Published Date: 18 September 1999

"Challenges for Exchanges"

Speech by DPM Lee Hsien Loong at the SIMEX 15th Anniversary Celebration Dinner, 18 Sept 1999

1   I am very happy to join you this evening to celebrate the 15th Anniversary of the Singapore International Monetary Exchange (SIMEX).

Challenges Facing Exchanges

2   We set in motion changes to the structure of our exchanges last year. We are demutualising and merging the securities and derivatives exchanges, deregulating commissions and opening up access to more players. The changes are well underway. The Exchanges (Demutualisation and Merger) Act was passed by Parliament on 4 August 1999, and the new integrated exchange will start business on 1 December 1999. It will be called the "Singapore Exchange". We are fortunate to have had Mr JY Pillay as Chairman of the pro-tem committee. Mr Pillay will become the Chairman of the Singapore Exchange. He will be supported by a good team of able and dedicated staff from SES and SIMEX. The team is being enlarged and strengthened for the challenges ahead.

3   We are bringing our exchanges up to date not a moment too soon. Even over the 10 months since we announced the merger of our two exchanges, the pace of change in the securities industry world-wide has been frenetic. The business of exchanges is in tremendous flux. Exchanges are facing intense competitive pressure, with cross border trades executed at the click of a button. Issuers and investors are gravitating to those markets that provide the greatest liquidity and best execution at the lowest cost. Margins are being squeezed by competition not just from other exchanges, but also from Electronic Communication Networks. The ECNs are so far most successful in the US, offering cheaper and, some argue, more efficient ways of trading. Exchanges are fighting back by deregulating brokerage commissions and opening access, which in turn puts pressure on the brokers, who have often been the owners of exchanges under the mutual structure.

4   In response to the twin forces of globalisation and technology, more and more exchanges around the world are demutualising to achieve greater efficiency and flexibility. Even the New York Stock Exchange, the most venerable of mutuals with over 1,300 members, is moving quickly towards demutualisation. The securities community has reached an implicit consensus that demutualisation maximises efficiency incentives and is critical to the continued survival of international exchanges.

5  . Besides demutualising, exchanges in the developed markets are forming international networks and bilateral alliances to combine liquidity pools. They are even considering ECNs, the generally perceived enemies of exchanges, as potential strategic partners.

6   Singapore is not exempt from these global forces, despite our success so far. SIMEX has come a long way from its humble beginnings in 1984. It is now the 11th most active futures exchange in the world, with the largest liquidity pool of international players in the Asia-Pacific region. 1998 was a record year in terms of total turnover, with 26 million contracts traded. We are on track to better that record this year. But we remain subject to challenges from new and existing players. Many of SIMEX's products are derived from other markets, which makes SIMEX highly susceptible to changes in the external environment.

Singapore Exchange Strategy

7   Over the past few months, the pro-tem committee and the Exchange's management, advised by their merger consultants (the Boston Consulting Group), have been developing new strategies for the merged Singapore Exchange.

8   The strategies aim to develop the capital markets infrastructure of Singapore to serve the Asian markets, and support the continued growth of Singapore as an international financial centre. The plans are ambitious, and require the Singapore Exchange to become more business-oriented and customer driven.

9   The plan includes three sets of initiatives. One, "Bolster" the Singapore-based business; two, "Grow" the business across borders through strategic alliances; and three, "Extend" the business portfolio to diversify the earnings mix.

10   The first set of initiatives (Bolster) aims to reinforce Singapore's trading and clearing infrastructure by fostering open and vibrant market participation, and to exploit synergies between securities and derivatives markets, in order to broaden the Exchange's product base and to deepen liquidity. They envision accelerating the liberalisation of broker commissions. They also seek to shift brokers from their traditional "buy-sell" transaction focus, and encourage them to develop asset management businesses. MAS has been studying how to improve the regulatory environment to facilitate these developments while preserving high standards.

11   The second set of initiatives (Grow) focuses on creating integrated access to trading and settlement across instruments and markets. It centres on developing common gateways linking fragmented liquidity pools in the region and across time zones. The forging of strategic alliances, anchored on sound and balanced trading and clearing business propositions, is central to this goal.

12   The third set of initiatives (Extend) outlines opportunities to diversify the Singapore Exchange's business portfolio by entering exchange-related processing services.

New Products

13   The Exchange will need some time to implement these business strategies. But whichever way the business develops, one certainty is that Asian capital markets will grow. Post-Asian crisis, there are ample savings within Asia to be mobilised for Asian capital investment, and substantial scope for attracting savings from developed countries in search of diversification. Equity and debt capital markets will provide the means for distributing credit risk among investors of varying risk profiles. Derivatives markets will complement cash markets, for hedging, arbitrage as well as investment opportunities.

