Session 3: "Supervisory and Regulatory Approaches for NBFIs"

A. Newfound Importance Of Non-Bank FIs in Asia

1   In my talk today I will cover some current developments in the supervision of non-bank FIs in Singapore.  My focus will be upon the regulatory regime for capital market intermediaries and activities. I will not cover in this session issues related to the enhancement of the supervisory regime for insurance companies.

2   This is not because I consider the resilience of the insurance industry to be unimportant.  In fact it is increasingly so and MAS has been working to strengthen the resilience of this industry in Singapore by seeking to raise standards of corporate governance, strengthening internal controls and professionalism and putting in place a new capital and supervisory regime.   Rather it is that my expertise and role in MAS is in capital market regulation.  Issues related to the role and supervision of the insurance sector will be canvassed in later sessions.

3   The supervision of NBFIs has taken on increased importance in recent years. Traditionally, the focus of much regulation has been on banks given their dominant role as financiers for industry. While the supervision of Banks remains very important, the role of NBFIs and how they are regulated took on greater importance in the later part of the 1990s as a result of two key developments.

4   The first was the Asian crisis in 1997 that led to an impetus to diversify away bank financing for funding needs, looking instead to the development of capital markets. The second development was the increased global convergence in financial services of banking and non-banking financial activities within consolidated financial groups. I will touch briefly on each of these.

5   First, the Asian crisis and NBFIs.  Pre-crisis, Asia's capital markets were by and large less developed than the banking system. Firms relied mainly on bank loans to fund capital expenditure and expansion. When the banks were forced to tighten their loan portfolios with the onset of the crisis, firms were left without other established sources of funding. When stability returned, many countries began to focus on developing their capital markets as an alternative avenue for companies to raise funds.

6   In Singapore, since 1998 measures have been implemented which progressively relaxed existing restrictions designed to foster the growth of our capital markets. In the securities market, access to the domestic market was opened and commissions liberalized to inject competition. Rules that had segregated equities and derivatives activities were reviewed and aligned to pave the way for single licensing. Meanwhile, the debt market benefited from increased issuance of government securities and the establishment of a benchmark yield curve. By 2001, a large proportion of M&A activities were funded through the issuance of corporate paper.

7   This new environment has made the supervision of NBFIs a more critical matter. Quite apart from the capital market and the intermediaries' renewed importance in fund-raising, liberalisation brings with it new sets of risks.  Less restricted access and increased competition make for more vibrant capital markets but also leads to industry consolidation, products across a broader risk spectrum available to retail investors and more complex choices for investors in these markets.

8   The second development is the consolidation of specialist financial institutions into financial conglomerates with cross-border presence. Before the 1990s, the regulatory regimes for banking, insurance and securities activities were quite distinct.

9   Even as cross-selling has reduced sector boundaries, financial innovation is blurring product lines. So we see securities firms offering cash management services, traditionally a banking function, while some banks engage in bancassurance. Meanwhile, insurance companies underwrite financial risks that were once the domain of investment banks while selling insurance policies with a large component of returns dependent on investments in securities.

10   The implication of this is that it is harder for regulation to be based on the clear-cut institutional or product distinctions of the past.  To do so can result in inconsistencies and regulatory arbitrage.  Even more significantly, risks or shocks that originate from one area, whether banking or non-banking, can transmit, either internally within financial groups or externally through converging product markets, and across borders to other areas of the financial sector.  It is increasingly important to ensure that supervision is based on a comprehensive overview by the regulator of domestic and cross-border risks across the entire financial system rather than purely on an industry-by-industry basis.

11   Having set the context, I will briefly touch on some of the ways that MAS has responded to these developments in Singapore.   My perspective is that of someone who has spent most of his career as a practical securities and corporate regulator in Australia, and now Singapore. This perspective means that increasingly I am of the view that it is not only the content of the regime or structure of the regulator that are important. In addition, there is a need to focus on regulatory practice: the way regulators go about their day-day activities: how they attract, retain and develop the skills of their staff; the practical supervisory approaches and techniques they deploy; and how they manage the relationships with market intermediaries, professional bodies and investor groups.

