Published Date: 04 November 1998

"Building A Premier Exchange"

Speech by DPM Lee Hsien Loong at the SES 25th Anniversary Celebration Dinner

Date: 04 Nov 1998

Mr Chua Kim Yeow, Chairman, Stock Exchange of Singapore
Distinguished Guests
Ladies and Gentlemen


1   I am very happy to join you this evening to celebrate the Silver Jubilee of the Stock Exchange of Singapore (SES).

2   The SES has come a long way from the Clifford Trading Rooms of the old Malayan Stock Exchange, and its subsequent premises in Clifford Centre, to the fully-electronic exchange now housed at The Exchange building. It has established a reputation in Singapore and abroad as an exchange where rules are upheld, investor rights are protected, and transparency and integrity prevail. It has played a full role in developing Singapore's capital market and corporate sector, and proven resilient in weathering the regional economic storm. Over 370 companies are listed on SES's mainboard and SESDAQ, with a current total market capitalisation of S$300 bn - 190% of Singapore's GDP.

3   Full credit must go to the successive SES Committees and management, whose professionalism and dedication have made this possible. I should especially mention the President of SES, Mr Lim Choo Peng, who has been with the SES throughout its 25 years. He has been instrumental in making the SES one of the first fully-electronic equities exchanges internationally, and in the continuous upgrading of the SES' trading and settlement systems to keep pace with advances in IT.

4   The question is how the SES can continue progressing. There is no simple answer. The Hong Kong Stock Exchange can always tap on and service the huge mainland Chinese corporate market. But the SES is in a different position. It therefore needs to take bold innovative steps to break through to a higher growth trajectory.


5   One major focus of our financial sector review has been to develop strategies to broaden and deepen Singapore's capital markets. We set up two private sector committees to review our capital markets - the Corporate Finance Committee chaired by Mr Lim Yong Wah, and the SES Review Committee chaired by Mr Lim Hua Min.

6   The Corporate Finance Committee has submitted its final report. Its thrust is to shift from merit-based regulation to a predominantly disclosure-based regime, streamline our regulatory framework, and improve our rules and regulations. Key recommendations include instituting a comprehensive legal obligation to disclose, consolidating securities laws and rules into a single piece of legislation, publishing regulatory policies and interpretations to facilitate appeals, and empowering the regulator to take civil action in the public interest against companies which have failed to comply with rules, thus causing losses to investors. The Government has accepted all the recommendations of the Corporate Finance Committee, which will be publishing its Report next week.

7   Earlier, the Government had also accepted most of the recommendations of the SES Review Committee to liberalise stockbroking commissions, and progressively open access to the exchanges.

8   The SES Review Committee highlighted the need to fundamentally review the governance structure of the SES before we open up access. We therefore set up a third committee, the Committee on Governance of the Exchanges (CGE), to follow up on this basic issue for both our exchanges, SES and SIMEX, so as to keep them competitive. The CGE comprises MAS officers, SES and SIMEX members, the Presidents of the two exchanges, capital market participants and corporate lawyers. They have worked intensively over the last two months. The Government has accepted their recommendations. I shall outline our plans for the two exchanges arising from this review.


9   Both SES and SIMEX have done well despite the regional crisis. On the SES, trading volume has held up despite the removal of Malaysian shares from Clob International. On SIMEX, this year's volumes of most key contracts are already at all-time highs. In a static environment, both would probably continue to hold their own when the economy picks up and the region recovers. But exchanges worldwide are finding themselves in an increasingly globalised and competitive environment.

10   Leading US and European equity and derivatives exchanges are competing furiously to link up into international networks, in order to combine liquidity pools, lower trading costs, and become the dominant player. Almost daily there have been press reports of exchanges linking up in London, Frankfurt, Paris, New York or Chicago. Equity and derivatives exchanges are merging to develop complementary products, provide more integrated trading facilities, and share overheads. Examples include the Deutsche Borse, Paris Bourse, Amsterdam Stock Exchange, Stockholm Stock Exchange and Tokyo Stock Exchange. Most recently, NASDAQ bought the American and Philadelphia stock exchanges to acquire new capabilities in equity-related derivatives products.

11   Electronic trading systems are rapidly replacing traditional trading floors. The DTB in Frankfurt wrested trading of German bund futures back from the London International Financial Futures Exchange (LIFFE) within a few months, because LIFFE was slow to abandon open outcry for electronic trading. LIFFE has just announced a major restructuring to reduce its operational costs by half, opening the way for partnerships with other exchanges and financial institutions.

12   Major financial institutions are increasingly seeking direct electronic access to exchanges and bypassing local intermediaries. If their needs are not met, they will bypass the exchanges altogether to trade amongst themselves.

