Published Date: 04 July 2006

Speech by Mr Ong Chong Tee, Deputy Managing Director, Monetary Authority of SingaporeAt the Schroders Investment Seminar, Conrad Hotel, Tokyo on 4 Jul 2006

"Refocus on Asia"

1   Good afternoon, ladies and gentleman. Before I begin, please allow me to thank Schroders for the opportunity to speak at this investment seminar. I am honored to be here. I understand that the focus of this year's seminar is on Asian Dynamism. This Asian theme is not surprising, given the economic rise of China and India and the recovery of Japan, which have been very much in the global spotlight.
2   The topic of my speech today is "Focus on Asia".  In a sense, this is more of a "Refocus on Asia" as many here will remember the "80s and early "90s when much was written and spoken about Japan and the four Asian Tigers.  A topic of this nature can run on either one of two tracks.  One, which I term the cyclical perspective, is to make the case for Asia by looking at the current economic environment and near term investment outlook for Asian assets.  From this perspective, one can cite reasons to be reasonably optimistic about Asian market prospects - judging from recent years' market performances.  Asian stock markets have risen by 86% [1] over the last 5 years, outperforming the markets in US and Europe.  Asian economies are projected to grow close to 6% over the next five years, as compared to 3% and 2% for US and Europe respectively [2].Certainly, there are risks: oil prices, geopolitical events, and so on.    But on balance, the consensus assessment including that of the IMF is that Asian economies and financial systems are on a much firmer footing now than in 1997, and even if a risk event occurs, we are unlikely to see a repeat of the Asian crisis meltdown.

3   But I do not wish to dwell too much on this.  Financial forecasts and market outlooks are challenging exercises which I would rather leave to the experts who are going to speak after me.  Today, I wish to take a different angle on this topic, what I term the structural perspective, that is to focus on recent structural developments in Asian financial markets; and how these would strengthen the case for Asian assets as viable, long-term assets from the point of view of a Japanese investor.

4   Let me take a step back to ask a more fundamental question: Why should long-term Japanese investors, particularly pension funds, invest in foreign assets at all?  Why not just stay at home - since Japan has the second largest stock market in the world and the world's largest public bond market?  A study done by OECD in 2002 showed that there is still a very strong home bias amongst pension funds in countries with well developed financial markets. 

5   Financial theory tells us that there are two main reasons why an investor, even one with predominantly domestic liabilities, should consider foreign assets.  First, it brings broader diversification benefits, allowing a portfolio to reduce risks while maintaining expected returns at the same or high level.  As the economist Paul Samuelson said, this is about the only "free lunch" you ever get in economics.  Second, for an investor in a developed economy like Japan, investing in emerging markets enhances returns because less efficient markets yield a larger excess return.  This is especially important for many pension funds that are facing a growing pension burden in a low yield environment.  I note that the Japan Pension Fund Association and Government Pension Investment Fund have indicated recently that they would be looking at alternative investments to boost returns.

6   That's the theory.  How does that match with reality?   In terms of diversification, historically, there is a relatively low correlation between Asian assets as a whole with the developed markets and Latin America, especially if one includes currency effects.  This is even more so after the 1997, when many Asian countries floated their exchange rates.  In terms of return, the case for Asian assets is possibly even stronger. 

7   Besides the near-term growth story, I believe that there are three broad reasons why Asian assets may produce good returns in the long term.  First, it is well known that savings rates in Asia are high, about 40% of Asia's GDP. This high savings rate can underpin the sustainable growth rate of the region, as the engine of growth shifts from exports to consumption.  In time to come, Asian domestic demand will become a key driver of global growth, possibly replacing the increasingly exhausted and indebted American consumer.  In addition, as Asian markets develop, more of these savings pool, which are currently invested in developed markets, will return home, thereby bolstering the value of Asian assets. The Asian wealth management industry is set to grow and will further catalyse investment demand for Asian assets.

8   Second, Asia' demographics are also favorable for growth as demographics translate into talent and domestic market size. More importantly, there are two billion people below the age of 30 in Asia, representing a third of the world's population. By 2007, young singles in the 11 key Asia pacific economies will account for 12% of the purchasing power in Asia. The sheer size of this generation means it can affect the development of consumer culture across the whole region. Asia's young generation is the largest in history and is poised to be a driving factor in the Asian growth story as they earn more than their frugal parents, enjoy greater social freedom, broader use of technology and a tendency to spend more and save less [3].

