Unlocking the Power of Global Financial Centres

1. “The Development of Global Financial Centres”byDatuk Seri Panglima Andrew L.T. ShengTun Ismail Ali Professor of Monetary and Financial EconomicsFaculty of Economics and AdministrationUniversity of MalayaThe Puteri Pacific Hotel, Johor BahruThursday, 18 May 2006

2. Contents • Role of Financial Centre in National and Global Context • How Hong Kong defended and enhanced position as largest international financial centre ex-Japan • Key issues in building IFCs • Potential for Malaysia

3. Cities and Financial Centres • Efficiency of economies all about efficiency of urban centres, e.g. New York vs. Mexico City • Cities are knowledge centres • Art, culture, politics, trade, news • Must have rich hinterland, linked by superior communications, e.g. river, sea, road, rail, air • Exchanges and Technology • Pre-telegraph, 100+ US exchanges, • Advent of radio, 22 (1935) • Advent of computers - 7 (1995)

4. Financial Markets are Networks Metcalfe’s Law - “The value of a network goes up as the square of the number of users” • Economies of Scale • Supply side - Biggest producer wins • Demand side - Biggest buyer determine standards • Critical Mass • Aggregation of local knowledge and skills • Best combination of skills create economies of scale • Critical Mass= Clusters = skills concentration • Supply Chain Management - where in the chain is real value?

5. Changing Structure of Financial Markets • Financial Innovation • Evolution of derivatives, options & futures • Technology & Telecommunications • Global 24 hours markets • From market place to market space • Deregulation • Lines of traditional businesses blurring

6. Finance is Derivative of Real Economy, Value defined by information + Knowledge • Commoditization means that low-knowledge products and services have high competition, low prices and are easily duplicated and therefore “taken away”. • Markets are all about“branding”and “high knowledge content products”. Knowledge content needs governance - value creation needs total inputs at production, design, packaging and marketing levels. • Network Economy demonstrates “winner-take-all” situation.Financial markets converge on key hubs, e.g. New York taking American time zone business, London taking European time zone business

7. Reliable InformationEssential for Quality of Markets • Quality Marketsrequire real time and reliable information to make sound risk management decisions in highly volatile environment • High quality informationrequires : • Good accounting and auditing standards • Reliable & timely statistics/reporting processes • Infrastructure to process information for making decisions critical to competitive success • Bad accounting = distorted information = poor decision making = bad risk management financial crisis

8. Wisdom Value Knowledge Information Data Hierarchy of Information • Robert W Lucky, “Silicon Dreams: Information, Man and Machine”, St Martin’s Press, 1991.

9. Sequencing and Hierarchy of Domestic Financial Markets Asset-backed securities and derivatives Corporate bond and equity markets Government bond market Treasury bill market and foreign exchange markets Money market Source: Karacadag, Sundrarajan & Elliot, 2003

10. Market DisciplineKey for Corporate Governance • Quality of marketsdepends on quality of corporate governance in listed companies • Corporate governanceis about three key disciplines: • Self discipline- ethics & fairness • Regulatory discipline- a level playing field • Market discipline- competition & accountability • Asia traditionally stressed first two disciplines atthe expense ofmarket discipline • The key to capital market development is to promote andenforcethese disciplines based onreliable information

11. Efficient Markets require: • Free Entryof Participants and Products • High degree of transparency/low information asymmetry • Efficient Operations bysolventparticipants underinternational rules of the gameat low transaction costs • Absence of incentive distortionsor bias that moves markets in unhealthy direction e.g. moral hazard or subsidies • Efficient regulationat low regulatory costs; • Orderly exit of insolvent participants [obsolete products and insolvent operators create huge dead costs on market] • Accountability[feedback and exit for bad players]

