Introduction

1   Good morning ladies and gentlemen.  To all our foreign guests, a very warm welcome to Singapore.  It  gives me great pleasure to be here today at the International Swaps & Derivatives Association's first Annual General Meeting to be held in Singapore.  I last had the privilege to address you all at the inauguration of ISDA's Asia-Pacific office here in Singapore in 2000. Since then, I have been told that ISDA has more than doubled their Asian membership base to 62 members. Let me extend my heartiest congratulations.

2   The world's capital markets are growing relentlessly both in size and complexity.  Financial institutions routinely move trillions of dollars across asset classes and across geographies, thus linking fragmented markets into one global arena.  Indeed, growth of financial derivatives volumes in the past few years has been phenomenal.  According to data from the Bank of International Settlements, the outstanding notional values of both OTC and exchange-traded derivatives have nearly tripled in the last 5 years.  In 2005 alone, the total value of these contracts rose 22% and is now almost US$300 trillion, with almost 70% of all contracts traded on an OTC basis. The growth of the derivatives world, however, goes beyond sheer volume; the number and types of participants have also expanded.   

3   It is clear that financial derivatives, once considered esoteric and exotic, have become a critical component of the global financial system.  Derivatives allow another channel for the transfer of risks to investors who feel they are willing and able to assume them. In addition, both financial and non-financial institutions have embraced derivatives as an integral part of their risk capital allocation and profit maximization activities. 

4   The growth in the use of derivatives reflects a variety of factors. First, technology has facilitated market-making, price discovery, and the ability to monitor risk exposures and pay-offs of derivatives portfolios. This has further enabled investors to raise the bar in the sophistication of the portfolio risks undertaken. At the same time, electronic after-hours trading has broken geographical boundaries, dissolved time zone barriers, and provided access to a wider pool of market participants. 

5   Second, the spectrum of players has widened.  It now stretches from the pool of patient capital provided by pension funds to the almost frenetically active hedge fund industry.  The versatility of derivatives is such that they have become mainstream enough for use by the traditional 'buy and hold' investors and yet offer innovative, higher yielding solutions that appeal to the more aggressive alternative investment managers.

6   Staying on this last point about alternative investment, Singapore has also observed rapid growth in the local hedge fund industry, where there are currently more than 100 hedge fund players managing about US$6bn.  This growth has also been seen in other Asian centres and so the spin-offs to growth in more sophisticated capital market instruments will be considerable. 

7   The third factor in the growth of the derivatives markets is the advent of more advanced methods of valuing derivative instruments.  This has fostered product innovation, with new ways of stripping out and combining different risks.

Growth of Singapore Market

8   Here in Singapore, we have seen strong growth in capital market and derivatives activity in the past year. Singapore ranks as the second largest OTC derivatives trading centre in Asia. Our last survey of treasury activities in Singapore for 2004 indicates that year-on-year growth was again robust at 20%.  Indeed from 2000 to 2004, the market grew an impressive 75%. 

9   On the Singapore Exchange (SGX), the warrants market has seen rapid growth in the last two years with US$6.5 billion in traded premium value in 2005. There are around 500 listed warrants on both domestic and foreign stocks.  The diverse products introduced on both markets demonstrate the increased sophistication of our local investment community as well as the international nature of our markets.

10   We have also seen significant growth in commodity derivatives trading with 9 new trading desks having set up in Singapore just last year alone. To reinforce our position as a major oil-trading, ship-broking and financial risk management hub, SGX will introduce an Asian OTC clearing facility for oil derivatives and freight forward agreements (FFA) in the first half of this year.  The clearing facility would serve to mitigate credit risks, enhance the OTC oil and FFA market in Singapore and bring about operational efficiencies for the marketplace.  The facility could be extended to cover financial OTC derivatives in the future. 

11   We have also seen rapidly growing demand for, and, supply of, Islamic finance products.  I understand that ISDA has observed similar trends and has made efforts to develop Shariah compliant standards for Islamic derivative products.  Furthermore, I am pleased to hear that in the formulation of the ISDA Master Agreement, there has been active dialogue with Islamic scholars. Many Middle Eastern investors are also looking at a number of Shariah-compliant product innovations including opportunities in Asia. Just a couple of weeks ago, the Singapore Exchange launched a FTSE-SGX Asia Shariah 100 Index, the first pan-Asian Islamic equity index to be introduced in Asia.  SGX is also working on a Shariah-compliant exchange-traded fund. Fund managers have been establishing Shariah-compliant property funds in partnership with Middle Eastern financial institutions.  Currently, S$2 billion of such products are managed out of Singapore. MAS continues to facilitate Singapore's development of Islamic finance product offerings by ensuring a level playing field for Islamic financial products..  The scope of Islamic finance extends beyond product origination however and  issues such as risk management are key topics that will require ongoing consultation with international bodies such as ISDA.

Issues/ Challenges

12   The rapid growth experienced in derivatives has brought about a new landscape in risk management, both in terms of the level of risk, as evidenced by the phenomenal growth in volume, as well as the sophistication of risk.  As instruments become more complex and volumes increase, the development of the infrastructure for managing and controlling risks must keep pace.  The challenges we face include not just how to measure and monitor market risks, but also how to manage operational and legal risks.

