A EXECUTIVE INSTITUTE D S B UMMARY I SERIES No. S48/01 ... · I No. S48/01 1 Tokyo Round Table on Capital Market Reform in Asia 10-11 April 2001, Tokyo ... Welcome and introduc-tions

ADBI Executive Summary Series No. S48/01 1

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ADBI No. S48/01

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Tokyo Round Table on Capital Market Reform in Asia10-11 April 2001, Tokyo

Focus on Progress Reports on Reform and Institutional Investors in Asia

ADB Institute—OECD Round Table Series

Executive Summary of Proceedings

The 2001 Tokyo Round Table focused on the theme of“Institutional Investors in Asia”. It was composed of anintroduction and four major parts. Welcome and introduc-tions were provided by Mr. Seiichi Kondo, Deputy Sec-retary-General, Organisation for Economic Co-operationand Development (OECD), and Dr. Masaru Yoshitomi,Dean, Asian Development Bank Institute (ADBI).Professor Anthony Neoh, Professor at Peking Univer-sity, Chief Advisor to the China Securities RegulatoryCommission, and former Chairman, Securities and Fu-tures Commission, Hong Kong, and Chairman, TechnicalCommittee, International Organisation of Securities Com-

Key Messages[¶] References are to paragraphs.

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CONTENTS

Key Messages 1Introduction 3 Progress in Capital Market Reforms in Asia 4

Session 1: Introduction 5A. People’s Republic of China (PRC) 5B. Hong Kong, China 6C. Indonesia 7D. Malaysia 8E. Korea 9F. Singapore 10G. Thailand 11H. Taipei,China 11I. Philippines 12J. Japan 13

Session 2: Viewpoint of International FinancialInstitutions 15

A. International Monetary Fund (IMF) 15B. World Bank 16

Designing a Financial Market Structurein Post-Crisis Asia—How to Develop CorporateBond Markets 17

Joint IOSCO-CPSS Recommendations forSecurities Settlement Systems 20

Overview of Institutional Investorsin Asia 22Session 1: Introduction 22Session 2: Development of Collective Investment

Schemes (CIS) and Pension Funds 23Question and Answer Session 27Session 3: Legal and Supervisory Frameworks

for CIS 27Session 4: Question and Answer Session 34

Conclusion 34 Chair’s Summary Statement on Third

Round Table on Capital Market Reform in Asia 35

missions (IOSCO), was then introduced as the Chair ofthe Round Table for the first day. In his introductoryspeech, Dr. Yoshitomi examined the nature of the Asianfinancial crisis, and the recovery from it. [¶ 1, 4, 104,117, 222, 226]

In the first part of the Round Table, representatives fromeconomies in Asia described the progress they had madeto date in implementing capital market reforms.Ms. Haiying Zhao, Commissioner, Strategy and Devel-opment Committee, China Securities Regulatory Com-mission (CSRC), described recent developments in thePRC securities markets. Ms. Alexa Lam, Executive Di-rector, Securities and Futures Commission, Hong Kong,described the securities markets in Hong Kong.

Part III

Part IV

Part I

ANNEX

Part II

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Mr. Herwidayatmo, Chairman, Capital Market Super-visory Agency (BAPEPAM), Indonesia, discussed the cur-rent situation concerning the Indonesian capital markets.Mr. Attila Emam, Manager, Economic Analysis Depart-ment, Securities Commission (SC), Malaysia, presenteda summary of the Malaysian economy and capital mar-ket. Mr. Yoon, Yeo Kwon, Director, International Co-operation Division, Financial Supervisory Commission,Korea, analysed the reform measures taken in the Koreancapital markets. [¶ 12, 18, 25-33, 42, 182, 224, 225]

Ms. Yeo, Lian Sim, Deputy Managing Director, Mon-etary Authority of Singapore (MAS), discussed the stateof the capital markets in Singapore. Mr. PrasarnTrairatvorakul, Secretary-General, Securities and Ex-change Commission (SEC), Thailand, spoke about recentdevelopments in Thailand. Mr. Wu, Tang-Chieh, ViceChairman, Securities and Futures Commission (SFC),Taipei,China spoke about developments in his capital mar-kets. Ms. Lilia Bautista, Chairman, Securities and Ex-change Commission (SEC), the Philippines, spoke aboutthe Philippine capital markets. Mr. Tatsuya Kanai, Di-rector, International Financial Markets, Financial ServicesAgency (FSA), Japan, summarised recent developmentsin the Japanese capital markets, focusing on the mainpoints of the financial issues in the government’s mea-sures announced on 6/4/2001 to respond to Japan’s eco-nomic situation. [¶ 50, 57, 62, 69, 76, 116, 117, 170,197, 223]

Mr. Haruhiko Kuroda, Vice Minister for InternationalAffairs, Ministry of Finance, Japan, gave the lunchtimespeech in which he discussed capital market reforms inAsia. [¶ 82]

In the second session of the first part of the Round Table,representatives from the international financial institutionspresented their views on capital market reforms in Asia.Mr. Garry Schinasi, Section Chief, Capital Markets andFinancial Studies, International Monetary Fund (IMF),discussed the role of capital markets in Asia. Mr. NoritakaAkamatsu, Lead Financial Economist, Financial SectorDevelopment Department, World Bank, described whatthe World Bank does in the area of capital market reformand development around the world, and then summarisedwhat the Bank was doing in Asia. [¶ 89, 93, 117, 223]

In the second part of the Round Table, Dr. Sayuri Shirai,Associate Professor, Keio University, Visiting Scholar,ADBI, and Dr. Masaru Yoshitomi, Dean, ADBI, talkedabout their report on “Designing a Financial Market Struc-ture in Post-Crisis Asia—How to Develop Corporate BondMarkets”. This was followed by a question and answersession in which the following people made interjections:Mr. Tak-Lam Norman Chan, Deputy Chief Executive,Hong Kong Monetary Authority, Mr. PrasarnTrairatvorakul, Dr. Ruben Lee, Managing Director, Ox-ford Finance Group, Mr. Mitsuo Sato, Senior Advisor,

Daiichi Life Research Institute, Ms. Lilia Bautista,Ms. Yeo, Lian Sim, Mr. Garry Schinasi, and ProfessorAnthony Neoh. [¶ 1, 50, 57, 69, 89, 104, 114, 116, 117,170, 172, 197, 222, 223, 226]

In the third part of the seminar, Mr. Salvatore Lo Giudice,Senior Economist, Market Regulation Department,CONSOB, Italy, discussed the CPSS-IOSCO (Commit-tee on Payment and Settlement Systems of BIS/Interna-tional Organization of Securities Commissions)Recommendations on securities settlement systems (SSS),and Mr. Stephen Lumpkin, Principal Administrator, Di-rectorate for Financial, Fiscal and Enterprise Affairs(DAFFE), OECD, discussed some issues relating to thefuture of national financial markets and trading centres.[¶ 118, 127, 213]

In the fourth part of the seminar, the key issues underdiscussion were how to promote institutional investors inAsia, and the regulatory framework necessary for theirsound development. The chairman for the second day ofthe Round Table was Dr. William Witherell, Director,Directorate for Financial, Fiscal and Enterprise Affairs(DAFFE), OECD. The fourth part was itself composedof four sessions. In the first, an introduction to the issueswas presented by Ms. Shamshad Akhtar, Manager, Fi-nance and Industry Division (East), Asian DevelopmentBank (ADB), who discussed the current situation in Asiawith regards institutional investors. [¶ 133, 134, 171, 226]

In the second session, long-term trends in the CollectiveInvestment Schemes (CIS) sector were discussed.Mr. John Thompson, Counsellor, Directorate for Finan-cial, Fiscal and Enterprise Affairs (DAFFE), OECD, ex-amined recent trends in CIS in OECD Countries. Mr. YutaSeki, Financial Industry Analyst, Capital Market ResearchUnit, Nomura Research Institute, examined the currentsituation of CIS in Asia. Mr. Hugh Davies, ExecutiveDirector, Prudential Corporation, analysed the develop-ment of pension systems and their relevance for capitalmarket development in Asia. Some questions and answerson this session were raised by Professor S. Ghon Rhee,K.J. Luke Distinguished Professor of International Fi-nance and Banking, University of Hawaii, Ms. ShamshadAkhtar, Mr. John Thompson, Mr. Mitsuo Sato,Mr. Ian Johnston, and Professor Neoh. [¶ 117, 134,143, 149, 156, 170-172, 190, 222, 224]

Professor Eisuke Sakakibara, Keio University, FormerVice Minister for International Affairs, Ministry of Fi-nance, Japan gave a lunchtime speech on the current eco-nomic situation in Japan. [¶ 169]

In the third session, some issues related to the legal andregulatory frameworks for CIS were examined.Mr. Robert Aitken, Financial Services Authority (FSA),UK, described the activities of IOSCO, and the UK ex-perience, concerning legal and regulatory frameworks for

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1. The ADBI–OECD third Tokyo Round Table focused onthe theme of “Institutional Investors in Asia”. It was com-posed of an introduction and four major parts. Welcome andintroductions were provided by Mr. Seiichi Kondo, DeputySecretary-General, Organisation for Economic Co-operationand Development (OECD), and Dr. Masaru Yoshitomi, Dean,Asian Development Bank Institute (ADBI). Professor AnthonyNeoh, Professor at Peking University, Chief Advisor to theChina Securities Regulatory Commission, and former Chair-man, Securities and Futures Commission, Hong Kong, andChairman, Technical Committee, International Organisationof Securities Commissions (IOSCO), was then introduced asthe Chair of the Round Table for the first day.

2. Mr. Kondo thanked the ADBI for co-sponsoring theRound Table with the OECD, and also the ADB, IOSCO, theIMF, and the World Bank for their co-operation. He identi-fied the key theme the Round Table would address as beingthe role of institutional investors in Asia. He commented thatexperience in the OECD countries shows that the presence of

institutional investors is one of the strongest stimuli to thedevelopment of capital markets. Noting that the institutionalinvestment industry in Asia is rather undeveloped, Mr. Kondostressed that the potential for growth in this area is high. Al-though many Asian countries have high aggregate rates ofsavings, these savings are often held in traditional vehiclessuch as bank deposits. Other key themes of the Round Tablewere also identified including an assessment of recent devel-opments in the progress of capital market modernisation inthe region, a study on the framework for developing bondmarkets in Asia, and the recent IOSCO-CPSS report on secu-rities settlement systems.

3. Mr. Kondo remarked on both the slow-down in the Asianeconomies at the end of 2000, and also the significant de-clines in the region’s equity markets. He identified a series offactors causing these problems: declines in technology, me-dia, and telecommunications sectors, a perceived vulnerabil-ity of emerging Asian markets to a global economic slowdown,delays in addressing structural distortions in the corporate andfinancial sectors, and the remaining high level of non-per-forming loans in the banking sector. He argued that corporatereforms, including de-leveraging and improved corporate gov-ernance, which relate directly to capital markets, are high pri-orities in order to address these problems, stressing the needfor more transparent ownership and governance patterns. Mr.Kondo recognised the efforts countries in the region are mak-ing to increase the resilience of their markets.

4. Dr. Yoshitomi examined the nature of the Asian finan-cial crisis, and the recovery from it. He noted that the finan-cial structure of firms had become one of the central issues inemerging markets and developing economies, reflecting agrowing recognition that the Asian financial crisis had beenpreceded by massive, un-hedged, short-term borrowing. Theselarge capital inflows aggravated the double mismatch, namelythe combination of the maturity mismatch and the currencymismatch, and thus affected the soundness of the domesticfinancial sector.

5. Dr. Yoshitomi recognised that following the Asian cri-sis, there has been a strong and increasingly prevalent viewthat the banking sector in much of Asia does not functionwell anymore, and that economic development should relyon capital markets. This view therefore seeks to promote do-mestic capital markets as an alternative to bank loans as a keysource of financing business investment. Dr. Yoshitomistressed that while this argument was understandable, it wasimportant to recognise that sound and deep capital marketsare not well developed in Asia, and that it will take time todevelop them. He therefore identified a key issue as beingwhat concrete policies should be undertaken, given both thatbanks are not functioning well and also that capital marketsare likely to remain under-developed for a while. Dr. Yoshitomithen noted a series of questions that need to be answered inorder to address the broad question of what needs to be done.These included: What went wrong with the banking systemin Asia? Did the Asian banking crisis simply reflect inherent

CIS. Mr. Yoon, Yeo Kwon, Director, International Co-operation Division, Financial Supervisory Commission(FSC), Korea, presented the experience of Korea regard-ing the legal and regulatory frameworks for CIS. Mr. IanJohnston, National Director, Financial Services Regula-tion, Australian Securities and Investments Commission(ASIC), described the Australian experience regarding thelegal and regulatory frameworks for CIS. Ms. Yeo, LianSim, Assistant Managing Director, Capital Markets, Mon-etary Authority of Singapore (MAS), presented theSingaporean experience regarding the legal and regula-tory framework for unit trusts. Mr. Gregory Mocek,Special Counsel to the Chairman, Commodity FuturesTrading Commission (CFTC), US, analysed the US ex-perience of commodity pool operators (CPO), and abusesthat occur in the CPO marketplace. Mr. StephenLumpkin, examined some issues concerning the consoli-dated supervision of CIS in the OECD. [¶ 42, 50,117,118, 127, 172, 173, 182, 190, 197, 205, 213, 222, 223]

In the last session, some questions and answers wereraised and provided by Professor Anthony Neoh,Mr. Robert Aitken, Mr. Ian Johnston, Mr. GarrySchinasi, Ms. Yeo, Lian Sim, Professor S. Ghon Rhee,Ms. Alexa Lam, Mr. Akamatsu, and Dr. Yoshitomi. [¶1, 4-10, 18, 50, 89, 94-104, 117, 170, 172, 173, 190, 197,222, 225, 226]

Dr. William Witherell, concluded the proceedings bythanking everybody for their participation, by thank-ing Professor Anthony Neoh for his excellent chairman-ship of the previous Round Tables, and by noting thatthis Round Table had once again been very successful.[¶ 133, 226]

Introduction

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weaknesses of deposit-taking financial institutions which havebeen observed before in developed countries, or did it arisebecause of something unique to Asian banks? Why are cor-porate bond markets under-developed in many emerging mar-ket economies? Why did it take so long to establish viablebond markets even in developed countries? and, What shouldbe done now, during what is likely to be a long transitionfrom a bank-centred financial system to a capital market-basedsystem in Asia?

6. Dr. Yoshitomi then analysed the merits of a banking sys-tem versus a capital market-based system. He argued that acentral barrier that stands between issuers of securities andpublic investors is that of information asymmetry. In particu-lar, issuers of a company’s securities know about its past per-formance and future prospects, in contrast to public investorswho generally do not know this information, and cannot there-fore directly verify the information provided by the company.Dr. Yoshitomi believed that this problem was especially seri-ous for small and medium enterprises (SME). He argued thatthe presence of such an information asymmetry was likely tohave adverse effects. In particular, if public investors do notknow which companies’ information is truthful, they will lowerthe bids they are prepared to pay for all issuing companies.Honest companies, whose insiders reveal true information abouttheir performance and prospects, will therefore not be able toreceive a fair price for their securities. High quality companieswill tend to leave the securities market, while low quality com-panies will tend to remain in the market, and this will exacer-bate the adverse-selection problem faced by investors.

7. Dr. Yoshitomi noted that the problem of informationasymmetry had only been partially solved in advanced coun-tries through the establishment of a complex set of laws andinstitutions which give investors a reasonable assurance thatissuers are truthful in the information they release. Amongthe most important of these institutions are so-called“reputational” intermediaries, such as accountants, underwrit-ers, banks, law firms, and stock exchanges. Dr. Yoshitomi ar-gued, however, that a serious problem arises in the context ofthese firms, because an established reputation is like a publicgood, in that incentives to invest in reputation tend to be low,and new entrants can free-ride on “reputational spillover” fromestablished investment banking institutions. In order to ad-dress this issue, regulators license intermediaries, fine or re-voke the licenses of misbehaving intermediaries, and initiatecriminal prosecution if an intermediary misbehaves intention-ally. Dr. Yoshitomi argued that the complexity of such a regu-latory response explains why many countries have not beenable to solve the problem of establishing well-functioningsecurities markets. As a consequence, only a limited numberof companies with high reputations have access to the capitalmarkets, while most SMEs do not.

8. Dr. Yoshitomi contended that monitoring in financial mar-kets has two key elements: the first is to monitor companyinsiders in order to ensure that they don’t steal from inves-tors, and the second is to monitor management performancein order to ensure that they maximize company value.

Dr. Yoshitomi maintained that a country can only developstrong securities markets if it can prevent self-dealing andprovide strong protections for minority shareholders. In con-trast, banks are more effective than securities markets at moni-toring whether managers of companies do in fact manage theircompanies well. This is because banks are in a better positionto collect, analyse, and process the idiosyncratic informationabout the management and performance of companies with-out a good reputation, as such information is not easily trans-ferable to the market. Dr. Yoshitomi concluded therefore thatthe information asymmetry between SME borrowers and ul-timate investors can be better handled by banks than securi-ties markets. He stated that it was for this reason that indeveloping countries, which are typically characterised by anabundance of SMEs, the banking system is the major sourceof finance to firms, and that banks tend to dominate the earlystage of economic development and corporate finance.

9. Dr. Yoshitomi also argued that the presence of many largereputable companies is a necessary prerequisite for the devel-opment of a bond market, since information about these com-panies as issuers may be relatively easily standardised. Theexistence of a diversified group of institutional investors isalso needed in order to develop sustained investment demandfor long-term securities.

10. Finally, Dr. Yoshitomi discussed the role of banks in de-veloping corporate bond markets in Asia. He stated that theywould continue to be important as issuers, as investors, andalso as underwriters in these markets because of two basic facts.First, there are a limited number of large, reputable, non-finan-cial firms which can issue bonds at reasonable cost. Second,there are a limited number of individual and institutional in-vestors in Asian developing countries. Dr. Yoshitomi maintainedthat this means that the banking sector and the bond market arelikely to be complementary, and not substitutes, to each other.Given this, he argued that there is a need for substantial effortsto strengthen and enhance the soundness of the banking sector,via improving banks’ information-generating and monitoringfunctions and their risk management capabilities. Prudentialand regulatory frameworks should be improved as well. Fur-thermore, policies that facilitate the development of the bondmarket should be adopted, particularly those improving invest-ment banking services, such as accounting, legal and regula-tory systems. Lastly the development of institutional investorsshould be encouraged.

Part I: Progress in Capital MarketReforms in Asia

11. The first part of the Round Table, following the intro-duction, was composed of two sessions. In the first, represen-tatives from economies in Asia described the progress theyhad made to date in implementing capital market reforms. Inthe second session, representatives from the international fi-nancial institutions presented their views on capital marketreforms in Asia.


Session 1: Introduction

A. People’s Republic of China (PRC)

12. Ms. Haiying Zhao, Commissioner, Strategy and Devel-opment Committee, China Securities Regulatory Commis-sion (CSRC), described recent developments in the People’sRepublic of China (PRC) securities markets. She examined thedevelopment of PRC economy, noting that it appeared that theeconomy had fully recovered from the Asian financial crisis.After two years of continuous deflation in 1988-9, the consumerprice index recorded a positive increase of 0.4% in 2000. RealGDP growth was 7.1% in 1999 and 8.0% in 2000, reaching anabsolute level of RMB 8,940.4 billion. However, the trade sur-plus in 2000 was US$ 24.1 billion which was US$ 5.1 billionlower than in 1999. This was due to a fall in exports to Asiafollowing the Asian crisis, and also the high value of the Chi-nese currency compared to other Asian currencies. In order toboost aggregate demand, China adopted an expansionary fiscalpolicy over the past two years, with the fiscal deficit increasingfrom 1.2% in 1998, to 2.1% in 1999, and 3.0% in 2000.

13. Ms. Zhao described a range of developments in the Chi-nese securities markets. She noted that China had one of thefastest growing securities markets in the world. In 1992 whenthe market was established, the ratio of total marketcapitalisation to GDP was 3%, and 54 firms were listed onthe domestic securities market. By 2000 the number of do-mestically listed firms was 1999 and the market capitalisation/GDP ratio was 57%.

14. Ms. Zhao described the various types of shares in themarkets, including A-shares for Chinese investors, B-shareswhich were originally designed for foreign investors, H-shareswhich are Mainland enterprises registered in the Mainland,and Red chip shares which are Mainland enterprises regis-tered in Hong Kong, China. She noted that in recent years theB-share market had been opened up to domestic investors withforeign currency deposits, and that this had improved the li-quidity of the B-share market, and significantly lowered theprice discount at which the B-share market had been tradingrelative to the A-share market. Ms. Zhao also observed that65% of the total equity shares of Chinese listed companieswere not publicly tradable, either because they were held bythe state, or were “legal person” shares owned by Chinesefirms or foreign partners, or were shares owned by companyemployees. These shares could only be “block transferred” atnegotiated prices, typically at a substantial discount to theprices on the public exchanges. The existence of these shareswas said to contribute to market misconduct and inefficiencyin the Chinese securities markets.

15. Several other aspects of the securities market were alsodescribed by Ms. Zhao: the growth in internet trading with anamount traded of RMB 200 billion in 2000, accounting for3% of total turnover; the fact that institutional investors onlyheld about 10% of total investment in China, but that more

funds and fund management companies would be establishedin the future; and the operations of the two exchanges, theShanghai Stock Exchange and the Shenzen Stock Exchange.

16. Ms. Zhao identified ten areas where reforms had been un-dertaken concerning financial infrastructure, as follows. 1) Su-pervisory Authorities: The development of the supervisoryauthorities for the markets up to the present situation up to thepoint in 9/1998 when the State Council formally designatedthe CSRC as the authority in charge of supervising China’ssecurities and futures markets. 2) Legal Framework: Ms. Zhaoobserved that at the end of 1999, the Chinese securities andfutures markets had been mainly governed by two laws, theCompany Law effective 1994, and the Securities Law effective1999. Given the dramatic changes in the Chinese economy,Ms. Zhao noted that the government was considering introduc-ing a new Company Law. 3) Marketization of the IPO: For thepast ten years, Ms. Zhao remarked that there had a quota sys-tem operated by the CSRC to determine which companies couldbe listed, and also what the P/E ratio of a share should be at itsoffering. She stated, however, that this quota system would beabolished in 3/2001, allowing issuers and underwriters to de-termine the offering price for their new issues. 4) Second Board:In the latest meeting of the People’s Congress, China announcedits intention to establish a second board to help the develop-ment of high technology and high-growth SMEs. 5) Cultivat-ing Institutional Investors: In order to encourage thedevelopment of institutional investors, open-ended funds wouldbe introduced in 2001, and insurance companies, pension funds,and social security funds would be allowed to enter the securi-ties markets. In addition, regulations covering the governanceof fund management companies would be enhanced, requiringamongst other things, that they have independent directors ontheir boards to protect the interests of small investors. 6) Glo-balization: Ms. Zhao noted that the negotiations for China toenter into the WTO were entering their last stage, and that thiswould bring new regulatory challenges, including the introduc-tion of joint venture securities firms, and joint venture fundmanagement companies. 7) Clearing and Settlement System:To date China had developed a nationwide integrated equitymarket system centred on the Shanghai and Shenzen Stock Ex-changes, each with their own clearing and settlement systems.In 3/2001 the new Central Clearance and Settlement Companywas established. 8) Compliance and Enforcement: Nine newenforcement agencies had been established, and many new pro-fessional experts had been recruited. 9) Improve Quality ofListed Firms: Non-state owned firms would be encouraged tolist on the Chinese stock exchanges. In addition more stringentguidelines for information disclosure and for the managementof listed companies had been introduced. Senior managementof listed companies would also be reminded of their fiduciaryduties. 10) Investor Education: Investor education is being en-hanced using a range of technologies including the internet.

