"Towards a World-Class Exchange"
Speech by DPM Lee Hsien Loong at the Launch of the Singapore Exchange
Date: 01 Dec 1999
Chairman, Singapore Exchange
Ladies and Gentlemen
A Review of Situation
1 The launch of the Singapore Exchange ("SGX") is a milestone in the development of Singapore's capital markets. As a demutualised, integrated stock and derivatives exchange, SGX has put in place the necessary business structure and strategies to surpass its past success and gain a strong foothold in the dynamic marketplace of the new millennium.
2 SGX's strategies aim to produce a Singapore-based, world-class capital markets infrastructure, promoting a free flow of capital across markets. The infrastructure will provide multiple instruments, serving issuers, investors and intermediaries across time-zones.
3 In the early stages of the development of Singapore's financial sector, safety and risk avoidance were paramount considerations. Reflecting these priorities, our capital markets policies emphasised sound, orderly and sustained growth. The first priority was to ensure a conducive environment in which to nurture basic investment skills.
4 We created a market where all investors, retail and institutional, are confident of fairness, and security of trading and settlement. Access was restricted to the more established players. They helped to anchor the brokerage industry, and provided core services throughout varying market conditions. Fixed commission rates protected the margins and viability of brokers, avoiding debilitating, cut-throat competition while they built up their capabilities.
5 The Pan Electric crisis in 1985 was a defining moment in the development of the industry. After the crisis, we evaluated the rules and safeguards. We tightened prudential requirements to provide greater assurance of market integrity. We raised capital requirements well above inter-national standards, to incorporate sizeable buffers and guarantee the financial soundness of intermediaries. We discouraged broker-dealers from pursuing multiple business activities within the same corporate entity to reduce the chances of risk contagion.
6 These arrangements worked well, and enabled the markets to grow steadily. No broker has defaulted since the mid-1980s. Singapore has earned the reputation of being a sound and well-regulated market where investors and issuers' rights are well protected. This is a brand-name we should preserve. But we have to change the old approach, because the higher costs and fees, lower efficiency and diminished liquidity that was its price are no longer tenable. Now that our market has developed, it needs more flexibility to react quickly and respon-sively to relentless global trends.
7 The globalisation of markets and technological advances allow liquidity to flow easily to where there are greater efficiencies and lower trading costs. In Europe and the United States, alternative trading systems are making aggressive inroads into the turf of traditional exchanges, and even of intermediaries. Increasingly savvy companies are seeking listings on foreign boards to obtain the best possible valuation and liquidity. Unless Singapore's capital markets meet the new standards of performance, more local companies will be listed on foreign exchanges. Local investors will bypass the home exchange and local intermediaries, and trade Singapo-rean companies' stocks through foreign trading houses.
8 This is why a year ago, at the SES 25th Anniversary, I announced a series of initiatives to make our markets more competitive and attractive. Since then, the pro-tem committee has worked hard on the demutualisation and merger of the stock and derivatives exchanges. The exchanges have introduced new products such as the Singa-pore interest rate derivative contract. Listing rules have been revised to provide flexibility for growth and technology companies to list on the SES' main board, and for foreign companies to list in Singapore dollars.
9 Global markets have not been static over this last year. Develop-ments have proceeded apace, even faster than we had expected. Singapore must respond vigorously; it must "mark to market" global developments and move quickly to stay ahead.
10 One major task has been to work out specific plans to liberalise the industry within the three years that we had decided upon. MAS and the exchanges have worked closely with industry on this. This is not simply a matter of letting go. We need a bold but coordinated plan to phase in competition, while ensuring that proper risk management systems are in place. At the same time as we relax measures that were more appropriate to an earlier stage in our development, we need to tighten up certain other aspects of our markets to bring them into line with international best practices.
B MEASURES TO BE IMPLEMENTED
11 We are now ready to proceed. The measures include phasing in open access and liberalised commissions, improving risk management by shortening the settlement cycle, revising capital requirements, and broadening the permissible scope of business of brokers.
12 MAS and the Exchange have finalised the timeframe for open access, in consultation with the Securities and Asset Management Sub-committee of the Financial Centre Advisory Group ("FCAG"). We will open up decisively over the next twelve months to build upon the momentum gained from the exchanges' demutualisation and merger.
13 Currently, International Members of the securities exchange are only allowed to accept trades valued above S$5 million from local clients. Below this limit, they have to put the trade through full members. We will reduce this limit to S$500,000 from Jan 2000, and remove it altogether one year later, in Jan 2001.
