised S$3.45 billion (which will likely be increased), and became the second biggest IPO in the country’s history. That’s the scarcity value of big new names in a small country where almost everything decent is already on the market.

Consequently the key mandate of the SGX’s management in the last 10 years has been to find new ways to wring volume, fees and diversification out of what they’ve got.

One sees this in two ways. One of the main thrusts at SGX in the last decade has been to attract listings from elsewhere in Asia – it calls it the Asian Gateway strategy. Its listings head, Lawrence Wong, has been pounding the region attempting to coax Thai, Indian, Chinese or even Russian companies to list in Singapore, and has had some success in finding niches. Clearly, the biggest opportunity in Asian capital markets is China, and inevitably the biggest state-owned behemoths go straight to Hong Kong, or increasingly just list in Shanghai. But Singapore has made itself the centre for second-tier Chinese companies, and by earlier this month had 160 such companies listed here. About 30% of Singapore’s market capitalization is now non-Singaporean companies.

The other is in product innovation. By necessity, SGX has put itself at the forefront of every new listing business you can think of. It is unquestionably the home of Asia’s real estate investment trust (REIT) industry; one issuer alone, Singaporean blue chip Capitaland, has launched six of these vehicles, including many of the biggest and most successful. SGX is the regional leader in exchange traded funds, the regional centre for listed hedge funds, offers more derivative products than any other Asian exchange, and this month launched American Depositary Receipts for 19 New York and Hong Kong-listed stocks. Next comes OTC clearing of financial derivatives, starting next month for the first time in Asia.

It has a track record of delivering what investors ask for. Need faster processing? Its new trading engine will be the world’s fastest when it gives live in July, with latency of less than 90 microseconds. Too much business avoiding Asia because of trading hours? It extended those hours to 2a.m. to ensure it’s around for part of the New York trading day. Need a tax break? It got the Inland Revenue Authority of Singapore to extend a concessionary 10% tax rate to global traders if they use Singapore as their base.

One characteristic has been to identify a threat and join forces with it. Exchanges around the region are nervous about Chi-X, the dark pool alternative liquidity provider that allows big block traders to bypass exchanges completely. But SGX instead launched a joint venture with it, called Chi-East. Earlier this month CEO Magnus Bocker described the venture as “who we are at SGX” for its willingness to learn from what looks like a challenger. Similarly when a new commodities exchange, the Singapore Mercantile Exchange, was launched last month, built and run by Indian interests and apparently in direct competition with SGX’s own Singapore Commodities Exchange subsidiary, Bocker expressed his delight about that too, saying it would make Singapore a commodity hub. Then he immediately announced an SGX tie-up with the London Metals Exchange to start trading metals contracts.

But for all its undoubted smarts, Singapore’s pursuit of opportunity has led to real problems, and this will be relevant for Australian retail investors hoping to diversify their holdings into Asia. When you bring second-tier Chinese companies to Singapore, you are taking a chance on the quality of management, and many have had problems. For example, shares in China Milk, a Singapore-listed Chinese dairy company, have been suspended since February after defaulting on a convertible bond and has been providing hopelessly inadequate information to investors on its financial position ever since. There are many success stories among Singapore-listed Chinese companies, known as S-shares, but also many disappointments. “We have a rule of thumb here about what the S in S-shares stands for,” says one Asia fund manager. “But I don’t think you’re going to be able to print it in your newspaper.”

This brings up another issue. In Australia, since the ASX has been listed, there has been a certain queasiness about having a company that is listed on itself also being the watchdog for other listed entities, and gradually the regulatory strength of the ASX is being passed elsewhere. Not so in Singapore, where it remains the arbiter of who can and cannot list – arguably a conflict given that its own revenues as a listed company depend on new listings.

But it is important to appreciate the squeeze on organic growth, and the push for new sources of revenue, in order to understand just why Singapore Exchange wants this deal with the ASX. In essence, it has no choice: it is running out of ways to grow. Former CEO Hsieh Fu Hua knew this, and negotiated with other exchanges for years. When Magnus Bocker took his place in December 2009 it was no coincidence that he had presided over some of the most significant mergers to have taken places in stock exchanges worldwide: seven Nordic exchanges, and then OMX and Nasdaq in 2008. That experience, of integrating exchanges despite all the political and regulatory noise around doing so, was why he got the job.

And for Australian investors? They get access to some quality Singaporean companies, and ETFs covering the whole region, not just in equities but commodities and fixed income. But when considering whether the merger will revolutionise the way Australians trade, it’s worth remembering that we have been here before. Early in the 2000s the ASX and SGX set up a trading link, enabling Australians to buy Singapore-listed stocks very easily, and Singaporeans to buy Australians. But it generated such little volume that the link was eventually scrapped. When direct trading access comes through – and it could still be at least a year from now – it will give Australians new opportunities, but that doesn’t necessarily mean they’ll bother to use them.