13   Exchanges are competing more fiercely not only with one another, but increasingly with new non-traditional players. Information providers like Reuters and Bloomberg already provide trading services. Longer term even non-financial companies like Microsoft with its global distribution network may enter the fray.

14   The gap between the exchanges in the premier league and the rest is widening. Those which cannot keep up will be marginalised into servicing their limited national catchments, and risk seeing even their traditionally protected markets being eroded.

15   These trends have not yet affected Asia in full force. Access to most Asian equities exchanges is still far from open, Singapore included, and many still have non-negotiable broker commissions. Consequently, Asia has some of the highest "all-in" trading costs in the world.

16   This gives us a window of opportunity to act swiftly, in order to capture the first mover advantage, and build ourselves up into the premier exchange in the region. It is no longer tenable for us to maintain a closed, static arrangement, with commissions fixed at levels comfortably higher than would prevail under free competition. We need to attract a critical mass of global investors by opening access widely to international brokers and other market participants. We also need more competition, to bring trading costs down through greater efficiency and innovation.


17   The present structure of both SES and SIMEX are "mutuals", i.e. they are legally owned by their members. Access to the SES is restricted to its 33 members. As a result a new player wanting access to trade on SES has to buy a seat from an existing member, unless the existing members agree to let SES sell additional seats. This acts as a barrier to entry, besides creating a scarcity value for the seat.

18   SIMEX is owned by the 35 clearing members, and access is restricted to them and to the non-clearing members, whose number is also controlled by a limited number of seats (presently 472). Access to SIMEX has been less rigid, as new seats have been issued periodically to meet new demand for trading rights.

19   The mutual structure of the exchanges is not ideal for the future development of our capital markets. The interest of existing members does not always coincide with the interest of the exchange itself, or indeed with the broader interests of the financial sector. The SES has partially addressed this problem by requiring non-brokers to sit on the SES Committee, and by coordinating closely with MAS on strategic issues. But open access is an increasingly critical success factor for our exchanges. To grow and compete, the exchanges must take bolder steps to liberalise access and deregulate commissions, and make more business strategy decisions themselves in response to investor and corporate needs. As they do so, the present arrangements will become increasingly problematic.

20   The solution is to demutualise the exchanges, i.e. change their governance structure to separate ownership rights from trading access rights. The exchange becomes a stock company with a more diversified shareholding structure, in which non-broker investors can own shares, and non-shareholders may participate.

21   This brings several important advantages:

  • First, it lessens the potential for conflict of interest. An exchange serves not only brokers, but also other capital market participants such as issuers, fund managers, investors and those trading on the exchange. A stock company structure with broader ownership allows more diversified interests to be directly represented in setting the directions for the exchange.
  • Second, in a stock company the share value and dividends will reflect more transparently earnings and prospects, maximising incentives for owners and management to raise operational efficiency and seek competitive advantage.
  • Third, funding can be obtained more efficiently and flexibly directly from the capital market. This is important because the exchange may need to make long-term strategic investments that will not always benefit existing brokers directly, and may require more funds than its limited membership can provide.

22   Several international exchanges have already demutualised. These include the German, Swedish, Dutch exchanges, and the Australian Stock Exchange which recently publicly listed itself. The Toronto Stock Exchange and LIFFE have announced similar plans.


23   The Committee on Governance of Exchanges has proposed, and the Government has agreed, that SES and SIMEX should be demutualised, as well as merged into a single integrated privately-held stock company. A new holding company will be formed, which will wholly own SES and SIMEX as subsidiaries.

24   Combining the cash and derivatives exchanges will yield significant advantages:

  • First, it will align cash and derivatives business strategies more closely. Integration can spur the development of complementary products with international appeal like equity-linked options and synthetics. The derivatives market is set to grow faster than the cash market, as it introduces more new products, and links up with strong international derivatives partners. This has also been the experience of the merged Amsterdam and Stockholm Stock Exchanges, both of which serve small domestic markets like ours.
  • Second, the combined entity will have more bargaining power to deal with prospective strategic partners. It will also be financially stronger to make the heavy capital investments necessary in future, for instance developing common front-end trading workstations and back-office processing systems.
  • Third, it will enable us to build one strong management team. The existing managements are highly capable and will remain integral team members. But because of the greatly expanded demands of the new enterprise, and the competitive challenges in the business, we need to consolidate and reinforce the existing teams to compete against other international exchanges.
  • Fourth, the combined entity can share overheads such as product development, technology management, marketing and risk management. The merging of administrative and backroom functions of the two exchanges should also yield cost savings, although this is not the main motivation.