17. Finally Ms. Zhao identified four broad areas in whichimprovements in the market were required: corporate gover-nance of listed companies and securities firms, the monitor-ing function of the stock exchanges, financial productdiversification, and internationalisation of the securities in-


dustry. She noted a range of areas where reforms were plannedfor the future, including, the regulatory framework for IPOs,the planned launch of the second board, further strengtheningthe regulation of listed companies, improving the technologyfor monitoring securities firms, sanctioning open-ended fundsand other investment management activities, encouraging theadoption of information technology in the industry, address-ing the problem of floating previously un-tradable shares, andpreparing for the establishment of joint ventures for securi-ties firms, and fund management firms.

B. Hong Kong, China

18. Ms. Alexa Lam, Executive Director, Securities and Fu-tures Commission, Hong Kong, China described the secu-rities markets in Hong Kong. She first examined themacroeconomic situation, noting that the economy returnedto positive growth in the second quarter of 1999 and contin-ued to grow during 2000. During the year, GDP registered10.5% real growth; total exports of goods grew by 17.1% inreal terms, exports to the US, EU and Asia all recorded double-digit growth; exports of services grew by 14.3% in real terms;visible and invisible trade, taken together, achieved a surplusof $60 billion; local consumer spending grew by 5.4% in realterms; and overall investment spending turned around andgrew by 8.8% in real terms. Ms. Lam remarked, however,that the effects of this economic improvement had not yetreached businesses on several counts. Profit margins remaintight, and are below those before the financial crisis. Althoughthe rate of unemployment is falling, it remains higher thanbefore Hong Kong’s recent economic setbacks. The down-ward adjustment in the property market has also meant that aconsiderable number of middle-income households find thatthe value of their property has fallen, in many cases into nega-tive equity levels.

19. Ms. Lam outlined the broad structure of Hong Kong’ssecurities markets. She noted that the stock market is run byHong Kong Exchanges and Clearing Limited (HKEx). HKExruns a main board and a second board known as the GrowthEnterprise Market (GEM). GEM provides fund-raising op-portunities for start-up companies with high growth potentialbut without proven track records. Ms. Lam observed that byend 2000, Hong Kong was the largest stock market in Asiaafter Japan, was the tenth largest in the world, and that it hadbecome a major fund-raising centre, especially for MainlandChina. She argued that the growth of the Hong Kong stockmarket was because of its liquidity, openness and high levelof participation by institutional investors.

20. Ms. Lam then summarised the financial market reformsbeing undertaken in Hong Kong, discussing first the estab-lishment of HKEx from the merger of four exchanges. Shenoted that the merger was aimed at centralising the securitiesand futures markets, as well as the trading and clearing func-tions, under a single holding company, which could operateon a commercial and profit-making basis. The merger was

completed on 6/3/2000, and the new entity listed its shares on27/6/2000. Ms. Lam identified several benefits arising fromthe demutualisation of the exchange including: the realisationof economies of scale in terms of operational efficiency, sav-ings in infrastructure investment, facilitation of risk manage-ment, and financial strength to meet external competition; andthe fact that the exchanges and clearing houses would nowact not only in their members’ interests, but also be respon-sive to market forces.

21. The two other key aspects of the reform process—namelyenhancing the infrastructure for the market and modernisingand rationalising the legal framework for the regulatory re-gime—were also discussed by Ms. Lam. She noted that theFinancial Secretary had appointed a Steering Committee onthe Enhancement of the Financial Infrastructure (SCEFI) tostudy and recommend the necessary improvements to the fi-nancial infrastructure in Hong Kong. Key issues for the Steer-ing Committee to pursue included establishing a singleclearing arrangement for securities, stock options, futures andother exchange-traded transactions; straight-through process-ing and achieving a scripless securities market. Ms. Lam de-scribed how, under SCEFI’s guidance, a dedicated Securitiesand Derivatives Network (SDNet) has been set up which elec-tronically links members of the securities and futures com-munity, so enabling them to automate previously paper-basedtasks. For example, electronic applications for shares wereaccepted for the first time for the MTRC public offering in10/2000, and the same month, AMS/3, the third-generationautomatic matching system, was also introduced.

22. Ms. Lam described how a new legislative framework toprovide Hong Kong’s financial markets with a high standardof supervision and investor protection, and the flexibility toanticipate and respond to rapid changes in the market, hasbeen put in motion. She noted that the reason for doing thiswas that Hong Kong’s existing legislation governing the se-curities and futures market is a patchwork of ten Ordinanceswritten over the course of the last 25 years. Ms. Lam arguedthat this legislative regime is complex, cumbersome and isbeing rendered obsolete by new changes brought about byglobalisation, technological innovations and the introductionof new products, services and trading methods.

23. Amongst the major new regulatory initiatives Ms. Lamdiscussed were the introduction of a single licence for mar-ket intermediaries to streamline regulatory arrangements andimprove the quality of intermediary services; the establish-ment of a civil Market Misconduct Tribunal and the expan-sion of the existing criminal route to combat marketmisconduct; new investigative powers for the Securities andFutures Commission; the modernisation of the regime fordisclosure of securities interests to enhance market trans-parency; the institution of a flexible framework for the regu-lation of new products and services, like automated tradingservices, to facilitate market innovation; and the provisionof more efficient channels of appeal against SFC decisionsfor aggrieved parties.


24. Ms. Lam concluded by noting that the objectives of thereforms are to enhance transparency in Hong Kong’s finan-cial markets, investor confidence, good corporate governance,market integrity, and Hong Kong’s position as an internationalfinancial centre.

C. Indonesia

25. Mr. Herwidayatmo, Chairman, Capital Market Su-pervisory Agency (BAPEPAM), Indonesia, discussed thesituation in Indonesia, examining first the current conditionof the Indonesian capital markets. Noting that the compositeprice index of the Jakarta Stock Exchange (JSX) may be thebest reflection of the political state of Indonesia, he observedthat after the last general election and the installment of thepresident and vice president in 10/1999, the composite priceindex reached 716.46, the highest level ever achieved in thehistory of Indonesia. Since then, however, as a result of po-litical instability, the index had consistently fallen, and that itnow stood below 400, the same level as in 1990. Mr.Herwidayatmo noted that the trend in market capitalizationwas also similar. After reaching the highest ever level in 1999of about Rp. 452 trillion, at end 2000 market capitalizationwas down to Rp. 259 trillion—a decreased of about 42.5%,and on 23/3/2001 it was down to Rp. 225—a further decreaseof about 13.4%. Mr. Herwidayatmo remarked that this de-cline would have been even higher, apart from the IPOs dur-ing 2000 and 2001, of which there were 226 and 3 respectively.Liquidity on the JSX, in terms of average daily turnover, dur-ing the last three years also showed the same pattern, declin-ing from about Rp. 600 million in 1999, to about Rp. 500 in2000, and about Rp. 370 during the current year.

26. Mr. Herwidayatmo observed that in terms of market com-petitiveness, the Indonesian market was no longer attractiveto foreign investors. The composition of investors in the mar-ket between local and foreign participants showed that for-eign investors had been leaving the market over the last fiveyears: in 1996 the composition was almost equal, but by 2001local investors dominated the market with foreign participa-tion at a level of about only 10%.

27. Mr. Herwidayatmo described some actions that had been,and were going to be taken, in Indonesia to reform the mar-kets. He observed that in 2000, 5 new rules had been issuedand 12 existing rules had also been revised. Some of the newrules were intended to facilitate the introduction of a scriplesstrading system, and some of the revised rules were aimed atimproving the IPO process by introducing book-building andthe use of red-herring prospectuses. Mr. Herwidayatmo notedthat in order to improve disclosure and transparency, revi-sions had been made to the rules on material transactions,changes in the line of business, tender offers, and acquisitionof public companies. A new rule on net adjusted working capi-tal was also implemented in 4/2000 in order to preserve theintegrity of the market.

28. A key event for the Indonesian capital markets Mr.Herwidayatmo identified, was the introduction in 7/2000 ofscripless trading and book-entry settlement. He noted that thecomputer trading systems of the SROs (i.e. the exhange, theclearing and guarantee, and the central depository) have beenfully integrated in order to support this new system and toensure that the system runs smoothly. In addition, he observedthat the JSX is preparing to implement a remote trading sys-tem in order to increase market liquidity and investor access,and that the Surabaya Stock Exchange is developing an on-line trading system to allow brokers to trade directly fromtheir offices.

29. Mr. Herwidayatmo observed that the number of enforce-ment actions increased in 2000—the number of parties onwhom sanctions were imposed over the last 2 years was morethan double the number in previous years. He noted that start-ing from 2000, fines were now imposed not only on listedcompanies but also on the management of the companies, ifit was found management misconduct was due to not imple-menting good corporate governance principles properly. Mr.Herwidayatmo remarked that there had also been an increasein the number of investigations undertaken—during 2000 39cases were detected, 28 of which were completed.

30. Mr. Herwidayatmo discussed how Indonesia is in the pro-cess of revising its Capital Market Law of 1996. He identi-fied several important issues that would be covered in the newlaw including: the granting of greater operational and finan-cial independence to BAPEPAM; the demutualization of thestock exchange; the issuance of stocks with no par value; theassignment of broader responsibilities to capital market pro-fessionals; the clarification of the definition of violations ofdisclosure and good corporate governance principles; the im-position of stronger sanctions for such violations; and the es-tablishment of a limitation on nominee clients’ accounts.

31. Mr. Herwidayatmo analysed the impact of the crisis, anddescribed some strategies to bring Indonesia back to a path ofstability and sustainable growth. He noted that the crisis hasbattered Indonesian self-confidence and increased a feelingof insecurity. He argued that the crisis had consequences thatwere beyond simply economics, and indeed that since theproblems are at root social and political, the healing processhad to be social and political as well. Mr. Herwidayatmo main-tained that there must be a clear policy to manage the transi-tion, such that at any time there is a reasonable balancebetween freedom and order, and between change and conti-nuity. Both the policy decision-making process and its imple-mentation need to be improved. In order to normalize thefinances of the economy, Mr. Herwidayatmo stressed the needfor new funds to revive economic activity. He also acknowl-edged the requirement for a strategy to maintain macroeco-nomic balances.

32. Mr. Herwidayatmo concluded by identifying three waysin which the international community can contribute towardshelping the Indonesian capital markets. First, he argued that


the international community should forcefully confirm itssupport for the integrity of the Indonesian nation, both in wordsand in deeds, in order to help reduce domestic anxiety andstrengthen the government’s efforts to reestablish law andorder. Second, the international community should calibratethe tone of their support for political reform, for improve-ment in governance, and for economic reform and recoveryin a more balanced fashion. Third, the international commu-nity should stand ready to help the Indonesia, including pos-sibly by arranging longer-term and more substantial debtrestructuring. Mr. Herwidayatmo also stressed, however, thatthe domestic government should first undertake the best ef-forts it could to resolve the problems.

D. Malaysia

33. Mr. Attila Emam, Manager, Economic Analysis De-partment, Securities Commission (SC), Malaysia, presenteda summary of the Malaysian economy and capital market. Henoted that Malaysia’s real GDP grew by 8.5% in 2000, led bya faster recovery in aggregate demand and the manufacturingsector, and that the external position remained robust as thecountry had sufficient international reserves to cover its ex-ternal debt, and a sustainable import cover. Mr. Emam ob-served that the total amount of funds raised through the capitalmarkets continued to increase, with the proportion issued bythe public sector growing; that the main source of financingwithin the equity market had been rights issues; and that thetotal funds raised in the corporate debt market has remainedthe same from 1999-2000, but that there had been changes inthe types of issuers which have been borrowing.

34. Mr. Emam noted that a range of domestic and externalfactors had had a negative impact on the Malaysian stockmarket, including changes in the reinstatement of Malaysiainto the MSCI indices, the launch of Malaysia’s Eurobondissue, and the declines in the US markets. Mr. Emam observed,however, that Malaysia’s performance over the past year of4.7% was broadly in line with the rest of the region. Tradingactivity has declined substantially, and there have been epi-sodes of high price volatility.

35. The central development in the Malaysian capital mar-kets identified by Mr. Emam was the launch of the CapitalMarkets Masterplan on 22/2/2001. He noted that this providesa strategic roadmap for the Malaysian capital market to beinternationally competitive, highly efficient, and supportedby a facilitative regulatory framework by 2010. Mr. Emamremarked that the Masterplan consists of 6 objectives, 24 stra-tegic initiatives, and 152 recommendations covering 11 keyareas of development, and that a Capital Markets AdvisoryCouncil had already been formed to advise the SC on how toimplement the Masterplan.

36. Mr. Emam described various measures with different ob-jectives that had been undertaken, or were about to be under-taken, in the market. The first set of measures were to enhance

standards and market integrity. He noted these included thereform of the Kuala Lumpur Stock Exchange’s (KLSE) list-ing requirements in order to bring into effect the MalaysianCode of Corporate Governance. These changes aimed to raisethe standards of conduct of directors and company officers oflisted companies, and to develop effective internal governanceand enforcement mechanisms. Mr. Emam observed that therehad been a shift towards disclosure-based regulations, withthe SC became the sole registering authority for prospectusesfor all offers of securities in 7/2000. It was anticipated that afull disclosure based set of regulations would be achieved bythe second half of 2001. A Minority Shareholder Watchdoghad also been created to promote minority shareholder pro-tection.

37. Mr. Emam discussed various measures instituted to pro-mote the development of the bond market. He noted that sub-stantial amendments to the laws were being made, includingcentralising the approval authority for private debt securities(PDS) with the SC, speeding up the approval process, the es-tablishment of new guidelines and regulations to govern PDSissuance process, the establishment of a shelf registrationscheme, and the specification of the contents of prospectusesfor debentures and the minimum content for trust deeds. An-other measure discussed by Mr. Emam was the establishmentof an effective benchmark yield curve. In order to achievethis, an issuance calendar was introduced in 3/2000 to pro-vide details of each Malaysian Government Security (MGS)issued to the market, and some MGS issues were re-openedso as to increase the amount outstanding and the liquidity ofthese issues. Mr. Emam observed that the guidelines on assetsecuritisation were also being developed. A National BondMarket Committee was also being established.

38. Mr. Emam identified four measures that were being takento strengthen market intermediaries and market infrastructure:1) The consolidation of the stockbroking industry which re-quired the development of a policy for appropriate consolida-tion and the formation of so-called Universal Brokers. Henoted that to date, nine brokers had agreed to merge with threeothers, and five had submitted applications for Universal Bro-ker status. 2) The reduction and liberalisation of brokeragecommissions—with the first phase implemented in 9/2000and full deregulation anticipated in 7/2001. 3) The establish-ment of a mandatory programme to promote professionalismamong licensed representatives. 4) The move from T+5 toT+3 for the rolling settlement cycle which started 20/12/2000.

39. Another area Mr. Emam talked about was the promotionof the use of e-commerce and technology within the capitalmarket. He noted that this was being done through the releaseof a consultation paper, and through the establishment of aWorking Group on Electronic Commerce in the Capital Mar-kets. Mr. Emam observed that there were currently fourteenstockbrokers providing Electronic Client Ordering Systemsvia the internet with approximately 8,000 clients registeredwith them.


40. Mr. Emam described some measures that were beingtaken to enhance the efficiency of the broader financial sys-tem, including the banking sector. He noted that a FinancialSector Masterplan was launched on 1/3/2001 to provide a blue-print for the development of an effective, competitive, resil-ient and dynamic financial system by 2010, and that itsrecommendations covered 6 areas of development. Mr. Emamalso discussed how the government was encouraging bank-ing sector consolidation, and that to date 50 of the 54 bankinggroups had been merged into 10 banking groups. He also ob-served that a range of liberalisation measures had been taken,including the fact that banking institutions were now allowedto outsource non-core functions to third party resident ser-vice providers.

41. Mr. Emam concluded by outlining some positive changesin the markets. He noted, in particular, that the capital in-jected into the financial system by Danamodal had been re-duced through repayments, that the financial sectorrestructuring process had improved—for example 44% of thenon-performing loans had been removed, and that the Corpo-rate Debt Restructuring Committee had also been making goodprogress.

E. Korea

42. Mr. Yoon, Yeo Kwon, Director, International Co-op-eration Division, Financial Supervisory Commission,Korea, analysed the reform measures taken in the Korean capi-tal markets. He discussed first some changes in capital mar-ket infrastructure. He noted that one of the objectives of thegovernment has been to reform the listing requirements andtrading rules in order to facilitate participation of small-sizedfirms with significant growth potential in the capital markets.The Korea Stock Exchange (KSE) listing requirements werethus amended to allow small-size firms to be listed more eas-ily than before, and also to boost foreign investors’ participa-tion in the Korean stock markets. He observed, for example,that the amendments now let the stocks of foreign firms, aswell as a part of the equity of firms already listed on offshorestock exchanges, to be listed on the KSE.

43. Mr. Yoon outlined the regulatory changes made to pro-mote the development of the KOSDAQ market. He noted thatmany practices that were deemed to have the potential tothreaten fair and sound trading have been abolished. For in-stance, from 5/2000 short selling has been prohibited exceptwhen settlement for the stocks sold was guaranteed. Also, ven-ture capital companies that invest in venture companies arenow required to deposit stocks for three months after issu-ance. Mr. Yoon remarked that numerous measures had alsobeen introduced to stabilize and boost the KOSDAQ market,and also that relevant regulations of the Korea SecuritiesDealer’s Association (KSDA) had been amended to reinforcethe accountability of venture capital firms and underwritingsecurity companies.

44. Mr. Yoon identified several improvements that had beenmade to the bond market in 2000. In order to improve thesecondary market, he pointed to the introduction of a regula-tion for the establishment of a type of securities firm special-ized in the trading and brokerage of bonds, and confirmedthat thirty-six specialized bond dealers had been appointed.He noted that the establishment of inter-dealer brokers hadbeen permitted, and that three private bond evaluation com-panies had been appointed to provide price information, andto facilitate the implementation of mark-to-market valuationrules. In addition, the KSDA had been required to discloseinformation about bond transactions so as to enhance markettransparency.

45. Mr. Yoon observed that the Korea Futures Exchange(KOFEX) started trading in 4/1999. He noted that trading vol-ume had doubled over the past year, and that the number ofinvestors had increased significantly. Mr. Yoon discussed arange of reforms taken to improve trading on KOFEX: theexchange had reduced the margin requirements for US dollarfutures and government bond futures; various laws and regu-lations were amended to help stimulate the market and to meetinstitutional hedging demands; KOSDAQ 50 futures wereintroduced onto KOFEX in 1/2001; and the initial depositrequired for trading stock index futures transactions had beenlowered.

46. Mr. Yoon described the policies that had been introducedrelating to internet trading of securities. He noted that as atyear-end 2000, on-line trading accounted for 55.9% of thetotal amount of contracts in Korean stock markets includingboth the KSE and KOSDAQ. The trading volume via theinternet amounted to 92.6% of total on-line trading, up from89.8% in 1999. Mr. Yoon described how the Korean govern-ment has responded to this rapid growth in trading. With rela-tion to the permission policy, the required amount of paid-incapital for the establishment and operation of on-line tradingbrokerages, was lowered. Due to the change, two brokeragefirms specializing only in internet stock trading were opened,and as of the end of 2000, 37 out of 43 securities companiesprovided online-trading services.

47. Mr. Yoon stressed that the relevant authorities had beenworking on ways to improve the security and privacy of theelectronic documentation relating to customers. For example,securities companies will be required by 10/2202 to adopthost-site back-up systems apart from their main systems. Toprevent investors from suffering reckless losses while tradingsecurities on the internet, the Financial Supervisory Service(FSS) provides both general advice on trading through theinternet, as well as detailed procedures to cope with unex-pected electronic accidents. In addition, the FSS instructs bothSROs and securities companies to provide investors with suf-ficient notification and information about internet securitiestransactions.

48. Mr. Yoon described how the increasing number of internettransactions has made it necessary to take enforcement ac-


tions against fraudulent public offerings via the internet. Henoted that offerings and transactions of securities via theinternet have increased sharply from the second half of 1998,but that some issuers have wilfully misled investors by fail-ing to disclose material information and by exaggerating fi-nancial statements. Since 10/2000, all issuers who want torecommend the purchase of stocks to more than 50 subscrib-ers are required to comply fully with established disclosurerules. If an issuer fails to comply with these rules, it is subjectto enforcement actions. The FSC may also refer any personto the public prosecutor’s office who violates the legal provi-sions against unfair trading.

49. Mr. Yoon concluded by describing some policies that hadbeen adopted to promote greater foreign participation in theKorean markets. A significant measure was to allow directinvestment by foreign investors into the KSE in 1/1992. Atthat time, total acquisition by foreign firms was limited to10% of each listed stock, and acquisition by foreign individu-als was limited to 3% of each listed stock. The investmentceilings for foreigners have been gradually raised ever sinceand were finally abolished on 25/5/1998. Foreign investors’participation in the KOSDAQ market has been allowed since12/1997. At that time, total acquisition by foreign firms waslimited to 15% of each listed stock, and acquisition by for-eign individuals was limited to 5% of each listed stock. Theselimits were also completely lifted on 25/5/1998. Mr. Yoonnoted that some acquisition limits still exist for the stocks ofa few companies restricted by other laws and ordinances. TheKorean bond market has been open to foreign investment since7/1994. All of the restrictions were finally abolished in 7/1998.

F. Singapore

50. Ms. Yeo, Lian Sim, Deputy Managing Director, Mon-etary Authority of Singapore (MAS), discussed the state ofthe capital markets in Singapore. She summarised the develop-ment of the Singaporean economy as follows: in year 2000,GDP growth was 9.9% (5.9% for 1999); financial services sec-tor growth was 4.1% (0.8% for 1999); CPI inflation was 1.3%(0% for 1999); and the current account surplus was S$37.6billion (S$36.9 billion). Ms. Yeo provided some statistics onthe performance of the capital markets: in year 2000, the num-ber of new listings was 81 (51 in 1999, 59% growth); the amountof new funds raised was S$14.2 billion (S$12.2 billion in 1999,16% growth); total turnover value was S$172 billion (S$197billion in 1999, 13% fall); market capitalization was S$417 bil-lion (S$470 billion in 1999, 11% growth); and the level of thestock market index at year-end was 1,927 points (2,480 points,22% fall). Ms. Yeo also noted there had been a steady growthof issuance in various sectors of the debt markets—both inSingapore dollars and non-Singapore dollars, and in the T-Billand Singapore Government Securities (SGS) markets.

