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“The Development of Global Financial Centres”
by
Datuk Seri Panglima Andrew L.T. Sheng
Tun Ismail Ali Professor of Monetary and Financial EconomicsFaculty of Economics and Administration
University of Malaya
The Puteri Pacific Hotel, Johor BahruThursday, 18 May 2006
2
Contents
1. Role of Financial Centre in National and Global Context
2. How Hong Kong defended and enhanced position as largest international financial centre ex-Japan
3. Key issues in building IFCs
4. Potential for Malaysia
3
Efficiency of economies all about efficiency of urban centres, e.g. New York vs. Mexico City
Cities are knowledge centres
Art, culture, politics, trade, news
Must have rich hinterland, linked by superior communications, e.g. river, sea, road, rail, air
Exchanges and Technology
Pre-telegraph, 100+ US exchanges,
Advent of radio, 22 (1935)
Advent of computers - 7 (1995)
Cities and Financial Centres
4
Metcalfe’s Law - “The value of a network goes up as the square of the number of users”
Economies of Scale
Supply side - Biggest producer wins
Demand side - Biggest buyer determine standards
Critical Mass
Aggregation of local knowledge and skills
Best combination of skills create economies of scale
Critical Mass = Clusters = skills concentration
Supply Chain Management - where in the chain is real value?
Financial Markets are Networks
5
• Financial Innovation
Evolution of derivatives, options & futures
• Technology & Telecommunications
Global 24 hours markets
From market place to market space
Deregulation
Lines of traditional businesses blurring
Changing Structure of Financial Markets
6
Finance is Derivative of Real Economy, Value defined by information + Knowledge
• Commoditization means that low-knowledge products and services have high competition, low prices and are easily duplicated and therefore “taken away”.
• Markets are all about “branding” and “high knowledge content products”. Knowledge content needs governance - value creation needs total inputs at production, design, packaging and marketing levels.
• Network Economy demonstrates “winner-take-all” situation. Financial markets converge on key hubs, e.g. New York taking American time zone business, London taking European time zone business
7
Reliable InformationEssential for Quality of Markets
• Quality Markets require real time and reliable information to make sound risk management decisions in highly volatile environment
• High quality information requires :– Good accounting and auditing standards
– Reliable & timely statistics/reporting processes
– Infrastructure to process information for making decisions critical to competitive success
• Bad accounting = distorted information = poor decision making = bad risk management financial crisis
8
Hierarchy of Information
Wisdom
Knowledge
Information
Data
Value
•Robert W Lucky, “Silicon Dreams: Information, Man and Machine”, St Martin’s Press, 1991.
9
Sequencing and Hierarchy of Domestic Financial Markets
Asset-backed securities and
derivatives
Corporate bond and equity markets
Government bond market
Treasury bill market andforeign exchange markets
Money market
Source: Karacadag, Sundrarajan & Elliot, 2003
10
Market DisciplineKey for Corporate Governance
• Quality of markets depends on quality of corporate governance in listed companies
• Corporate governance is about three key disciplines:– Self discipline - ethics & fairness
– Regulatory discipline - a level playing field
– Market discipline - competition & accountability
• Asia traditionally stressed first two disciplines at the expense of market discipline
• The key to capital market development is to promote and enforce these disciplines based on reliable information
11
• Free Entry of Participants and Products
• High degree of transparency/low information asymmetry
• Efficient Operations by solvent participants under international rules of the game at low transaction costs