12   These are large and important topics. In today's talk I only briefly skim across the surface and lightly touch upon a few of these topics.

B. Creating the Regulatory Regime

13   Despite changes in the financial markets the broad objectives of regulation remain much the same. That is, to ensure systemic soundness, to ensure an efficient, dynamic financial system and to achieve an appropriate level of investor protection.

Regulatory Content

14   At the heart of the regulatory framework for the capital markets in Singapore is the new Securities and Futures Act ("SFA"). The SFA was enacted in September last year and is designed as a single rulebook covering the range of capital market activities undertaken in Singapore. There are several key aspects to this legislation.

15   First, it sets out a single licensing framework for all securities and futures market intermediaries. This is a shift from the pre-existing regime where multiple licences were issued to market intermediaries according to their business activities depending on whether this involved securities, futures or asset management activities. With intermediaries increasingly seeking to become involved in multiple business segments, separate licensing along product lines was becoming increasingly inflexible.

16   The SFA instead sets out a modular licensing framework for all securities and futures intermediaries whereby just one capital market services licence ("CMSL") is needed to conduct multiple regulated activities. These include securities dealing and futures trading, leveraged foreign exchange trading, advising on corporate finance, fund management, securities financing, and custodial services. The regime is intended to reduce both capital and compliance cost for intermediaries and allows them to engage in a wider spectrum of capital market activities.

17   The issue of overlapping supervision for banks, insurance companies and other institutions that are already supervised under other legislation is dealt with through exemption from the SFA's licensing provisions. To ensure the playing field does not tilt unfairly in favour of banks or insurance companies, relevant business conduct rules, disclosure as well as other appropriate regulatory requirements must still be met regardless of the nature of the financial institutions.

18   Second, to complement the modular licensing of intermediaries, regulations have been drawn up under the SFA setting out a risk based capital framework. Under the framework, CMSL holders need only maintain capital sufficient for the business risks they undertake, according to their respective operations. As I mentioned earlier, this is a part of developing vibrant capital markets where intermediaries are permitted to engage in different range of activities without facing one-size-fits-all capital requirements. The shift to a more dynamic risk-based calculation of required financial resources is also better aligned to risk-based approaches taken in the banking sector under the Basel recommendations.

19   The new capital framework will be a single, harmonised structure for CMSL holders dealing in the securities or futures market or both. The capital requirement will comprise two elements - a common minimum dollar requirement depending on whether the CMSL holder is engaged in clearing activities, and a risk-based financial resources requirement that is dependent on the specific risks that are assumed by the firm.

20   Third, the SFA also formalizes the regulation of exchanges as well as clearing and settlement facilities. It introduces a framework for the regulation of markets and clearing facilities. With advances in telecommunication technology, cross-border trade conducted through the electronic medium has increased. New electronic trading services mean that traditional concepts of entities that either operate a market, or act as an intermediary, have blurred.

21   In other words, the issue relating to such Alternative Trading Systems is whether they should be regulated as markets or intermediaries. In Singapore, the Monetary Authority has taken the position that only 'facilities' which bring together many buyers and many sellers to transact will be regulated. To cater for facilities which brings multiple buyers and sellers together but which do not provide the full suite of exchange services, the SFA has introduced a recognition regime known as Recognised Trading System Providers ("ReTS"). Such facilities will require authorisation under the Act and the regulatory requirements will be commensurate with the nature and risk of the model in question.

22   Fourth, Collective Investment Schemes ("CIS"), previously more commonly termed unit trusts, have been brought within the SFA's ambit. CISs are to be approved by the MAS before they are offered to the public. The public is further safeguarded through an industry code of best practice that sets out the investment and operational requirements for such CIS. Examples include investment guidelines for different types of funds, and rules on practices such as soft commission practices and relevant disclosures.

