Malaysia capital markets roundtable

Emerging Markets,September 2011

EM: Malaysia’s first capital market masterplan (CMP1), which guided the development of the market from 2001 to 2010, aimed to build a capital market that would meet the country’s capital and investment needs. How far did it succeed and what still needs to be done?

Dato’ Seri Johan Raslan, PwC: The first capital market masterplan built a strong foundation for the development of core market segments, including the bond market, investment management industry and the Islamic capital market. It was a holistic model for the development of an emerging capital market. Among other things, it enabled Malaysia’s elevation to advanced emerging market status in the FTSE Global Equity Index Series and also, at the end of 2010, to cross the RM2 trillion threshold for the first time ever.

However, while our total market capitalization grew at a respectable rate of 10% per annum over the last nine years, neighbouring stock markets in Indonesia and Singapore grew at 24% and 17%, respectively. Our liquidity ranking in Asia also dropped from third in 1996 to 14th in 2011. With other destinations in the Asian region increasingly attracting investor attention, we need to bounce back.

Tan Sri Azman Hashim, AmBank: The first masterplan provided a comprehensive roadmap for the orderly growth and diversification of Malaysia’s capital markets. Evidence of CMP1’s success is that by the end of 2010, 95% of the 152 recommendations the plan made had been completed. It has led to structural changes in the channels for mobilizing and intermediating savings in Malaysia, while the sources of financing have also been broadly diversified, an important ingredient in ensuring sustainable economic growth in an open economy. Deregulation and liberalization introduced under the CMP1 has also helped lower friction costs while increasing economies of scale.

On the other hand, the challenges faced during the decade were rather different. Among other things, deeper and broader markets are necessary to enable the private sector to expand its role in intermediating savings to meet the investment needs of the population, and to provide competitive funding sources to the private sector. While CMP1 has reached its targets, a newer master plan was needed (CMP2) in order to ensure the continued expansion and improvement, and to keep pace with our target of becoming a high income nation by the year 2020

Dato’ Tajuddin Atan, Chief Executive Officer of Bursa Malaysia: Our stock market is home to more companies than any other in ASEAN, our bond market is the third-largest in Asia, and our Islamic capital market is renowned as a leading voice in the world. Credit certainly has to go to the first capital market masterplan that laid the framework for this extraordinary growth.

But the economic challenges facing Malaysia in 2011 are very different from those we faced in 2001. The landscape has changed and is changing, even as we speak. The world is interlinked by trade, and capital flows are much freer. We are now seeing a rising trend in electronic trading replicated by multiple trading venues. We need scale to matter in the global context and we need to be part of an international network to participate in these capital flows. The ASEAN link platform, for instance, is a demonstration of select ASEAN markets coming together as an asset class to raise the collective visibility of the offerings on this end of the market.

What specifically would you like to see take place in the evolution of the capital market in terms of size, tenor and range of issuers?

Raslan: Over the next 10 years, apart from the CMP2, much also depends on the GTP and ETP [Government and Economic Transformation Programmes] initiatives to drive investments, which should in turn boost Malaysia’s capital market performance and draw foreign investor interest. Ultimately, the health of the capital market rests on the economy. From an investor perspective, the hallmark of any successful capital market is open, transparent and even-handed stewardship. It’s clear that this is recognized, with close to half of CMP2’s strategies being focused on governance.

Azman: There is still room for improvement in terms of size and range of issuers. Of particular importance is attracting inward investments from the regional super powers of China and India. Malaysia has had some success in attracting  MNC’s, but given its unique capability around language and capacity around infrastructure, a sharper focus on attracting Chinese and Indian investments may yield positive results.

Reductions in transaction costs, and better communications infrastructure, would further improve Malaysia’s capital markets. Another potential improvement is to simplify the tax system currently used in Malaysia. Potential investors look foremost at simplicity, consistency and clarity of the taxation legislation of a country in considering whether to invest in it.

Atan: The theme for CMP2 is growth with governance. This will capture the essence of Malaysia’s journey towards becoming a developed nation because we must do everything we can to ensure that Malaysia’s capital market doesn’t just grow, it grows with managed and mitigated risks in a well-regulated environment.

To this end, under the CMP2, the Securities Commission will begin the process of regulatory reform, streamlining the existing regulatory framework to achieve higher levels of operational efficiency, enhancing the standards for fair and ethical business practices, and strengthening internal controls around business conduct and the management of risk.

