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Continued from
FrontPage of Article
Speech by Mr Ong
Chong Tee, Deputy Managing Director, Monetary Authority of Singapore
At the Schroders Investment Seminar, Conrad Hotel, Tokyo
"Refocus on
Asia"
1. Good afternoon,
ladies and gentleman. Before I begin, please allow me to thank
Schroders for the opportunity to speak at this investment seminar. I
am honored to be here. I understand that the focus of this year's
seminar is on Asian Dynamism. This Asian theme is not surprising,
given the economic rise of China and India and the recovery of
Japan, which have been very much in the global spotlight.
2. The topic of my speech today is "Focus on Asia". In a sense,
this is more of a "Refocus on Asia" as many here will remember the
"80s and early "90s when much was written and spoken about Japan and
the four Asian Tigers. A topic of this nature can run on either one
of two tracks. One, which I term the cyclical perspective, is to
make the case for Asia by looking at the current economic
environment and near term investment outlook for Asian assets. From
this perspective, one can cite reasons to be reasonably optimistic
about Asian market prospects - judging from recent years' market
performances. Asian stock markets have risen by 86% [1]
over the last 5 years, outperforming the markets in US and Europe.
Asian economies are projected to grow close to 6% over the next five
years, as compared to 3% and 2% for US and Europe respectively
[2].Certainly, there are risks: oil prices,
geopolitical events, and so on. But on balance, the consensus
assessment including that of the IMF is that Asian economies and
financial systems are on a much firmer footing now than in 1997, and
even if a risk event occurs, we are unlikely to see a repeat of the
Asian crisis meltdown.
3. But I do not wish to
dwell too much on this. Financial forecasts and market outlooks are
challenging exercises which I would rather leave to the experts who
are going to speak after me. Today, I wish to take a different
angle on this topic, what I term the structural perspective, that is
to focus on recent structural developments in Asian financial
markets; and how these would strengthen the case for Asian assets as
viable, long-term assets from the point of view of a Japanese
investor.
4. Let me take a step
back to ask a more fundamental question: Why should long-term
Japanese investors, particularly pension funds, invest in foreign
assets at all? Why not just stay at home - since Japan has the
second largest stock market in the world and the world's largest
public bond market? A study done by OECD in 2002 showed that there
is still a very strong home bias amongst pension funds in countries
with well developed financial markets.
5. Financial theory
tells us that there are two main reasons why an investor, even one
with predominantly domestic liabilities, should consider foreign
assets. First, it brings broader diversification benefits, allowing
a portfolio to reduce risks while maintaining expected returns at
the same or high level. As the economist Paul Samuelson said, this
is about the only "free lunch" you ever get in economics. Second,
for an investor in a developed economy like Japan, investing in
emerging markets enhances returns because less efficient markets
yield a larger excess return. This is especially important for many
pension funds that are facing a growing pension burden in a low
yield environment. I note that the Japan Pension Fund Association
and Government Pension Investment Fund have indicated recently that
they would be looking at alternative investments to boost returns.
6. That's the theory.
How does that match with reality? In terms of diversification,
historically, there is a relatively low correlation between Asian
assets as a whole with the developed markets and Latin America,
especially if one includes currency effects. This is even more so
after the 1997, when many Asian countries floated their exchange
rates. In terms of return, the case for Asian assets is possibly
even stronger.
7. Besides the near-term
growth story, I believe that there are three broad reasons why Asian
assets may produce good returns in the long term. First, it is well
known that savings rates in Asia are high, about 40% of Asia's GDP.
This high savings rate can underpin the sustainable growth rate of
the region, as the engine of growth shifts from exports to
consumption. In time to come, Asian domestic demand will become a
key driver of global growth, possibly replacing the increasingly
exhausted and indebted American consumer. In addition, as Asian
markets develop, more of these savings pool, which are currently
invested in developed markets, will return home, thereby bolstering
the value of Asian assets. The Asian wealth management industry is
set to grow and will further catalyse investment demand for Asian
assets.
8. Second, Asia'
demographics are also favorable for growth as demographics translate
into talent and domestic market size. More importantly, there are
two billion people below the age of 30 in Asia, representing a third
of the world's population. By 2007, young singles in the 11 key Asia
pacific economies will account for 12% of the purchasing power in
Asia. The sheer size of this generation means it can affect the
development of consumer culture across the whole region. Asia's
young generation is the largest in history and is poised to be a
driving factor in the Asian growth story as they earn more than
their frugal parents, enjoy greater social freedom, broader use of
technology and a tendency to spend more and save less
[3].