23   As part of the supervisory framework over CISs, the trustees of the schemes must also be approved. This will be on a one-off basis but trustees will now also be subject to regulatory inspections to check that statutory duties and disclosures have been carried out.

24   Fifth, the SFA itself sets out elements that are crucial to the supervision of capital market intermediaries. Key amongst these is a legal framework that facilitates the development of a disclosure-based regime for capital markets in Singapore. Under this framework, disclosure standards for prospectuses have been tightened. Issuers and their advisers are now more accountable for making relevant disclosure with inadequate or misleading disclosures and material omissions subject to statutory penalties.

25   Prospectuses that are lodged with MAS under this framework will be publicly accessible through the Internet on the Offers and Prospectuses Electronic Repository and Access ("OPERA") system. For a 2-week period, the public and interested bodies can scrutinise and give comments on the prospectuses that must comply with statutory disclosure requirements.

26   For listed companies, the SFA mandates the continuous disclosure of material information giving statutory effect to what was previously an exchange-listing requirement. Failure by a company to disclose material information could render it liable to the payment of civil fines, or to criminal prosecution where the failure is intentional or reckless.

27   In summary, two principles can be distilled of the regulatory approach encapsulated in the SFA. First, regulation should be designed too be provide consistent treatment across the spectrum of participants with minimal distinctions based on individual product or activity classification, working instead from a common approach, based on assessing the particular risks involved, as is the case of the risk-based approach to calculating capital.

28   Second, an increased emphasis on market discipline through a disclosure-based regime. Implicit in this approach is that the regulator will not generally seek to pre-judge the risks and benefits or the suitability of products or services for the investing public.

29   The role of the regulator therefore moves away from being a "gatekeeper" to one more focused on ensuring and enforcing high disclosure standards. In this type of regime investors are also called up to make and take greater responsibility for their investment decisions. Accordingly, market disclosure requirements and rules designed to prevent market manipulation or trading on insider information are required to be in place and effectively enforced to maintain investor confidence in the system.

C. Enforcement & Remedies

30   This brings me to the second aspect of the regulatory structure - an effective enforcement regime. A disclosure-based regime demands an effective market enforcement regime that deals with any transgressions swiftly and firmly, in order to preserve investor confidence in the capital markets. 

31   In Singapore several measures have been instituted to enhance the market enforcement framework. First, insider-trading laws have been updated to reflect the underlying principle that those who knowingly have inside information should not gain unfairly at the expense of other market participants. This should be regardless of whether those with undisclosed market sensitive information are persons connected with the company.

32   Next, investors are given access to effective civil remedies against wrongdoers who have caused them to suffer loss. Under the new SFA regime in Singapore, the Monetary Authority is empowered to bring an action in court against a defendant for a civil penalty.  If found guilty, the offender will also be liable for civil damages payable to investors who suffer losses as a result of the offender's act. An advantage of a civil remedy regime is the lower burden of proof, on the balance of probabilities, as opposed to criminal prosecution where guilt must be demonstrated beyond reasonable doubt. Under the SFA, the civil remedy regime extends to market rigging, manipulation, publishing false or misleading information and fraudulent or deceitful dealing.  We see this new civil penalty regime as a useful complement to criminal action for less serious cases of market misconduct. Criminal sanctions remain for serious market misconduct

33   Third, the concept of calibrating enforcement action to the seriousness of the market misconduct. The division of enforcement responsibilities falls between the exchange, the regulator, and in serious cases the criminal affairs division (CAD). In relatively minor breaches of rules, the exchange may be best placed to investigate the circumstances of the breach in question. There are advantages to this as the exchange, as market operator has better access to issuers and intermediaries in addition to monitoring and keeping trading data. This is particularly true for instances where the focus of the investigation revolves mainly around direct market participants, breaches of exchange rules and the exchange's disciplinary powers adequate to impose a suitable penalty on its members.