But to take full advantage of the new opportunities being created under the CMP2 and to meet the challenges of the evolving intermediation landscape, we need to build capacity and to foster a spirit of competitiveness, risk-taking and innovation.

One challenge for Malaysia, like much of Asia, is intermediating large domestic savings from the country’s population, to investments in the Malaysian economy itself, rather than offshore (often dollar-denominated) assets. How can this be done?

Yu-Tsung Chang, Standard & Poor’s: Keeping savings within local capital markets is a common challenge in many Asian countries. Progress has been made in the last few years with Asian companies raising more capital in their local currencies. This helped to insulate them from the worst effects of the liquidity squeeze during the global financial crisis.   But a lot more work can be done.

We believe that deep and liquid debt markets are a regional imperative as many countries in Asia seek to build market maturity. Fostering national credit cultures built on transparency, creditors’ rights, and independent and objective credit analysis cannot be understated; such credit cultures enable and strengthen the development of fully functioning local corporate bond markets and broader regional markets.

In Malaysia, sound and transparent regulatory and market structures have supported the rapid growth of its bond market. Modern depository, delivery, and settlement systems have facilitated the issuance, trading, and settlement of bonds in Malaysia. Independent and objective credit analysis from local credit rating agencies and major investment banks is also well established. Recent offerings such as bond pricing services, a credit bureau, and a bond guarantee organization further strengthen the market’s infrastructure.

Over the past five years, international investors have become increasingly interested in Malaysian bonds—today they own about 10% of the country’s issuance.  And during the global financial crisis, cross-border issuers continued to issue debt into Malaysia.  While there is great potential to develop the market even further, liquidity can be a constraint for international investors because corporate issue sizes are relatively small. Other concerns include the protracted process for enforcement of legal claims in the courts and the lack of a developed secondary market for fixed income securities.

Azman: Malaysia’s high savings are expected to drive the rapid growth of the investment management industry, with assets under management projected to rise from RM377.4 billion in 2010 to RM1.6 trillion in 2020. However, in order to translate these high levels of savings in promoting economic growth, the challenge remains to divert the savings from investments in offshore assets to domestic sources.

Improving the efficiency of intermediation will likely play a major role in attracting savings into financing the economic developments of this nation. The recent announcement by the Prime Minister of a review of institutional investment strategies, to ensure optimal deployment of Government Linked Investment Company (GLIC) funds, is a step in the right direction.

Atan: Malaysia is fortunate in that it is well-positioned to finance its investment needs through its large pool of accumulated domestic savings. What we need to do is to substantially increase the creation of income-generating assets to meet the needs of domestic institutional investors.

There should be a review of the system-wide effects of institutional investment strategies, particularly to ensure the optimal deployment of government-owned funds. More efficient intermediation of national savings will have far-reaching effects on accelerating capital formation, private sector participation, secondary market liquidity, risk-taking and expanding product and service diversity.

A new private pension fund framework to enable the setting up of private retirement schemes should be in place by the end of the year. This will promote greater diversity in the management of long-term savings. There are also plans to attract specialist fund managers and to promote greater diversity in investment strategies.

Expanding the number of products on the derivatives market is another development that is crucial to deepening market liquidity, improving the ability to trade across markets and to hedge risks. The strategic alliance between Bursa Malaysia Derivatives and the CME Group has already widened the distribution of Malaysian derivative products across the world: the annual notional trading value on the derivatives market is expected to grow rapidly from the RM512 billion recorded in 2010 to RM4.2 trillion in 2020, with positive spill-over effects for stock market liquidity.

Is secondary market liquidity sufficient?

Azman: The secondary market liquidity in the capital markets, particularly in equities, is somewhat low. Based on data from Bloomberg, the average daily volume in the last six months was US$297 million, compared with US$476 million for Indonesia, US$811 million for Singapore, US$966 million for Thailand and over US$6 billion for Korea.

The government is taking steps to improve trading liquidity, with Khazanah spearheading efforts to place out stakes in government-linked companies in an orderly manner. The government is encouraging the listing of government-linked large-cap companies on Bursa Malaysia, such as Petronas Chemical and Malaysia Marine and Heavy Engineering.

Atan: Market liquidity in Malaysia has remained low over the past 10 years despite efforts to enhance the trading environment. The requirement for major domestic institutions to hold large and liquid stocks on a long-term basis reduces the amount of readily-available sizeable blocks for trading. This also increases the price impact of large trades, making it more expensive to buy or sell stocks. The deepening of secondary market liquidity here requires promoting greater diversification of portfolio asset allocations by the major domestic institutions.