25   SES and SIMEX will initially be separate legal entities under the combined exchange, and operate their trading and clearing functions substantially as they do now. There will therefore be no immediate impact on the way brokers or investors trade on SES and SIMEX.

26   In particular, the clearing processes for SES and SIMEX trades will initially be kept separate, as different divisions within one umbrella clearing subsidiary. This way the different risk profiles of cash and derivatives trading will be retained. SIMEX's "common bond" system will continue unchanged for the time being. Its clearing members will have the same rights and obligations, and earn clearing fees from derivatives trades. Existing qualifying criteria for clearing membership will also remain unchanged and SIMEX clearing members will continue to have a strong say in running the clearing function.

27   In the longer term, SES and SIMEX will probably become a single legal entity, and share a common trading platform when this becomes technologically feasible. No trading engine is yet operational to cater to both cash and derivatives. The exchange can also bring together the separate clearing and settlement functions of SES and SIMEX. This will create scale and allow the exchange to expand into the clearing of off-exchange products like OTC derivatives and fixed income instruments.


Business Development

28   Combining the two exchanges into one is by itself not sufficient for the continued development of our capital markets. The combined exchange must grow its business. At present, the SES is domestically-oriented, like most equity exchanges elsewhere. It is highly dependent on our local corporate base and retail investor pool. SIMEX is an important regional and international player, but it relies heavily on trading of non-proprietary products, like the Eurodollar and Euroyen interest rate contracts. SIMEX has started introducing a range of regional index futures contracts, and will need to further broaden its product offering.

29   The new exchange needs to develop a range of Singapore and Asian equity products and equity-linked derivatives, in order to become the equity centre in the Asian timezone. Only then can it attract Asian investors, as well as G7 investors wanting exposure to the Asian cash and derivatives markets.

Freeing Access and Commissions

30   The combined exchange will phase in the complete freeing of SES commissions, and fully open access to both SES and SIMEX. Open access means that any institution which meets standard requirements, such as capital and competence, will be admitted to trade on the exchange, regardless of local or foreign ownership, and without any quota on the total number of seats. I expect this process to take three years, completing by January 2002.

31   This is in line with the SES Review Committee's recommendation that the liberalisation take place within 5 years. Three years will give local brokers reasonable time to prepare to meet the multiple challenges of a more competitive environment, and develop new capabilities and areas of business.


32   Sound capital markets also require a strong local broker community, fully committed to Singapore's financial centre vision, with the indigenous capability to provide value-added services to a wider pool of international investors.

33   To play this role, local brokers must take full advantage of the three years of transition to restructure the industry, expand their capabilities and build up their talent base. Those intending to stay in the industry need to take some hard decisions, work out their own business strategies and find new ways to add value in the new environment of deregulated commissions and free competition. Some may choose to become niche players, providing specialist services in research or asset management. Others may try to build up to compete with international securities firms.

34   Some local brokers have already begun to upgrade their range of services, like providing Internet access and more investment advice. A few are planning to merge. They are conscious of the challenges ahead, and are already staking out their positions.

35   The MAS supports the aspirations of local brokers to develop themselves. It will review its regulations to help brokers diversify into other financial services, and compete on a more level playing-field. SES and SIMEX will organise educational seminars and programmes to help brokers gear up for new opportunities.


36   The freeing up of commissions and increased competition in the industry will impact greatly the way retail clients are serviced. The changes will mean that like the broking companies, remisiers must upgrade themselves to provide more services to customers. For instance rather than just transacting shares, remisiers may cover markets other than just local equities, and over time build asset advisory capabilities like US brokers.

37   Some may find these changes daunting, but they are not avoidable. For the innovative, there is still a world of opportunity to develop a good business and a viable future.


Capital Structure

38   Government will pass legislation to effect the transfer of 100% of the shares of SES and SIMEX to the new holding company, which will be set up by Government. The SES and SIMEX's entire existing assets and cash reserves will be transferred to the new company. In return, existing members of SES and SIMEX will be allocated shares in the new combined entity. The Government will sell its remaining shares in the new entity to new investors.

39   Awarding existing members shares is justified, because firstly they have contributed much to developing the two exchanges. Secondly, the Government is changing the rules to remove the brokers' monopoly franchises, which will substantially diminish the existing value of their seats. Thirdly, giving existing brokers a stake in the new exchange will ensure their commitment and vested interest in the success of the new enterprise. In all other cases where exchanges have been demutualised, similar arrangements have been made for existing members.

40   The Government has decided that the value of shares allocated to each SES member should be slightly below the current estimated market value of an SES seat. This is fair considering that the liberalisation of access and commissions will be phased out over three years, and will not take place immediately. Furthermore this liberalisation would have happened even if the exchanges were not demutualised, though perhaps not as quickly, so that the seat values in any case could not have remained at past levels. Each of the 33 members of SES will therefore receive S$6 mn worth of shares in the new entity..