34   Nonetheless, exchanges do not typically have the benefit of the more comprehensive powers available to the regulator. MAS is empowered under the SFA to conduct investigations that extend beyond direct market participants. In instances where criminal prosecution is more appropriate than civil penalties, the matter will be referred to the CAD   for criminal investigation.

35   Ultimately, the key objective of enforcement action is to ensure that investor confidence is preserved.

D. Organisation of the Regulator

36   Implicit in the notion of calibration I have just described is that different bodies have different roles to play. This is true of the enforcement process and also true in the wider context of capital market regulation and supervision.  I will briefly touch on the roles of regulators, exchanges and professional bodies.

37   MAS, as the statutory regulator, monitors compliance with the laws and regulations that govern the integrity of the markets, seeks enforcement of the laws under the civil penalty regime or by referring matters to the CAD, and propose amendments in order to keep the law relevant in a changing market environment. MAS's role extends beyond capital market activities and includes banking and insurance supervision. In regulating the financial sector, MAS does not act alone but co-ordinates with other agencies responsible for the wider corpus of corporate law, enforcement and accounting standards.

38   The structure of the regulator can and does take different forms in different jurisdictions. A recent trend has been a shift towards more integrated supervision with banking, insurance and capital market regulation being brought within one organisation. The UK FSA is an example of integrated supervision while Australia's twin regulators (ASIC and APRA) focus on prudential and market conduct functions, respectively. 

39   As noted above, MAS covers both prudential supervision of the banking and insurance sectors, capital market regulation and business conduct regulation across the financial system.  MAS has recently adjusted its organisational structure to further refine its focus on more integrated risk based regulation across the financial system while maintaining the depth of specialist skills in specific sectors.  In the recent changes, MAS has further integrated our prudential and market conduct policy functions across banking, securities and insurance and enhanced our ability to take a more comprehensive view of risks posed by complex institutions.

40   But while an appropriate structure is important, equally, if not more, important is the depth and spread of expertise of the staff within the regulatory agency. Ultimately the strength and quality of supervision will depend on the success of the regulator in developing the relevant skills, technical expertise, broad-based financial sector knowledge, and inculcating a high standard of professionalism of its staff.             

41   Regional and international collaboration plays a role in developing such expertise. At present, there are differing levels of structured training available as between bank-related and non-bank financial services. Central Banks for instance, collaborate to provide training on banking supervision, monetary policy, and payment and settlement systems. This training is highly structured with intermediate and advanced courses held regularly on an annual cycle.

42   In contrast, there seem to be less availability of structured courses to help regulators develop expertise on the supervision of capital markets. IOSCO goes some way towards meeting this need through its Seminar Training Program, while individual regulators have begun implementing topical training seminars that are open to international participants.

43   While some progress is being made this area, this represents a challenge for jurisdictions trying to quickly develop their expertise in capital market regulation. This means that issues of HR policy such as recruitment, salary scales, training and overall staff development issues are central to developing quality regulation. In my view a challenge for most regulators is how best to enhance their internal capabilities to provide high quality technical training in their core supervisory, regulatory and enforcement activities. 

44   Ultimately the quality of regulation depends on a regulator's key resource, the commitment and expertise of its staff.

E. Working with Investor and Professional Bodies

45   In a disclosure-based regime, vigilance on the part of the regulator and the exchange needs to be complemented by the activities of professional bodies in raising standards and in investors becoming more informed about products and their risks.