51. Ms. Yeo described a series of reforms MAS had madein the equity and futures markets to respond to the funda-mental changes in the global financial landscape of techno-

logical developments, cross-border financial transactions, andthe breakdown of the financial services value chain. She notedthe demutualisation, merger and listing of the Singaporeanexchanges. The Stock Exchange of Singapore (SES) andSIMEX were both demutualized on 1/12/1999, and mergedinto a single integrated entity Singapore Exchange Limited(SGX), which itself was listed on 23/11/2000. Ms. Yeo dis-cussed how access had been opened to the Singaporean mar-kets. In particular, trading restrictions on existingforeign-owned stockbrokers were removed in 1/2001, SGXhas been admitting new members since 1/7/2000, trading re-strictions on new members are to be lifted in 1/2002, andmembers are allowed to hold dual membership since 1/7/2000.

52. Ms. Yeo analyzed what was being done to promote foreignparticipation and cooperation in the markets. She noted that MASwould introduce a regulatory framework for Alternative Trad-ing Systems (ATS), including foreign ATS, so as to increase therange of securities trading services. Ms. Yeo also commentedthat in the context of exchange linkages and cooperation, SGXhad been active in pursuing alliances including the SGX-ASXco-trading link, and a joint venture with AMEX to trade ETFs.It was thought that such strategic alliances and cooperative part-nerships could widen the investor base and product range, andalso serve as channels for the exchange of know-how.

53. Ms. Yeo noted that in order to improve corporate gover-nance, three committees had been set up to review the corpo-rate regulatory framework, disclosure and accountingstandards and corporate governance practices, and a Code ofCorporate Governance had been accepted by the government.She confirmed that SGX would require compliance by listedcompanies with the Code, and also explanations for any de-viations. Amongst the major areas covered by the Code wereboard composition, remuneration matters, audit and account-ability, and communications with shareholders. Ms. Yeo men-tioned that stockbroking commissions were totally liberalizedon 1/10/2000, and that the settlement period had been shortedto a T+3 cycle with effect from 15/3/2000.

54. Ms. Yeo described a number of initiatives that had beentaken since 1998 to help the debt market grow, noting that thesewere underpinned by several fundamental factors, including amore active SGS market, a conducive environment for bondissuers, a diverse investor base, and a strong talent pool. In or-der to develop the SGS Market, Ms. Yeo remarked that the is-suance size of benchmark issues had been increased toS$2.0-S$2.5 billion, that regular SGS repurchase programmehad be established, and that some existing issues had been re-opened as new benchmarks. Ms. Yeo commented that severalother steps had been taken to enhance secondary market li-quidity, including: fostering a liquid swap market by allowingoffshore banks to engage in swaps with non-banks, and liftingthe reserve requirement on banks for SGD swaps with non-bank financial institutions and corporates; shortening the lock-up period for bonds issued without a prospectus; and thefacilitation of e-bond trading.


55. Ms. Yeo took stock of the current situation as follows:there had been a record number of 81 new listings in 2000, 17of which were foreign-based companies; SGX had admitted10 new members since opening access in 7/2000; brokeragecommission rates had fallen to as low as 0.25% of contractvalue, contributing to the proportion of total trading volumeconducted online increasing from 3.4% to 5.5%; healthy SGStrading volumes and increase in corporate debt issuance; andthe SGS had been included in the JP Morgan Global Govern-ment Bond Index.

56. Ms. Yeo concluded by identifying two legislative initia-tives for the future. The first was the Omnibus Securities andFutures Act which aimed to merge, streamline and updateexisting legislation pertaining to securities and futures. Thesecond was the Financial Advisers Act governing the provi-sion of financial advice on investment products including thesale of collective investment schemes and life insurance.

G. Thailand

57. Mr. Prasarn Trairatvorakul, Secretary-General, Se-curities and Exchange Commission (SEC), Thailand, spokeabout recent developments in Thailand. He first discussed theactivities that were being taken to strengthen the equity mar-ket, and noted that despite the bearish conditions in the mar-ket, efforts continued to reinforce the three basic buildingblocks of the market: stimulating market demand for securi-ties; enhancing quality supply of securities; and improvingthe market infrastructure. On the demand side, Mr.Trairatvorakul identified the following activities: the issuanceof Non-Voting Depositary Receipts (NVDR) to facilitateshareholdings of foreign investors, the expansion of the long-term institutional investor base by supporting the establish-ment of the Retirement Mutual Fund (RMF) for self-employedand independent professionals, and the expansion of the indi-vidual investor base through on-line trading.

58. On the supply side, Mr. Trairatvorakul noted several ef-forts were being pursued: the promotion of information dis-closure and good corporate governance, establishing taxincentives for listed companies for a specified period, expe-diting the privatization of state enterprises, supporting the list-ing of companies in target industries, expediting the launchof derivatives, and supporting the establishment of exchange-traded funds linked with foreign investments. In the contextof market infrastructure, Mr. Trairatvorakul identified thecorporatisation of the Stock Exchange of Thailand (SET),setting the guidelines for the supervision of on-line securitiesbusiness, the liberalization of the commission structure, andthe expansion of the scope of business for securities firms.

59. Mr. Trairatvorakul described the four areas where atten-tion was being focused in order to develop the bond market,as follows: 1) The establishment of a regular and predictablesupply of government bonds to help the development of anefficient government bond market. 2) The rationalisation of

the tax treatment of transactions to enhance the liquidity ofthe secondary market. 3) Amendments to the legal and taxtreatment of asset securitisations in order to facilitate theiruse. 4) Adoption of electronic technology to enhance theworking of the bond market, via scripless trading and the de-velopment of an electronic trading platform.

60. Mr. Trairatvorakul remarked on how the Thai SEC incooperation with the Bank of Thailand and market partici-pants was in the process of reviewing the scope of financialservices being provided by different types of financial insti-tutions. He noted that it hoped to come up with some recom-mendations within a year.

61. Mr. Trairatvorakul commented that several laws are be-ing amended, and that several new laws are also being intro-duced. Amendments were being made to the Securities Actand the Public Companies Act to give better protection forpublic investors, to make the market more transparent, and togive better flexibility for business restructuring. Civil proce-dures were also being introduced for market misconduct.Among the new laws being introduced identified by Mr.Trairatvorakul were the Derivatives Bill and the Trust Bill forCapital Assets.

H. Taipei,China

62. Mr. Wu, Tang-Chieh, Vice Chairman, Securities andFutures Commission (SFC), Taipei,China, spoke about de-velopments in the their capital markets. He summarised somemacroeconomic development indicators as of the end of 2000.He noted that over the past year economic growth rate was5.98%, the consumer price index grew 1.3%, exports wereUS$148.37 billion and imports were $140.01 billion, foreignexchange reserves were US$106.7 billion, the personal sav-ings rate was 25.2%, and the unemployment rate was 2.99%.Mr. Wu stated that these figures indicated that the economicfundamentals were sound and robust.

63. Mr. Wu presented some statistics summarising the activ-ity in the capital markets. At the end of 2000, a total of 531companies were listed on the Taiwan Stock Exchange (TSE)with par value of NT$ 3,630 billion (US$ 108 billion). Themarket value of equity shares was NT$ 8,191 billion (US$248 billion—down from a level of US$ 375 billion the yearbefore). Mr. Wu noted that despite the small number of listedcompanies (less than a quarter of that in Tokyo), trading vol-ume stood at NT$ 30.8 trillion (US$ 993 billion) in 2000,ranked the seventh largest in the world. The average dailytrading value was NT$ 112.6 billion (US$ 3 billion). Mr. Wunoted that the TSE’s large trading volume was thus due to ahigh turnover rate.

64. Mr. Wu observed that the number of companies listed onthe Over-The-Counter Securities Exchange (ROSE) had in-creased rapidly in the past few years, from 11 firms at the be-ginning of 1994 to 300 firms at the end of 2000. The market


value of registered equity shares increased over 100 times, toNT$ 1.05 trillion (US$ 31.8 billion). Trading volume includ-ing stocks and bonds on the ROSE in 2000 totalled NT$ 73.4trillion (US$ 2.22 trillion). Outstanding bonds listed on the TSEand the ROSE at the end of 2000 included NT$ 1.48 trillion(US$ 44.8 billion) of government bonds, NT$ 443 billion (US$13.4 billion) of corporate bonds, and NT$ 113 billion (US$ 3.4billion) of 17 foreign bonds. In order to summarise the level offoreign investment, Mr. Wu observed that the total accumu-lated net inward remittances was US$29.4 billion, of whichover 90% was kept in the form of equity shares, with the re-maining balance was kept mainly in bank deposits, commer-cial paper, and beneficiary certificates. He noted also that since30/12/2000, there had been no limitation on foreign investors’shareholdings except for certain industries.

65. Mr. Wu summarised the main capital market reforms un-dertaken in 2000 as follows. The SFC announced on 7/8/2000guidelines to allow TSE-listed and OTC-quoted companiesto buy their back shares. Mr. Wu noted that foreign entry indiscretionary investment management would be opened up inthe future. The SFC had allowed securities investment trustcompanies (SITE) and securities investment consulting com-panies (SICE) to open discretionary investment businesses.He remarked that the SFC had requested the TSE to extendstock market trading hours in order to match the internationaltrend. Mr. Wu observed that a Second Board was establishedon the OTC Exchange in 4/2000. It is expected that manysmall and medium enterprises, and start-up technology andinternet firms would be interested in floating their shares onthe Second Board, as Taiwan [sic] Innovative Growing Entre-preneurs (TIGER). At the end of 1/2001, 12 companies hadlisted on the Second Board.

66. Mr. Wu remarked that the government wanted to pro-mote on-line trading, and had established TAIWAN-CA.COMInc. in order to provide security certificate services. He ob-served that by the end of year 2000, 74 securities firms openedon-line businesses, and had captured 7.73% of the total mar-ket share by trading value. Mr. Wu confirmed that the gov-ernment wanted to lift the restrictions on foreign share holdingof listed companies, and that since 30/1/2000, except for somespecial industries such as banking and telecommunications,there has been no share holding restrictions on foreigners toinvest in Taipei,China securities markets. Mr. Wu stated thatthe government had increased the penalty for insider tradingto up to seven years in custody.

67. Mr. Wu concluded by describing some measures antici-pated in the future concerning the reform of the capital mar-kets. He noted that the government wanted to encourageacquisitions and mergers among businesses in order to en-hance competitiveness. To do this, it was in the process ofenacting the Financial Holding Company Law, and had pro-mulgated some “Points to be Noted in the Merger of ListedCompanies” to ensure the integrity of the market during merg-ers. Mr. Wu remarked that the IPO application process wouldbe simplified: the pre-listing observation period would be

shortened from two years to one year, self-regulation of un-derwriters would be strengthened, and there would be a re-view of the contents of prospectuses and of disclosuremethods. He stated that brokers would be allowed to tradenon-listed securities of publicly-held companies—and that therole of brokers in this market and the procedures of clearingand settlement, were being studied.

68. Mr. Wu remarked that dematerialisation of securities wasbeing promoted. He noted that the legal basis for asset man-agement would be reformed, and that the government wasenacting the Securities Investment Trust Law and the Securi-ties Investment Consulting Law. Mr. Wu observed that thequantitative restrictions on corporate bond issuance by pub-licly traded companies would be relaxed. Other reforms in-cluded that the feasibility of listed companies issuing bondswith warrants was being reviewed, that the SFC was evaluat-ing a new type of futures contract which would be one fourththe size of current ones, in order to facilitate small-mediumsized investors to conduct risk-hedging, and that the TSE In-dex Option would begin trading this year on the Taiwan Fu-tures Exchange.

I. Philippines

69. Ms. Lilia Bautista, Chairman, Securities and Ex-change Commission (SEC), the Philippines, spoke aboutthe Philippine capital markets. She described the macroeco-nomic situation in the country, noting that the economic re-covery that began in 1999 after the Asian crisis and El Ninowas sustained until the first three quarters of 2000. There was,however, a marked economic slowdown during the fourthquarter of 2000 as the Estrada administration faced a politicalcrisis, coupled with economic concerns including the weak-ening peso, the widening budget deficit and interest rate con-cerns. In spite of the confluence of adverse factors affectingthe market, Mrs. Bautista noted that the economy continuedto post growth. Overall, GNP expanded by 4.2% in 2000 from3.7% in the previous year, and GDP rose to 3.9% from 3.3%in 1999. The balance of payments incurred a deficit US$918million (as of 11/2000) from a positive US$3,236 million atthe end of the previous year. However, a positive balance oftrade continued to grow from US$4,295 million for 1999 toUS$6,691 million, an increase of almost 56%.

70. Mrs. Bautista examined the development of the capitalmarkets. She noted that year-on-year the composite index lost30.26% or 647.47 points. For the year, the total value of trans-actions on the Philippine Stock Exchange (PSE) was Pesos357.66 billion ($8.09 billion), less than half of the previousyear’s turnover of Pesos 780.96 billion ($19.98 billion). Thetotal volume of transactions was 659.43 billion shares, or289.53 billion shares less than last year’s total number ofshares traded (a decline of 30.51%). On 20/10/2000 the Com-posite Index slid to its lowest level since 8/10/1998 at 1,251.23points. The market capitalisation grew, however, by 33.03%to P2.577.68 billion (US$51.56 billion). There were 7 com-


panies which applied for an internet trading license from thePhilippine SEC in 2000, 3 of which started operations beforeyear-end. The average monthly value of trades through onlinetrading was P13,722,818.

71. Mrs. Bautista described the reforms planned to enhancethe debt market. She noted that historically debt securitieshad only been traded in the OTC market. In order to provideflexibility to corporations in raising capital either through debtor equity, the Commission approved the “PSE Listing Guide-lines and Trading Procedures for Debt Securities”. Mrs.Bautista remarked on the PSE’s initiative to list Small De-nominated Treasury Bonds on 15/1/2001, and also noted thatthe Bankers Association and Investment Houses had beenworking to create a new debt securities exchange.

72. Mrs. Bautista examined the development of market in-frastructure, and described the reform of the regulatory frame-work. She noted that the legal infrastructure for capital marketregulation was substantially strengthened in 7/2000 by thepassage of the new Securities Regulation Law (Code) whichbecame effective in 8/2000. The Code incorporated interna-tional best practice standards, including full and fair disclo-sure by public companies, codification of the role andregulation of SROs, and technological developments, and alsoaddressed local market abuses. In addition, it requireddemutualisation of the PSE by 8/2001, and enabled the SECto reorganize its structure in 11/2000. Mrs. Bautista observedthat in 12/2000 approximately 93 regulations were adoptedimplementing the new Code, and that these rules became ef-fective on 2/1/2001.

73. Mrs. Bautista described the SEC’s actions concerningthe PSE. She noted that the SEC suspended the Self Regula-tory Organization (SRO) status of the PSE on 7/3/2000 fol-lowing the mass resignation of the exchange’s Complianceand Surveillance Group (CSG) in protest at the PSE’s Boardof Governors alleged “white washing” of the CSG’s investi-gative report. This SRO status was restored on 8/9/2000 afterpassage of the Code and compliance by the PSE with the termsand conditions set by the SEC. Mrs. Bautista observed thatamongst the most important of these conditions was that thePSE increased the number of its non-broker members on itsBoard from three to eight. Out of these eight non-broker mem-bers, three should be independent directors and persons whorepresent the interests of issuers, investors, and other marketparticipants, and who had not been associated with any bro-ker, dealer, or member of the exchange for a period of twoyears prior to their appointment. Mrs. Bautista observed thatthe Code requires all exchanges existing under the previousSecurities Law to be organized as stock corporations withinone year from enactment. The PSE’s demutualization plan isrequired to be submitted for approval to the SEC no later than30/4/2001.

74. Mrs. Bautista discussed how the SEC approved on 11/5/2000 the Exchange Rules governing additional listing of shareswhen there was likely to be a significant demand for shares

from existing shareholders. She noted, however, that the Ex-change was not allowed to permit the listing of shares subscribedthrough private placement, debt-to-equity conversion, share-for-share or property-for-share swap, or similar transactions, un-less a rights offering or public offering for such shares was firstundertaken. Mrs. Bautista remarked that the Commission alsoapproved the Exchange’s “Rules on Voluntary and InvoluntaryDelisting”. These allowed securities listed on the Exchange tobe suspended from being traded, or to be removed from the list,under certain conditions. This could occur if the Exchange de-termined that the issuer failed to comply with the Listing Agree-ment or the Listing and Disclosure Rules of the Exchange, or ifthe trading volume of the company fell below that required bythe Exchange, or if there was no objection to the proposeddelisting from at least 10% of the outstanding shareholders.

75. Mrs. Bautista remarked on the changes to the clearingand settlement systems that were being made. As of 5/10/2001, the current settlement deadline of 11.00 am on T+4was changed to 12.00 pm on T+3. She noted that the SEC hadestablished new rules related to internet trading, includingpublic offerings and disclosure through the internet. The SEChad also issued new guidelines for the electronic delivery ofprospectuses, which incorporated international best practiceand sought to ensure that an investor will be provided withthe same protections whether prospectuses are delivered per-sonally or through the mail.

J. Japan

76. Mr. Tatsuya Kanai, Director, International FinancialMarkets, Financial Services Agency (FSA), Japan,summarised recent developments in the Japanese capital mar-kets, focusing on the main points of the financial issues in thegovernment’s measures announced on 6/4/2001 to respond toJapan’s economic situation. He discussed initially the mea-sures taken to revitalize the financial and corporate sector.Mr. Kanai noted that an integrated approach to the NPLs ofbanks and excessive corporate debt had been developed whichwas composed of several goals and policies. The first goalwas the drastic removal of NPLs from banks’ balance sheets.In order to do this there was to be a time limit on creditors toachieve this within two years; there would be periodic disclo-sure of the actual record of removals of NPLs by the banks,which would be monitored by the FSA; and banks would berequired to develop schemes for improving the quality of thoseloans to debtors which were classified as “needing attention”.

77. The second goal identified by Mr. Kanai was the need topromote corporate reorganization. This would be achieved byestablishing guidelines regarding the process of corporate re-organization and debt forgiveness through private-sector con-sultation in which the authorities participated (along the linesof the principles of the International Federation of InsolvencyProfessionals and the “London Approach”). In addition, Mr.Kanai noted that the Law on “Special Measures for IndustrialRevitalization” would be used.


78. The third goal noted by Mr. Kanai was the enhancementof debt forgiveness by financial institutions. This would beimplemented by enhancement DIP (Debtor-in-Possession)finances, by using debt-equity swaps, and by supportive taxtreatment, and other measures by public financial institutions,concerning the above-mentioned guidelines.

79. The fourth goal of the integrated approach to the NPLsof banks and excessive corporate debt discussed by Mr. Kanaiwas that loan assets be sold. In order to effect this, the con-tracts and transaction procedures for trading loans would bestandardized, and the Resolution and Collection Corporationwould be enhanced to include trustee and other business.

80. Mr. Kanai examined another key set of measures takento revitalize the financial and corporate sector, namely thoseaimed at limiting the shareholdings of banks. In order to ef-fect this, he noted that the amount of shares that a bank canhold was to be limited to the equivalent of the bank’s capital.Any portion of shareholdings exceeding this limit would haveto be sold within a certain period. Mr. Kanai described howthe Banks’ Shareholding Acquisition Corporation (BASAC)was being established, jointly by banks and other institutions,in order to facilitate this. As a temporary measure, shares heldby banks were to be purchased by BASAC at market value,and such purchases would be supported by public-sector fund-ing. ETFs (exchange-traded investment trust funds), invest-ment trust funds, and investment defined contribution pensionfunds would be actively used for the sale of shares acquiredby BASAC. Mr. Kanai mentioned that a work plan for BASACwould be developed as soon as possible.

81. The second broad topic Mr. Kanai analysed was the struc-tural reform in the securities markets. He identified four re-forms in this area, remarking first that the acquisition ofown-shares by issuing companies (“treasury stock”) wouldbe allowed under certain conditions. To achieve this, Mr. Kanainoted that relevant rules would be revised and the capacity ofthe Securities and Exchange Surveillance Commission wouldbe strengthened to prevent insider trading and price manipu-lation. In addition, the net-asset requirement per investmentunit in shares would be removed. The second measure aimedat reforming the securities markets mentioned by Mr. Kanaiwas the introduction of defined contribution pension schemesand defined benefit pension schemes. He identified third thecreation of a book entry system for securities, in order to en-able paperless trading and shorten the settlement period. Fi-nally Mr. Kanai remarked on the introduction of anExchange-Traded Fund (ETF) linked to stock price indexes,which could contribute to market activity by enabling conve-nient and prompt investment in small amounts of money.

82. Mr. Haruhiko Kuroda, Vice Minister for InternationalAffairs, Ministry of Finance, Japan, gave the lunchtimespeech in which he discussed capital market reforms inAsia. He noted that the East Asian region as a whole has acapital surplus, and argued that healthy capital markets whichefficiently recycle long-term funds within Asia will contrib-

ute to solving those economic and financial problems stillremaining in each country. Mr. Kuroda discussed the lessonsthat have been learned from the Asian crisis, noting that at thetime the scope and magnitude of short-term capital flows werenot fully recognized by either the lending or borrowing coun-tries or by international organizations. He argued that suffi-cient attention was not paid to early warning signs, and thatthe disclosure of accurate information about economic con-ditions in the emerging markets would have played an impor-tant role in formulating correct market perceptions and inpreventing abrupt changes in capital flows. To prevent futurecrises, Mr. Kuroda observed that Asian countries have beenseeking to build strong financial sectors, domestic capitalmarkets, and frameworks of supervision.

83. One key area Mr. Kuroda analysed as being necessary wasthe development of capital markets, and especially bond mar-kets, as they can provide an important balance to over-relianceon banking loans which have been the main source of funds forcorporate growth in Asia. He identified four key areas for thedevelopment of bond markets. The first was infrastructure.Mr. Kuroda commented on various reforms aimed at improv-ing the infrastructure of the Japanese bond market. These in-cluded restructuring the Bank of Japan’s Financial NetworkSystem, for example, by introducing a Real Time Gross Settle-ment (RTGS) system, the consideration of appropriate legisla-tion to integrate the bond settlement systems, and thesimplification of the tax system. The second key area of impor-tance for the development of bond markets, identified by Mr.Kuroda, was the need to broaden the investor base. One way todo this is to offer attractive bonds, for example, by issuing as-set-backed securities (ABS) that increase the variety of bondsin the markets, while at the same time raising creditworthiness.

84. The third area of relevance noted by Mr. Kuroda for thedevelopment of the bond markets was credit rating. He con-tended that small companies are having difficulty in tappingthe bond market because potential investors are unable bythemselves to judge their creditworthiness, and that large com-panies in Asia are also said to have experienced some diffi-culty with credit ratings. Mr. Kuroda thought this could bebecause the dominant non-Asian rating agencies do not pos-sess in-depth understanding of the region, and therefore rateAsian companies lower than is warranted, just to be safe. Heobserved with interest that some Asian rating companies areexploring the possibility of collaborating among each other,thereby enriching their historical data and expanding theirratings coverage. He also commented that the US credit rat-ing agencies are expected to learn more about how things workin Asia. Mr. Kuroda stressed that public regulators should paycloser attention to the credit rating agencies’ performance,while maintaining a dialogue with them.