14   One factor behind SIMEX's success has been its ability to identify and fulfil market demands by introducing relevant products. Not all SIMEX products have done well; but some have succeeded brilliantly, like the Nikkei-225 stock index. The 3-month Singapore Dollar interest rate futures contract, which was listed on 10 September 1999, is likely to be successful, as suggested by its encouraging initial trading volume. This is our second local contract. It meets the demand for a short-term interest rate futures contract based on the Singapore dollar, to support the growing bond and swap market. As the bond market develops, we will probably need to introduce a long-term interest rate contract, to satisfy the need for a wider array of interest rate instruments.

15   But Asian exchanges need to go further, and offer a comprehensive array of financial products spanning equities, debt, and derivatives. Regional exchanges must help regional companies raise funds. They can create and trade regional indices, to enable regional and international investors to channel liquidity efficiently across the region.

Exchange Linkages

16   In terms of one strategy, SIMEX has been ahead of the market. Well before linkages between exchanges became fashionable, SIMEX had established a long and rewarding relationship with the Chicago Mercantile Exchange (CME). Its 15-year association with CME through the Mutual Offset System has been further strengthened by a tri-partite GLOBEX Alliance formed in March this year between CME, the SBF-Paris Bourse and SIMEX. The Alliance will enable each partner exchange to trade the products of all three exchanges on their respective electronic trading platforms, which will be directly linked via state-of-the-art technology. The GLOBEX Alliance has been strengthened by the addition of the Brazilian futures exchange BM&F last week, and the Montreal Exchange earlier this week.

17   We also welcome possibilities of linkages with other exchanges in the Asia-Pacific region. While the regional exchanges compete vigorously, they also have a great deal of scope to work together. By coming together, we can create a common liquidity pool which can be accessed by customers. This will generate more trading volume, and benefit all the exchanges.

18   The experience of European exchanges suggests that it is in our enlightened self-interest to cooperate to increase our collective strength, despite historical rivalries. European exchanges have been busily linking up with one another, but despite this Europe may be moving too slowly, particularly in terms of harmonising different national standards and rules. The BBC recently reported that major international banks are making a major thrust to bypass the leading European stock exchanges 1. They are frustrated by the lack of progress towards a planned pan-European exchange alliance, and are looking to set up their own share market.

Responsible investing

19   While we are busy developing the business of exchanges, we should not forget that exchanges and capital markets are not ends in themselves. They exist to match investors who want to invest money with companies that need to raise capital, and to enable their customers to hedge financial risk exposures. Well-functioning markets enable investors to earn the best returns for their funds, and companies to raise capital at the lowest possible cost.

20   In the stock market particularly, the average long-term rate of return on equities is typically higher than on government securities or fixed deposits. This compensates for the greater volatility of equity prices: while the average long-term return may be higher, the probability of short-term losses is also greater. Therefore, equity investors should think in terms of years, rather than weeks or days. The stock market is not an avenue for immediate riches, far less a sure-win lottery, as evidenced by the recent findings on the level of losses associated with day trading in the US markets.

21   These basic truths are sometimes forgotten in a stock market boom. Companies may then see the stock market as an easy source of funding. Investors see buying shares as a no-lose proposition, especially shares in fixed-price IPOs. They are encouraged in this belief when companies, and issue managers, price IPOs below what the market is willing to pay, so that anyone lucky enough to receive IPO shares immediately makes a large capital gain. Many other investors then hope for the same the next time, and scramble for IPO shares. And so the excitement continues until at some point sentiments change and the market turns, often suddenly.

22   There are some signs that this has been happening on the Singapore share market. IPOs are being heavily over-subscribed, and are trading at significant premiums to their issue prices. In one recent case, the IPO was over-subscribed by 335 times! What is most surprising is that everyone thinks this huge over-subscription is a sign of tremendous success. Financial commentators and journalists who should know better talk about companies "netting" or "scoring" a subscription rate, and how they have outdone other companies in this respect; as if over-subscription were a sensible way to gauge the success of an IPO, or perhaps an end in itself. Even the companies whose shares have been sold way below what they could have fetched seem happy.

23   Strictly from the point of view of the supervisor of financial markets, there is no reason for MAS to be happy or unhappy at the way a company IPO turns out - how it is priced, and what reception it receives. But from the point of view of developing mature, stable equities markets, this is not the way we want to go. When investors, especially retail investors, treat every IPO as if Santa Claus is coming to town, they are not likely to develop a more sophisticated understanding of the value of shares, or the risks of share ownership. And when the market is dominated by such short-term considerations, the risk of a speculative bubble developing is increased.