9. Third, the maturity
of the region's financial markets. Developed markets have a longer
financial market history and investment houses have dedicated more
resources to research the companies and economies, compared to their
Asian counterparts. Developed financial markets have matured and
present less investment opportunities. On the other hand, Asian
financial markets are still in nascent but developing phase,
reinforced by the continued efforts of Asian authorities to broaden
and deepen capital markets. Thus, investment opportunities still
exist.
10. So by and large, I
would say that the case for Asian ex-Japan assets is strong. In
reality, though, investors are still underinvested in Asia. An
Asiamoney survey conducted in 2005 showed that many global investors
still view investments in the Asia ex-Japan region as a peripheral,
tactical play as opposed to a long term strategic positions. In
addition, investors still perceive emerging Asian investments to be
highly risky and loosely regulated. Allocations to Asia ex-Japan
are small, with the typical global fund management firm still
typically allocating around only 4 to 5% of total investable funds
to the region's market. The allocation is even less for many pension
funds in the US, Germany and UK. To be sure, there are exceptions.
For instance, ABP Investments, Europe's biggest pension fund which
actively manages Euro 180 billion on behalf of Dutch public
servants, has tripled its investment in Asia ex-Japan since 2003 to
around 9% of its equity allocation. But as a whole, it is fair to
say that Asia ex-Japan is under represented in global portfolios.
Data from the IMF [4] backs this:
Aggregate foreign liabilities [5] in
Asia currently amounts to 65% of aggregate GDP which is less than
the 80% recorded in Latin American emerging markets and 100% in US
and Euro area combined.
11. So why is it that
many investors have not invested more into Asia? The simple
explanation is the relatively low Asian ex-Japan allocation in major
indices. Asia ex-Japan contributes 28% of the world's GDP, while
Asia's share of market cap is low: at only 2% of the MSCI World
Index and 3% of the Lehman Aggregate index. But this simple
explanation is incomplete. The low weighting in major indices
reflect deeper factors that hold back global investor interest. In
my view, there are four main factors:
- Capital controls;
- Perception of corporate governance standards;
- Inaccessibility of markets; and
- Narrow spectrum of asset classes for investments.
Fortunately, things are changing rapidly and many of these issues
are being addressed. Let me discuss each of them in turn.
Capital
controls
12. Fundamentals aside, there is the
practical issue of capital controls in Asia which have kept
investors away. But in this regard, Asia is not a homogenous bloc.
I think we can broadly place Asian countries into three groups.
First, there are the markets which do not have any capital
controls - like Hong Kong and Singapore. Second, there are markets
that have substantially liberalized since the Asian crisis. Korea,
Indonesia and Thailand are some examples in this category. In all
these markets, foreign investors are now allowed to invest freely in
their domestic securities. Some restrictions on derivatives and
offshore transactions remain but are being gradually loosened.
Korea for example, has announced that it would free up currency
restrictions by 2007.
13. Finally, there are
countries that still have strict capital controls, most notably
China and India. In both countries, substantial steps are underway
to liberalize their capital accounts. China has allowed markets to
play a bigger role in determining the value of its currency as well
as allowed freer conversion of the local currency into foreign
currencies. India has joined in relaxing controls on domestic
investors to invest overseas and for foreign investors to invest in
local companies.
14. The reforms have not
been limited to improving the mobility of capital, but have also
included steps to broaden investment channels and tools for hedging
risks. For example, China now allows trading of currency swaps and
forwards and is even considering introducing interest rate and stock
index futures. Such reforms aim to encourage innovations in the
capital market, foster more investment products and are tantamount
to partial liberalization.
15. The actions of
policy makers in Asia reflect the recognition that Asia can no
longer remain isolated, and that Asian markets have reached a stage
to increasingly be able to handle the volatilities of more open
markets. To a certain degree, there is also a realization that over
the longer term, capital controls can become less efficient as
market participants find loopholes to get around such controls.
Therefore, liberalization of the capital account becomes more
compelling and even inevitable.
16. A better capital
market can provide effective financing instruments by improving the
pricing mechanism and hence, improving the investment efficiency of
resource allocation. A more efficient capital market is likely to
emerge in the future and in turn, reduce the need for capital
controls.