41   SIMEX commissions are already freely set, but the SIMEX seats still command a scarcity value because their number is controlled. So for SIMEX members, the Government has also taken a small discount on the average seat and share values from Jan-Oct 1998 1. We are using the average as the benchmark, to smooth out the highly volatile SIMEX seat prices. SIMEX members will receive S$115,000 worth of shares for each SIMEX share owned, and S$170,000 worth for each seat owned. Clearing members (who typically own 1 share and 3 seats) will therefore receive S$625,000 worth each. Non-clearing members, both individual and corporate, will receive S$170,000 worth per seat.

42   The actual number of shares of SES and SIMEX members in the new entity will depend on the exact valuation of the new entity. This will be determined by a financial advisor. The net tangible assets of the new entity amount to about $600 mn. A valuation range of S$600 - 800 mn would give SES and SIMEX members together a total of 40 - 50% of the new entity. Assuming a valuation of S$700 mn for example, SES members will collectively receive shares amounting to 28% of the new exchange, and SIMEX members 15%.

43   To diversify the ownership pool, the remaining shares in the new entity will be offered to new investors including financial institutions, fund managers and listed companies. Brokers (both SES and SIMEX) may also purchase these shares. To ensure ownership stability and balance long-term financial sector interests with short-term profit motives, the Government will encourage a pool of strategic investors to take a significant stake in the new entity. These may include the local banks, and government-linked entities like Temasek Holdings.

44   Shareholders in the new exchange will be allowed to trade their shares immediately. The percentage of total shares owned by brokers will be subject to a ceiling of 75%, and a floor of 33 1/3%. This will ensure that brokers retain a significant but not an over-dominant stake in the new entity.

45   As other exchanges have done, single owner share-holding limits will be imposed to ensure a diversified ownership structure. Holdings beyond 5% will require MAS approval. For strategic investors who are allowed to go beyond 5%, we will set a further requirement to seek approval for shareholding beyond 10%.

46   The new entity will not be publicly listed immediately. It needs time to consolidate its resources and develop new strategies. We also want existing SES and SIMEX owners to maintain meaningful stakes during the transition. However, we do envisage an IPO in the medium term, within say 5 years. This will give an incentive for owners and management to commit to the success of the new enterprise.

47   You may want to know what will happen to the proceeds from selling shares in the new entity. They will not go into the Government's Consolidated Fund. Instead they will be placed in a Financial Sector Development Fund administered by MAS. This Fund will be used to promote training and upgrading, and to undertake projects to develop the financial sector, including of course helping brokers to train and upgrade their human resources.


48   A Pro-Tem Committee will be formed soon to oversee the formation of the new exchange. We need to engage a financial advisor to value the combined entity, place shares with new investors, pass legislation, complete pre-merger integration work, and develop the new regulatory framework. Preparation for the corporate integration of SES and SIMEX as well as conversion to a privately-held stock company should take about 9 months. We therefore expect to launch the new entity in late 1999.


49   The new for-profit exchange will continue to be responsible for routine regulatory functions such as listing approvals and market surveillance, like other demutualised exchanges. However, MAS will enhance its regulatory oversight over the exchange. MAS will inspect the new entity regularly to ensure it performs its supervisory functions adequately and properly. We will also encourage the exchange to price its services competitively, especially in functions which are natural monopolies, such as depository services. MAS will study the necessary regulatory arrangements more fully.


50   I have focussed on the structural changes necessary for our exchanges to continue to develop, and to support our role as a regional financial centre. We will put in place the right incentives, but success will depend on growing our talent pool, and developing proprietary benchmark Asian products with international appeal.

51   This will be a challenging task, especially as we begin to build momentum. The development of regional business will not be a smooth path. In the present uncertain environment, many countries are preoccupied with immediate problems, and some are taking steps to restrict the free operation of capital markets. However, capital markets play a vital economic role mobilising funds for corporates, and providing liquidity to investors who might otherwise stay away from the countries altogether. As the region recovers, the countries will feel more keenly the need for free but well-regulated capital markets. Each country will promote its own capital markets, but in addition there will be a role for regional hubs servicing the whole region and deepening the overall pool of liquidity.

52   We should start to prepare ourselves now for this opportunity. SES' strong foundation, laid over the last 25 years, will help it and SIMEX to restructure and take the next major step forward together, to become a premier exchange, and make Singapore a hub for capital markets in Asia.

1 The average price of seats and shares traded between Jan and Oct 1998 is about S$190,000 and S$125,000 respectively.