14 The exchange will also admit new members from July 2000. There will be no quota on the number of new members, but they must be brokers with the reputation and financial strength to contribute to developing our markets. Initially, new members will be able to trade directly with local investors for a minimum value of S$500,000. This limit will be reduced to S$150,000 after one year, in July 2001, and then removed completely from Jan 2002.
15 From Jan 2002 onwards, there will no longer be any restrictions on qualified players who wish to trade on our market. Open access will allow the SGX to better serve market needs. Having more trading parties transacting freely with one another and with local clients will increase the liquidity and depth of the market. It will also help SGX to leverage on the forces of technology and globalisation, and make for a more attractive and important capital market.
16 Access to the derivatives market is already more open than to the cash market. To make the system more flexible, trading access to SGX's derivatives contracts will from today be based on trading permits instead of membership rights. The permits will cater for both floor-based trading, and trading via the Electronic Trading System ("ETS").
17 The derivatives exchange successfully launched its electronic trading system in October. Several contracts are already traded concurrently, both on the floor and the ETS. The exchange will remain responsive to the needs of investors. It is prepared to move to fully electronic trading as soon as necessary.
18 Next, we will replace fixed brokerage fees with freely negotiated commissions. The fixed brokerage system has served its purpose in the past, but it now makes our markets uncompetitive. This is clearly seen in internet trading. In developed markets where commissions are determined solely by competitive pressures, lower commission rates for online trades have been the norm, resulting in dramatic increases in liquidity. But in Singapore, although some brokers have introduced online trading, interest has been slow to develop. The primary incentive of cheaper transactions simply does not exist.
19 Freeing up commission rates must take place in step with the opening of access. Following the recommendations of the SES Review Committee last year, we had decided that from 1 Jan 2000, commissions for large trades (above $150,000) would be fully negotiable, while the minimum commission on retail trades (below S$150,000) would be lowered to 75 basis points . The SES Review Committee had also recommended full liberalisation of commissions by Jan 2003 at the latest. After consulting the FCAG Subcommittee and members of the broking industry, we have now decided that commissions on all trades will be fully negotiable from 1 Jan 2001.
20 For online trades, SGX will evaluate the feasibility of fully liberalising commissions sooner, before Jan 2001. SGX will assess how much time the industry requires to improve its system capabilities and risk management systems for online trades, to be ready for the significant increase in trading volume expected. SGX will announce its findings shortly.
Improved Risk Management
T+3 Settlement Cycle
21 Greater market access and lower transaction costs will intensify competition. Therefore in parallel, we need to strengthen risk management systems. In Singapore, the settlement cycle of T+5 no longer sits well with present day scripless trading and near-instantaneous flows of funds in seamlessly-connected financial channels. The T+5 cycle was implemented prior to electronic trading and reflected the time required for trades to be settled in earlier years. However, its effect has been to allow high volumes of contra trades, with investors "punting" on market movements during the 5-day settlement period. This has contributed liquidity to the market, but at the price of a higher risk to brokers. The risk is further compounded by the informal credit mechanism extended by brokers to prevent settlement failures, which is unsatisfactory. In contrast, margin trading facilities are provided by brokers to allow for reasonable leverage, but they are carefully monitored to manage overall risk exposure to market movements.
22 Most international exchanges have adopted the Group of 30's recommendation for trade settlement to take place on T+3. SGX has decided to implement a T+3 settlement cycle, from 15 March 2000. This will lower settlement risk and raise efficiency.
Goal of T+1 Settlement Period
23 Moving to T+3 is not the final step. Major US exchanges are exploring the possibility of T+1 settlement cycles and it is not inconceivable that T+0 will follow. They have initiated discussions with key market participants and international straight-through processing groups to move in this direction. Unlike the shift from T+5 to T+3, moving to T+1 goes beyond simply further raising internal efficiencies. It requires standardising and integrating information flows among market participants, and accelerating the flow of cross-border trade information. The move will also intensify pressure to reduce the costs of cross-border trade settlements. SGX will work towards the ideal of shortening the equities settlement cycle to T+1.
24 To further improve risk management, the exchange will study requiring investors to place up-front security deposits before they begin trading. The practice is already prevalent in the United States and Australia, and is particularly necessary to facilitate online trading. Such a step will help to protect the broking houses' financial integrity in the event of a market down-turn.
Securities Borrowing & Lending
25 Market participants tell us the implementation of a shorter T+3 settlement period will generate demand for borrowed securities. There is scope for SGX to meet this demand. We have earlier agreed with the SES Review Committee's recommendation to look into developing a Securities Borrowing & Lending ("SBL") market, as a superior and more transparent mechanism for allowing investors to take short market positions. SBL is already possible, but only off-exchange, and between depository agents. A formal arrangement organised on the exchange would extend the service to retail investors.