How have the challenges for the Malaysian capital market changed in a more globalised world – and one in which macroeconomic shocks have been frequent?

Chang: Malaysia has an open, diversified, and competitive economy, with a moderately flexible labour market, relatively developed infrastructure in the region, ample supporting industries, and a high savings rate. The government’s economic policies are generally pragmatic. Efforts to enhance transparency and corporate governance have improved Malaysia’s business environment.

However, recent global events point to an increasingly uncertain and challenging environment ahead. If the U.S. and European economies contract deeply again or their recovery is delayed, export-dependent economies with large exposure to the U.S. or Europe would feel a pronounced economic impact. In such a scenario, Malaysia could experience export-driven slowdowns either through weaker demand or lower export prices, or both. Malaysia, like several other similarly positioned countries, would benefit from greater flexibility in fiscal and monetary policies to adjust and mitigate any exogenous shocks.

Atan: In a more globalised world, we are fighting for our share of that proverbial investment dollar. Malaysia is totally cognisant of new and fast-growing emerging markets which create a much more competitive landscape. But our market initiatives include the promotion of our key strengths – both as a country and as a capital market. For example, the ETP will be a key driver for economic growth and corporate earnings.

The Malaysian market cannot be completely decoupled from global macroeconomic shocks but it does offer relative resilience in times of regional volatility. Clearly, we stand out in terms of the domestic consumption theme, commodity stocks, oil and gas plays as well as Islamic products.

What degree of integration is desirable, and realistic, among Asean nations’ capital markets?

Raslan: We must recognize that individually, our national capital markets in ASEAN countries are very small. Only together can we make any impact in a globalised world. It is imperative that ASEAN moves towards an integrated economic zone.

Chang: There’s a long way to go in terms of integration. But intra-ASEAN market movement will help promote the further development of the local capital markets, for example, by shifting issuers from G3 markets to ASEAN local currency bond markets. There’s a lot of potential for this to happen as only about 3% of ASEAN market capitalization is invested within the region.

We are deeply committed to supporting the continued growth of ASEAN’s domestic capital markets, especially in promoting stronger financial market integration. Two years ago, we introduced an ASEAN rating scale to provide a credit benchmark that allows investors to compare risk profiles within an ASEAN context. We have already assigned more than 70 ASEAN scale ratings and expect the number to grow as the capital markets deepen.

Atan: The ASEAN Economic Blueprint envisages ASEAN becoming a single market and production base with free flow of goods and services, investment, skilled labour and freer flow of capital. The ASEAN Capital Markets Forum (ACMF) supports the above blueprint through the ACMF Implementation Plan 2015.

With this as a background, the ASEAN Exchanges are working towards the promotion of ASEAN as an asset class both within ASEAN and also internationally. The aim here is to ease and promote cross-border trading as well as global access to ASEAN markets.

Country exchanges typically have geographical jurisdictions and national asset type characteristics. Hence, integration is not a target that can be achieved in a short space of time.  However, collaboration between exchanges, which is already underway, can generate greater visibility, harmonisation and efficiencies across the ASEAN markets. This will ultimately lead to greater flows into ASEAN and within ASEAN.

Malaysia has built the most sophisticated domestic Islamic finance industry in the world, including its capital markets. How will the Islamic markets develop in future?

Raslan: With our comprehensive legislative, regulatory, legal and Shariah frameworks, Malaysia was the world’s largest exchange for sukuk listings in 2010 – some US$27.7 billion.

To further promote Malaysia as a preferred destination for raising sukuk and Islamic fund management, we need to deepen the IF legal and regulatory frameworks to facilitate international flow of funds; build closer cooperation with GCC and other Asian countries’ financial communities; develop greater clarity and consistency on the interpretation of Shariah and documentation of IF products; and address talent deficiency.

Chang: Standard & Poor’s was proud to be the first major rating agency to assign ratings in the Islamic finance sector with its rating on Malaysia Sukuk Inc in 2002. We are committed to helping global investors better understand Islamic finance, broadening their potential pool of capital.

We see a bright outlook worldwide for Islamic finance on the back of steady growth and geographic diversification. Southeast Asian countries will continue to fuel the advance of Islamic finance in Asia. We expect Malaysia to still lead the global sukuk market in issuance. Malaysia has a well-established Islamic banking system, strong regulatory framework, and government support for Islamic finance.