• Absence of incentive distortions or bias that moves markets in unhealthy direction e.g. moral hazard or subsidies
• Efficient regulation at low regulatory costs;
• Orderly exit of insolvent participants [obsolete products and insolvent operators create huge dead costs on market]
Accountability [feedback and exit for bad players]
Efficient Markets require:
12
Malaysia already has balanced financial sector(% of GDP)
Bank Deposits Equity Market Bond Market
1990 2004 1990 2004 1990 2004
China 75.6 177.8 n.a. 40.3 8.5 29.4
Hong Kong 205.6 299.3 107.2 486.3 1.5 28.3
India 31.4 51.1 10.4 48.4 19.9 31.7
Indonesia 29.8 38.9 4.4 24.9 0.4 24.1
Japan 100.0 120.5 121.7 73.2 85.9 181.6
Korea 32.6 68.8 48.2 56.1 34.1 74.9
Malaysia 52.1 88.7 100.7 152.6 69.8 89.3
Singapore 74.3 104.4 95.8 149.0 27.8 58.6
Thailand 56.8 79.7 29.2 72.3 9.7 38.9
Germany 53.8 96.7 21.7 42.2 51.6 80.3
UK 87.8 115.0 85.2 123.0 36.8 43.9
US 59.6 58.8 57.5 131.6 122.0 157.2
Source : World Bank Financial Sector Dataset, February 2006
13
August 1998: HK Govt intervened with US$15 billion in stock market to stop hedge fund speculation
Immediate action: Rebuild Market Credibility Close Gaps with London/New York:
better regulation, more products, greater liquidity Build Stronger Links with China and Asia:
more research, better marketing, closer connections
Medium and long-term: Greater integration with Pearl River Delta to
compete against Yangtze River Delta/Shanghai Wall Street in Asia
Case Study: Hong Kong as IFC after 1998 Stock Market Intervention
14
Low Transaction Costs Rule of law with advanced property rights system Free and open economy with world-class financial
system Low tax rate and simple tax system
Low Exchange Rate Risk and Uncertainty Fully convertible currency Exchange rate linked firmly to USD Fully open and deep capital market
Next to Rapidly Growing Southern China Potential for lowering production costs Potential for expanding turnover Potential for servicing new wealth
Strengths of Hong Kong
15
Pre-WTO, Hong Kong had premium as external window for China and East Asia, when access to markets and knowledge was poor
Franchise is eroding when China gains access to WTO and through Web
However, biggest value added is “Localization of Global Knowledge” - add value by being:
Preferred financial centre in Asian Time Zone
Best logistics centre in ATZ
Importing external skills [e.g. marketing, finance, technology and tailoring for local markets
Understanding Strengths and Weaknesses
16
Lessons from Shanghai and Singapore: Clear vision, sound strategy and detailed blueprint Effective coordination among local and central
governments and business No economic borders to residents or outsiders
Lessons from Japan, Taiwan and other Asian economies: Political stability key to stable growth Protectionist policies only delay pain People and capital move faster than policy changes
Implications for Hong Kong: Economic and financial integration of Hong Kong
(finance), Southern China (manufacturing) and Taiwan (technology).
Hong Kong could provide the best service for Mainland, Taiwan, Asia and international business
Learning from Competitors
17
Hong Kong domestic market alone too small to have critical mass
In areas where HK has critical mass, play dominant player strategy
e.g. Financial services - improve quality to capture value in Supply chain management
In areas where HK has no critical mass, cooperate and affiliate
e.g. Move manufacturing where there is cheap labour
e.g. cooperate with others to achieve economies of scale [airports, power, environment]
Competition & Co-operation Strategies
18
The greater the friction cost, the more the market moves to areas with lower friction costs
The lower the friction cost, the higher liquidity
Friction costs depend on the following:-
Time [speed to market]
Factor costs [Labour, Capital, Taxes]
Infrastructure costs - how good is physical utilities?
“Government costs” - are rules & policies costly?