85. The fourth key area for the development of bond mar-kets is credit enhancement. Mr. Kuroda argued it was impor-tant to bridge the gap between investors’ appetite for risk andthe quality of bonds. In response, he noted that Japan hadestablished two credit enhancement facilities for bond issu-


ance to help Asian issuers from crisis-affected countries tapinternational markets. In 1999, the Japan Bank for Interna-tional Cooperation expanded the coverage of its credit guar-antee scheme to include public bonds issued by developingcountries. The Asian Currency Crisis Support Facility wasalso established in the ADB, and funded by Japan, to assistthe crisis-affected countries of Asia in their recovery.

86. Mr. Kuroda discussed regional financial cooperation inAsia, and recognized that joint efforts and cooperation amongEast Asian countries were crucial for the financial stability ofthe region. To this end, he observed that the Finance Ministersof ASEAN + 3, (namely PRC, Japan, and the Republic of Ko-rea), met in Chiang Mai, Thailand, last May, and agreed to cre-ate a network of bilateral swap and repurchase agreementfacilities. Mr. Kuroda commented that it was obvious that in alarge-scale crisis like that of 1997, the international commu-nity as a whole must cooperate to meet the foreign currencyneeds of crisis-hit countries. He argued, therefore, that the newswap arrangement was designed to provide supplementary as-sistance to that of the international financial institutions. Heexpected that several bilateral arrangements would have beenconcluded by the time of the next ASEAN + 3 Finance Minis-ters’ Meeting in May. Mr. Kuroda maintained that the ChiangMai Initiative will be effective as a mechanism to handle futurecurrency and financial contingencies in the region. In addition,he thought the development of a financial cooperation frame-work would help promote serious policy dialogue, and greatermutual understanding and cooperation, in response to economicdevelopments in the Asian region. This in turn was expected tofurther enhance regional financial cooperation among Asianeconomies to prepare for future contingencies.

87. Mr. Kuroda concluded by discussing the Japaneseeconomy. He noted that the economy grew by 3.2% at anannualised rate in the fourth quarter of last year, that GDPgrew 1.7% in 2000, but that recently the recovery appeared tobe stalling. Exports have decreased, with the result that in-dustrial production has weakened, private consumption re-mains broadly flat, and the unemployment rate is at ahistorically high level. Mr. Kuroda argued, however, that as aresult of restructuring efforts, the balance sheets of Japanesecompanies have improved, and that they have enough finan-cial strength to increase investment once the situation clears.Provided there was no further deterioration in the externalsituation, such as a prolonged weakness in the US economy,Mr. Kuroda maintained that the slowdown would be tempo-rary, taking into account the impact of the measures for mon-etary-easing implemented by the Bank of Japan (BOJ). Theseincluded changing its operating target from the overnight callrate to the outstanding balance of the checking accounts atthe BOJ, with an eye to stabilizing the consumer price indexabove zero, and increasing its outright purchase of long-termgovernment bonds, where this is thought necessary for pro-viding liquidity.

88. Mr. Kuroda was confident that there would not be a cri-sis, such as a crash of JGBs or a sharp decline of the yen

because Japan was still running a current account surplus ofabove 2% of GDP with net foreign assets at almost 20% ofannual GDP, and because Japan does not have either a fiscalor current account deficit and does not need foreign money tofinance its deficit. He acknowledged that NPLs still remainedon banks’ balance sheets, and that they were depressing banks’core profitability, which ultimately was affecting the recov-ery of the economy. Mr. Kuroda noted that to respond to thisthe Government announced a package of economic measuresin April which required banks to remove outstanding NPLsclassified in certain categories within 2 to 3 years, and whichalso placed certain limitations on banks’ equity holdings. Ascheme would also be established to buy up at market pricethose equities that banks were required to sell. Mr. Kurodacommented that Japanese companies were also under intensepressure to become more efficient: mergers and acquisitionswere in vogue, cooperation beyond traditional business rela-tionships was being strengthened, companies were reconsid-ering their employment policies, and deregulation wasunderway. Mr. Kuroda argued that such structural adjustmenttakes time to produce results, but was crucial for the economyto transform itself to meet the challenges of the new century.

Session 2: Viewpoint of InternationalFinancial Institutions

A. International Monetary Fund (IMF)

89. Mr. Garry Schinasi, Section Chief, Capital Marketsand Financial Studies, International Monetary Fund (IMF),discussed the role of capital markets in Asia. He argued thatone of the important lessons of the crises of the 1990s—andnot just the Asian crisis—was that the performance and struc-ture of a country’s financial system is an important fundamen-tal factor for assessing that country’s overall economicperformance and prospects. He noted that many Asian coun-tries are making strong efforts to reform their financial systemsand move in the direction of a market-intermediated financialsystem away from an exclusively bank-intermediated system.He noted a concern, however, that many of the measures thatwere being taken were only necessary, and not sufficient, foreffective securities markets. A critical element was a recogni-tion that finance—both in banks and markets—is primarilyabout pricing and allocating capital and risk.

90. Mr. Schinasi discussed several key factors in the Asiancontext. He noted that Asia has high domestic savings andinvestment needs, large gross capital inflows and outflows,and bank-dominated financial systems. He argued that, in Asiaas elsewhere, securities markets can improve opportunitiesand returns for savers, reduce costs for borrowers, and im-prove opportunities for pricing risk, and therefore for effec-tive risk management. From a national perspective they canreduce the concentration of risk in the banking and paymentssystem, and improve the ability to prevent systemic problemsby disbursing the ownership of risk. Mr. Schinasi contended


that there are two important reasons why Asia needs securi-ties markets. He said, first, it is simply a more transparent andin some ways a more effective way of pricing and distribut-ing risk, namely of diversifying the financial system. Second,in order to attract and sustain capital flows from abroad, andto allocate more effectively domestic savings at home, inves-tors prefer well designed and regulated markets that are deep,liquid, and transparent, to those that are not. Given the choiceinvestors will gravitate to the safer markets that are more likelyto ensure liquidity, even during turbulent periods.

91. Mr. Schinasi discussed the factors which were necessaryto support the establishment of effective private securities mar-kets. He identified five key elements vital for the developmentof corporate debt markets: 1) well-functioning money markets;2) an appropriate balance between excessive regulation andregulatory delay on the one hand, and weak regulation and su-pervision of markets on the other hand; 3) the elimination ofimpediments to market development from within the financialindustry itself, most often in the form of market power in thefinancial industry which seeks either to stifle access to mar-kets, or to impede the functioning of markets; 4) investmentbanking expertise; and 5) the existence of a domestic investorbase. Mr. Schinasi stressed, however, that these factors werenecessary, but not sufficient characteristics of securities mar-kets, and that there were other more fundamental determinantsincluding legal structures, cultures and histories. Mr. Schinasistated that there was accordingly no simple recipe for how tofoster the development of securities markets.

92. Mr. Schinasi concluded by examining some key charac-teristics of securities markets, and stressed two of them. Thefirst was market liquidity. Mr. Schinasi noted that this cannotbe dictated by regulation, but must be promoted and nurturedby instilling investor confidence, in part by fostering marketintegrity, investor protection, and an effective market infra-structure. Similarly, Mr. Schinasi identified the existence ofan investor base with an appetite for evaluating and trading incredit risk as being a critical factor in developing markets.

B. World Bank

93. Mr. Noritaka Akamatsu, Lead Financial Economist,Financial Sector Development Department, World Bank,described what the World Bank does in the area of capitalmarket reform and development around the world, and thensummarised what the Bank was doing in Asia. He noted thatthe World Bank’s operations in financial sector developmentcould be divided into several categories as follows: 1) Finan-cial Sector Assessment Programs (FSAP); 2) traditional op-erations in the financial sector; 3) lending operations: includingStructural Adjustment Loans (SAL), Private Sector Adjust-ment Loans (PSAL), and Financial Sector Adjustment Loans(FSAL); Financial Intermediation Loans (FIL), back-stop fa-cility loans; 4) and non-lending operations: including research,Technical Assistance (TA), TA loans, and grant-funded andfee-based activity.

94. Mr. Akamatsu noted that the FSAP program was createdin recognition that the IMF and the World Bank needed to bebetter prepared to respond swiftly and effectively to crises inthe financial sector in client countries, such as those whichbroke out in Asia in 1997. He explained that an FSAP is de-signed to make a comprehensive assessment of the state ofthe financial sector of a country with a focus on: i) short-termvulnerability to shocks, and ii) developmental challenges, andpolicy recommendations for reforms. It covers capital mar-kets as part of the financial sector. A decision to conduct anFSAP in a country is based on an agreement with the govern-ment of the recipient country. Mr. Akamatsu confirmed thatduring Fiscal Year 2000, the World Bank and the IMF con-ducted twelve pilot FSAPs which included India andKazakhstan from Asia and Central Asia. He observed that inthis Fiscal Year, 15 FSAPs had been conducted so far exclud-ing those currently going on or in preparation, and that it isplanned to conduct about 20 FSAPs every year.

95. Mr. Akamatsu stated that one specific type of assessmentthe World Bank does in an FSAP is an assessment of acountry’s compliance with various international standards,particularly those for financial sector regulation and supervi-sion. The standards include the IOSCO Principles, the BasleCore Principles for bank supervision, and the IAIS Standardsfor insurance supervision. Mr. Akamatsu noted that assess-ment against the IOSCO Principles is not being done for ev-ery country where an FSAP is conducted, but only for thosefor which a need was recognized in consultation with the hostgovernment. On the other hand, assessment against the BasleCore Principles has been done for all countries so far. Mr.Akamatsu remarked that FSAPs use IOSCO Self-AssessmentQuestionnaires and Methodologies.

96. Mr. Akamatsu explained that the second category of ac-tivities the World Bank undertakes, namely the traditionalWorld Bank operations, can be divided into several sub-cat-egories. They can be divided into lending operations and non-lending operations. A Structural Adjustment Loan (SAL), onekey type of lending operation, which is lent against agovernment’s commitment to implement a set of reform mea-sures agreed with the Bank, can be designed specifically forthe financial sector, and is then called a Financial Sector Ad-justment Loan (FSAL). Another type of SAL which is oftenused to promote non-banking financial sector reform is a Pri-vate Sector Adjustment Loan (PSAL). A general SAL can alsoinclude conditionalities to reform the financial sector. Mr.Akamatsu noted that these various SALs involving financialsector policies are often supported by TAs to strengthen thebanking and the NBFI sectors.

97. A Financial Intermediation Loan (FIL) is a World Bankloan designed to provide credit to banks on condition that thebanks follow a specific lending program (for example SMElending). It is also designed to strengthen the banking sectorparticularly in terms of assessing borrowers’ creditworthiness,typically supported with TA. In comparison, Mr. Akamatsucommented that a Back-Stop Facility Loan is a new lending


instrument with which the Bank has experimented. One ex-ample of this is a sort of standby credit by the Bank to sup-port liquidity in domestic debt securities. The loan is designedto support the sustainable financing of issuers of debt securi-ties. The issuers may be required to follow a certain invest-ment or financing program. Another objective of such ascheme may be to support the development of the domesticbond market.

98. Mr. Akamatsu noted that in addition to the loan-supportedresearch and TAs, the Bank is trying to do more non-lendingoperations which are independent from its lending operations.He observed that many of the Bank’s client countries, includ-ing some in Asia, have attained a middle-income country sta-tus and are able to borrow competitively from the internationalcapital markets or other commercial sources (as well as frombilateral sources). The importance of the multilateral lenderssuch as the World Bank is therefore decreasing. He main-tained, however, that some of these countries still need policyadvice and TAs which the World Bank is able to provide. Mr.Akamatsu observed that for these countries, the Bank’s ad-herence to the practice of linking TAs to loans is not veryconvenient. In some contexts, therefore, Mr. Akamatsu sug-gested that the World Bank is trying to become a combina-tion of a consulting firm and a lending institution.

99. Mr. Akamatsu noted that TA can be financed in variousways. It can be financed with a moderate size Bank loandesigned specifically for that purpose, or with a grant fromone or more bilateral sources. For example, a Capital Mar-ket Development Project (CMDP) is a TA loan designed tofinance a set of TA projects to provide comprehensive sup-port for capital market development. The World Bank, byits charter, can lend only to the public sector such as thecentral/federal government, local governments and/or state-owned companies. Therefore, the contents of a loan-fundedTA tend to be heavily public sector-oriented. In contrast,the International Finance Corporation can provide TA forprivate businesses. TA can be provided also on a fee basis ifthe beneficiary government pays out of its own funds ratherthan borrow from the Bank.

100. Mr. Akamatsu summarised the World Bank’s capital mar-ket operations in Asia, focusing first on work relating to bondmarket development. Following the Asian crisis in 1997, theBank provided a range of urgent assistance, both financialand technical, in which the financial sector was at the core ofthe assistance program. Aside from assisting the restructur-ing of the troubled banking sectors, the Bank focused on sup-porting domestic bond market development. In Asia, the WorldBank conducted a study of the domestic bond markets in 1995,and produced a publication known as “The Emerging AsianBond Market”. In the wake of the crisis, the Bank immedi-ately focused on supporting the “implementation” of policymeasures to develop the market. It also used a significant in-ternal budget to provide policy and technical advice directly,which made this crisis management assistance different fromconventional Bank assistance.

101. Mr. Akamatsu described how in Thailand, for example,the World Bank assisted the Ministry of Finance to createthe Domestic Bond Market Committee, to define theCommittee’s terms of reference and to implement them. TheCommittee established eight Task Forces to address spe-cific issues. While the Bank was closely involved in thepolicy dialogues regarding many of the relevant issues, theTask Forces themselves decided and implemented most ofthe issues. The Bank instead provided assistance to addressspecific technical issues for which some external expertisewas needed. Mr. Akamatsu noted that the Bank attemptedto provide similarly comprehensive assistance for Korea,but its management was organized differently. He stressedthat because countries differ in their institutional strengths,and their need and readiness to work with the Bank, theBank needed to be flexible. He noted that in Indonesia, theBank’s assistance had so far been devoted to public debtmanagement.

102. Mr. Akamatsu observed that other Bank operations oncapital market development in Asia have often been com-bined with, or placed under, differently titled projects. InPRC, for example, the Bank started assisting the govern-ment in its policy towards interest rate liberalization, gov-ernment debt market development, and the government bondsettlement system. In India, the Bank provided advice onthe migration from the account period settlement with a prac-tice called Badla to a rolling settlement. This was a TA pro-vided as a result of the FSAP. In contrast, Bank’s operationsin the transition economies of Central Asia have been drivenby the need for economy-wide privatisation similar to thatin Eastern Europe.

103. Mr. Akamatsu noted that one issue commonly recognizedas important across many countries, including parts of Asia,was that of corporate governance. He observed that the Bankwas assisting a number of countries in the region with a rangeof issues concerning this, and also confirmed that the Bank ismonitoring the impact of information technology, globaliza-tion of the market, and growing inter-market competition. Mr.Akamatsu concluded by stressing that the World is preparingitself to play a useful role in these developments regionally,or internationally, as well as in each domestic market, and isreviewing its resource requirements in order to respond moreeffectively to assist the needs of the clients.

Part II: Designing a Financial MarketStructure in Post-Crisis Asia—How toDevelop Corporate Bond Markets

104. In the second part of the Round Table, Dr. Sayuri Shirai,Associate Professor, Keio University, Visiting Scholar, ADBI,and Dr. Masaru Yoshitomi, Dean, ADBI, talked about theirreport on “Designing a Financial Market Structure in Post-Crisis Asia—How to Develop Corporate Bond Markets”. Thiswas followed by a question and answer session.


105. Dr. Shirai noted that after the Asian crisis, two strongviews became increasingly prevalent. The first was that theheavy dependence on the banking sector was the cause of thecrisis and that the banking system did not perform properlyin Asia. This was thought to contribute to the double mis-matches, and implied that less emphasis should be placed onbanks in the future. The second view was that there was aneed to focus more on developing domestic capital markets,and particularly bond markets.

106. Dr. Shirai identified a series of stylized facts about fi-nancial market structures in Asia. Although banking systemshad been dominant in financing firms’ new investment, coun-tries were increasingly depending on capital markets. Corpo-rate bond markets were, however, largely underdeveloped.This was due to limited issue sizes, relatively short maturi-ties, illiquid secondary markets, and the fact that most bondsare guaranteed or privately placed. Dr. Shirai noted that therole of the banking sector in different countries’ bond mar-kets varied considerably. In different markets across Asia,banks undertook different combinations of the roles of issu-ers, underwriters, investors, and guarantors. Dr. Shirai ob-served that corporate bond markets were underdeveloped dueto a range of factors: underdeveloped government bond mar-kets and a lack of benchmark bonds; a limited supply as therewere few large, reputable firms willing to borrow; limited de-mand because of low per capita incomes and asset accumula-tion, and a preference for bank deposits; underdevelopedinstitutional investors; government policies such as liquidityrequirements, regulations on investments, and interest ratepolicies; and an overall lack of adequate informational, legal,and judicial infrastructures.

107. Given these observations, Dr. Shirai emphasized that thefollowing fundamental questions need to asked. Why are com-mercial banks generally dominant at the relatively early stageof economic development and corporate formation? What doexisting theoretical and empirical studies say about the raisond’etre, functions, and features of bank loans? If these studiesstress banks’ unique roles, then what went wrong with the bank-ing system in Asia? Why are corporate bond markets largelyunderdeveloped? Why does it take a long time to establishviable and sound capital markets, particularly bond markets,even in advanced countries? And, Will Asian countries be ableto develop bond markets in a relatively short time span?

108. Dr. Shirai examined the fundamental differences betweenbank loans and corporate bonds. She noted that firms’ choicesbetween bank loans and bond finance depend on three fac-tors: the severity of the information asymmetry between ulti-mate creditors and ultimate borrowers; the stage of economicdevelopment and whether the relevant country had large, repu-table firms and both institutional and individual investors; andthe development of the informational, legal, and judicial in-frastructures.

109. Dr. Shirai discussed the problems arising from informa-tion asymmetries. She noted that ex ante they can lead to ad-

verse selection problems because those companies which seekto borrow money are most likely to be borrowers who preferrisky projects. Moral hazard problems can also arise and leadsto companies breaking their commitments and yield bad out-comes. Ex post problems can also occur because the exist-ence of liquidation costs may lead to the discontinuation ofloans to viable borrowers. Dr. Shirai observed that there weredifferent methods to reduce agency problems. With bank loans,these included, inside information, repeated transactions,monitoring with expertise and inside information, collateral,and diversifications amongst borrowers. With bond finance,remedial methods include standardized information, the roleof investment banks, monitoring with publicly available in-formation, risk-ratings, and diversifications among investors.Dr. Shirai outlined the importance of the stages of economicdevelopment and corporate formation a country was at, forthe choices of borrowers between bank loans and bond fi-nance.

110. Dr. Shirai described the main features of the informa-tional, legal and judicial infrastructures for bank loans andbond finance. She noted that two areas had different objec-tives. With banks loans, the key objective was how to limitexcessive risk-taking behaviour by banks, and how to avoidsystemic banking crises. The main instruments to achieve thisobjective were enforceable banking laws, prudential regula-tions, the existence of supervisory authorities, deposit insur-ance systems, a lender of last resort, and collateral andinsolvency laws. With bond finance the key objective was howto ensure public confidence in the bond market. The maininstruments to achieve this objective were enforceable secu-rities law, proper accounting, auditing, disclosure rules set onissuers; a securities commission, risk-rating and other infor-mation generating agencies; and a comprehensive judicialsystem. Dr. Shirai argued that a banking system can surviveeven without adequate informational, legal, and judicial in-frastructures (provided that banks hold proper incentives), andthat banks emerge at the early stages of economic develop-ment and corporate formation. In contrast, she maintained thatbond finance requires stringent informational, legal, and in-stitutional infrastructures, and consequently takes time to de-velop.

111. Dr. Shirai asked the question what went wrong with com-mercial banks in Asia if existing studies stress the unique ad-vantages of banking systems. She stated that there were threemain factors for the failure of Asian banks: government inter-ventions in directing credit for projects selected by govern-ments; bailing out banks regardless of viability; and bankownership structures. Together these factors reduced banks’incentives to process inside information and monitor firms.There was a heavy reliance on collateral without adequatemonitoring, there was also inadequate prudential supervision,and finally “relationship-based” banking turned into“cronyism”.

112. Dr. Shirai addressed the issue of why corporate bond mar-kets are largely underdeveloped in Asia. She gave five con-


tributory factors: 1) limited supply; 2) limited demand; 3) in-adequate informational, legal, and judicial infrastructures; 4)underdeveloped government bond markets; and 5) illiquidsecondary markets due to a range of government policies, in-cluding interest rate policy on government and corporatebonds, stamp duty, liquidity requirements, and regulations onasset portfolios. Based on these observations, Dr. Shirai con-cluded that commercial banks are likely to remain dominantin post-crisis Asia, and that it will take time to develop viablecorporate bond markets.

113. Given this, Dr. Shirai asked what can Asian countries doto minimize the risks of double mismatches. She noted thefirst response is to strengthen the soundness of the bankingsector. This requires removing government policies that dis-tort banks’ incentives to collect information and monitor bor-rowers, enhancing internal risk management, and also adoptingprudential regulations. A second policy is to improve the in-formational, legal, and judicial infrastructures that promotethe development of corporate bond markets. The role of thebanking sector in the corporate bond market needs to be re-considered, given that banks can also act as issuers, under-writers, investors, guarantors in the bond markets. Dr. Shiraiconcluded that banking systems and corporate bond marketsare therefore complementary.

114. Dr. Shirai examined the advantages and disadvantagesof “universal bank-type” businesses. She noted that the uni-versal banking model has several major advantages. It allowsfor the full exploitation of “insider information” and moni-toring functions of banks. It may be cheaper due to savings offixed costs. It gives banks more control over profits from se-curities businesses, and this may lead to economies of scaleand scope. Dr. Shirai observed, however, that the bank hold-ing company model also has several advantages. It shieldsbanks against risks that securities activities may entail with“firewall provisions”. It promotes a level playing field be-tween banking and non-banking competitors. It may mitigateconflicts of interest (such as those occurring in insider trans-actions), and may thus be easier to supervise. It promotes capi-tal markets, and may improve efficiency by removingunprofitable activities with high costs and low quality ser-vices. Dr. Shirai noted, however, that it may be difficult toimplement “firewall provisions”.

115. Dr. Shirai drew five tentative conclusions from theanalysis. First, universal banks are currently dominant inAsia. Second, the intermediate financial structure in Asiahas the following features: banks are major buyers and in-vestors, they follow a buy and hold strategy, and reliance onbanks’ interim monitoring leads to underdeveloped creditrating agencies, and to few conflicts between bank creditorsand securities holders. Third, the difference between bankloans and bonds comes from a lengthening of the maturity,so this mitigates a maturity mismatch. Fourth, namely, thequestion of which of the organizational forms for banks (uni-versal banking, holding companies or subsidiaries) was bet-ter, still needed to be resolved. Finally, Dr. Shirai noted that

it is desirable to institute a separation between banks andcommercial firms, thereby limiting banks’ holdings of non-financial firms’ equity.