12. Malaysia already has balanced financial sector(% of GDP) Source : World Bank Financial Sector Dataset, February 2006

13. Case Study: Hong Kong as IFC after 1998 Stock Market Intervention • August 1998: HK Govt intervened with US$15 billion in stock market to stop hedge fund speculation • Immediate action: • Rebuild Market Credibility • Close Gaps with London/New York: better regulation, more products, greater liquidity • Build Stronger Links with China and Asia: more research, better marketing, closer connections • Medium and long-term: • Greater integration with Pearl River Delta to compete against Yangtze River Delta/Shanghai • Wall Street in Asia

14. Strengths of Hong Kong • Low Transaction Costs • Rule of law with advanced property rights system • Free and open economy with world-class financial system • Low tax rate and simple tax system • Low Exchange Rate Risk and Uncertainty • Fully convertible currency • Exchange rate linked firmly to USD • Fully open and deep capital market • Next to Rapidly Growing Southern China • Potential for lowering production costs • Potential for expanding turnover • Potential for servicing new wealth

15. Understanding Strengths and Weaknesses • Pre-WTO, Hong Kong had premium as external window for China and East Asia, when access to markets and knowledge was poor • Franchise is eroding when China gains access to WTO and through Web • However, biggest value added is “Localization of Global Knowledge” - add value by being: • Preferred financial centre in Asian Time Zone • Best logistics centre in ATZ • Importing external skills [e.g. marketing, finance, technology and tailoring for local markets

16. Learning from Competitors • Lessons from Shanghai and Singapore: • Clear vision, sound strategy and detailed blueprint • Effective coordination among local and central governments and business • No economic borders to residents or outsiders • Lessons from Japan, Taiwan and other Asian economies: • Political stability key to stable growth • Protectionist policies only delay pain • People and capital move faster than policy changes • Implications for Hong Kong: • Economic and financial integration of Hong Kong (finance), Southern China (manufacturing) and Taiwan (technology). • Hong Kong could provide the best service for Mainland, Taiwan, Asia and international business

17. Competition & Co-operation Strategies • Hong Kong domestic market alone too small to have critical mass • In areas where HK has critical mass, play dominant player strategy • e.g. Financial services - improve quality to capture value in Supply chain management • In areas where HK has no critical mass, cooperate and affiliate • e.g. Move manufacturing where there is cheap labour • e.g. cooperate with others to achieve economies of scale [airports, power, environment]

18. Markets are a function of Liquidity & Friction Costs • The greater the friction cost, the more the market moves to areas with lower friction costs • The lower the friction cost, the higher liquidity • Friction costs depend on the following:- • Time [speed to market] • Factor costs [Labour, Capital, Taxes] • Infrastructure costs - how good is physical utilities? • “Government costs” - are rules & policies costly? • Barriers to Entry - competition policy

19. Structural Costs Compared HKSARChinaUSJapan Production Costs High Low High High Transaction Costs LowHigh Low Medium Infrastructure Cost High Medium Low Medium Saving Rate MediumHighLow High Expected Investment Return Low High Medium Low Speed to market Slowing Improving Good Slow “Government Costs” Low High Low High Barriers to Entry Rising Lowering Low High

20. Hong Kong’s 1999 Three-Pronged Reform Programme • Market reform: SEHK and HKFE were demutualized and merged to form the HKEx in Mar 2000, listed on 27 Jun 2000 • Infrastructure reform: fully electronic web-friendly world-class high tech infrastructure by 2002/2003 • Legislative reform: Securities and Futures Ordinance passed in 2001 Complete Corporate Governance and Enforcement overhaul 2001-2005

21. Hong Kong – Largest Market in Asia ex-Japan,1988-2006 (US$ bn) Remark: x = increase from end 1988 to end Mar 2006 Sources : WFE and IFC

22. Capitalization and Turnover of Major Markets(end Mar 2006, US$ bn) Remarks: Turnover - for the 12 months ending Mar 2006, P/E ratio - end Mar 2006 Due to different reporting rules & calculation methods, turnover figures are not entirely comparable P/E ratio for China is the weighted average of A and B shares markets Sources: WFE and websites of various exchanges