24   A high over-subscription rate for an IPO simply means that the shares have been substantially under-priced. This is confirmed by the large jump in prices that we frequently see when such shares start trading. Whether or not the companies realise it, under-pricing IPO shares increases the cost of raising equity to companies. In some other countries, companies whose shares have been priced too low have sued their lead managers for negligence.

25   The last time MAS publicly pointed out the excesses of IPOs which were under-priced and over-subscribed was in 1993, 6 years ago. For a while this succeeded in cooling the frenzy, but markets, and memories, are cyclical. Hence a reminder is now needed. I hope that as our market matures, such reminders will become less and less necessary.

26   We want to develop capital markets which are stable and efficient, with prices that are well-based on fundamentals, and that reflect the collective judgment of investors who evaluate companies and equities professionally. This will take years to develop, but we should start now.


27   With that in mind, the Government has decided to make some changes to the CPF Investment Scheme (CPFIS). The purpose is to encourage CPF members to place their funds with financial institutions and professional fund managers, rather than investing the funds themselves in individual stocks. Institutional managers offer products designed to diversify portfolios, and reduce the volatility associated with individual stocks. The gains on such portfolios may sometimes not appear as spectacular as the gains on individual stocks, but the risks assumed are far lower. This will better cater to the long-term retirement needs of CPF members.

28   Currently, the amount that CPF members can invest under the CPFIS is subject to a limit of 80% of the investible balance in his CPF account, after setting aside the prevailing CPF Minimum Sum. This 80% limit applies whether the member invests the money himself, or whether he buys a unit trust or some other professionally managed investment product.

29   To encourage members to invest their funds through professionally managed instruments, the CPF Board will raise the limit for such investments from 80% to 100%. At the same time, the limit for direct investment in shares by members themselves will be lowered from 80% to 50%. Most CPF members are below this 50% limit, and will not be affected by the change. Only a small number - 26,000 CPF members - are presently above this limit. These members cannot make additional investments in shares, but they can continue to hold on to their existing shares until these are sold.

30   Besides the 80% cap, the CPF Board presently imposes a 20% sub-limit on investments in non-trustee shares. CPF members have thus generally been constrained to purchase trustee shares. However, historical data have shown that trustee shares have not significantly outperformed non-trustee shares over the long term. Furthermore, trustee status is not an absolute guarantee of the safety of the investment. A trustee company can still go wrong, either because its business does badly, or because of some monkey business, as in the case of Amcol.

31   Hence, the CPF Board has decided to remove the difference in treatment between trustee and non-trustee shares in the CPFIS. The new 50% limit on direct share investments will apply to all Singapore dollar denominated shares of Singapore incorporated companies that are listed on the SES, trustee or non-trustee, main board or SESDAQ.

32   While the previous rules did not imply that trustee stocks were absolutely risk free, neither do the new rules mean that all shares are equally safe or attractive investments. CPF members who want to invest their retirement savings in shares must study the individual shares carefully, in order to understand the risks and prospects of their proposed investments. This is a responsibility that neither the Government nor anyone else can discharge on their behalf.

33   The changes to the CPFIS will take effect from 1 December 1999. I should add that these changes only concern the CPFIS. They do not affect the status of trustee stocks under the Trustees Act. The Trustees Act imposes restrictions on investment powers of small private trusts and statutory boards. That is a completely separate matter which is being studied by the Ministry of Law and other agencies.

Corporate Finance Committee

34   The Singapore Exchange has a solid reputation among local and foreign investors and issuers for protecting investor rights, transparent application of rules and rigorous upholding of market integrity. But we have to constantly strive to match international best practices in regulatory standards, because that is how international participants will benchmark us.

35   We formed the Corporate Finance Committee (CFC) to upgrade our capital markets infrastructure. The Committee recommended fundamental changes to shift from merit-based regulation to a predominantly disclosure-based regime. It proposed wide-ranging changes to legislation, regulations and SES rules in order to promote entrepreneurship and business flexibility, whilst maintaining the integrity of the securities market. It made 38 specific recommendations, most of which the Government accepted.

36   Since then the relevant agencies, including MAS, the Ministry of Finance, Stock Exchange of Singapore, Registry of Companies and Businesses, Commercial Affairs Department and Attorney General's Chambers have been working together in several committees to implement the CFC recommendations.

37   The Committees have completed 60% of their work. I will highlight five issues of greater significance to the financial and legal community. These are: the recognition of red-herring prospectuses, allowing price-stabilisation of Singapore dollar initial public offerings, changes to the SES business rules, the introduction of a civil remedy for insider dealing, and enhancement of the present disclosure regime.