Question and Answer Session

116. Mr. Tak-Lam Norman Chan, Deputy Chief Executive,Hong Kong Monetary Authority, made three comments onthe merits of a corporate bond market. First he noted thatthe absolute size of corporations matters very much, andthat in this context there may be a threshold for the size ofcompanies below which it is not effective to operate a bondmarket. He noted that the median size of firms in the UnitedStates was high versus the median size of companies in Asia.Mr. Chan observed next that many Asian corporations havea short history, so it is difficult for investors to assess theirrisks. He noted this could be mitigated by the assignment ofappropriate collateral. He argued that sometimes the ratingagencies overreacted because normally bonds do not havecollateral backing them up. Finally Mr. Chan suggested vari-ous ways for breaking the dominance of banking systems,including the use of securitization and negative pledges. Mr.Prasarn Trairatvorakul argued that bankers also face diffi-culties in getting information, and that the measurement ofrisks, though difficult, should be enhanced. Dr. Ruben Lee,Managing Director, Oxford Finance Group, discussed twoissues which were relevant for non-government bond mar-kets in Europe, and which could also be relevant in Asia: theenhanced use of covenants with appropriate disclosure, andthe fact that there is a liquidity-returns trade-off in privateplacements.

117. Mr. Mitsuo Sato, Senior Advisor, Daiichi Life ResearchInsti tute, argued that the notion that there was acomplementarity between bond markets and the bankingsystem was too optimistic. He observed, for example, thatJapanese banks had been strongly opposed to deregulationof the bond market. He also argued that if there was a sepa-ration between securities firms and commercial banks, thenthere would be a dedicated group of people interested inthe securities markets, which does not occur in a universalbanking model. Ms. Lilia Bautista noted that there wereissues concerning confidentiality that arose in an universalbanking context which might conflict with the desires of aregulatory commission for disclosure. Ms. Yeo, Lian Simnoted that the core activity of banks was that of lending,but that under a universal banking model, banks can offer arange of services. Mr. Garry Schinasi identified a differ-ence between wholesale and retail banks. The wholesaleones are international and global and carry large invento-ries of risks in different categories. The retail banks tend tooperate in small communities. He also noted that the uni-versal model of banking and the non-universal model wereconverging. Professor Anthony Neoh argued that whilestructural discussions were important, the most importantissue was pricing.


Part III: Joint IOSCO-CPSSRecommendations for SecuritiesSettlement Systems

118. In the third part of the seminar, Mr. Salvatore LoGiudice, Senior Economist, Market Regulation Depart-ment, CONSOB, Italy, discussed the CPSS-IOSCO (Com-mittee on Payment and Settlement Systems of BIS/International Organization of Securities Commissions) Rec-ommendations on securities settlement systems (SSS), andMr. Stephen Lumpkin, Principal Administrator, Director-ate for Financial, Fiscal and Enterprise Affairs (DAFFE),OECD, discussed some issues relating to the future of na-tional financial markets and trading centres.

119. Mr. Lo Giudice noted that the Task Force that wrote theCPSS-IOSCO Recommendations was created in response toa changing environment in the securities markets due to a rangeof trends: the increased importance of markets in intermedi-ating flows of funds and providing a vehicle for managingrisks; the growth in the volume of cross-border securities trans-actions fuelled by the growth in “collateral transactions” (in-cluding repos and securities lending); changes in marketinfrastructure (such as the evolution of central counter-party(CCP) services, and the convergence of existing infrastruc-ture); the development and modernisation of SSSs in manycountries (in particular emerging economies); and greaterspeed and virulence with which financial turmoil can spread.

120. Mr. Lo Giudice observed that these trends had two im-portant consequences. First, market participants had becomedependent on clearing and settlement facilities not located intheir own jurisdictions. Second, although the current arrange-ments for settling cross border transactions rely heavily onintermediaries, a desire has grown for more efficient and ro-bust settlement arrangements through remote access, links, andintegration. Mr. Lo Giudice then commented on the variousexisting standards for settlement. He argued that: 1) the G30standards for securities settlements (1989) no longer repre-sented best practices in some areas, and did not address somekey issues; 2) IOSCO principle No. 30 was not detailed, andat too high a level to be practically implemented; 3) IOSCO’sdocument “Towards a legal framework for clearing and settle-ment in EMC” focused on legal frameworks, and was not uni-versally applicable; 4) the CPSS “Principle for SystemicallyImportant Payment Systems” related only to payment systems;5) the European Central Bank’s standards were applicable tothe Eurosystem only, and did not address some issues; and 6)the other initiatives, including the FIBV paper on “Clearanceand Settlement Best Practices” (1996), and the ISSA recom-mendations (2000), were private sector initiatives which didnot have widespread support or official endorsement.

121. Mr. Lo Giudice noted that the CPSS-IOSCO Recommen-dations had two broad objectives. The first was safety, whichmeant containing systemic risks in securities settlement sys-

tems and payment systems, and protecting investors. The sec-ond was efficiency, which meant lowering costs both to us-ers, and thereby enhancing their returns, and to issuers, andthereby increasing the rate of capital formation. He identifiedthree key aspects of the scope and characteristics of the rec-ommendations. They should be universally applicable to alltypes of securities including equities and fixed income, andto emerging as well as developed markets. They should em-ploy a functional approach, given the diversity of institutionalarrangements internationally, and should not be narrowly fo-cused on CSDs. Finally the recommendations should be “riskdriven”.

122. Mr. Lo Giudice identified the key risks in clearing andsettlement in securities markets, and described how the vari-ous recommendations sought to respond to these risks. Hedefined first the notion of legal risk as being the risk that lossescould arise because laws are applied in an unexpected wayand/or fail to support system rules, property and other legalrights. He noted that Recommendation 1 responded to this bysuggesting that settlement systems should have a well founded,clear, and transparent legal basis.

123. Mr. Lo Giudice defined the concept of pre-settlement riskas being the risk that a counterparty to an outstanding transac-tion for completion at a future date, will fail to perform on thecontract or agreement during the life of the transaction. He notedthat the effects of this could include one market participanthaving to pay the replacement cost of the failed trade, liquiditypressures on the whole market (if settlement is delayed), andeven potentially systemic risk. Mr. Lo Giudice observed thatsolutions to these problems include: timely verification of tradeson a T+0/T+1 basis (Recommendation 2), the reduction ofsettlement cycles to T+3 (Recommendation 3), the use of tradenetting, while assessing the costs and benefits of a CCP (Rec-ommendation 4), the use of securities lending to minimize fails(Recommendation 5), and the immobilization or dematerial-ization of securities in CSDs (Recommendation 6).

124. Mr. Lo Giudice identified the notion of settlement riskas involving two key risks. The first is principal risk wherethe seller of a security delivers a security but does not receivepayment, or the buyer of a security makes the payment butdoes not receive delivery. Such an event would mean that thefull value of a transaction is at risk, and had the potential togenerate systemic risk. The second element of settlement riskis liquidity risk, where a counterparty does not settle an obli-gation for full value when due, but on some unspecified datethereafter. Mr. Lo Giudice discussed three recommendationsmade in the report to respond to settlement risk as follows.Recommendation 7 states SSS should eliminate principal riskby linking securities transfers to funds transfers in a way thatachieves delivery versus payment. Recommendation 8 statesthat final settlement on a DVP basis should occur no laterthan the end of the settlement day, and that intra-day or real-time finality should be provided where necessary to reducerisks. Recommendation 9 discusses Central Securities Deposi-tory (CSD) risk controls.


125. Mr. Lo Giudice summarised a series of other risks in thesecurities markets the Task Force identified, and describedhow recommendations were made in the report to address theserisks. The other risks included: 1) the possibility that the fail-ure of a bank that provides cash accounts to settle paymentobligations for CSD members could disrupt settlement, andresult in significant losses and liquidity pressures for thosemembers; 2) the operational risk that deficiencies in informa-tion systems or internal controls, human errors, or manage-ment failures will result in unexpected losses; 3) custody risk,which could arise from the loss of securities held in custodyoccasioned by the custodian’s insolvency, negligence, mis-use of assets, fraud, poor administration, or inadequate record-keeping; 4) conflicts of interest amongst different stakeholdersin SSS; 5) the existence of a quasi-monopoly situation in anSSS; 6) governance and access costs and inefficiencies; 7)opaqueness in an SSS, and 8) inadequate regulatory oversight.

126. Mr. Lo Giudice anticipated that the recommendationswould be implemented in most jurisdictions via a nationalplan, developed with cooperation between the private andpublic sectors. He also noted that the IMF and World Bankcould potentially also be involved in assessing implementa-tion via the Financial Stability Forum’s key standards, viaReports on Observance of Standards and Codes (ROSCs), andvia the Financial Stability Assessment Programs (FSAPs).

127. Mr. Stephen Lumpkin, Principal Administrator, Di-rectorate for Financial, Fiscal and Enterprise Affairs(DAFFE), OECD, discussed some issues relating to the fu-ture of national financial markets and trading centres. He ex-amined the question of why should trading centres, be theyregional, national, or international, develop in the first place,and identified four underlying factors. The first was theminimisation of search costs, namely the expenses of findingcounterparties in a market. The second was the minimisationof transport costs. Mr. Lumpkin contended that a tradingcentre’s location is important because it may determine howfar a market participant in a different location will have to goto get there. He argued that because transportation costs doexist, it would suggest some dispersion of financial markets.The third key factor Mr. Lumpkin noted in determining thedevelopment of financial centres was economies of scale. Heargued that as the magnitude of trading and market activity ina given trading centre increases, benefits accrue to marketparticipants and to their operations. Mr. Lumpkin discussed,fourth, the importance of liquidity, noting that investors ev-erywhere prize markets in which they can trade cheaply,quickly, and without large price reactions. As a market at-tracts participants by virtue of its liquidity, it becomes evenmore liquid, and therefore even more attractive to potentialparticipants, and so on in a virtuous cycle.

128. Given the above factors, Mr. Lumpkin examined the ques-tion of why regional and national trading centres continuedto exist at all. He identified five broad reasons: 1) Informa-tion barriers which can arise from differences in language,accounting standards, and incomplete knowledge regarding

foreign investment opportunities, and which dissuade inves-tors from investing in foreign securities. 2) Illiquidity and smallcountry bias. Given that the liquidity of a market is very im-portant to institutional investors, Mr. Lumpkin contended thatsmall countries may be at a disadvantage in this respect, whiledeep and liquid markets benefit greatly. 3) Regulatory barri-ers which governments may erect for a variety of reasons,some of which may be perfectly justified, but whose effectmay discourage foreign investment by domestic investors, ordiscourage domestic investment by foreign investors. 4) Theprimacy of sovereign debt. As typically the largest issuer ofdomestic currency debt securities, and as the ultimate sourceof regulatory authority, Mr. Lumpkin argued that the govern-ment is often the most important player in the domestic fixed-income market, and might prefer that a market be domesticallylocated. 5) The existence of a domestic currency may be animportant factor supporting the existence of a domestic mar-ket, given that use of such a market may eliminate foreignexchange risk for domestic issuers and investors.

129. Mr. Lumpkin identified seven big trends affecting thefuture of national financial markets and trading centres: 1)Globalisation, which he referred to as the increasing integra-tion of nations’ economies. Mr. Lumpkin noted that key ele-ments of globalisation include rising trade in goods andservices, rapid dissemination of technologies, and rising cross-border capital flows. 2) The dismantling of regulatory barri-ers. Mr. Lumpkin noted that ultimately, it is issuers andinvestors, not financial institutions, that are the primary driv-ing force behind the globalisation of the financial interme-diation process. 3) Institutionalisation of Savings. Mr.Lumpkin remarked that there had been a marked increase inthe institutionalisation of savings, as populations age, national“pay-as-you-go” pension programs lose their long-term cred-ibility, and private pension funds and mutual funds havegrown. 4) Technology. Mr. Lumpkin discussed how the ad-vent of electronic trading platforms had the potential to in-crease the competition faced by regional and national tradingcentres, making previously static markets and market activi-ties more mobile, and eliminating the need for physical prox-imity in many market functions. 5) Disintermediation. Mr.Lumpkin described how the advent of direct market financ-ing for large borrowers, techniques such as securitization, andthe institutionalisation of savings, has led to thedisintermediation of financial institutions. 6) Transparency.Mr. Lumpkin noted an increasing desire among investors fortransparency, especially in traditionally opaque fixed-incomemarkets. 7) The trend toward alliances among exchanges. Mr.Lumpkin argued that the ultimate goal is to provide firms thatdo business on a worldwide basis with the opportunity to belisted on exchanges around the world, so that investors aroundthe world will have the opportunity to trade the stocks of in-ternational companies after the home exchange of the com-pany has closed.

130. Mr. Lumpkin analysed the implications of this analysis forthe future viability of national financial markets. He noted thatfrom the point of view of a small open economy, there are three


reasons why there could be concern about the future viability ofnational financial markets: access of domestic investors to glo-bal capital markets, access of domestic issuers to reasonablypriced capital, and the employment and other spin-off benefitsof having a developed domestic trading centre. Mr. Lumpkinargued that the first of these concerns was perhaps the easiest toaddress, because if a global market develops as a result of inter-linkages of domestic markets, then domestic investors wouldenjoy direct access to global markets. He thought the most diffi-cult issue was the second, given that smaller countries, a domes-tic intermediated debt and small cap stock market may not be ata sufficient scale to be competitive. Mr. Lumpkin noted that thelack of reasonably priced capital, particularly for small and me-dium-sized firms could slow economic growth. When examin-ing the third issue, although Mr. Lumpkin accepted that possibilitythat there might be a loss of employment if a portion of a domes-tic financial sector relocates to a global financial centre, this wouldalso be likely to lead to new-found efficiencies in the financialsector, and would free up resources for other productive uses.

131. Mr. Lumpkin argued that the developments he had out-lined would be positive for the world economy, and especiallyfor the economies of the OECD area. He therefore recom-mended that policy not impede developments that improvethe efficiency or stability of the markets. He noted that themove towards global efficiency may be complicated by na-tional borders. The main beneficiaries of globalisation willbe the receiving countries, and those experiencing most ofthe costs will be the smaller countries losing portions of theirfinancial centres. If there is no diminution of services offeredand costs are cut, global financial markets will become moreefficient and all users of financial services will experience anet gain. Mr. Lumpkin stated, however, that on an interna-tional scale, there are few opportunities for the winners tocompensate the losers. He argued this could encourage coun-tries at risk to consider policies to hamper these developments,but that ultimately such policies would only create growingdistortions and would be doomed.

132. Mr. Lumpkin maintained that at a national level regula-tory bodies should support the appropriate, comprehensiveinternational regulation of global financial markets, whetherthrough an international super-regulator or through the evo-lution of existing structures. National regulatory bodies shouldalso seek to ensure an optimal level of transparency in mar-kets, and redundancy in the networks to support the efficiencyand resiliency of markets. Finally, Mr. Lumpkin maintainedthat the development of efficient and robust markets that par-ticipants are comfortable with, is paramount as increased trad-ing leads to the positive externality of greater market liquidity,and hence, stability.

Part IV: Overview of InstitutionalInvestors in Asia

133. In the fourth part of the seminar, the key issues underdiscussion were how to promote institutional investors in Asia,

and the regulatory framework necessary for their sound de-velopment. The part was composed of four sessions. In thefirst, an introduction to the issues was presented. In the sec-ond, long-term trends in the Collective Investment Schemes(CIS) sector were discussed. In the third session, some issuesrelated the legal and regulatory frameworks for CIS were ex-amined. Question and answers were discussed in the last ses-sion. The chairman for the second day of the Round Tablewas Dr. William Witherell, Director, Directorate for Fi-nancial, Fiscal and Enterprise Affairs (DAFFE), OECD.

Session 1: Introduction

134. Ms. Shamshad Akhtar, Manager, Finance and Indus-try Division (East), Asian Development Bank (ADB), dis-cussed the current situation in Asia with regards institutionalinvestors. She noted that institutional investors play the fol-lowing key roles: efficient pooling of investments to providelong-term funding and stability to capital markets; risk mitiga-tion and diversification for intermediaries’ and investors’ port-folios; reduced reliance on, and exposure to, commercial banks;financial innovation, in that they provide an impetus for themodernization of capital markets and contribute to competitivebidding for corporate securities; transparency and informationdisclosure by strengthening corporate governance and marketintegrity; and protection of minority shareholders from marketmanipulation and exploitation by controlling groups.

135. Ms. Akhtar remarked that a robust and efficient institu-tional investor sector requires three key factors: the availabilityof long-term funds channeled by exploiting pension and insur-ance funds; the presence of a well-developed and modern se-curities market, and supportive depository, clearing, andsettlement infrastructure. She then commented on the condi-tions that are sufficient for institutional investors. These includean adequate regulatory framework; adequate investment op-portunities in sound companies demonstrating good governance,disclosure and compliance; the existence of a rational tax re-gime that treats equity and debt securities equally, that doesnot create disincentives by taxing premiums, but that does pro-vide tax incentives for pension collection; the enforceability offinancial regulations and property rights; conducive regulationsthat promote competition, sound practices and transparency;the development of professional fund managers; and the pres-ence of a network for investors’ advocacy and education.

136. Ms. Akhtar noted a range of constraints limiting the growthof institutional investment, including: the dominance of thebanking sector in financial intermediation; the existence of largerural populations who have no access to collective investmentvehicles or other modern high-yielding instruments; the depen-dence on family conglomerates which rely more on internalcorporate earnings than on capital markets; the difficulties ofleveraging alternative domestic long-term funds due to the slowgrowth of securities markets and institutions; the pre-emptionin some countries of private sources to meet immediate fiscalrequirements; and investment criteria restrictions placed on pen-sion funds and insurance companies.


137. Ms. Akhtar discussed the three main types of institutionalinvestors in Asia in turn, namely pension systems, the insur-ance industry, and investment companies and mutual funds.She noted that although Asian pension systems vary substan-tially both in terms of their coverage, and the terms and condi-tions they offer, several groupings may be identified. These aremandatory provident funds, mixed pension systems based on acombination of pay-as-you-go (PAYG) and occupational plans;and a variant of a mixed pension system or a multi-pillaredsystem. Ms. Akhtar noted that the ADB has been promotingpension reform in most developing market countries by seek-ing to raise funding, streamline benefits and contributions,strengthen administrative systems, and develop capital markets.

138. Ms. Akhtar identified a range of issues and challenges fac-ing pension systems. These included increasing old-age depen-dency ratios and inadequate coverage of the existing populations;unfunded and generous PAYG schemes for government and pub-lic sector employees; the economic unsustainability of currentpension systems, complicated by the difficulties of formulatingviable policy options and selling them to the electorate; conflictbetween the competing objectives of earning adequate returnson investments and the need to “mop-up” government securi-ties at low returns; relatively low retirement ages; weak admin-istrative structures for collecting contributions, recordmaintenance, and pension payments; weak design of benefitsdue to high replacement rates, and a lack of portability of pen-sion systems; regressive and uncertain tax treatment of pensionsavings; and a lack of depth in the capital markets.

139. Ms. Akhtar commented that the Asian insurance industryis small compared to those in North America and Europe. Atone end of the spectrum are Japan and Korea where life insur-ance sector penetration is among the highest in the world. At theother end, in a number of transitional and very poor countries,life insurance is virtually non-existent. Ms. Akhtar identified thefollowing issues and constraints facing the insurance industry:low statutory paid-up capital and solvency requirements; inap-propriate financial reporting; limited consolidation of the insur-ance sector; difficulties in rationalizing and consolidating theinsurance industry, because of vested interests and a lack of ef-fective oversight; the difficulties of using public capital to re-capitalize the industry; ineffective retailing of insurance products;a lack of competitive pricing; weak management; and the weakcapacity of regulators and supervisors of the insurance sector.

140. Ms. Akhtar noted that the mutual fund industry is at dif-ferent stages of development across Asia. She observed thatfor the industry to grow, the following impediments needed tobe addressed: the fairly high front-end fee structure, includingboth management fees and switching fee, and a lack of govern-ment incentives, particularly advantageous tax treatment.

141. Ms. Akhtar identified five broad sets of obstacles hinder-ing the development of institutional investors: 1) Macroeco-nomic constraints, such as unstable price behaviour, negativereal interest rates, a lack of exchange convertibility, oneroustax regimes and unequal tax treatment of debt versus equity,and structural constraints in the design of old age security sys-

tems that operate on a PAYG basis. 2) Capital market constraints,including a lack of depth and breadth in the markets, low mar-ket capitalizations with limited numbers of stocks, the illiquid-ity of government bond markets, the absence of domesticcorporate debt markets, and a lack modern clearing, settlement,and depository systems. 3) Regulatory constraints includingthat in some economies large proportions of pension and insur-ance funds are preempted, in order to provide cheap sources offinance for government, restrictions on the composition of in-vestment portfolios, low capital standards, and a lack of effec-tive supervision. 4) Weak governance standards, which allow,for example, privately-controlled groups to further the inter-ests of market participants other than fund beneficiaries. 5) Weaklegal infrastructure, including inadequate trust provisions, con-tract law, and bankruptcy law, and also difficulties in the en-forceability of contracts.

142. Ms. Akhtar concluded that economic growth and the ac-cumulation of savings in a secure environment, is essentialboth for social protection and to prevent individuals from slip-ping below the poverty line. She noted that at present Asiancapital markets are too volatile for individuals to entrust theirsavings, and in some economies do not have the sort of vol-ume to enable them to indulge in proper diversification. Bybringing together the savings of individuals, institutional in-vestors take the stakes and risks, and wield the clout whichindividuals cannot, and by doing so, they can increase theoverall stability of the markets.

Session 2: Development of CollectiveInvestment Schemes (CIS) and PensionFunds

143. Mr. John Thompson, Counsellor, Directorate for Fi-nancial, Fiscal and Enterprise Affairs (DAFFE), OECD,examined recent trends in CIS in OECD Countries. He firstnoted that different kinds of CIS operate in different coun-tries, including mutual funds (US), unit trusts (UK, Australia,New Zealand, Singapore, Hong Kong, China), investmenttrusts (Japan and Korea), European contractual funds (FondsComons de Placement, Kapitalanlagefonds), and Europeancorporate funds. A key difference is between open-endedfunds, which have an unlimited number of shares, and areredeemable at Net Asset Value (NAV), and closed-ended fundswhich have a fixed number of shares, are listed on exchanges,and which fluctuate in price depending on supply and demandfactors.

144. Mr. Thompson observed that CIS typically have severalcommon characteristics. They allow small investors to pooltheir savings, and thereby obtain more opportunities in capi-tal markets and diversify their portfolios. Mr. Thompson notedthat normally small investors cannot trade efficiently, but alsothat the Internet was beginning to enable such investors toraise their efficiency of trading. Mr. Thompson remarked thatCIS normally have a defined legal and governance structure,are subject to special laws and regulatory structures, have their


own internal systems to resolve conflicts of interest, are sub-ject to disclosure rules, and are typically managed profession-ally with transparent investment policies and low costs ofexecution.