9   Third, the maturity of the region's financial markets.  Developed markets have a longer financial market history and investment houses have dedicated more resources to research the companies and economies, compared to their Asian counterparts.  Developed financial markets have matured and present less investment opportunities. On the other hand, Asian financial markets are still in nascent but developing phase, reinforced by the continued efforts of Asian authorities to broaden and deepen capital markets. Thus, investment opportunities still exist.

10   So by and large, I would say that the case for Asian ex-Japan assets is strong.  In reality, though, investors are still underinvested in Asia. An Asiamoney survey conducted in 2005 showed that many global investors still view investments in the Asia ex-Japan region as a peripheral, tactical play as opposed to a long term strategic positions. In addition, investors still perceive emerging Asian investments to be highly risky and loosely regulated.  Allocations to Asia ex-Japan are small, with the typical global fund management firm still typically allocating around only 4 to 5% of total investable funds to the region's market. The allocation is even less for many pension funds in the US, Germany and UK. To be sure, there are exceptions.  For instance, ABP Investments, Europe's biggest pension fund which actively manages Euro 180 billion on behalf of Dutch public servants, has tripled its investment in Asia ex-Japan since 2003 to around 9% of its equity allocation.  But as a whole, it is fair to say that Asia ex-Japan is under represented in global portfolios.  Data from the IMF [4] backs this: Aggregate foreign liabilities [5] in Asia currently amounts to 65% of aggregate GDP which is less than the 80% recorded in Latin American emerging markets and 100% in US and Euro area combined.

11   So why is it that many investors have not invested more into Asia?  The simple explanation is the relatively low Asian ex-Japan allocation in major indices.  Asia ex-Japan contributes 28% of the world's GDP, while Asia's share of market cap is low: at only 2% of the MSCI World Index and 3% of the Lehman Aggregate index.  But this simple explanation is incomplete.  The low weighting in major indices reflect deeper factors that hold back global investor interest.  In my view, there are four main factors:

- Capital controls;
- Perception of corporate governance standards;
- Inaccessibility of markets; and
- Narrow spectrum of asset classes for investments.

Fortunately, things are changing rapidly and many of these issues are being addressed.  Let me discuss each of them in turn.

Capital controls

12   Fundamentals aside, there is the practical issue of capital controls in Asia which have kept investors away. But in this regard, Asia is not a homogenous bloc.  I think we can broadly place Asian countries into three groups.  First, there are the markets which do not have any capital controls - like Hong Kong and Singapore.  Second, there are markets that have substantially liberalized since the Asian crisis.  Korea, Indonesia and Thailand are some examples in this category.  In all these markets, foreign investors are now allowed to invest freely in their domestic securities.  Some restrictions on derivatives and offshore transactions remain but are being gradually loosened.  Korea for example, has announced that it would free up currency restrictions by 2007. 

13   Finally, there are countries that still have strict capital controls, most notably China and India.  In both countries, substantial steps are underway to liberalize their capital accounts.  China has allowed markets to play a bigger role in determining the value of its currency as well as allowed freer conversion of the local currency into foreign currencies. India has joined in relaxing controls on domestic investors to invest overseas and for foreign investors to invest in local companies.

14   The reforms have not been limited to improving the mobility of capital, but have also included steps to broaden investment channels and tools for hedging risks. For example, China now allows trading of currency swaps and forwards and is even considering introducing interest rate and stock index futures. Such reforms aim to encourage innovations in the capital market, foster more investment products and are tantamount to partial liberalization.

15   The actions of policy makers in Asia reflect the recognition that Asia can no longer remain isolated, and that Asian markets have reached a stage to increasingly be able to handle the volatilities of more open markets. To a certain degree, there is also a realization that over the longer term, capital controls can become less efficient as market participants find loopholes to get around such controls. Therefore, liberalization of the capital account becomes more compelling and even inevitable.

16   A better capital market can provide effective financing instruments by improving the pricing mechanism and hence, improving the investment efficiency of resource allocation. A more efficient capital market is likely to emerge in the future and in turn, reduce the need for capital controls.