Barriers to Entry - competition policy
Markets are a function of Liquidity & Friction Costs
19
Structural Costs Compared
HKSAR China US Japan
Production Costs High Low High HighTransaction Costs Low High Low Medium
Infrastructure Cost High Medium Low MediumSaving Rate Medium High Low HighExpected InvestmentReturn Low High Medium Low
Speed to market Slowing Improving Good Slow“Government Costs” Low High Low HighBarriers to Entry Rising Lowering Low High
20
1. Market reform: SEHK and HKFE were demutualized and merged to form the HKEx in Mar 2000, listed on 27 Jun 2000
2. Infrastructure reform: fully electronic web-friendly world-class high tech infrastructure by 2002/2003
3. Legislative reform: Securities and Futures Ordinance passed in 2001
Complete Corporate Governance and Enforcement overhaul 2001-2005
Hong Kong’s 1999 Three-Pronged Reform Programme
21
Hong Kong – Largest Market in Asia ex-Japan, 1988-2006 (US$ bn)
0
200
400
600
800
1,000
1,200
1,400
China Hong Kong Australia Taiwan Korea Singapore
Ma
rke
t C
ap
(U
S$
bn
)
end 1988end 2000end 2001end 2002end 2003end 2004end 2005end Mar 20066.2x
16.3x
N/A
12.3x
4.1x
8.0x
Remark: x = increase from end 1988 to end Mar 2006Sources : WFE and IFC
22
Capitalization and Turnover of Major Markets(end Mar 2006, US$ bn)
Remarks: Turnover - for the 12 months ending Mar 2006, P/E ratio - end Mar 2006Due to different reporting rules & calculation methods, turnover figures are not entirely comparableP/E ratio for China is the weighted average of A and B shares markets
Sources: WFE and websites of various exchanges
Market change over Market change over P/E Cap Mar-05 Turnover Mar-05 ratio
Japan 4,775 35.9% 5,186 58.1% 23Hong Kong 1,207 43.3% 543 29.4% 13Australia 858 18.3% 707 26.1% 18Korea 752 55.1% 1,389 128.8% 11India 678 86.7% 354 39.1% 20Taiwan 490 11.5% 639 9.7% 18China 441 4.8% 452 13.4% 18Singapore 294 29.3% 134 34.8% 14Malaysia 195 11.6% 51 -9.9% 15Thailand 135 9.0% 96 -11.5% 9Indonesia 100 29.0% 37 6.8% 20Philippines 45 26.9% 7 31.6% 14
US (NYSE) 14,072 11.4% 16,041 33.0% 23US (Nasdaq) 3,787 15.6% 10,616 17.1% 39UK 3,253 16.2% 6,164 18.4% 13Germany 1,400 19.0% 2,126 38.7% 16
23
Financial Sector Masterplan (FSMP)• A 10-year plan (2001 – 2010) outlining strategic focus & actions, with 119
recommendations and encompassing 6 sectors:• Banking• Insurance• Islamic Banking and Takaful
• Objectives• Create a more efficient (services at lowest cost), effective (broad range of services)
& stable (minimal systemic risks) financial system• Meet socio-economic agenda in an effective & efficient manner• Meet international commitments & prepare domestic financial institutions for global
competition
• Implementation Phases• Phase I (3 years)
- Enhance capacity of domestic institutions to compete- Enhance financial infrastructure
• Phase II (3-4 years)- Intensify competitive pressure in the domestic financial sector- Level playing field with incumbent foreign banks
• Phase III (after 7 years)- Assimilate into global arena- Introduce new foreign competition
Source: Bank Negara Malaysia
•Development Financial Institutions•Labuan IOFC•Alternative Modes of Financing
24
Capital Market Masterplan (CMP)• A 10-year plan (2001 – 2010) outlining strategic focus & actions, with 152
recommendations to address 4 key Malaysian capital market challenges:• Lingering effects of the regional financial crisis• Meeting the needs of a growing economy• Heightened global competition for business and investment• Changing demands on the regulatory framework and authorities