26 The government has since worked on the technical issues related to SBL, including the tax rules that apply to SBL activities. These tax rules are being finalised. The central depository is studying the feasibility of operating an SBL agent facility, bringing together lenders and borrowers with efficient automatic borrowing and lending programs.
27 Next, capital requirements. The existing extremely conser-vative capital requirements have seen us through the last decade and a half. We need to modify them, as we shift from a standardised one-size-fits-all regulatory framework to a risk-based supervisory approach. The level of capitalisation must correspond more closely to the risk presented by business activities, and must not create an entry barrier for legitimate and qualified players.
28 We are comprehensively reviewing the capital framework for the securities, futures and fund management industry. We will develop a risk-based method of determining capital requirements, where the size of capital will depend on the type and extent of the firm's business activities. We aim to have this new capital adequacy framework in place by the beginning of 2001.
29 Meanwhile, we will take interim measures to revise capital require-ments towards more appropriate but still conservative levels, so that these requirements do not impede competition and access to the industry. This is possible especially as the shortening of settlement cycles to T+ 3 will reduce settlement risks.
AI to ANC Ratio
30 The key component of the capital requirements is the extent of gearing that is permissible in relation to the liquid capital. The SES Review Committee had recommended raising the maximum ratio of dealers' total borrowings to liquid capital - known to the trade as the "Aggregate Indebtedness to Adjusted Net Capital ratio". Dealers are currently required to inform MAS when the ratio exceeds 6 times, and their licences will lapse if the ratio exceeds 8 times for four consecutive weeks.
31 With effect from 1 Jan 2000, dealers need only inform MAS when the ratio exceeds 8 times, and the licence will lapse if the ratio exceeds 10 times for four consecutive weeks. The equivalent ceiling in the United States is 15 times and in Hong Kong 20 times. Thus our revised gearing limit is still well below regional and international norms. But it will be a prudent measure until the full, risk-based capital requirements are in place in a year's time.
Minimum Paid-Up Capital and ANC
32 With effect from 1 Jan 2000, the statutory minimum paid-up capital for dealers will also be reduced from S$30 million to S$15 million. At the same time, the minimum adjusted net capital ("ANC") requirements will be reduced to S$5 million with the warning level set at S$8 million, from the existing S$8 million and S$10 million respectively. These new levels are also still substantially above regional and international norms.
33 These changes do not represent radical shifts in the risk frontiers tolerated by SGX or MAS. Singapore continues to uphold its reputation of rigorous prudential standards. These standards should not rely solely on tight regulatory measures imposed regardless of the risk profile of the firm or the quality of internal risk management systems. They can and will be met through continual awareness, strict compliance with realistic and appropriate limits, and upgraded risk management practices in line with the best international norms.
Broadening Brokers' Business Scope
34 The strength of our capital markets also depends on intermediaries adopting viable business models. At present, commissions are the primary source of revenue for our local brokerage industry. This strategy is not sustainable. To survive, grow, and flourish, brokers must reinvent their business models and diversify their business portfolios and earnings streams, branching into other related value-adding activities. One such value-added service is the Cash Management Account.
Cash Management Account
35 Cash Management Account ("CMA") is used in Singapore as a generic phrase to describe an integrated one-stop financial service provided by brokers, including the handling of cash transactions. It is a natural extension of services provided by brokers. CMAs come in many forms. One form entails investors maintaining a securities trading account with the stockbrokers. When the customer has a credit balance, the broker places the money in bank deposits or money market funds on the customer's behalf, to earn an investment return.
36 To offer the CMA, brokers may apply for an Investment Adviser's ("IA") licence to manage idle cash balances. As in other jurisdictions, brokers will not be able to take customer deposits onto their own books. But they can tie-up with banks to offer integrated deposit and securities broking services. Some brokers have already entered into arrangements with banks to offer a seamless repertoire of financial services, which include chequing and credit card services.
Management of Money Market Funds
37 Managing money market funds is a comparatively straightforward responsibility. These are not esoteric derivatives, or exotic emerging markets. To facilitate brokers wishing to obtain an IA licence solely to manage money market funds, we will reduce the requirement for fund managers' expertise to two fund managers, one of whom should have at least three years' experience, and the other at least two years' experience. This is less stringent than the existing ten and five-year requirements for full-service fund management companies that manage a broader range of funds.