17   The challenge is for the governments to balance capital liberalization with financial and macroeconomic stability. This requires adequate risk management capabilities and monitoring and surveillance systems. Therefore, capital liberalization is not something that can be done in the short term and one that Asian governments are proceeding with caution but definitely in the right direction.

Perception of corporate governance standards

18   The second factor impeding global investors is corporate governance standards or the perception that standards are still lax.   In this regard, policy makers and companies alike in Asia are also recognizing the importance and need for better corporate governance.  Corporate governance reforms in Asia have been in the form of legal and jurisdiction changes, investor education and activism led by regulators, exchanges as well as market forces.

19   For example, regulators in China embarked on a drive to restructure ownership of listed stocks and have encouraged the introduction of foreign strategic investors with the purpose of improving the governance structure of Chinese companies. They have also enacted a law on the "Code of Corporate Governance for Listed Companies" as well as stricter anti-bribery laws and enforcement.

20   In addition, as Asian companies expand and develop business outside their home countries, they face more requirements to tap global capital markets. When they do, these companies would have to conform and match up to the corporate governance standards of developed markets.

21   A PERC (Political and Economic Risk Consultancy) report on perceptions of corporate governance standards in Asia reflects a bullish view. Investors surveyed reported improving corporate governance standards in 8 out of the 11 Asia ex-Japan countries. Investors can expect the trend of improving corporate governance and investor protection to continue.

Inaccessibility of markets

22   Investments into Asia have also been hampered by the inaccessibility of certain markets and the difficulties navigating various tax regimes and regulatory restrictions. Again, policy makers in Asia have not overlooked this and have taken steps to address this, by lowering the barriers of entry for investors.  Let me highlight just some examples.

23   Under the ASEAN Capital Market Forum, ASEAN securities regulators are collaborating to harmonize standards on disclosure, rules of distribution and qualifications of accounting and investment professionals. The objective of the collaboration is to reduce the cost to the issuer who otherwise has to comply with the different applicable regulations. This could then facilitate cross border distribution of securities and mutual fund products.

24   At the same time, the ABMI (Asian Bond Market Initiative) is looking to encourage debt securitization, provision of credit guarantee and investment mechanism, foreign exchange transactions and settlement issues and the development of local and regional credit rating agencies.

25   One of the more publicized regional initiatives would probably be the Asian Bond Funds launched by the EMEAP (Executives Meeting of East Asia and Pacific Central Banks Group) central banks in Asia. This initiative was intended as a catalyst to stimulate investor interest and trigger infrastructural improvements as well as tax and regulatory reforms to facilitate cross-border investments.

26   This initiative has delivered results and demonstrated that passive managed funds are viable products in Asia. For instance, the Pan Asian Index Fund would be the first foreign institutional investor to be granted access to China's inter-bank bond market. Tax regulations have been reformed to exempt withholding tax on investment income from local currency bonds. Exchange Traded Fund regulations have been created or enhanced. Foreign exchange administration rules have been liberalized to allow better access by foreign bond issuers and for investors to hedge. Private sector investors can also now adopt or customize the transparent and impartial ABF index. Regional market infrastructure has improved and cross-border settlement risk reduced with the establishment of a custodian network covering all eight EMEAP markets by ABF's global custodian. This is another first.

27   On the equity front, there are also efforts to ease foreign investors' entry into Asia.  One such initiative is the ASEAN Stock Index, which was launched by five ASEAN exchanges together with FTSE in September last year.  There are plans to launch an ETF on this index, which will allow global investors an efficient way to invest in 40 of the largest companies in SE Asia.

28   Of course, capital market development isn't limited to just regional efforts. Asian countries for example, are also taking steps to improve the accessibility of their own domestic bond markets, particularly in the area of secondary market liquidity.  Price transparency will also help improve liquidity.  For this purpose, several Asian countries, including India, Thailand and Singapore have launched electronic platforms.  I believe Singapore is among the first Asian countries to roll-out an electronic trading platform for its government securities. Progress from an OTC market to a more accessible and impartial platform will increase price transparency and facilitate price discovery. Thus, foreign and retail investors will not have any information disadvantage.  Within ASEAN, there is also a task force to consider how to link the various platforms together to increase inter-market accessibility.