38   The first three areas relate to the liberalisation and development of the Singapore capital market, while the remaining two strengthen the regulatory framework in Singapore. We need to achieve the right balance between liberalisation and supervision, in order for our financial markets to flourish.

Red-Herring Prospectus

39. Let me speak first about red-herring prospectuses, which are also known as pathfinder prospectuses.

40   Under our Companies Act, a public offering of shares or debentures requires a prospectus that provides all the information specified in a checklist. This includes the price of the security, and the amount to be offered for subscription. No document advertising an offer of securities may be sent to potential investors without such complete information. Yet, determining the right price and quantity is an interactive process. Often the price and quantity can only be accurately fixed after investors have read and considered a preliminary prospectus. Such a document is called a red-herring prospectus.

41   Red herring prospectuses are typically targeted at sophisticated investors like fund managers, who assess the securities based on the preliminary information disclosed, and give an indication of the price they are willing to pay and the amounts they are able to absorb. From the issuer's viewpoint, this method of making a market sounding helps to reduce the underwriting risk, and lowers the cost of capital. But, presently, red herring prospectuses are technically not possible, as they do not meet the full disclosure requirements of the Companies Act. We are therefore in a Catch 22 situation.

42   The Registry of Companies and Businesses has already been granting exemptions for red-herring prospectuses on a case by case basis. The Government will institutionalise the practice by amending the Companies Act to allow the Registrar to grant a class-order exemption for prospectuses that satisfy the conditions laid out in the Order. Meanwhile, until the amendments are passed, RCB will issue a Practice Direction setting out the guidelines for exemptions.

Price Stabilisation for S$ IPOs

43   Even with the pathfinder mechanism, miscalculation or an unexpected shift in market demand may still cause sharp fluctuations in prices immediately after an initial price offering. In other developed markets like the US, issuers and their advisers are allowed to stabilise the price of IPO shares for a limited period of time. This helps to smooth the transition from short-term to longer-term investors, moderates severe price fluctuations, and ensures a more orderly aftermarket for the shares.

44   In Singapore, price stabilisation has for some time been allowed for foreign currency denominated IPOs, but not for S$ IPOs. Technically, for S$ IPOs, price stabilisation constitutes market manipulation, which is an offence under the Securities Industry Act.

45   We have just changed our rules to allow issuers and their advisers to carry out price stabilisation for S$ IPOs as well. These amendments were gazetted and came into force on Wednesday, 15 September.

SES Business Rules

46   Since the Government accepted the CFC report, the Stock Exchange of Singapore has made several changes to its business rules in order to facilitate corporate fundraising. The latest changes, which SES made public on Wednesday, are to the listing criteria for Main Board companies.

47   The present listing criteria were established in 1990. They have attracted good listings of traditional commercial and industrial companies, but they do not capture the needs of new, emerging technology companies. The CFC recommended modifying these criteria. The SES studied the matter carefully, and has decided to adopt new criteria with effect from next Monday, 20 September.

48   The revised criteria will allow highly profitable companies to be listed with much shorter track records. They will also allow promising companies which are not yet profitable to be listed, provided their market capitalisation exceeds $80 million. They will give SES more flexibility to cater to a wider spectrum of companies with different financial and operating characteristics, including knowledge-based companies in high-tech and internet-related sectors.

49   Over time, the profile of listed companies will change. It will now include younger and more dynamic companies. Some may not even be making profits yet, due to heavy reinvestment expenditure. But their inclusion, with adequate information on the companies and the nature of the businesses they are in, will give investors a broader range of opportunities from which to assess risks and seek good value in the long run.

50   We have had 30 IPOs this year, a third of which are in computer-related and electronics businesses. SES is working with 20 more companies to raise $1 billion from now till the end of November. I am sure more companies will seek a listing under the new criteria, particularly those in technology businesses. However, the statement that was reported in the Business Times, that SES' mandate "is to list everybody", should not be taken literally. SES will only list companies which satisfy its listing criteria, meet high disclosure standards, withstand the scrutiny of due diligence done by issue managers and garner sufficient market interest. In this practice, the SES is no different from other internationally reputable exchanges.

Civil Remedy for Insider Dealing

51   These changes - to allow red herring prospectuses, to allow price stabilisation for S$ IPOs, and to modify SES business rules - reflect the coming of age of our Exchange and markets. They are to make the Singapore Exchange an efficient and orderly market, not a swash-buckling cowboy town. We still expect companies to issue prospectuses which set out fully their plans and the risks involved. We will still not tolerate market manipulation to cream off unsuspecting investors. And we still seek good, promising companies to list on the exchange. Listed companies and those who buy their shares will face risks, even considerable risks. But these should be honest businesses, facing honest business risks.