• Objectives• To be the preferred fund-raising center for Malaysian companies• To promote an effective investment management industry and a more conducive
environment for investors• To enhance the competitive position and efficiency of market institutions• To develop a strong and competitive environment for intermediation services • To ensure a stronger and more facilitative regulatory regime• To establish Malaysia as an international Islamic capital market centre
• Implementation Phases• Phase I (3 years)
Strengthen domestic capacity, and develop strategic and nascent sectors
• Phase II (2 years)Further strengthen key sectors and gradually liberalise market access
• Phase III (5 years)Further expansion and strengthening of market processes and infrastructure towards becoming a fully-developed capital market, and enhancing international positioning in areas of comparative and competitive advantage
Source: Securities Commission Malaysia
25
Global Competitiveness: Malaysia’s Standing
CountriesIMD Ranking1 WEF Ranking2
2005 2004 2005 2004
United States 1 1 2 2
Hong Kong 2 6 28 21
Singapore 3 2 6 7
Australia 9 4 10 14
Taiwan 11 12 5 4
Japan 21 23 12 9
Malaysia 28 16 24 31
Korea, Rep. 29 35 17 29
Thailand 27 29 36 34
Indonesia 59 58 74 69Source: World Economic Forum (WEF), 2005/06; Institute for Management Development (IMD), 2005
1 IMD World Competitiveness Ranking 2 WEF Growth Competitiveness Index Ranking
26
Malaysia’s Competitiveness Trend
CategoryIMD World Competitiveness Ranking
2001 2002 2003 2004 2005
Economic Performance
9 29 25 16 8
Government Efficiency
24 19 14 16 26
Business Efficiency
31 24 18 13 25
Infrastructure 35 31 31 30 34
Overall 28 24 21 16 28
Source: Institute for Management Development (IMD), 2005
27
Global Competitiveness: Government Efficiency Perspective
Countries
Public Finance
Employment in Public Sector
Government Budget
General Govt. Expenditure
Collected Total Tax Revenues
United States 23 40 29 21
Hong Kong 9 12 10 4
Singapore 1 19 15 10
Taiwan 13 37 16 9
Japan 2 54 18 24
Malaysia 15 46 22 15Korea, Rep. 2 14 17 23
Thailand 11 16 3 13
Indonesia 17 26 8 7
Source: Institute for Management Development (IMD), 2005
28
Countries
Institutional Framework
Government Decision
TransparencyPublic Service
BureaucracyBribing and Corruption
United States 16 18 19 23 20
Hong Kong 47 25 9 5 9
Singapore 1 3 12 1 6
Taiwan 30 33 10 9 29
Japan 41 51 30 28 28
Malaysia 22 22 24 25 36
Korea, Rep. 33 34 20 22 33
Thailand 5 32 28 16 44
Indonesia 55 56 47 51 55
Source: Institute for Management Development (IMD), 2005
Global Competitiveness: Government Efficiency Perspective
29
Countries
Openness
ProtectionismPublic Sector
Contracts
International Transactions
Foreign Investors
Access to Capital Market
United States 26 28 31 15 9
Hong Kong 1 4 1 1 1
Singapore 7 11 13 23 15
Taiwan 31 33 35 43 34
Japan 43 58 43 50 36
Malaysia 50 53 44 54 47Korea, Rep. 35 39 38 37 35
Thailand 42 27 42 53 40
Indonesia 57 47 49 52 50
Source: Institute for Management Development (IMD), 2005
Global Competitiveness: Government Efficiency Perspective
30
Countries
Competition and Regulations
Government Subsidies
SubsidiesPrice
ControlsRegulation Intensity
Ease of Doing
Business
United States 13 33 16 23 4
Hong Kong 1 2 4 1 1
Singapore 3 4 24 5 2
Taiwan 15 16 27 18 8
Japan 21 46 31 21 30
Malaysia 17 37 53 22 17Korea, Rep. 4 13 51 45 45
Thailand 19 19 44 30 19