145. Mr. Thompson assessed the size of the CIS Market in2000 to be $6,900 billion in the US, $4,500 billion in Eu-rope, $450 billion in Japan, and $180 billion in Korea. Henoted various factors underlying the growth of CIS in OECDCountries. These included: disintermediation, namely theprocess whereby the capital markets are gaining at the ex-pense of banks; the strong performance of the US and Euro-pean bond and equity markets since the early 1980s; theimportance of funded pensions (and especially defined con-tribution plans) for retirement; and the institutionalization ofwealth. Mr. Thompson observed that financial institutions arenow targeting individual savings for portfolio management.He also identified a range of institutional reforms in OECDCountries that were increasing the demand for CIS, includ-ing deregulation, pension reform, CIS reform, and the UCITSDirective in the EU.

146. Mr. Thompson discussed the distribution channels forCIS. He noted that in the early days, they had been controlledby the fund promoters, namely banks with their branch net-works, full service brokers with their account executives andsales personnel, and insurance companies with their salesforces. This was enhanced because of the reputations of thepromoters, and also the large amount of proprietary funds theymanaged. Mr. Thompson observed, however, that there was agrowing diversification of channels. New providers includedpension plans, discount brokers, fund specialists, independentfinancial advisors (IFAs), cross selling, and over the Internet.Consumers were more oriented towards fund performance.Mr. Thompson suggested that in the future the industry mightbe organized on an open architecture basis with few ties be-tween fund promoters and distributors.

147. Mr. Thompson then described the range of investment strat-egies CIS pursue, noting that with more competition and infor-mation, the range of strategies had increased. The strategiesinclude investing in equities, bonds, money markets, balancedfunds, or funds with a choice over their asset allocation.Amongst the types of strategies followed in equity investmentswere those investing in growth stocks, value stocks, small capstocks, high technology stocks, sector investments, and inter-national stocks. Mr. Thompson noted that there were differentdegrees of manager discretion, ranging from funds followingan index, to discretionary funds, to those pursuing active value.Mr. Thompson observed that there is an informational asym-metry between the small number of large intermediaries andthe dispersed group of small investors. He noted, however, thatthe infrastructure for information dissemination concerning CIShad developed over time from the general financial press,through the specialized CIS Press, through the rating services(for IFAs and for retail investors), to the Internet.

148. Mr. Thompson concluded by identifying the followingissues and problems concerning CIS. The issue of market ac-

cess in different countries remained controversial, and this isclosely related to international agreements on internationaltrade in services. There remain gaps in information about theperformance of some CIS, and the costs associated with them.CIS are likely to have a growing role in corporate governance.There is a growing trend for ethical and environmental funds.Competition is growing from newer products, including closedend funds, exchange traded funds, and customized investmentbaskets. The markets might be facing a turning point in theirperformance, after a long period of rising prices, and it isunclear whether the growth in CIS would continue in the faceof a sustained bear market.

149. Mr. Yuta Seki, Financial Industry Analyst, CapitalMarket Research Unit, Nomura Research Institute, exam-ined the current situation of CIS in Asia. He identified severalfactors why CIS are important in Asia. They may facilitatethe optimization of personal financial wealth asset manage-ment, by providing individuals a vehicle for diversificationinto more risky assets with a long time horizon. The estab-lishment of professionally managed CIS may broaden the in-vestor base, and deepen the capital market. Mr. Seki arguedthat this could act as a counter-balance to the previously ob-served trend of participants in Asian capital markets all mov-ing in the same direction simultaneously, and thus contributingto the bubble-burst cycles. He noted that fostering the fundmanagement industry may also positively impact domesticfinancial industries, through the development of financial tech-nology and internationalization of financial market activities.Mr. Seki observed that many Asian countries are moving to-wards making the fund management industry more competi-tive.

150. Mr. Seki identified a range of key trends affecting thedevelopment of CIS in Asia. He noted that a high domesticsavings rate is a common characteristic in Asian countries,but that there had been a low penetration rate of CIS in Asia.Mr. Seki argued that although the assets under managementin Asia have been rapidly growing during the past decade,this was not because of the growing popularity of CIS, butrather because of overall household asset accumulation. Heobserved that it was difficult to explain the unpopularity ofCIS in Asia. Amongst the reasons could be cultural issues,the biased capital markets in the region—such as the pres-ence in Japan of the Postal Savings system in gathering house-hold assets which might have created a “safety zone” isolatedfrom the competitive market mechanism, and the fact that se-curities houses and fund managers may not have made greatefforts to win investors’ trust.

151. Mr. Seki discussed the Japanese environment for CIS.He noted that the Japanese government had conducted threemajor regulatory reforms governing CIS over the past de-cade. Amongst the key elements of the first two reforms werethe liberalization of the licensing system, the expansion ofpermitted investment assets, and enhanced disclosure andreporting. As a result of this deregulation, Mr. Seki notedthat the number of asset management companies in Japanincreased significantly, especially with the entry of Ameri-


can and European asset managers. Mr. Seki described howthe third “Tokyo Big Bang” program started to be imple-mented in 12/1998, and the evolution of the investment trustsystem was one of the major goals of this program. In 1999,a CIS working group was set up in the Financial SystemCouncil, the advisory board for Ministry of Finance, andthis working group sought to revise two laws: the SpecialPurpose Company Law and the Investment Trust Law. Thesetwo revisions passed the Diet in 5/2000, and became effec-tive 11/2000.

152. Mr. Seki observed that the new Investment Trust Lawhad two drastic changes. First, it broadened the range of in-vestments allowed. Under the former legislation, an invest-ment trust was supposed to be a collective fund mainly forinvesting in public securities, but now investment in almostall types of financial assets is allowable. The second changein the law was to redesign investment trust schemes. Mr. Sekinoted that three types of investment trust schemes are nowallowed in Japan. Two are contractual-type investment truststructures: a non-discretionary investment trust, which is themost common structure in current Japan, and a discretionaryinvestment trust, which is a newly established form of invest-ment trust. Under a discretionary investment trust, trust banks,which formerly played only a custodian role, can managefunds by themselves. The third type of fund allowed is a cor-porate-type investment trust, called an investment corpora-tion. Units of an investment corporation are similar to theshares of an ordinary corporation, and the investment corpo-ration structure resembles the US mutual fund structure.

153. Mr. Seki discussed three aspects of innovation in CIS inAsia, focusing on new products. The first was the develop-ment of Real Estate Investment Trusts (REITs), or propertyfunds. In Japan, these newly allowed funds are called J-REIT.Mr. Seki noted the four major characteristics of J-REITs: 1)J-REIT funds will be invested in commercial real estate andnet operating income will be distributed to unit holders—thisimplies that they be provided stable, relatively high-yield,“cash machines”, as the net income of REIT was not expectedto depend on any capital gains of the underlying assets. 2) J-REITs are tax-transparent, which implies that double-taxa-tion can be avoided if an investment trust pays out over 90%of income available for dividends. 3) Regardless of corpo-rate-structure, J-REITs must be operated externally. 4) Unitsof J-REIT will be traded on a stock exchange.

154. The second type of innovation in CIS Mr. Seki describedwas the introduction of the defined contribution pension plan.He noted that they were being established against a back-ground of rapidly aging populations, an increase in the mo-bility in the labour market and the need for portability ofpensions, worsening economic performance, diminishing con-fidence in defined benefit plan, and projected excessive debtin corporate pension funds. Mr. Seki observed that the keybenefits of defined contribution pension plans are that thebenefits are determined by returns from pension funds, thatemployees can choose their own plan among many financialproducts, and that employees may enjoy tax benefits even if

they change jobs. Mr. Seki remarked on the impact of thisdevelopment on the fund management industry, with the en-try of new players and a race to develop new products.

155. The third type of innovation relevant for CIS Mr. Sekianalyzed was the creation of Exchange Traded Funds (ETF).He noted that these are listed funds or investment trusts thathold portfolios of common stocks which closely track theperformance and dividend yield of specified price indexes.Mr. Seki noted that ETFs had several benefits: they could betraded at any time during the trading day, unlike most invest-ment trusts which can be redeemed only next day after aninvestor request; ETFs have no sales loads, although broker-age fees will apply; they are passively managed; and theygenerally have lower management and expense fees.

156. Mr. Hugh Davies, Executive Director, Prudential Cor-poration, analysed the development of pension systems andtheir relevance for capital market development in Asia. Hestressed that the most important factor underlying the push to-wards better pensions systems in Asia is demography, and theageing of the workforce. He noted that Japan is a prime ex-ample, where there will be as many adults over the age of 80 by2020 as there are children under the age of 8. One in four peoplewill be over 65. He noted that the US Census Bureau had pre-dicted that 422 million people will be over 60 in Asia by 2025,more than double the number today. The percentage of work-ing-age people in the population will also be shrinking.

157. Mr. Davies argued that long term savings schemes,whether life insurance or pensions have many benefits notonly for the individual, but also for the national economy.Such schemes bring together the small savings of individualsand channel them into productive and stable long-term in-vestments. Mr. Davies observed that it is in countries whosefinancial systems are least modernised, that the developmentof institutional pension schemes will have the greatest impacton capital markets. A major benefit is that, through domesti-cally mobilised capital accumulation, countries become moreself-sufficient and less reliant on foreign funds and loans.

158. Mr. Davies summarised how seven economies in theregion—Hong Kong, China; PRC, India, Singapore, Malay-sia, Vietnam and Taipei,China—are addressing the pensionsissue. Discussing Hong Kong, China first, he noted that theMandatory Provident Fund (MPF) system coming into op-eration provides for joint contributions by employer and em-ployee, each contributing 5% of the employee’s relevantincome to a registered MPF trust scheme, subject to a maxi-mum and minimum level of income for contribution purposes.The accrued benefits will be fully vested in the scheme mem-bers and can be transferred from scheme to scheme whenemployees change or cease employment. A self-employedperson will have to contribute 5% of his relevant income. Innormal circumstances, benefits must be preserved until re-tirement.

159. Mr. Davies observed that the last twelve months hadbeen hectic as preparations for the MPF have gone ahead


and the scheme has been launched. He believed the effecton the Hong Kong capital markets would be substantial. Itis estimated that annual MPF contributions will amount tomore than HK$10 billion in the initial years of operation,rising to some HK$60 billion per year when the systemmatures after 30 years. As a result a significant local institu-tional investor base will develop. Mr. Davies observed thatthe MPF should prompt strong demand for Hong Kong dol-lar fixed assets allowing the local bond market to develop asa source of funds for SAR government entities andcorporates, as well as mainland borrowers. There will alsobe increased demand for trust and custodial services, invest-ment management and scheme administration.

160. Mr. Davies noted that PRC’s situation is complicated by anumber of factors: the size of the country, its diversity, its enor-mous numbers of people, the restructuring of State Owned En-terprises (SOEs), which is resulting in the dismantling of theformer pensions and welfare systems of the earlier socialistmodel, and the impact of the one-child family policy, whichdespite its positive impact in contributing to the raising of liv-ing standards, will add to the financing difficulties as PRC movesto establish a nation-wide social safety net. Mr. Davies observedthat the PRC Government is establishing a hybrid public/pri-vate pension system, which is still at an experimental stage,and has so far been applied only in limited geographical areas.

161. The model is based on the Three Pillars approach. Pil-lar One is a reformed mandatory state-run “pay as you go”contributory system. Pillar Two is a supplementary fully-funded defined contribution pension, to which employers areencouraged to contribute (but with little success to date, giventhat there is no compulsion and no tax benefits). Pillar Threeis an entirely voluntary individual privately managed savingsscheme, which is becoming increasingly popular among thebetter-paid urban workforce. Mr. Davies noted that the firstpillar is most developed, that for the second pillar, unlike manyother emerging markets, PRC is not facilitating the creationof competing privately managed funds, but rather a centralisedand state-managed system, and that the third pillar will con-sist of voluntary privately managed arrangements.

162. Mr. Davies identified two problems that are occurring inthe transition to the new environment: first, the fact that thepresent generation of pensioners and those going to retire overthe next 15 years will not have made sufficient contributionsto be eligible for the new pension; and, second, the real like-lihood that many SOEs will be financially unable to meet theirpensions obligations. He observed that the government hasthus needed to raise money through bond issues to enableenterprises to meet these liabilities, and argued that this un-derlines the need for PRC to move rapidly to expand the capi-tal markets. Mr. Davies stressed that there is a determinationin the country to take the necessary steps to do this. One keyissue he discussed was the urgent need to allow foreign insti-tutional participation in the capital markets.

163. Mr. Davies observed that India faces many similar prob-lems to PRC. Its population is growing rapidly, is ageing, 89%

of the working population have no formal provision for old-age security, the existing four public occupational pensionprograms suffer weaknesses, particularly because of their lowreturns due to a regulatory requirement to invest only in gov-ernment securities, and early withdrawals are also notpenalised. Mr. Davies described a series of reform proposalsnow under consideration to respond to these problems. Theyinclude that the pensions system: should be accessible by allpeople at any point of presence, such as nation-wide post of-fices, or banks; should be individualised, portable, voluntaryand easy to understand; should not receive any governmentsubsidies or tax incentives, but should have a 10% penalty onearly withdrawal; should have no lower limit on contributions;should have accounts which may be used as collateral againstbank loans, while leaving the pension funds untouched; shouldhave private fund managers, with a target 0.25% cap oncharges; and finally should be such that upon retirement theaccumulated funds should buy an annuity.

164. In discussing Singapore, Mr. Davies noted that the Cen-tral Provident Fund (CPF) had contributed significantly to theeconomic development of Singapore and to the welfare of itscitizens. He commended its flexibility, with three separateaccounts, allowing individuals to use some of their CPF sav-ings for different approved purposes, including house pur-chases and medical insurance. He noted, however, that it doesinvolve unusually large contributions in normal circumstances,of 20% of salaries by employees plus 20% by employers. Mr.Davies discussed how the investment of CPF contributionshad been steadily broadened over time from a highly conser-vative strategy that guaranteed a safe return, to a moreliberalised spread of vehicles, while retaining important safe-guards. He noted that further liberalisation is taking place thisyear, the effect of which would be to increase the proportionof savings over which individuals take their own financial plan-ning responsibility. Mr. Davies argued that the CPF had pro-vided a very large pool of capital for Singapore’s capitalmarkets over many years, and had been a crucial factor be-hind the development of the country’s role as an internationalfinancial centre.

165. In discussing Malaysia, Mr. Davies observed that the EPFin Malaysia had the same origins as Singapore’s CPF, but thatits management over the years had been somewhat different.He contended that despite a rising trend of contributions, Ma-laysia, with its ageing population, must find new ways of pro-viding for the retirement needs of its people. This isparticularly so, since expectations of higher living standardsmean that today’s and tomorrow’s retirees will be looking formore retirement income than their parents. He argued that theEPF is therefore likely to prove inadequate for increasing num-bers of individuals whose retirement provision could be en-hanced by additional privately-funded pensions. He believedthat if further supplementary savings vehicles were encour-aged by the government, there would be knock-on benefitsfor the markets more generally.

166. Mr. Davies argued that Viet Nam would have a demo-graphic and pensions time bomb in about 20 years’ time. He


noted that the country has relied heavily on the traditionalfamily support mechanisms to protect the older generations,supplemented by basic social provision for the more desti-tute, but that the hyperinflation rates in the 1980s have greatlyreduced the payout value for pensioners. Mr. Davies stressed,however, that reforms were being introduced. The Vietnam-ese authorities have invited some foreign insurance compa-nies into Viet Nam, and this has attracted enormous attention,and the flow of premiums into life insurance policies has beenconsiderably faster than the most optimistic forecasts. He ob-served that the creation of pension funds is not expected foranother few years. Mr. Davies argued that a decision to openup the financial market further would create a strong founda-tion for the pensions industry. Viet Nam has one of the mostunder-developed capital markets in the region. However, thingsare changing for the better, witnessed by the opening of thestock market and the government’s recent experiment withissuing bonds at an interest rate determined by the market.

167. Mr. Davies observed that Tapei,China will face demo-graphic pressure within a few years on retirement benefits. Atpresent, however, there is no government-run pension scheme.The only statutory driving force on the local pension marketis the Labour Standards Law (LSL). Under the LSL, compa-nies are required to cover all the pension costs of employees.Employers must contribute a minimum of 2% of employees’salary, up to a maximum of 15% to the Central Trust of China.This fund has a minimum return guarantee, based on two-year term deposit rates and coverage of any shortfall by thegovernment treasury. The individual’s fund cannot be trans-ferred out of the Central Trust except for retirement payment.The private pensions market in Taipei,China is still small andparticipation is not common.

168. Mr. Davies concluded by noting some general trends.More people are living longer, with higher expectations of areasonable quality and standard of life. The challenge for eachsociety is to find the best solution, suitable for its own citi-zens, based on its own traditions and expectations, but onecapable of meeting the aspirations of both the retirees and ofthose in the workforce into the future. In order to be success-ful, these solutions will have to go hand in hand with the de-velopment and modernisation of local capital markets.

169. Professor Eisuke Sakakibara, Keio University,Former Vice Minister for International Affairs, Ministryof Finance, Japan gave a lunchtime speech on the currenteconomic situation in Japan.

Question and Answer Session

170. Professor S. Ghon Rhee, K.J. Luke Distinguished Pro-fessor of International Finance and Banking, University ofHawaii, noted that unfunded pension liabilities comprise upto 100% of GDP in some countries, and wondered what anappropriate policy response to that was, given also that thesecountries might already have a large amount of governmentdebt relative to GDP, and that corporate debt might be rising

in the recession. Ms. Lilia Bautista suggested that companypension funds appeared not to be regulated in many coun-tries, and wondered whether this was true. Mr. Aitken ob-served that many companies are out-sourcing the pensionfunds to fund managers, who are normally regulated. Mr.Prasarn Trairatvorakul observed that there was a close corre-lation between the size of CIS and the performance of thecapital markets. He then asked the question as to whethergovernments should allow CIS to invest abroad.

171. Ms. Shamshad Akhtar noted that the ADB advocates thatgovernments should allow fund managers to invest overseas.However, she observed several factors that might go againstsuch a policy. For example, countries may have very limitedlong-term funds, and allowing them to go abroad would evenfurther reduce the amount, and it may be politically sensitiveto allow investment abroad. The ADB promotes a policy mixfor the provision of pension funds. This includes seeking toimprove public resource management, tightening retirementand benefits packages, and for those countries which own largestate assets, selling them to fund liabilities. Mr. John Thomp-son noted that all OECD countries had removed controls oninvestment, and argued that funds should seek to maximisethe interests of the final investor, and that national consider-ations should not bias this goal.

172. Mr. Mitsuo Sato suggested that institutions must seek toimprove the corporate governance of the companies in whichthey invest, in order to enhance their returns. Mr. Ian Johnstonenquired about the rate of growth of investors in CIS com-pared to the rate of growth of direct holdings in shares. Mr.John Thompson responded that in most markets, it is the in-stitutional side which is growing faster. Mr. Ian Johnston notedthat in Australia there was regulatory concern that individu-als’ investments in privatised shares are not sufficiently di-versified. Professor Neoh noted that the sequencing device ofa demographic reserve, set aside from fiscal reserves, couldfacilitate transition periods for the provision of pensions. Thismight be relevant for countries with a large amount of assetswhich were to be privatised, a percentage of which could beplaced in the demographic reserves.

Session 3: Legal and SupervisoryFrameworks for CIS

173. Mr. Robert Aitken, Financial Services Authority (FSA),UK, described the activities of IOSCO, and the UK experi-ence, concerning legal and regulatory frameworks for CIS. Henoted that Working Party 5 of IOSCO had done a range of work,including developing principles for the regulation of CIS, de-tailing best practice standards in a number of areas of CIS op-erations, and analysing particular aspects of CIS operations fromthe various countries’ regulatory stand- points. The WorkingParty initially established some principles covering both theregulation and supervision of CIS, including international co-operation in relation to cross border activity, and then followed


this up with more detailed work on some technical aspects ofCIS. Mr. Aitken noted that members shared not only their cur-rent legal and regulatory regimes covering such issues but alsotheir more detailed and practical experiences of these issues.He stressed that as cross-border activity grows, and factors suchas the Internet demonstrate that there are no boundaries, thecontinued work of Working Party 5 is viewed as vital by IOSCOin enhancing the co-operation and the exchange of informationbetween member states.

174. Mr. Aitken identified several subjects on which WorkingParty No 5 was currently working, including: the relative riskassessment of CIS operators, using a questionnaire and riskmodel; simplified prospectuses; CIS investment restrictions;corporate governance of CIS; and CIS performance advertis-ing. Other issues being examined are countries’ standards con-cerning past performance disclosure, and countries’ standardsregarding investment restrictions.

175. In his discussion of the UK experience, Mr. Aitken notedthat the legal basis for the FSA was going to be established inthe new Financial Services and Markets Act, and hesummarised the anticipated timetable leading up to the pas-sage of the legislation. He then outlined the structure of thenew “FSA Handbook of rules and guidance”, noting that itcontained a five-level structure. Block 1 contained the highlevel standards including principles, businesses and individu-als’ and senior management responsibilities. Block 2 containedthe business standards, and included being detailed informa-tion about prudential and conduct of business rules, marketconduct and money laundering. Block 3 contained the manu-als for regulatory processes about authorisation, supervisionand enforcement. Block 4 contained information about re-dress, complaints and compensation. Finally Block 5 con-tained specialist sourcebooks with detailed rules.

176. Mr. Aitken summarised the FSA’s new operating frame-work, by describing how the statutory objectives and prin-ciples guiding the FSA would feed into a continuous cycle ofactivity in which risks were identified, then assessed andprioritised, then optimal regulatory responses were decided,then resources appropriately allocated, and finally regulatoryperformance was evaluated. Changes in the scope of regula-tion, and major new product developments would also inputinto this cycle. Mr. Aitken noted that the chief aims are toidentify the main “risks” to the statutory objectives imposedon the FSA, to assess their impact and probability, to create apreliminary risk profile of firms and risk categories, and tocatalogue and detail the FSA’s regulatory toolkit. Mr. Aitkenargued that while regulation in the past has tended to focuson individual institutions, and while this was still important,a regulator needs to look beyond individual institutions if itwishes to be pre-emptive in identifying and mitigating risks.

177. Mr. Aitken noted that the FSA had concluded that risks toits objectives would come from three main sources: 1) the ex-ternal environment, for example an economic downturn or mar-ket turbulence; 2) consumer and industry wide risks, for examplenew products or new technology; and 3) regulated institutions.

He noted that the new legislation requires the FSA to adopt aproportionate approach to regulation so that it must considerthe costs to institutions and consumers as a result of regulationin conjunction with the benefits derived. Mr. Aitken observedthat the priority the FSA gives to a particular risk depends onits assessment of two factors: impact and probability.