52   Therefore the Exchange must have a strong and sound regulatory framework. We need an optimal degree of regulation to give investors confidence in our capital markets, without hindering companies seeking to raise finance in innovative ways. It is crucial to maintain this balance, as investors and issuers are in a long-term relationship, where trust and integrity are important considerations.

53   In this context, insider dealing is a particularly damaging activity, as it destroys the trust between investors and issuers. There is a school of thought, mainly among academic economists, that insider dealing is not necessarily bad. They argue that it improves market efficiency, by moving prices to take into account the insider's information.

54   The MAS does not subscribe to this philosophy. Investors need to have confidence in the fairness and integrity of the market. They should be able to trade without fear of being taken advantage of by those who possess inside information. The exchange itself has a long-term reputation to build up and uphold, as a place where market participants can expect fair treatment and protection from improper market practices.

55   Under the law, insider trading is currently already a criminal offence. However, there is often reason to consider civil action in an insider trading case, either in addition to criminal action, or as an alternative to it. The standard of proof in a civil action (which is based on a balance of probabilities) is lower than in a criminal action (where guilt has to be proved beyond reasonable doubt). So in some cases investors can obtain a civil remedy even if the prosecutor cannot prove that a criminal offence has been committed.

56   Unfortunately, it is currently difficult for investors to lodge a claim against an insider for losses suffered. This is because the insider must first be successfully convicted of a criminal offence before a civil suit can be filed. Furthermore, there is a stringent time limit of two years, within which the civil action must be commenced. So if criminal proceedings take more than two years, including appeals, civil action will automatically be barred.

57   We will introduce provisions in the Securities Industry Act to allow recovery of civil damages and penalties without having to first secure a criminal conviction, while retaining the option to bring criminal prosecution against insiders. In addition, the time bar will be raised from 2 to 6 years.

Disclosure Standards

58   Another important issue from an investor's perspective is disclosure standards. As we shift from a merit-based regulatory environment, we have to ensure that investors have the information to make intelligent decisions, particularly as financial instruments become more complex. If they are not assured of this, they will not participate in our markets.

59   Disclosure has to be both timely and comprehensive. To make disclosure more timely, we will amend the Companies Act to shorten the time period for a listed company to present its annual report to shareholders to 5 months from the present 6 months.

60   To facilitate the shortened annual reporting period, auditors will be allowed to express opinions on consolidated financial statements without all the financial statements of the subsidiaries having to be signed off by their respective auditors. Subsidiaries will also be allowed to have different financial year-ends so that the parent company can adhere to an earlier reporting date.

61   Improving the substance of what is disclosed is more complicated, and is still under study. We will introduce provisions in securities legislation to require an issuer to make disclosures, both in the prospectus and on a continuous basis, which will satisfy the reasonable investor. That is, disclosure requirements will no longer be based on a static, one-size-fits-all checklist. Instead, companies should provide sufficient information as warranted by their particular circumstances. They will consequently have to be more pro-active in monitoring what has to be disclosed. However, we intend to provide some guidance as to what a reasonable investor would want to know in different circumstances. The new provisions will add teeth to existing requirements in the Companies Act and Listing Manual.

62   We will announce further progress in implementing the CFC recommendations when the implementation committees complete their work.


63   The challenges facing the new Exchange, regulators and market participants are complex and multiple. Markets are changing so quickly that we have to move on all fronts. At today's rapid business pace, we do not have the luxury of time to wait for events to unfold. While we are beset with uncertainties, one thing is certain: a "Do-Nothing" approach is bound to fail. New products, new alliances, even new structures are necessary, for Singapore to retain our relevance and competitive edge in international financial services. Tonight, I have described some of the changes to legislation, the amendments to the Exchange's business rules, and the Exchange's strategic business directions for the development of our capital markets. They are not a complete solution to meet the Exchange's challenges, but they are steps in the right direction.

64   The SES and SIMEX have done well in the last 15 years. We do not know what shape the Exchange will take in the next 15 years. I am sure there will still be a Singapore Exchange. But the way it trades, where it trades, what it trades, and who trades on it - all that we cannot foretell now. If the Exchange rises to the challenges ahead, it will most likely be transformed beyond recognition. But if it fails to do so, the Exchange will become a quaint irrelevance. All those concerned with the markets need a pioneering, go-getting spirit to push the edge of the envelope, create a sound and progressive business environment, and stay in the game as the game itself changes over the years to come.

1 BBC World Service World Business Report, 14 Sep 99.