13   In particular, the surging credit derivatives market is now worth over US$12 trillion worldwide.  Notably, the quantitative modeling of credit risk is considerably more difficult than the modeling of market risk.  This is in part due to insufficient data on defaults and the assumptions that have to be made about default correlations. Also it has been an almost one way bet on the market for a long while now that credit spreads are compressing to very thin layers: will this unravel in an orderly manner? You and other regulators around the world are asking the same question. The infrastructure for settlements of credit derivatives is also something that warrants our attention. 

14   The settlement backlog in the derivatives market is an example of a situation where the front office developed much more quickly than the back office.  The complexity of the instruments was only one reason behind the backlog.  Another reason was the volume of new participants in the market.  The development of a standardized electronic settlement platform will reduce the strain manual settlements place on the back-office resources of market participants and will further transition the market toward straight through processing.  In both the US and Europe, a concerted effort has gone into automating the settlement process through platforms such as the New York-based Depository Trust & Clearing Corporation, and the European Equity Derivatives Wholesale Service.  We commend their efforts which we think are positive steps towards improving the infrastructure to reduce post-trade risks in the these markets.

Responses

15   How should we respond to the challenges presented by the growth in derivatives and its associated risks and issues?  Given the transnational characteristics of derivatives trading, this calls for concerted efforts between the industry as well as international regulators.  The key is a balanced approach.  On the one hand fostering the growth of this market in order to provide more efficient risk transfer and risk management while at the same time guarding against systemic risks that might be caused or accentuated by the inappropriate use of such instruments.  Like any other regulator, the MAS try to get this balance right. 

16   MAS' aim is to maintain a supervisory framework that is robust and responsive, one that cultivates a safe and sound financial system, and at the same time, encourages the growth of the financial sector.  Over the years, MAS has shifted to a risk-based and stakeholder-reliant supervisory aproach.  We streamline our supervisory intensity to match the risk profiles of the financial institutions that we oversee.  We also try to make our rules more principles-based in order to give financial institutions room to innovate while at the same time having the assurance of consistent regulatory treatment.

17   As part of MAS' ongoing review of industry practices and in response to industry requests, MAS continually provides guidance to the industry to promote sound risk management practices.  The risk management guidelines that we have recently issued emphasize the importance of board and senior management oversight, the presence of appropriate risk management controls and the need for competent personnel in the risk management and control functions. The guidelines are not intended to be exhaustive or prescribe a uniform set of risk management requirements. Financial institutions should implement a risk management framework which is commensurate with the nature, size and complexity of their operations.

18   On market conduct issues, we are now also seeing a proliferation of retail structured products which are packaged from an array of derivatives instruments.  It is important that meaningful disclosure of characteristics and risk of the products is provided to consumers before they make decisions on investments.  We are looking into how this can be best achieved in a manner that is streamlined and cost-efficient for the industry. We have received valuable feedback from the industry on these issues and we will continue with the dialogue as our review progresses.  We look forward to initiatives from industry associations to raise disclosure and marketing standards. Really what we all want to avoid is having to resuscitate a little 80 year old lady after she realises she has been sold a synthetic CDO when all she wanted was to place a fixed deposit.

19   I had earlier mentioned the growth in commodity derivatives trading in Singapore.  In order to streamline the regulatory framework for commodity futures in Singapore, MAS is also working towards assuming regulatory oversight for commodity futures.  These are currently regulated by IE Singapore under the Commodity Trading Act.  This will be brought under the Securities and Futures Act, which is administered by MAS. 

20   Turning to stakeholder reliance as one of our principles of supervision, let me focus on the role of industry.  On good example is the work done by the industry-led Counterparty Risk Management Policy Group in the US which provided very useful industry guidance for users of highly complex financial instruments and in highlighted areas of vulnerability for both industry and regulators to focus on. 

21   In the same vein, the efforts of ISDA have been commendable.  The development of the ISDA novation protocol would aid in easing the assignment confirmation process by simplifying the transfer of existing trades. ISDA's continued work in ensuring the streamlining of settlement processes for derivatives, and thereby reducing the associated operational and legal risks, is a very important one. ISDA has also played an invaluable role in promulgating standardized, legally enforceable master netting agreements that has helped to reduce market and counterparty risk in the global financial system. MAS recognizes the value of netting arrangements in reducing transaction costs and its risk mitigating effects, such as during default scenarios. MAS recently issued a consultation paper regarding the recognition of bilateral netting for the purposes of determining regulatory capital. I would like to thank ISDA for your active participation and constructive feedback on the consultation paper. In fact, based on our review and your feedback, I am happy to say that MAS would generally accept independent legal opinions commissioned and collated by ISDA as meeting our requirements on bilateral netting.   We certainly hope to maintain this constructive working relationship with ISDA and with the industry. 

Conclusion

22   In conclusion, let me say that, almost by definition, rapid financial innovation will mean there could be an emergence of gaps.  For example, the gap arising from the pace with which front offices rush to capture new opportunities and the pace at which the middle and back offices strive to keep up.  There is also another possible gap and that is how far back we the regulators are in catching up with the whole front-middle-back office train.  We have to make sure that all the carriages are hooked up properly and that we don't have runaway or derailed trains.  Ladies and gentlemen, let us all continue to work together to minimize these gaps so that our financial markets grow not just in dynamism but also in resilience. Again it is a great pleasure to see you all here today and I wish you all a most fruitful meeting.  Thank you.