17. The challenge is for
the governments to balance capital liberalization with financial and
macroeconomic stability. This requires adequate risk management
capabilities and monitoring and surveillance systems. Therefore,
capital liberalization is not something that can be done in the
short term and one that Asian governments are proceeding with
caution but definitely in the right direction.
Perception of
corporate governance standards
18. The second factor impeding global
investors is corporate governance standards or the perception that
standards are still lax. In this regard, policy makers and
companies alike in Asia are also recognizing the importance and need
for better corporate governance. Corporate governance reforms in
Asia have been in the form of legal and jurisdiction changes,
investor education and activism led by regulators, exchanges as well
as market forces.
19. For example,
regulators in China embarked on a drive to restructure ownership of
listed stocks and have encouraged the introduction of foreign
strategic investors with the purpose of improving the governance
structure of Chinese companies. They have also enacted a law on the
"Code of Corporate Governance for Listed Companies" as well as
stricter anti-bribery laws and enforcement.
20. In addition, as
Asian companies expand and develop business outside their home
countries, they face more requirements to tap global capital
markets. When they do, these companies would have to conform and
match up to the corporate governance standards of developed markets.
21. A PERC (Political
and Economic Risk Consultancy) report on perceptions of corporate
governance standards in Asia reflects a bullish view. Investors
surveyed reported improving corporate governance standards in 8 out
of the 11 Asia ex-Japan countries. Investors can expect the trend of
improving corporate governance and investor protection to continue.
Inaccessibility of markets
22. Investments into Asia have also been hampered by the
inaccessibility of certain markets and the difficulties navigating
various tax regimes and regulatory restrictions. Again, policy
makers in Asia have not overlooked this and have taken steps to
address this, by lowering the barriers of entry for investors. Let
me highlight just some examples.
23. Under the ASEAN
Capital Market Forum, ASEAN securities regulators are collaborating
to harmonize standards on disclosure, rules of distribution and
qualifications of accounting and investment professionals. The
objective of the collaboration is to reduce the cost to the issuer
who otherwise has to comply with the different applicable
regulations. This could then facilitate cross border distribution of
securities and mutual fund products.
24. At the same time,
the ABMI (Asian Bond Market Initiative) is looking to encourage debt
securitization, provision of credit guarantee and investment
mechanism, foreign exchange transactions and settlement issues and
the development of local and regional credit rating agencies.
25. One of the more
publicized regional initiatives would probably be the Asian Bond
Funds launched by the EMEAP (Executives Meeting of East Asia and
Pacific Central Banks Group) central banks in Asia. This initiative
was intended as a catalyst to stimulate investor interest and
trigger infrastructural improvements as well as tax and regulatory
reforms to facilitate cross-border investments.
26. This initiative has
delivered results and demonstrated that passive managed funds are
viable products in Asia. For instance, the Pan Asian Index Fund
would be the first foreign institutional investor to be granted
access to China's inter-bank bond market. Tax regulations have been
reformed to exempt withholding tax on investment income from local
currency bonds. Exchange Traded Fund regulations have been created
or enhanced. Foreign exchange administration rules have been
liberalized to allow better access by foreign bond issuers and for
investors to hedge. Private sector investors can also now adopt or
customize the transparent and impartial ABF index. Regional market
infrastructure has improved and cross-border settlement risk reduced
with the establishment of a custodian network covering all eight
EMEAP markets by ABF's global custodian. This is another first.
27. On the equity front,
there are also efforts to ease foreign investors' entry into Asia.
One such initiative is the ASEAN Stock Index, which was launched by
five ASEAN exchanges together with FTSE in September last year.
There are plans to launch an ETF on this index, which will allow
global investors an efficient way to invest in 40 of the largest
companies in SE Asia.
28. Of course, capital
market development isn't limited to just regional efforts. Asian
countries for example, are also taking steps to improve the
accessibility of their own domestic bond markets, particularly in
the area of secondary market liquidity. Price transparency will
also help improve liquidity. For this purpose, several Asian
countries, including India, Thailand and Singapore have launched
electronic platforms. I believe Singapore is among the first Asian
countries to roll-out an electronic trading platform for its
government securities. Progress from an OTC market to a more
accessible and impartial platform will increase price transparency
and facilitate price discovery. Thus, foreign and retail investors
will not have any information disadvantage. Within ASEAN, there is
also a task force to consider how to link the various platforms
together to increase inter-market accessibility.