178. Mr. Aitken summarised the principal indicators used toassess the impact of individual firms, by sector, as follows: forbanks, it is their total assets/liabilities and deposits (weightedaccording to type of holder); for life assurers, their total assets/liabilities; general insurers—gross premium income; for secu-rities and futures firms, their total assets/liabilities, financialresources requirements, number of registered individuals, vol-ume and value of daily trades; for fund management firms in-cluding CIS operators, their funds under management; and forinvestment advisory firms, their number of registered individualsand annual turnover. Mr. Aitken observed that probability as-sessments would be based on an assessment of business andcontrol risks. He observed that the FSA sub-divided businessrisks into issues relating to: market, credit, operational and le-gal risk; financial soundness; strategy; and the nature of a firms’customers, products and services. Control risks arise from in-stitutions; marketing, selling and advice practices, systems andcontrols; organisation; and board, management and staff.

179. Mr. Aitken outlined the broad types of regulatory toolsavailable to the FSA as follows: diagnostic tools—to iden-tify, assess and measure risks; monitoring tools—to track thedevelopment of identified risks; preventative tools—to limitor reduce identified risks and prevent them crystallising orincreasing; and remedial tools—to respond to risks when theyhave crystallised.

180. Mr. Aitken noted five main elements the FSA would usein its relationship with its regulated institutions: 1)authorisation (including initial risk assessment), which re-quires firms demonstrate, both initially and on a continuousbasis, that they are meeting the “threshold conditions”; 2)baseline monitoring, which is designed to ensure institutionscomply, on a continuing basis with their regulatory require-ments; 3) sectoral reviews, which validate information pro-vided by firms, and thematic work which assesses the risksposed by a particular issue; 4) programmes designed to miti-gate specific risks in individual institutions (but Mr. Aitkennoted that the FSA does not have a zero failure regime); and5) work undertaken after particular risks have escalated orcrystallised.

181. Mr. Aitken stressed that the FSA aims to give institu-tions a greater incentive to behave in ways which reduce theirregulatory burden. So institutions which represent a low riskto the FSA’s objectives and which may in the past have beensubject to regular routine monitoring visits, should see suchvisits cease. Instead such visits will be replaced by a combi-nation of sample visits to monitor general compliance stan-dards in a sector; visits as part of sectoral reviews or cross-FSAthematic work, and visits to deal with issues that arise fromthe FSA’s baseline monitoring of returns. While Mr. Aitken


noted that some of the current close and continuous interac-tion with the FSA would lessen considerably, institutions mayhave contact with the regulator in differing ways as the toolkitis developed. He also emphasised that with the introductionof senior management responsibilities, firms will need to en-sure that they take their regulatory responsibilities seriously.

182. Mr. Yoon, Yeo Kwon, Director, International Co-op-eration Division, Financial Supervisory Commission(FSC), Korea, presented the experience of Korea regardingthe legal and regulatory frameworks for CIS. He noted thatthere are two major types of investment funds allowed inKorea: investment trusts which are governed by the Securi-ties Investment Trust Act, and mutual funds, which are gov-erned by Securities Investment Company Act.

183. Mr. Yoon first discussed investment trusts. Anyone whowants to start a trust management company must obtain a li-cense from the FSC. He noted that there are several types ofrelated institutions, including custodians, distributors, and gen-eral administration trustee companies. Each type is requiredto register with the FSC. Mr. Yoon described how trust man-agement companies are obliged to report periodically and dis-close their business operations, via a three-stage process. First,they have to submit a business report and an operational re-port to both the FSC and the Korea Investment Trust Compa-nies Association (KITCA). Then, the FSC and the KITCAdisclose these documents to the public. Then KITCA com-pares the operating results including the details of changes inthe companies’ net asset value for their each trust propertyand discloses the results to the public.

184. Mr. Yoon stressed that CIS are subject to strict pruden-tial regulations. He noted that the relevant regulations aremainly concerned with sound management and the use ofundisclosed asset operation information. For instance, trustmanagement companies are required to observe investmentlimits. Mr. Yoon observed that the FSC is entitled to take cor-rective actions against any companies that engage in activi-ties which are deemed harmful to the beneficiaries, ordetrimental to the fair trading of securities. He also noted thatthe prudential regulations forbid any unfair use of undisclosedasset operation information.

185. Mr. Yoon remarked that utmost attention and efforts havebeen exerted to establish and monitor CIS in order to protectinvestors. For example, the FSC had strengthened the qualifica-tions which fund managers in both securities trust companiesand mutual funds are required to obtain. Trust management com-panies are required to hire qualified fund managers as full-timeofficers and employees. Securities investment companies haveto register with KITCA all matters concerning fund managers,and all fund managers must meet appropriate qualifications.

186. Mr. Yoon discussed how regulation aims to promotesound business practices. He noted that management and sell-ing companies must provide prospective buyers with a pro-spectus on investment trusts, and must explain the majorelements of the prospectus. There are also auditing require-

ments for all management companies, and Mr. Yoon observedthat the FSC has the right to order the auditors to hand overthe relevant data, draft a report, or take other necessary mea-sures, when deemed necessary to protect the interest of in-vestors. All securities trust companies are required to compilea report on the operation of the trust property, and make itavailable to the beneficiaries of the trust property at least onceevery six months.

187. Mr. Yoon examined the role and importance of internalcontrol systems. He noted that trust management companiesare required to appoint outside directors, an audit committee,and compliance officers. Only people who have never workedfor the concerned management company as managing direc-tors may be appointed as outside directors. Companies whosetotal amount trust assets is greater than 6 trillion Korean wonshould appoint no less than 3 outside directors, and the num-ber of outside directors should not be less than half the totalnumber of directors. An audit committee is mandatory forany management company with total trust assets of more than6 trillion Korean won, and no less than two-thirds of the num-ber of members of the audit committee should consist of out-side directors. Compliance officers are responsible formonitoring the implementation of internal control standards.Management companies are required to appoint at least onecompliance officer.

188. Mr. Yoon discussed how securities investment compa-nies are required to adopt strict internal control systems forsound management and investor protection. He noted that theroles of the three main types of officers—executive directors,supervisory directors, and auditors—have been reinforced.Executive directors’ main responsibilities are to administerand to represent the business affairs of a securities investmentcompany. They are obliged to report on the company’s busi-ness status and progress to the board of directors at least onceevery three months. Mr. Yoon noted that supervisory direc-tors, on the other hand, supervise the business managementof executive directors, and, when deemed necessary, have theright to request the auditors to submit an audit report. Anauditor’s main role is to report promptly to the supervisorydirectors when an executive director violates any statute orarticle of incorporation concerning the performance of hisduties, or undertakes an action that might cause significantlosses to the securities investment company concerned.

189. Mr. Yoon concluded by examining the impact the con-solidated supervisory organization—established in 1/1999from the merger of the banking, non-banking, securities andinsurance regulators—had had so far on the Korean economy.He stated that the establishment of the consolidated supervi-sory authority had improved regulations and systems, andclarified the direction of supervisory policies, with the aim ofraising transparency in supervisory policy and enhancing over-all prudent regulation by adopting effective measures againstunlawful acts. He observed that the regulator had conducteditem-by-item evaluations of policies, including compliancesystems, risk management systems, construction of fire-walls,and publicly disclosed the results in order to induce volun-


tary efforts and more autonomous restructuring of the finan-cial industry. In addition, Mr. Yoon noted that the regulatorhad implemented a real-time surveillance system to monitortrades through an advanced computer system, with on-lineconnections between trust investment companies and the su-pervisory organization. He observed that the supervisory sys-tem could now determine the source of any extraordinarytransactions directly after detection, through contact with thecompliance officer of the related company.

190. Mr. Ian Johnston, National Director, Financial Ser-vices Regulation, Australian Securities and InvestmentsCommission (ASIC), described the Australian experienceregarding the legal and regulatory frameworks for CIS. Henoted that the Australian collective investments industry is asignificant, and rapidly growing sector of the economy, pro-viding a major source of investment funds. There is a largevariety of managed investment schemes, with currently over$255 billion invested in the Australian managed investmentsindustry (excluding superannuation monies, and over $590billion with superannuation included). Of this, 51% is sourcedfrom the Australian retail sector while the remaining 49% issourced from the wholesale sector.

191. Mr. Johnston described the key features of the regula-tory framework. He noted that the Australian regulatory frame-work for CIS underwent a radical change in 1998 with thecommencement of the Managed Investments Act (MIA). Asingle responsible entity now has ultimate responsibility forall aspects of the operation of regulated schemes. The respon-sible entity is required to be a public company holding a li-cence from ASIC to operate the scheme. In order to obtain alicence, the relevant entity must demonstrate the capacity andexpertise to operate the scheme. Mr. Johnston commented thatthe licensing requirement therefore acts as an initial gatewayfor potential participants in the managed investments indus-try. Only operators meeting minimum financial requirementswill be licensed.

192. Several other aspects of the regulatory framework werenoted by Mr. Johnston. For the most part, schemes, must beregistered with ASIC. Registration does not, however, createor incorporate the scheme, but merely records the scheme withASIC. Documents have to be lodged with the regulator, andinvestors’ rights must be clearly set out in the documents.Mr. Johnston observed that compliance monitoring on the partof the operator is introduced through a requirement for eitherhalf of the board of the responsible entity to be independent,or for a separate compliance committee to be established. Afurther, independent layer of monitoring is imposed throughthe compulsory appointment of an auditor to audit compli-ance with the compliance plan annually. Mr. Johnston stressedthat self-regulation therefore plays an important role.

193. Mr. Johnston noted that the MIA expressly allows ASICto require scheme property to be held by an agent as a licencecondition—but otherwise, an independent custodian is notmandated by the law. For this purpose, ASIC has set downstringent requirements for custodianship, which may be met

by the responsible entity itself. However, those requirementsmay, in many cases, effectively require the responsible entityto appoint an independent custodian. Mr. Johnston stressedthat the current regime does not involve any mechanism tofilter out or exclude schemes on the basis that the scheme orinvestment plan itself is a bad investment. Rather, this is leftto market forces. Investors are free to make their own assess-ment as to the quality and riskiness of the investment, pro-vided they are given all information relevant to their decisionto invest.

194. Mr. Johnston identified a series of challenges for the regu-lator. He noted that the MIA allowed a transition period oftwo years for existing schemes regulated under the previousregime to prepare for compliance with the new regime. Henoted that ASIC had put much time and energy into assistingthe industry to transition, and that the new regime caused ASICto review its approach to a number of types of investmentschemes which had been brought more clearly within the scopeof regulated activity. He observed that while ASIC had ob-served a gradual improvement in compliance cultures and at-titudes following the reform of the regulatory regime,embedding compliance had been difficult for the smaller com-panies in the managed investments industry. Mr. Johnstonremarked that ASIC had needed to develop and publish nu-merous new public policy statements describing how it wouldadminister and enforce the new laws, and that the operationof the new laws generated a number of issues and teethingproblems. In the course of surveillance, ASIC had also facedthe difficult challenge of how to apply universal standardsacross the incredibly wide variety of industry participants anddiverse schemes that are now regulated in Australia.

195. Mr. Johnston identified several reforms planned for thefuture in the financial services sector. He noted that the gov-ernment has proposed laws to introduce an integrated regula-tory framework for the entire industry. Part of the objectivefor the reform is to provide consistent regulation of function-ally similar markets and products. This will involve theharmonisation of existing, diverse regulatory arrangementsfor the various financial markets and products, including man-aged investments, life and general insurance and superannua-tion. Mr. Johnston noted that another reform is to establish asingle licensing regime. All the various participants in the fi-nancial services industry will require what is to be called anAustralian Financial Services Licence. Mr. Johnston remarkedthat a single disclosure regime had been proposed, so as tobring about a single standard for the offer of all financial prod-ucts, apart from shares and debentures. He noted that it washoped that the establishment of a general disclosure standardwould bring about consistency and assist investors to makecomparisons across financial products.

196. Mr. Johnston concluded that enormous challenges arelikely to face ASIC when the new laws take effect either later2001 or early 2002, as ASIC’s role will expand considerably.Already, as of 7/1998, ASIC has been responsible for con-sumer protection and market integrity across the financial


services sector generally. ASIC will now also be responsiblefor administering a greatly enlarged licensing regime encom-passing virtually all participants in the financial services in-dustry.

197. Ms. Yeo, Lian Sim, Assistant Managing Director,Capital Markets, Monetary Authority of Singapore (MAS),presented the Singaporean experience regarding the legal andregulatory framework for unit trusts. She noted that unit trustshad been gaining favour in Singapore for various reasons.Savings traditionally placed in deposits have been invested inequities, investment in bonds had also become more popularlately, and the public has become more aware of the benefitsoffered by professionally managed funds.

198. Ms. Yeo described the current manner in which MASregulates unit trusts. Each unit trust must have a trust deedwhich contains required covenants describing the responsi-bilities of trustee and manager, a key one of which is that atrustee has a duty to safeguard the interests of the unit-hold-ers. The trust deed must be approved by MAS. Each trustfund must also have a prospectus issued by the manager. Themanager is responsible for full and accurate disclosure, andis subject to statutory liability.

199. Ms. Yeo then outlined the new regulatory approach MASwas going to adopt. It would authorize funds directly, insteadof approving documents, and it would recognize foreign funds.Under the current feeder-fund regulatory structure, Ms. Yeonoted that the manager and trustee must both be public com-panies incorporated in Singapore. She argued that althoughthis regulatory structure for feeder-funds for investment inforeign funds means that the interests of Singapore investorsare well protected, because there is direct legal access to themanager and trustee, it does impose high costs on the inves-tor. In the future, MAS would allow foreign funds to be of-fered directly in Singapore. Ms. Yeo anticipated that this wouldlower the costs of foreign funds, and expand the range of fundsavailable. It is also expected that an increase in foreign fundoffers would facilitate a wider diversification of investmentportfolios.

200. Ms. Yeo noted that a range of Exchange Traded Funds(ETFs) based on global/foreign share indices are being intro-duced in Singapore. These would be different from unit trusts,in that they had better price discovery, and could be bought orsold throughout the trading day. Ms. Yeo also commented thatthe SGX-AMEX linkage allows co-trading of ETFs on thetwo exchanges, thus hopefully enhancing liquidity and trad-ing opportunities. Ms. Yeo identified a range of drivers forthe growth of CIS. On the supply side, these included theentry of foreign funds and the introduction of ETFs, and onthe demand side, these included an increased awareness ofmanaged instruments, and the increased flexibility of the Cen-tral Provident Fund (CPF) Investment Scheme.

201. Ms. Yeo summarized how the CPF operates. She notedthat it is a defined contribution scheme which enables savingfor retirement, places the responsibility on individuals to plan

their investments, but allows the CPF Investment Scheme toutilize investment opportunities in the market. Each employeecontributes 20% of his salary tax-free, and his employer con-tributes another 20% to the individual’s CPF account, whichis then divided into three sub-accounts: an ordinary sub-ac-count, a special sub-account, and a medisave sub-account.Elements of the ordinary sub-account and the special sub-account may be invested in different unit trusts with differentrisk weightings. Ms. Yeo argued that the benefits of the CPFare that it enables members to achieve more attractive returnsfor old-age security, that it balances higher returns with a needto safeguard principal sums, and that it caters to diverse riskprofiles of investors.

202. Ms. Yeo noted that a range of prudential safeguards hadbeen imposed on CPF-Approved Unit Trusts. In particular,the CPF Board had to determine the investment guidelines,and an independent investment consultant was required toevaluate a fund manager and the suitability of individual unittrusts, and to determine the risk-classification of a fund. Inaddition, quarterly risk-adjusted performance reports wereprovided to investors.

203. Ms. Yeo observed that financial advising was becomingmore holistic—leading to more educated investors, greateravailability of funds for investment, an increasing variety ofinvestment options, and increasing demand for financial ad-vice. As a result, Ms. Yeo noted that a Financial Advisers Acthad been proposed. She anticipated that there would be sev-eral benefits from a single regulatory framework for financialadvisers. They included that financial advisers would be au-thorized to provide personal advice on a wide range of alter-native investments, including shares, unit trusts and insuranceproducts, that the new law would promote uniform standardsof business conduct, and that the new law would reduce thecosts associated with multiple licenses.

204. Ms. Yeo concluded by identifying the two main goals ofthe regulatory development work-in-progress: first to constructa regulatory framework to maintain a sound investment envi-ronment, and second to empower investors with greater choiceand more information.

205. Mr. Gregory Mocek, Special Counsel to the Chair-man, Commodity Futures Trading Commission (CFTC),US, analysed the US experience of commodity pool opera-tors (CPO), and abuses that occur in the CPO marketplace.He noted that the CFTC is the regulator for certain CIS in theUS futures markets, called commodity pools, which are ve-hicles engaged in the business of investing customers’ moneyin commodity interests. Mr. Mocek remarked that it is notthe pools themselves, but the persons or companies who so-licit funds to invest in a commodity pool, the CPOs, who fallunder the oversight of the CFTC. He stressed that althoughthere are abuses, the vast majority of American CPOs pro-vide benefits and add liquidity to the marketplace by offer-ing investment diversification, professional tradingmanagement, and limited liability to those who would ratherinvest in a collective environment.


206. Mr. Mocek noted that the CFTC must be certain that thefutures markets are safe in order to ensure that US and inter-national investors are protected from fraud and abusive prac-tices. He emphasised that markets have become moreinternational and diverse, and that fraud is thus not only adomestic US problem. He argued that this meant that regula-tors must pay attention to each other’s regulatory structures,as well as enforcing and prosecuting offenders of their ownnational regulations and CIS laws.

207. Mr. Mocek described how CPOs are regulated by theCFTC. He noted that, essentially, the US Commodity Ex-change Act provides a statutory definition of a CPO, and if acompany or person falls under that definition, it must registerwith the National Futures Association, which is the self-regu-latory organization that is the front line regulator for the fu-tures industry in the US. Mr. Mocek commented, however,that the definition of a CPO gives the CFTC flexibility to ex-clude persons if they are beyond the intent of the definition.In practice this means that the CFTC exempts certain types ofpools from registering. In addition, Mr. Mocek remarked thatthere are many pools that operate legally that are unregis-tered. He stressed that the bulk of CPO fraud in the US oc-curs in situations where the CPO is unregistered but notexempt.

208. Mr. Mocek observed that over the last ten years, the CFTChad prosecuted over 1,000 persons and entities. Many of thosewere CPOs. He described the typical pattern of CPO fraud asfollows. The CPO is many times an educated and intelligentperson, who is highly articulate. The CPO has some type oftrading system which he thinks can provide incredible invest-ment profits. The CPO solicits his futures trading expertise toa select group of people (such as friends, members of hischurch or club, co-workers at his plant, alumni of his school).The CPO publishes a false track record of his trading results.The CPO fraudulently issues incorrect account statements tohis customers—always showing profits. The CPO starts los-ing money for most of his clients, yet continues to tell themhe is making profits. The CPO begins to Ponzi (pyramid) cus-tomers’ investments by using one investor’s money to pay offanother. The CPO commingles his personal funds with thoseof his investors. The CPO starts using investor funds to payfor his personal lifestyle.

209. In order to illustrate how easy it is to fall into the trap ofan international CIS fraudster, Mr. Mocek described two ex-amples of such fraud. The first concerned somebody he referredto as “Mr. M”. Mr. M was in the real estate business in Ohio,but after losing most of his money in bad real estate invest-ments, he decided to start a new life in Florida. In 1992, heopened M International Investment Corporation. Then heopened two investment funds, incorporated a trading corpora-tion in Belize, and opened a Bahamian corporation, to act astrading manager for the trading corporation. Mr. M printed upexpensive-looking sales brochures that described his new in-vestment funds, and told prospective investors that he had $450million under management, and that he had a secret specialcomputer program that allowed him to achieve returns of ap-

proximately 51% per year. He then found a few prominent busi-nessmen to invest, and used their names to find other investors.He hired young salesman from local wealthy families to solicitother investors. From 1992-2000, Mr. M raised $127 milliondollars from 170 US and foreign investors. While he did investsome of his clients’ money in securities and in futures con-tracts—he also invested in many other things, including a failedmortgage company, a failed golf and country club resort, a failedcigar lounge, and a very expensive personal lifestyle.

210. By the time the SEC and the CFTC caught up withMr. M, he had lost $46 million dollars of his customers’money. By violating US futures laws, Mr. Mocek observedthat Mr. M had figured a way to stay in business for quitesome time—basically because he sent his customers reportsthat falsely showed that he was making profits, concealedthe fact that he was losing their money, and because he usednew investor monies to pay off older investors that wantedto cash out of his funds.

211. The second example Mr. Mocek described concerned aman referred to as “Mr. A”. Mr. A became a commoditiesconsultant and charged his clients upwards of around $2,000an hour—yet he did this while he allegedly owed millions inback taxes. Mr. A reportedly also advised foreign governmentsand companies on financial issues, yet he filed for personalbankruptcy. Mr. A distributed sales literature and a marketingresume to companies, and spoke at seminars. Despite the factthat Mr. A had these reported tax problems, a previous run inwith the CFTC, and sported murky credentials, he was ableto raise approximately 3 billion dollars from Asian financialinstitutions by claiming to have a conservative futures trad-ing program, and selling bonds that guaranteed an average of4% interest to institutional investors. By the time the SECand the CFTC sued Mr. A and his companies, Mr. A had lostand/or spent close to $600 million. So far, approximately only$85 million worth of assets had been found.

212. Mr. Mocek remarked that the CFTC is diligently investi-gating and prosecuting CPO fraud cases, and that it worksclosely with foreign criminal and civil authorities to shareinformation. It is developing advanced investigation and co-operative enforcement techniques to combat abuses in CIS,and is seeking civil monetary penalties to deter future mis-conduct. However, Mr. Mocek stressed that the best way todeter fraud was to inform people how it happens. He con-cluded by expressing the hope that through continued inter-national cooperation, and the development of Memoranda ofUnderstanding between countries, all regulators could pro-tect their citizens from market participants trying to circum-vent CIS regulatory schemes.

213. Mr. Stephen Lumpkin examined some issues concern-ing the consolidated supervision of CIS in the OECD. He notedthat over the past decade, a number of OECD countries hadimplemented, or had announced plans to implement, struc-tural reorganisations of their financial supervisory frameworks.These changes had generally reflected efforts to realign su-pervisory structures with a profoundly changed institutional


environment. Mr. Lumpkin observed that there had been in-creased consolidation within institutional sectors, and con-vergence across institutional types, as institutions have soughtopportunities to cross-sell products, expand across borders,and achieve scale economies. These developments have ledto a blurring of traditional lines of demarcation among thefour pillars of the financial system, namely banks, insurancecompanies, pension funds, and securities firms.

214. Mr. Lumpkin recognised that the existence of integratedfinancial service groups complicates the task of supervision.This is because as financial groups and conglomeratescentralise their risk assessment and management, it becomesmore difficult to oversee them on a purely institutional basis,due to the complexity of their corporate structure and the in-ter-linkages therein. He argued that monitoring of firewallsin such circumstances becomes increasingly important, yetincreasingly difficult. At a minimum, Mr. Lumpkin maintainedthat the formation of complex financial groups increases theneed for information sharing, co-ordination and co-operationamong supervisory authorities with responsibility for differ-ent institutional components of a financial group, so that agroup-wide perspective may be achieved.