23. Financial Sector Masterplan (FSMP) • A 10-year plan (2001 – 2010) outlining strategic focus & actions, with 119 recommendations and encompassing 6 sectors: • Banking • Insurance • Islamic Banking and Takaful • Objectives • Create a more efficient(services at lowest cost),effective(broad range of services) • & stable(minimal systemic risks)financial system • Meet socio-economic agenda in an effective & efficient manner • Meet international commitments & prepare domestic financial institutions for global competition • Implementation Phases • Phase I (3 years) • - Enhance capacity of domestic institutions to compete • - Enhance financial infrastructure • Phase II (3-4 years) • - Intensify competitive pressure in the domestic financial sector • - Level playing field with incumbent foreign banks • Phase III (after 7 years) • - Assimilate into global arena • - Introduce new foreign competition • Source: Bank Negara Malaysia • Development Financial Institutions • Labuan IOFC • Alternative Modes of Financing

24. Capital Market Masterplan (CMP) • A 10-year plan (2001 – 2010) outlining strategic focus & actions, with 152 recommendations to address 4 key Malaysian capital market challenges: • Lingering effects of the regional financial crisis • Meeting the needs of a growing economy • Heightened global competition for business and investment • Changing demands on the regulatory framework and authorities • Objectives • To be the preferred fund-raising center for Malaysian companies • To promote an effective investment management industry and a more conducive environment for investors • To enhance the competitive position and efficiency of market institutions • To develop a strong and competitive environment for intermediation services • To ensure a stronger and more facilitative regulatory regime • To establish Malaysia as an international Islamic capital market centre • Implementation Phases • Phase I (3 years) • Strengthen domestic capacity, and develop strategic and nascent sectors • Phase II (2 years) • Further strengthen key sectors and gradually liberalise market access • Phase III (5 years) • Further expansion and strengthening of market processes and infrastructure towards becoming a fully-developed capital market, and enhancing international positioning in areas of comparative and competitive advantage • Source: Securities Commission Malaysia

25. Global Competitiveness: Malaysia’s Standing Source: World Economic Forum (WEF), 2005/06; Institute for Management Development (IMD), 2005 1 IMD World Competitiveness Ranking 2 WEF Growth Competitiveness Index Ranking

26. Malaysia’s Competitiveness Trend Source: Institute for Management Development (IMD), 2005

27. Global Competitiveness: Government Efficiency Perspective Source: Institute for Management Development (IMD), 2005

28. Global Competitiveness: Government Efficiency Perspective Source: Institute for Management Development (IMD), 2005

29. Global Competitiveness: Government Efficiency Perspective Source: Institute for Management Development (IMD), 2005

30. Global Competitiveness: Government Efficiency Perspective Source: Institute for Management Development (IMD), 2005

31. Malaysia’s Competitiveness Disadvantages Source: World Economic Forum (WEF), 2005/06

32. Global Competitiveness: Stock Market Perspective Source: Institute for Management Development (IMD), 2005

33. Global Competitiveness: Stock Market Perspective Source: Institute for Management Development (IMD), 2005

34. World Bank: Doing Business Global Index Source: World Bank, 2006

35. Bottom Line: Malaysia already has the Plans + HR + Infrastructure to be IFC • Its not about Vision, Mission or Infrastructure • Advantage 1: We have spent RM3 billion and 10 years to make Labuan a viable Offshore Financial Centre • Advantage 2: KL has the lifestyle and infrastructure to be attractive Asset Management Centre for Asia • Advantage 3: Malaysia is already leading Islamic Banking Centre • Advantage 4: Over 15,000 Malaysian professionals in Hong Kong alone, excluding Singapore and elsewhere - global talent is recruitable • Advantage 5: Malaysian costs are lower than other regional financial centres. EXECUTION and IMPLEMENTATION is key to success.