46   Statutory provisions cannot define all aspects of business conduct standards. In supervising market participants, it is neither possible nor desirable to legislate for all aspects of good customer service standards or precise technology protocols to ensure secure transactions. There are some areas better addressed through industry-defined codes of good practice, and industry and professional bodies have important roles to play in educating and training their members and helping lift standards of conduct and professionalism. This is particularly important in areas that are relatively new without a tradition of professionalism, for example, in newly developing areas such as financial advisory services for retail customers

47   I will share with you two examples of such private-public partnership in Singapore. The first example is the Singapore Institute of Directors that was formed in 1998. The institute is a voluntary association that is governed by a council comprising industry leaders and government representatives. Its charter is to improve and develop professional standards for those who hold directorships. By establishing a body specifically to focus on the standards of directorship, the objectives are to raise the level of awareness of directors' legal and moral responsibilities, professional conduct in the boardroom, and standardise the implementation of legal remedies for shareholders seeking redress for fraud and other corporate malpractices.

48   Since its formation, a code of conduct for directors of listed companies has been developed. In addition, a director certification program modelled after the British and Australian programs is being implemented. This enables directors of newly listed companies and others to enhance their skills and knowledge as directors. In the 4th quarter of last year, the institute announced its intention to incorporate a wholly owned company to help in the search for independent directors. This is in line with the push to strengthen the board structure of public companies where independent directors will play an enhanced role in providing feedback and guidance on the companies' internal practices.

49   The second example is a recent initiative announced earlier this quarter in the area of setting accounting standards. This is the introduction of legislation that provides for the establishment of an independent panel to prescribe accounting standards for Singapore companies. The proposed panel would be a public-private partnership and comprise members from businesses, professional organisations, academic institutions and government, to be known as the Council on Corporate Disclosure and Governance ("CCDG").

50   In addition to setting accounting standards, the CCDG will also make recommendations to the government on the review and enhancement of Singapore's corporate governance and disclosure practices. In the overall regime for corporate regulation generally, the CCDG represents a collaborative mechanism for the private and public sectors to continuously review and improve the corporate governance and regulatory framework.

51   Competition can bring benefits to investors in terms of lower costs and availability of a greater array of innovative products. But at the same time it can introduce new risks with investors called upon to increasingly look after their own interests. This is especially pertinent to this region, where products such as managed funds or alternate management funds are relatively new and investors relatively inexperienced. But in my experience it is true also in places such as Australia and United Kingdom and both these jurisdictions have enhanced a focus on consumer education in the financial sector in recent years.

52   Professional investment players, such as fund managers, have an interest in well-informed investors and in contributing to investor education efforts. This activity can help grow their potential client base and ensure that the industry is developed on a sound footing.  In Singapore, investors have also made the first step towards promoting their own interests through the formation of the Securities Investors Association (Singapore) in 1999. The SIA has set for itself the twin missions of investor education and acting as the voice for minority shareholders. In these roles, it has also provided inputs on corporate governance matters from the perspective of retail investors.

F. Conclusion

53   In summary, my quick survey of developments in Singapore in the regulation of capital markets has focused on a number of themes. 

54   The first is the need to update the content of regulation so that it responds to changes in the structure of financial institutions that are increasingly cross border with blurring of institutional and product distinctions.

55   Second, that confidence in the regime and the market relies on effective enforcement that enables speedy, effective and appropriately calibrated responses to market misconduct.  Confidence and reputation are costly goods to acquire but easy to lose. 

56   Third, while the structure of the regulator is important, the quality, commitment and expertise of regulatory staff are essential.  This is even more so as regulators move away from simple one-size-fits-all "gatekeeper" models of regulation to a more flexible risk based approach where depth of technical industry knowledge, exercise of discretion and ability to consult and interact with a wide variety of interests becomes increasingly important.   This requires that we pay more attention to the development of both internal and external training relevant to regulatory staff in these areas.

57   Finally, the regulator and its rules are only part of a broader environment required for good regulation. One key aspect is the role of professional bodies in promoting good standards of professional conduct by market participants and the role of investor bodies in promoting greater levels of awareness and education among investors. 

58   Putting in place this complex mosaic of regulatory conditions makes designing and implementing an appropriate regulatory framework for NBFIs such a challenge.  But it is also what makes financial market regulation such an interesting, challenging and important task.