Indonesia 33 56 57 51 54Source: Institute for Management Development (IMD), 2005
Global Competitiveness: Government Efficiency Perspective
31
Malaysia’s Competitiveness Disadvantages
WEF Growth Competitiveness Index Rank
WEF Business Competitiveness Index Rank
24
23
Notable Competitiveness Disadvantages (position out of 117 countries)
Macroeconomic Environment
Government surplus/deficit – 96
Government debt – 49
Public Institutions
Irregular payments in public utilities – 47
Irregular payments in exports & imports – 45
Irregular payments in tax collection – 36
Organised crime – 31
Technology
Gross Tertiary enrolment – 63
Telephone lines – 61
Company Operations and Strategy
Nature of competitive advantage – 54
National Business Environment
Extent of bureaucratic red tape – 101
Centralisation of economic policymaking – 80
Others
Freedom of press – 83
Telephone/fax infrastructure quality – 45
Prevalence of trade barriers – 38
Informal Sector – 37
Reliability of police services – 37
Foreign ownership restrictions – 37Source: World Economic Forum (WEF), 2005/06
32
Global Competitiveness: Stock Market Perspective
CountriesStock
Markets Financing
CapitalisationValue
Traded (US$ per capita)
Listed Domestic
Companies
Stock Market Index(US$ bn) (% of GDP)
United States 2 1 10 2 2 53
Hong Kong 1 9 1 3 10 40
Singapore 13 27 5 14 16 38
Taiwan 15 15 9 10 14 56
Japan 31 2 25 16 5 52
Malaysia 25 26 3 34 11 39
Korea, Rep. 37 16 31 23 7 47
Thailand 17 33 21 35 18 58
Indonesia 39 42 51 56 21 12
Source: Institute for Management Development (IMD), 2005
33
CountriesShare-
holders’ Rights
Financial Institutions
Transparency
Cash Flow
Corporate Debt
Factor-ing
Adaptability of
Companies
Ethical Practices
United States 10 16 9 11 27 7 15
Hong Kong 25 8 1 1 21 1 16
Singapore 23 13 4 6 35 13 28
Taiwan 48 32 7 21 1 3 22
Japan 54 49 20 33 41 35 29
Malaysia 34 40 34 40 51 25 31
Korea, Rep. 46 35 28 35 53 24 36
Thailand 39 30 21 32 50 32 34
Indonesia 51 51 53 55 54 59 60
Source: Institute for Management Development (IMD), 2005
Global Competitiveness: Stock Market Perspective
34
World Bank: Doing Business Global Index
CountryStart business
no. of procedures
Getting licence (days)
Cost of license (% of income
per capita
Registering Property (days)
Singapore 3 129 24 9
Australia 2 121 12.3 32
Hong Kong 5 230 38.5 83
Korea 12 60 232.6 11
Thailand 8 147 17.3 2
China 13 363 126 32
Taiwan 8 235 250.9 5
Malaysia 9 226 82.7 143
Source: World Bank, 2006
35
Bottom Line: Malaysia already has the Plans + HR + Infrastructure to be IFC
• Its not about Vision, Mission or Infrastructure• Advantage 1: We have spent RM3 billion and 10 years to
make Labuan a viable Offshore Financial Centre• Advantage 2: KL has the lifestyle and infrastructure to be
attractive Asset Management Centre for Asia• Advantage 3: Malaysia is already leading Islamic Banking
Centre • Advantage 4: Over 15,000 Malaysian professionals in Hong
Kong alone, excluding Singapore and elsewhere - global talent is recruitable
• Advantage 5: Malaysian costs are lower than other regional financial centres.
EXECUTION and IMPLEMENTATION is key to success.
36
Finance is not a zero-sum game in Asia. Malaysia can offer niche
services at lower costs• Malaysia can be Global Islamic Financial Centre -
watch the competition.• KL can be Asset Management Centre for Asia -
Labuan is already booking centre. • We can be outsource subcontractors in
accounting, secretarial, cartoons, sound, film, book production etc to high cost centres.