29. Developments in the
front-end of investments cannot succeed without back-end operational
support. That is why, as mentioned earlier, the Asian Development
Bank has embarked on a drive to enhance regional settlement
efficiency to boost confidence of investors. A working group is
studying the idea of a pan-regional settlement provider, linking
different depositories and clearing systems to create a more
efficient and highly secure body for transaction settlements.
However, this is no easy task as such linkages are most effective in
an environment of full currency convertibility, sound regulation and
free capital flow. A customized solution could possibly be a
regional insurance product for securities transactions where each
country contributes to a guarantee of settlement.
Narrow spectrum
of asset classes for investments
30. The final reason why there are not
more global investments in Asian assets is the limited variety of
asset classes. For many years, the main invest-able assets were
equities and real estate. Since the Asian crisis, many governments
started developing debt capital markets. As a result, Asian
countries have increased issuance of government debt and encouraged
issuance of corporate bonds. As at the end of 2005, total amount of
government bonds outstanding was US$833b or more than five times the
level in 1997. Including corporate bonds, total market size in Asia
is now US$1.7 trillion [6]. But beyond
this, newer asset classes are also emerging. I will name three of
the more prominent ones.
31. First, real estate
investment trusts or REITs. These have seen explosive growth,
particularly in Singapore and Hong Kong over the last 3 years. Now
more markets are also launching REITs, including Malaysia, Taiwan
and Thailand. The estimated market capitalization of REITS in Asia
is US$37b. In Singapore, the market capitalization weighted-average
returns since IPO have been exceptional at over 30%. The market has
also moved beyond traditional REITs to other products like shipping
trusts and hotels.
32. Second, asset-backed
debt instruments. This is partly the result of the REITs
phenomenon, which issued a host of Collateralized Mortgage Backed
Securities (CMBS). In Singapore, there is on average, S$1.5bn of
CMBS issuance every year. The underlying assets of debt instruments
have also broadened. For example, Singapore recently issued debt
backed by loans from small and medium enterprises. This is due to
the clear regulatory framework and environment which saw the
Monetary Authority of Singapore (MAS) relaxing the leverage
requirement and allowing market forces to determine the appropriate
debt composition. Singapore is also a fertile ground for CMBS
development due to its stable economic environment (sovereign credit
rating AAA/Stable/A-1+) and robust legal and land title system which
have enabled structured finance issuers to raise highly rated debt.
However, growth and diversity in asset-backed debt instruments have
not been limited to Singapore. In the last 12 months, China issued
their very first Credit Linked Obligations (CLOs) and Thailand
issued debt that was backed by government offices.
33. More assets can potentially be securitized, particularly in the
area of infrastructure finance. A joint study by the World Bank
and ADB estimated that East Asian countries will need to spend
US$250bn per year on infrastructure over the next five years. Most
of these will be in China, India, Indonesia and Indo-China. For
example, in India alone Prime Minister Manmohan Singh had said that
India would need US$150 billion of investment in ports, roads, power
plants and other projects to keep the economy growing at more than
8% over the next decade. And the absence of a deep bank loan market
suggests that secured debt financing may be the most efficient
route.
34. Third, private
equity. According to the Centre of Asia Private Equity Research,
over U$17.6b of fresh capital flowed into the Asian market, a two
and a half fold increase from 2004. Private equity investments in
Asia are attracting the attention of both pension funds and
institutional investors as the region grows and investors search for
a way to participate in and benefit from this growth. We are seeing
a trend where more hedge fund managers are setting up offices in
Asia to look for private equity opportunities in search of yields.
Private equity has become a vehicle to overcome the limitations of
small financial markets and market inaccessibility.
Conclusion
35. In conclusion, I believe that asset markets in non-Japan Asia
are in the midst of very exciting transformations. Steps are being
taken to broaden and deepen capital market liquidity, improve market
access and strengthen market infrastructure. Over the medium term,
we can expect an even more thriving regional market place.
***
[1] MSCI
AC Far East ex-Japan Index
[2] Economist Intelligence Unit
[3] CLSA Sept2005 report "Me Me Me"
[4] Deepening Financial Ties, IMF
Finance & Development, June 2006
[5] Combined stock of FDI, foreign loans
and foreign equity holdings
[6] ADB Asia Bond
Monitor 2006, March 2006
Source:
www.mas.gov.sg News Release 4
Jul 2006
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Singapore sees growth in debt
capital market
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