Financial Advisory Services
38 Stockbroking firms may also offer financial advisory services to their clients. In mature markets, there is usually a class of financial planners who provide comprehensive advice according to the client's individual financial situation and investment objectives. There is no reason why stockbrokers should not perform this role in Singa-pore. One way they can do this is by leveraging on remisiers who have had experience in dealing with clients' investment needs and are keen to extend their services.
39 In the past, brokers were discouraged from pursuing multiple business activities to prevent risk contagion. As financial markets become increasingly integrated and the delineation between securities and futures products becomes less defined, the advantages of a single entity holding multiple licences have grown. There is increasing need for intermediaries to simultaneously deal in and advise on both the cash and derivatives markets.
40 In the coming year, SGX will study how it can give members cross-access to both the cash and derivatives markets, as single entities running consolidated businesses, without raising the level of systemic risk in each market. The risk-based supervisory and capital requirements will reduce the problem of risk contagion. Allowing a single entity to hold licences to participate in both the cash and derivatives markets will streamline reporting systems and generate greater synergies.
C TECHNOLOGY VISION
41 All these measures rectify existing inefficiencies in our capital markets and sharpen their competitive edge. But an improved framework on its own is insufficient. The exchange and market intermediaries must move quickly with plans to reposition or reinvent their businesses for the future.
42 Technology will be a large part of the SGX vision. The global capital markets are being transformed by technology. Price discovery, matching, depository, clearing and settle-ment, and even regulatory functions that have traditionally been performed exclusively by exchanges are being vigorously challenged by new entrants, some barely two or three years old.
43 The Internet has become the global distribution channel of choice linking issuers with investors, not just within the confines of a given jurisdiction but globally. Issuers have begun raising capital directly from investors, and investors are transacting directly with each other both within and across traditional market boundaries.
44. The Exchange's technology vision, and its successful execution, will be a key component of its business strategies. It will determine whether the Exchange achieves critical mass and continues to grow, or becomes irrelevant as liquidity drains away.
45 The technology vision for the Exchange is best defined by one word: access. The adoption of a robust and open architecture will enhance the Exchange's global connectivity. Industry players should be able to connect their computers directly to SGX; or to connect seamlessly to end-customers; or to other industry players. SGX must be able to deliver the right information at the right time to the right player.
Single Trading Interface and Integrated Clearing
46 SGX will develop a single trading interface for its securities and derivatives products, and a fully integrated facility for clearing and settlement of both products. It can then offer a comprehensive range of both Singaporean and global products through a single point of access.
47 As a first step, SGX has proposed that the clearing and settlement of Singapore Government Securities be moved from the system presently run by MAS, to the Central Depository. MAS has agreed and this will take place in the 4th quarter of 2000.
48 SGX must adopt the most exacting international technology standards, protocols and business practices. Together with single access capability, they will be a source of competitive advantage that make our capital markets more attractive, and enhance Singapore's standing as an international financial centre.
49 As exchanges around the world are demutualising, regulators are having to decide where the self-regulatory functions of the demutualised exchanges should properly reside. Different jurisdictions have adopted different approaches and reached varied conclusions. Some have essentially retained the pre-demutualisation supervisory framework, while other regulatory authorities have announced their intention to retrieve some of the exchanges' self-regulatory functions.
50 The MAS has reviewed the considerations and trade-offs, and decided that in the Singa-pore context, SGX will continue to regulate itself, and also perform market surveillance. It is in the front line, in constant and direct contact with the market and intermediaries. We do not expect a conflict of interest to arise, because it is in the Exchange's business interest to preserve its brand value as a fair and sound marketplace, where rules are vigilantly but intelligently enforced and prudential standards are met.
51 At the same time, MAS will strengthen its supervision over the Exchange's operations. MAS and the exchanges have always had a close professional working relationship. These arrangements will be reviewed from time to time as the market continues to evolve.
52 Singapore's capital markets have been well-served for many years by SES and SIMEX. SGX now takes over the torch from them. It must be quick to anticipate, act, respond and capitalise on developments that occur almost daily. Global capital markets are in such dynamic and continuous flux that nobody can see clearly very far into their future. But SGX does not lack resources, desire or determination to run with the best. It has a head start, having started demutual-ising earlier than most other exchanges, and put in place a sound structure together with carefully mapped strategic plans. I am confident that, under the leadership of its competent manage-ment team, SGX will measure up to the challenges ahead and emerge as a successful world-class exchange.
1 For approved fund managers, commissions on all trades will be fully negotiable, regardless of size. For this reason, rebates on such trades for approved fund managers will be discontinued.