• Need focused implementation and constant benchmarking to international standards, plus partners from all over the world.
• Outsourcing and Services business needs widespread and stable broadband.
37
Development and Growth is a Process: To have Sustainable Growth, you need a Process to
Manage Development Process• Development is complex, because those who face most problems are
those who are closest to the problem [the poor, SMEs, private sector, grass root public servants].
• It’s not about QUANTITY OF GROWTH, BUT QUALITY.
• In the past, development has been top-down. Aid, not trade. Today, we understand that we have to use market forces to lead growth.
• Therefore, the key to sustainable growth is to have inclusive, transparent and accountable processes to manage the growth process.
• This is a co-operative venture, not public-private competition. This includes using national + global talent and skills.
38
ABC of Knowledge EconomyACADEMIA - Holders of Knowledge, but bogged down in
teaching. Segmented from market or governmentBUSINESS - Close to market, but do not use Academia for
R&D and sees Civil Service as hindrance rather than partner
CIVIL SERVICE - Holder of massive public information and resources that can help growth. Currently, rarely uses Academia for R&D and policy work. Focuses more on regulation rather than BUSINESS facilitation. Competing internationally means that transactions costs of doing business and “time to market” in Malaysia must come down. Its all about teamwork. We have to operate as truly Malaysia Inc.
39
Change Management is Tough
• Clarity of Role and Objectives
• Rules have no meaning unless they are enforced
• It’s the outdated processes that must change
• Prioritization of “Doables”
• Getting staff and public buy-in
• The whole world is adjusting - pain is inevitable
• Deliver small winners to achieve credibility - the big winners will take care of themselves
40
Focus and Prioritize
“Pick important problems and fix them and tell everyone”..
“The essence of the [regulatory] craft lies in picking the right tools for the job, knowing when to use them in combination, and having a system for recognizing when the tools are inadequate so that new ones can be invented.”
Professor Malcolm Sparrow, The Regulatory Craft, Harvard University.
41
Fixing the Problem
Old-style regulators: “Nitpicking, unreasonable, unnecessarily adversarial, rigidly bureaucratic, and incapable of applying discretion sensibly.”
It is often the obsolete and defective systems, not the people, that create
problems.
Change is the constant. Be prepared to change.
42
Enforcement of Laws, not Laws per se, is critical
OECD - “Too often, legislators issue laws as symbolic public action, rather than as practical solutions to real problems. Regulatory inflation erodes the effectiveness of all regulations, disproportionately hurts small and medium businesses, and expands scope for misuse of administrative discretion and corruption.”
43
Implications for Johore
• Johore has huge advantage by being next to Singapore, which is already an IFC.• Key is connectivity: reduction of friction costs to and from JB - Singapore. Stable broadband enables outsourcing from
Singapore to Johore. • In RMK9, notice that MRT is being considered. Can MRT link to Singapore be considered to enable flow of people and ICT
pipes?
44
Implementation of 9th Plan will focus on Southern Johor Economic Region
•RM12.2 bn allocated to develop SJER, building up Nusajaya, Danga Bay waterfront, a transport hub and high speed rail link from JB to Kuala Lumpur.•6,480 ha of land will be developed in Nusajaya, housing Johor’s new administrative centre, universities, theme park and industrial/residential estates•Logistic hub will include Tanjung Pelepas, Senai Airport and Pasir Gudang.
45
FIRST CLASS SERVICE
• As small open economy, Malaysia has already reached Middle-Income Status. We are caught in middle bulge. Not big enough to have economies of scale, but not too small to be marginalized.
• Korea learnt key lesson from Asian crisis: the governance structure of DEVELOPED COUNTRY status is very different from EMERGING MARKET status. Korea paid for this lesson.
• Go for quality of service, not quantity. Go for value, not size. Quality of governance at both public and private sector key to success.
• To reach 2020 DEVELOPED economy status, we are already benchmarked against global standards.