36. Finance is not a zero-sum game in Asia. Malaysia can offer niche services at lower costs • Malaysia can be Global Islamic Financial Centre - watch the competition. • KL can be Asset Management Centre for Asia - Labuan is already booking centre. • We can be outsource subcontractors in accounting, secretarial, cartoons, sound, film, book production etc to high cost centres. • Need focused implementation and constant benchmarking to international standards, plus partners from all over the world. • Outsourcing and Services business needs widespread and stable broadband.

37. Development and Growth is a Process: To have Sustainable Growth, you need a Process to Manage Development Process • Development is complex, because those who face most problems are those who are closest to the problem [the poor, SMEs, private sector, grass root public servants]. • It’s not about QUANTITY OF GROWTH, BUT QUALITY. • In the past, development has been top-down. Aid, not trade. Today, we understand that we have to use market forces to lead growth. • Therefore, the key to sustainable growth is to have inclusive, transparent and accountable processes to manage the growth process. • This is a co-operative venture, not public-private competition. This includes using national + global talent and skills.

38. ABC of Knowledge Economy ACADEMIA - Holders of Knowledge, but bogged down in teaching. Segmented from market or government BUSINESS - Close to market, but do not use Academia for R&D and sees Civil Service as hindrance rather than partner CIVIL SERVICE - Holder of massive public information and resources that can help growth. Currently, rarely uses Academia for R&D and policy work. Focuses more on regulation rather than BUSINESS facilitation. Competing internationally means that transactions costs of doing business and “time to market” in Malaysia must come down. Its all about teamwork. We have to operate as truly Malaysia Inc.

39. Change Management is Tough • Clarity of Role and Objectives • Rules have no meaning unless they are enforced • It’s the outdated processes that must change • Prioritization of “Doables” • Getting staff and public buy-in • The whole world is adjusting - pain is inevitable • Deliver small winners to achieve credibility - the big winners will take care of themselves

40. Focus and Prioritize “Pick important problems and fix them and tell everyone”.. “The essence of the [regulatory] craft lies in picking the right tools for the job, knowing when to use them in combination, and having a system for recognizing when the tools are inadequate so that new ones can be invented.” Professor Malcolm Sparrow, The Regulatory Craft, Harvard University.

41. Fixing the Problem • Old-style regulators: “Nitpicking, unreasonable, unnecessarily adversarial, rigidly bureaucratic, and incapable of applying discretion sensibly.” • It is often the obsolete and defective systems, not the people, that create problems. • Change is the constant. Be prepared to change.

42. Enforcement of Laws, not Laws per se, is critical OECD - “Too often, legislators issue laws as symbolic public action, rather than as practical solutions to real problems. Regulatory inflation erodes the effectiveness of all regulations, disproportionately hurts small and medium businesses, and expands scope for misuse of administrative discretion and corruption.”

43. Implications for Johore • Johore has huge advantage by being next to Singapore, which is already an IFC. • Key is connectivity: reduction of friction costs to and from JB - Singapore. Stable broadband enables outsourcing from Singapore to Johore. • In RMK9, notice that MRT is being considered. Can MRT link to Singapore be considered to enable flow of people and ICT pipes?

44. Implementation of 9th Plan will focus on Southern Johor Economic Region • RM12.2 bn allocated to develop SJER, building up Nusajaya, Danga Bay waterfront, a transport hub and high speed rail link from JB to Kuala Lumpur. • 6,480 ha of land will be developed in Nusajaya, housing Johor’s new administrative centre, universities, theme park and industrial/residential estates • Logistic hub will include Tanjung Pelepas, Senai Airport and Pasir Gudang.

45. FIRST CLASS SERVICE • As small open economy, Malaysia has already reached Middle-Income Status. We are caught in middle bulge. Not big enough to have economies of scale, but not too small to be marginalized. • Korea learnt key lesson from Asian crisis: the governance structure of DEVELOPED COUNTRY status is very different from EMERGING MARKET status. Korea paid for this lesson. • Go for quality of service, not quantity. Go for value, not size. Quality of governance at both public and private sector key to success. • To reach 2020 DEVELOPED economy status, we are already benchmarked against global standards.

46. Thank you Questions to as@andrewsheng.net