29   Developments in the front-end of investments cannot succeed without back-end operational support. That is why, as mentioned earlier, the Asian Development Bank has embarked on a drive to enhance regional settlement efficiency to boost confidence of investors. A working group is studying the idea of a pan-regional settlement provider, linking different depositories and clearing systems to create a more efficient and highly secure body for transaction settlements. However, this is no easy task as such linkages are most effective in an environment of full currency convertibility, sound regulation and free capital flow. A customized solution could possibly be a regional insurance product for securities transactions where each country contributes to a guarantee of settlement.

Narrow spectrum of asset classes for investments

30   The final reason why there are not more global investments in Asian assets is the limited variety of asset classes.  For many years, the main invest-able assets were equities and real estate.  Since the Asian crisis, many governments started developing debt capital markets.  As a result, Asian countries have increased issuance of government debt and encouraged issuance of corporate bonds. As at the end of 2005, total amount of government bonds outstanding was US$833b or more than five times the level in 1997. Including corporate bonds, total market size in Asia is now US$1.7 trillion [6]. But beyond this, newer asset classes are also emerging.  I will name three of the more prominent ones.

31   First, real estate investment trusts or REITs.  These have seen explosive growth, particularly in Singapore and Hong Kong over the last 3 years.  Now more markets are also launching REITs, including Malaysia, Taiwan and Thailand.  The estimated market capitalization of REITS in Asia is US$37b.  In Singapore, the market capitalization weighted-average returns since IPO have been exceptional at over 30%. The market has also moved beyond traditional REITs to other products like shipping trusts and hotels.

32   Second, asset-backed debt instruments.  This is partly the result of the REITs phenomenon, which issued a host of Collateralized Mortgage Backed Securities (CMBS).  In Singapore, there is on average, S$1.5bn of CMBS issuance every year.  The underlying assets of debt instruments have also broadened. For example, Singapore recently issued debt backed by loans from small and medium enterprises. This is due to the clear regulatory framework and environment which saw the Monetary Authority of Singapore (MAS) relaxing the leverage requirement and allowing market forces to determine the appropriate debt composition. Singapore is also a fertile ground for CMBS development due to its stable economic environment (sovereign credit rating AAA/Stable/A-1+) and robust legal and land title system which have enabled structured finance issuers to raise highly rated debt.  However, growth and diversity in asset-backed debt instruments have not been limited to Singapore. In the last 12 months, China issued their very first Credit Linked Obligations (CLOs) and Thailand issued debt that was backed by government offices.

33   More assets can potentially be securitized, particularly in the area of   infrastructure finance.  A joint study by the World Bank and ADB estimated that East Asian countries will need to spend US$250bn per year on infrastructure over the next five years.  Most of these will be in China, India, Indonesia and Indo-China.  For example, in India alone Prime Minister Manmohan Singh had said that India would need US$150 billion of investment in ports, roads, power plants and other projects to keep the economy growing at more than 8% over the next decade. And the absence of a deep bank loan market suggests that secured debt financing may be the most efficient route. 

34   Third, private equity.  According to the Centre of Asia Private Equity Research, over U$17.6b of fresh capital flowed into the Asian market, a two and a half fold increase from 2004.  Private equity investments in Asia are attracting the attention of both pension funds and institutional investors as the region grows and investors search for a way to participate in and benefit from this growth. We are seeing a trend where more hedge fund managers are setting up offices in Asia to look for private equity opportunities in search of yields. Private equity has become a vehicle to overcome the limitations of small financial markets and market inaccessibility.


35   In conclusion, I believe that asset markets in non-Japan Asia are in the midst of very exciting transformations.  Steps are being taken to broaden and deepen capital market liquidity, improve market access and strengthen market infrastructure. Over the medium term, we can expect an even more thriving regional market place.


[1] MSCI AC Far East ex-Japan Index
  Economist Intelligence Unit
  CLSA Sept2005 report "Me Me Me"
  Deepening Financial Ties, IMF Finance & Development, June 2006
  Combined stock of FDI, foreign loans and foreign equity holdings
  ADB Asia Bond Monitor 2006, March 2006