215. Mr. Lumpkin stated that supervision of the financial ser-vices industry varies greatly in detail across countries. Manyfactors play a role in shaping the ultimate regime a given coun-try adopts. The relevant factors include: the unique circum-stances of the country; the different initial conditions aroundwhich the financial services industry is structured in the coun-try; political and social structures and government, industryand societal relations; and the relative importance of thecountry’s financial services industry.

216. Mr. Lumpkin contended that the challenge in designingsupervisory structures is to create a framework that helps en-sure the safety of the financial system as a whole, while at thesame time enhancing competition and improving efficiency.He argued that the diversity of supervisory regimes in prac-tice suggested that there is no consensus as to the existence ofa “best” approach to achieve this end. He noted one typologythat identifies three broad approaches to the structure of fi-nancial supervisory regimes: (1) institutional/sectoral, inwhich supervision is focused on the type of institution, (2)functional, in which supervision is directed at the underlyingbusiness activities, regardless of the service provider, and (3)objectives-based, in which supervision is organised accord-ing to the objectives of supervision. Mr. Lumpkin observedthat not only are all three models found in practice, but alsothat increasingly a consolidated approach is employed with acombination of the three approaches.

217. Mr. Lumpkin recognised that two divergent views re-garding the proper aim of financial supervision had been putforth. The “twin peaks” approach proposes the establishmentof a single conduct of business agency and a single prudentialsupervisory agency to ensure the soundness of the system asa whole and control all risks for all types of financial institu-tions. Mr. Lumpkin noted that the twin peaks approach had,

however, been criticised as being “too all embracing and fail-ing to recognise the significant differences between institu-tions and types of business”. An alternative approach calledfor a structure of financial supervision based on a broaderrange of objectives, comprising: 1) a systemic regulator (whichcovers banks and other depositories); 2) a separate prudentialregulator for securities firms, insurance companies and othernon-bank financial institutions; 3) a conduct of business regu-lator for retail financial business; 4) a separate conduct ofbusiness regulator for wholesale financial business; 5) selfregulation for exchanges; and 6) a competition authority,which need not be limited to financial businesses.

218. Mr. Lumpkin observed that the consensus approach nowhas three objectives: 1) Systemic stability, which means en-suring the safety of the financial system as a whole plus thereliability and integrity of payment systems. 2) Prudentialoversight, which covers the safety and soundness of individualinstitutions, in the absence of systemic consequences, with aview toward protecting consumers and investors from lossesin the event of an institution’s insolvency. 3) Conduct of busi-ness regulation, which focuses on market misconduct, ad-dresses information asymmetries, and covers other aspects ofthe ways in which financial institutions carry out their busi-ness activities with clients.

219. Mr. Lumpkin argued that, given the potential shortcom-ings of exclusively institutional and functional approaches tosupervision when institutions are diversified, the tendencytowards conglomeration in financial services had strength-ened arguments in favour of supervision based on the objec-tives of regulation. He noted that the range of supervisorystructures in place suggests that there is no single approach tothe institutional structure of financial supervision that is “best”in all circumstances. Supervisory frameworks must be adaptedto meet the requirements of the specific environment in whichthey are to be implemented, taking into account the size andcomplexity of financial institutions and the institutional setup in the country. It has become more widely accepted thatlarge, complex institutions with systemic importance shouldbe treated differently than small institutions, and that sometype of “group-wide” approach is needed for complex groups.

220. Mr. Lumpkin remarked that the different legislativeframeworks under which consolidated supervisory agencieshave been created and the diverse activities they undertakegive rise to significant differences in their operational struc-tures. He identified four general structures: 1) An institutionalmodel in which supervision is organised according to institu-tional groups, supplemented by a policy function, which maybe incorporated into the institutional divisions or may be stand-alone. 2) An operational model in which supervision isorganised according to the type of supervisory activity, with-out regard to the types of institutions involved, with typicallya separate policy division. 3) A functional model in whichsupervision is organised according to the type of financialproduct/service. 4) A mixed model in which supervision isorganised on an operational basis, but within supervisory ac-tivities there are clear institutional groupings and practices.


221. Using these four generalised models as benchmarks forcomparison with actual structures, Mr. Lumpkin determinedthat the majority of consolidated supervisory agencies are ei-ther structured along institutional lines, or have a mixed ap-proach. Most agencies have not established separate units forprudential supervision of financial conglomerates or othercomplex groups. In general, supervisory oversight of theseentities is carried out by the regular supervisory divisions.Mr. Lumpkin maintained that it had proven exceedingly dif-ficult to have one entity deal with all types of institutions.While the supervisory agency itself may be consolidated,operationally there are distinct units that typically focus onparticular types of institutions. Consequently, the operationalstructure of integrated agencies in some cases begins to ap-proach the structure of separate agencies that existed prior toconsolidation.

Session 4: Question and Answer Session

222. Professor Anthony Neoh asked what was the experiencein the UK of regulating complex groups. Mr. Robert Aitkenreplied that a range of regulatory activities were undertaken.There was contact at the high-level and managerial levels ofthese entities. A close and continuous relationship was estab-lished. Much more contact with overseas regulators for theseinstitutions than for others was required. Large positions weremonitored internationally. Mr. Ian Johnston noted that in Aus-tralia new legislation will assist regulators to look across awhole bank. An MOU was being created among all the regu-lators so they could share information, and they liaised everyquarter. Sometimes there were cultural differences betweenthe different regulators, particularly between regulatorscharged with maintaining systemic stability who might bemore cautious about acting against a large firm than a con-duct-of-business regulator. There were also issues about firmswhich were members of a clearing house, and which weresupervised by both a banking and a securities regulator. Thesecurities regulator might in some circumstances be waryabout telling the banking regulator about potential problems,because were the banking regulator to stop credit lines to theinstitution, the firm could fall, with adverse consequences forthe clearing house.

223. Mr. Garry Schinasi commented that in acute situations,enforcing the law has to be balanced by systemic consider-ations. He noted that monetary stability was not equivalent tofinancial stability except in a crisis. In a crisis, the monetaryaggregates start to implode and a central bank has to act tostop a credit crunch. There may therefore be a dichotomybetween free markets and monetary stability. Mr. Schinasi alsonoted that at the core, there are probably only thirty to fiftyinstitutions which operate using a global financial architec-ture. He argued that what was most likely to push these firms

into dangerous positions was monetary policy, not financialpolicy. The consequences would be imprudent risk-taking orexcessive leverage. Mr. Schinasi was concerned that at a glo-bal level no institution was watching the mix of monetaryand financial policies. Ms. Yeo, Lian Sim noted that she wasconcerned about avoiding a major crisis caused not by badmonetary policy, but by bad pricing, excessive risk-taking orhedging. Mr. Schinasi responded by saying that a key reasonwhy such activity is undertaken is that capital is available toocheaply—as a result of monetary policy.

224. Professor S. Ghon Rhee noted that a regulatory shift froma merit to a disclosure-based approach required a functionalspecialisation in the appropriate regulatory bodies. Ms. AlexaLam noted that there was a difference between supervisionduring normal times and crisis management. Supervision andsurveillance are intended to prevent crises, but crisis manage-ment requires a very different type of regulatory mechanism.She recognised the problem of herding in markets, but ar-gued that a big problem is only a problem when it cannot beworked out on a reasonable time basis. Ms. Lam suggestedthat each crisis is different from each other one, so solutionshave to be different, and have to reflect relevant national in-terests. She believed it would not be easy to devise a rulebookfor crisis management. Mr. Schinasi argued that herding hasbigger consequences in finance as compared to other indus-tries because of the nature of banking.

225. Ms. Alexa Lam argued that a risk-based approach to regu-lation may be beneficial in a regulator with limited resources,but that it was necessary to balance the costs and benefits ofthe approach. Mr. Akamatsu contended that the IMF’s workwill continue to be valuable in preventing future crises, as aresult of the enhanced surveillance it was undertaking. Dr.Yoshitomi maintained that the recent Asian crisis was differ-ent from previous ones, and was essentially a capital accountcrisis. He maintained that for a new disease, new medicine isrequired. He then outlined the seven policy recommendationsthat he and the Asian Policy Forum had developed for such acrisis. They included choosing an appropriate exchange-rateregime, short term capital controls, strengthening the bank-ing sector, developing a long-term capital market, “bailingin” the banks, limiting the holding of domestic currency bynon-residents, and the provision of high levels of internationalcapital liquidity.

Conclusion

226. Dr. William Witherell, Director, Directorate for Financial,Fiscal and Enterprise Affairs (DAFFE), OECD, concluded theproceedings by thanking everybody for their participation, andin particular Professor Anthony Neoh for his excellent chair-manship of the previous Round Tables, and by noting that thisRound Table had once again been a resounding success.


ANNEX

Third Round Table on Capital Market Reform in Asia

ADB Institute, Tokyo, 10 to 11th April 2001

Organisers: OECD, ADB Institute

Chair’s Summary Statement*

The OECD-ADBI third Round Table on Capital Market Reform in Asia was held at the Asian Development Bank Institute(ADBI) in Tokyo on 10th and 11th April 2001. The meeting was chaired by Mr. Anthony Neoh, Chief Advisor to ChinaSecurities Regulatory Commission and Dr. William Witherell, Director, Directorate for Financial, Fiscal and Enterprise Affairs,Organisation for Economic Co-operation and Development (OECD). Mr. Neoh is also the former Chairman of the Securitiesand Futures Commission of Hong Kong Special Administrative Region, People’s Republic of China, and the former Chairmanof the Technical Committee of the International Organisation of Securities Commissions (IOSCO). The meeting was jointlysponsored by the OECD and the ADBI. Dr. Masaru Yoshitomi, Dean, ADBI, and Mr. Seiichi Kondo, Deputy Secretary-General,OECD, made welcoming remarks.

The Round Table was attended by Chairmen and other top-level representatives of securities market regulatory bodies, as well ashigh ranking officials of governments and central banks from the People’s Republic of China, Hong Kong Special Administra-tive Region of the People’s Republic of China, Indonesia, Malaysia, Philippines, Singapore, Taipei,China and Thailand. Alsopresent were senior officials from securities market regulatory bodies, governments and central banks of OECD member coun-tries and international organisations. Experts in the field from stock exchanges, industry, and academic circles also participatedin the meeting.

The Round Table was held in co-operation with IOSCO, IMF, the World Bank and ADB. It provided an important occasion forsenior executives of Asian economy regulatory organisations who are members of IOSCO, their colleagues from OECD coun-tries, and experts in the field of capital markets to discuss future initiatives in capital market reforms in Asia.

This Round Table is the third in a series. The first Round Table on Capital Market Reforms in Asia was held in Tokyo in April1999 and the second one was held in Tokyo in April 2000. The main topic of the third Round Table was “Institutional Investorsin Asia”. In addition, the following three topics were discussed as well:(1) Progress in Capital Market Reform in Asia, (2) Designing a Financial Market Structure in Post-Crisis Asia—How to DevelopCorporate Bond Markets, and (3) Joint IOSCO CPSS Recommendations for Securities Settlement Systems.

Part I: Progress in Capital Market Reforms in Asia

Looking at developments in the capital markets, after a big increase in equity prices in 1999, the equity market declined consid-erably in the latter part of 2000, continuing into 2001. There is a perceived vulnerability of emerging Asian markets to a globaleconomic slowdown. Judging from the continuing weakness of equity markets, structural problems are still key issues to beaddressed to enable the region to take advantage of improvement in the world economic climate when it comes.

Thus, economies in the region are making efforts to increase the resilience of their financial markets. They are also dealing withthe challenges posed by globalisation and technological advances. In this regard, there is a marked tendency among the marketsin the region to increase the quality and the variety of services they provide so as to satisfy customer demands. This tendencytowards greater attentiveness to the needs of the customer is being accelerated by the competition among the markets within theregion and with exchanges overseas. At the same time, regulators and market participants are beginning to plan for the prospectof global electronic networks and/or remote access to major trading platforms, as they may provide new opportunities for themarkets in the region.

In this regard, the following topics were particularly noted.

The rapid expansion of Internet trading is one of the biggest challenges for securities regulators in the region. While facilitatingits development, regulators need to address the issues of minimum standards of investor protection, for example in the regulationof on-line trading or IPOs via the Internet.

* Terms and names used by Chair in his statement released jointly by ADBI and OECD, may not follow ADB conventions.


Demutualisation and the merger and alliance of exchanges pose new challenges to the securities regulators. With demutualisation,exchanges can be expected to assume fewer functions as self-regulatory bodies in setting and enforcing rules for investor protec-tion and market integrity. Securities regulators need to pay particular attention to this issue.

The issues related to the establishment of “second boards” or second-tier exchanges were discussed as well.

Part II: Designing a Financial Market Structure in Post-Crisis Asia—How to DevelopCorporate Bond Markets

The ADB Institute, which organised the Asian Policy Forum as its Secretariat by inviting 17 policy-oriented research institutesin Asian economies, presents an analytical framework that is needed to derive policy recommendation s on how to developcorporate bond markets in bank-dominated Asian economies.

Main points of the recommendations are as below.

Asian countries should place priority on strengthening the soundness of the banking system in the short- to medium-term, whileat the same time initiating to develop a domestic corporate bond market. Given the dominance of the banking sector and, at thesame time, declining profitability from traditional banking businesses in Asia, the banking system and the corporate bondmarket could become complementary to each other, not substitutes. For instance, commercial banks are likely to play a majorrole as underwriters, investors, issuers, and guarantors of bonds while they continue to provide traditional banking services.

This means that the banking sector will become important institutional investors in the corporate bond market in developingcountries in Asia. This is because other potential institutional investors, such as pension funds, insurance industries, and provi-dent funds, are largelyunderdeveloped, reflecting a low level of per capita income and asset accumulation. Thus, it is importantto formulate a regulatory system that can cope with the new types of risk that would be encountered by commercial banks and topromote new risk-management skills. Furthermore, the banking sector could be major issuers given that there are few largereputable firms that are able to issue bonds at reasonable costs in Asian developing countries. In this regard, it might be a goodidea to establish long-term credit banks (that issue bank debentures and provide long-term loans) in order to promote thedevelopment of the bond market in the intermediate situation.

However, in designing such an intermediate financial market structure between the bank-dominantand market-based one, a careshould be taken so that banks will not be too powerful in the future, undermining the development of a highly liquid and broadbond market.

Another recommendation made at the meeting was the idea of using asset securitisation and credit enhancement as a means ofcreating a viable corporate bond market for institutional investors in the region. In appropriate cases, issues can be structured athigh investment grade level, even exceeding sovereign rating.

Part III: Joint IOSCO CPSS Recommendations for Securities Settlement Systems

The IOSCO Technical Committee and the Committee on Payment and Settlement Systems (CPSS) set up a Task Force todevelop “Recommendations for Securities Settlement Systems”. The draft of the recommendations was released in January2001 for public consultation, which will last for three months.

The meeting discussed these recommendations.

The report identifies minimum requirements that securities settlement systems should meet and the best practices that systemsshould strive for. These encompass the legal framework for securities settlements, risk management, access, governance, effi-ciency, transparency, and regulation and oversight. The proposed recommendations are designed to cover systems for all secu-rities, including equities, corporate and government bonds and money market instruments, and securities issued in bothindustrialised and developing countries. They also aim to cover settlement of both domestic and cross-border trades.

The participants, in general, agreed that the recommendations do adequately address all the relevant topics and issues andprovide a useful guidance for the development/modernization of securities settlement systems in Asia. They also discussedpossible obstacles in implementing the recommendations in Asia. Among these obstacles was the existence of weak legalsystemsrelative to advanced economies.


Part IV: Overview of Institutional Investors in Asia

The main issue of this part is how to develop institutional investors in Asia and the necessary regulatory framework for theirdevelopment.

1. Introduction

Institutional investors, such as insurance companies, collective investment schemes (CIS) and pension fund managers, havebeen gaining in importance in the capital markets of both OECD and non-OECD countries. The presence of institutional inves-tors is one of the strongest stimuli favouring the development of capital markets.

a) Highlights of the Experience of Institutional Investors in OECD Countries

As background to the common factors of the development of institutional investors in the OECD countries, the following issueswere noted, namely: Ageing populations and pension reforms, technological progress in communications and information pro-cessing, deregulation of the banking and securities industries. Positive effects of institutionalization on the development ofcapital market, the importance of the role of professional fund managers and the necessity of appropriate regulation on invest-ments by institutional investors were also noted.

b) Current Situation in Asian Countries

Many countries in the region have high aggregate rates of savings, but these savings are often held in traditional outlets such asbank deposits. The institutional investors sector is in general underdeveloped. Nevertheless the same factors that facilitated thedevelopment of institutional investors in the OECD countries are now developing in the region and it can be assumed thatinstitutional investors can develop fairly well in this region in the near future.

In the field of insurance, the Asian insurance market has changed significantly in the past decade. During this period newlegislation and regulations reformed some of the most important markets. These reforms have begun to produce growth, diver-sity in coverage and competition-driven pricing. The penetration index—i.e. life insurance premiums as a percentage of GDP—is relatively low in mo st Asian countries, except for Korea and Japan. This indicates that the scope for expansion of thelife-insurance sector is considerable. Liberalisation and further improvements in regulatory systems and other elements of theinfrastructure will largely determine the prospects for insurance markets in Asia.

In general, many participants pointed out that though there has been a progress in this area, there are still a number of impedi-ments to the development of institutional investors in the region. It was also pointed out that in some cases institutions and fundmanagers in Asia are lacking in the necessary independence from government and industry to operate in the interests of inves-tors. The participants discussed how to strengthen the fiduciary duties of fund managers toward investors. They also discussedthe role of foreign institutional investors in domestic markets and how they contribute to the professionalism in the asset man-agement industry, which is a crucial parameter for the development of institutional investors.

2. Development of Collective Investment Schemes (CIS) and Pension Funds

The development of Collective Investment Schemes (CIS) is one of the key factors in the development of capital markets.Though the CIS industry in most Asian countries is still rather underdeveloped, the potential for growth is believed to be quitehigh.

a) Main Points of Recent Trends and Prospects for the CIS Industryin the OECD Countries

The factors which facilitated the development of institutional investors in general can be pointed out as elements supporting thegrowth of the CIS. In particular the extraordinary growth of CIS in the OECD countries reflects several factors:(1) CIS are the main avenue for small inventors to take advantage of the investment opportunities in bond and equity markets,which have been producing very attractive returns.


(2) Many governments have taken measures to strengthen the legal and regulatory framework for CIS.(3) CIS are very well adapted to retirement plans, especially defined contribution plans.

Investment performance and fees and expenses of the CIS were also discussed as one of the key relevant issues in this field andit was stressed that the monitoring and evaluation ofperformance of portfolio managers is important part of the duties of thoseresponsible for fund governance.

As for the prospects for the CIS industry in the OECD countries, there are good prospects in principle. In particular, CIS areexpected to play a major role in providing retirement income. The rising sophistication of investors and better information havestimulated diversification among distribution channels and an increasing variety of products and this trend is expected to con-tinue. The availability of investor information will be an additional force for modernisation.

b) Current Situation of CIS in Asia

Though the CIS sectors are rapidly growing, the share in the financial market is still low in Asia. But the potential for growth isbelieved to be quite high, especially for the larger economies.

The structure of the banking industry in most Asian markets has hampered the growth of mutual funds. Lack of competition hasled to situations where banks have redirected fund investors into deposits. Custodial arrangements tend to be costly.

A major barrier to the development of CIS is the design and prudential regulation of private pension funds. Main obstacles to thedevelopment of Asian mutual funds are: stocks are preferred as an investment to CIS; volatile performance of some domesticmarkets; underdeveloped money market funds; only a few countries have private retirement schemes; lack of distribution chan-nels; and tax disincentives.

Efforts are underway to develop the CIS industry by removing some of these obstacles. For example, some Asian economies arerestructuring or selling off publicly managed CIS. The entry of foreign funds or foreign involvement in the CIS sector is beingencouraged so as to introduce best practices in domestic fund management. The introduction and the development of mandatoryprovident funds can also highlight the need for long-term investments and CIS.

The participants agreed that, though in general there are potentially good prospects in CIS in the region, a lot of effort is stillneeded for their significant acceleration. The participants also discussed the performance of CIS products and the situation offees and expenses of the CIS in the region.

c) Pension Funds

The introduction of defined contribution pension systems is now most actively considered in the OECD countries where afunded pension system does not exist at present. This is a system that has direct consequences for capital markets in thatindividuals own financial assets directly.

The pension sector in many Asian countries faces a great deal of challenges, including the dominance of PAYG systems, highadministrative costs, inadequate coverage, reactive regulatory systems, archaic investment regulations, and inadequate financialinfrastructure.

Many new Asian pension systems are based on a defined-contribution formula (fully funded by definition). Hence, also in thiscase the need to ensure the financial security of pension benefits is a public policy issue, especially where these plans have (orwill) become the main providers of pension benefits.

Reform of pension systems, in particular the shift to funded pensions can provide the region with a good opportunity to facilitatecapital market development. The participants discussed policy measures, which can exploit this opportunity for further develop-ment of the capital market.


3. Legal and Supervisory Frameworks for CIS

For the sound development of CIS, an appropriate regulatory framework is indispensable. Among the statements issued by theOECD and the IOSCO, there are common understandings on the importance of investor protection and the necessity of indepen-dent custodian, appropriate disclosure etc. IOSCO is still working on these issues and developing further elaborated principles.

A possibility, that over-regulation could stifle the growth of institutional savings, and, on the other hand, a risk, that looseregulation may lead to lack of appropriate investor protection and thus undermine the confidence of investors in the relevantproducts, were discussed. In this regard, the necessity of an appropriate sequencing of policies for the sound development of theinstitutional investors in the region was emphasized.

Another big challenge for regulators is how to deal with the different types of industries in the CIS business. A key issue forregulators is how to maintain the integrity of regulation; that is to avoid duplications as well as gaps in regulation and to secureconsistency of regulation. The creation of an integrated single regulator may be an answer to this challenge. On the other handthe US iscoping with this problem under a segmented regulatory system. The pros and cons of a consolidated regulatory systemand a segmented regulatory system were discussed.

The summary of the discussions will be available on the following web sites.

OECD: http://www.oecd.org/dafADBI: http://www.adbi.org

For further information, contactOECD: Mr. Fujiki Hayashi, Head, Outreach Unit for Financial Sector Reform, Directorate for Financial, Fiscal and Enterprise

Affairs, OECD, Paris,tel. (33) 1 45 24 18 38;fax. (33) 1 45 24 18 33

ADBI: Mr. Naoki Kajiyama , Director, Administration, Management & Coordination, Asian Development Bank Institute,Tokyo,tel. (81) 3 3593 5500;fax. (81) 3 3593 5571


The views expressed by presenters and speakers, and the findings, interpretations, and conclusions of authors are their own and arenot necessarily endorsed by the Asian Development Bank Institute. They should not be attributed to the Asian Development Bank, itsBoards, or any of its member countries. The Institute does not guarantee the accuracy or reasonableness of the contents herein andaccepts no responsibility whatsoever for any consequences of its use.

© 2001 Asian Development Bank Institute. Further proceedings online at http://www.adbi.org/forum/forum.htmADBI Publishing 12/01

Executive Summary SeriesAll these titles and much more available online and fully searchable at http://www.adbi.org/publications/● International Finance Seminar

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