Address by Mr. Ong Chong Tee, Deputy Managing Director, Monetary Authority of Singapore, at the IMAS Conference 2009, Raffles City Convention Centre, 10 March 2009
Mr Lester Gray, Chairman of IMAS
Mrs Patricia Khoo, Chairman of the Organizing Committee
Mr Michael Lim, Executive Director of IMAS
Ladies and Gentlemen,
1 Four years ago, I had the pleasure of delivering a speech at this same event. It is a stark contrast of the business environment today compared to 2005.
2 Some commentators have described the current times as a “major turning point” as all financial institutions including asset managers stand at the cusp of structural changes in the industry. But even back in 2005, some of you may recall that we spoke on the need to manage the effects of financial innovation and how the increasingly new complex products would require deeper understanding of valuations and risks. Since then, the epicenter of a US subprime crisis has morphed into a global financial tsunami that led to the demise of Bear Stearns, Lehman Brothers and others – and its ripple effects and aftershocks are still being felt today as balance sheet deleveraging and risk aversion continued to prevail. Quickly, the ‘shadow banking system’ has dealt a major blow to the traditional banking system.
3 Earlier last month, there was a report that stated that almost half of all the complex credit products ever built out of slices of other securitized bonds have now defaulted. A few weeks ago, S&P also warned of another potential systemic risk for European leveraged loans with concerns that the debt of just 35 different borrowers appears in nearly half of the 184 CLOs that it rates; so the default of just one of these names can send another wave of panic about credit quality of the portfolios of nearly 90% of European CLOs. So clearly, financial markets are still in an unsteady state of flux. Cost cutting, business consolidation, heightened risk management and core expertise focus have taken on heightened importance in the Board rooms of many financial firms – and appropriately so.
4 The storm that gripped Wall Street has now moved to Main Street and we are facing concurrently, a negative second round effects arising from the economic downturns globally. Consider that global equity market capitalization of over US$62 trillion some 18 months ago has plunged to less than US$28 trillion now – that is a massive destruction of wealth that has affected households and consumers globally and in a significant way. The ensuing loss of jobs and deteriorating consumer confidence interact in a negatively reinforcing loop.
5 I am pleased to note the conference theme of “Rebuilding Confidence: Positioning for Recovery”. On the one hand, it is indeed important to focus on the heart of what has gone wrong and which has yet to be fixed – a breakdown of trust and the loss of confidence at many levels of financial activities. On the other hand, it is unwise to believe that financial markets will never recover. Therefore, the industry should consider what that recovery phase – as and when it happens – will mean in terms of what will matter to investors, to regulators and to counterparty intermediaries that will shape the future industry winners.
6 In October last year, just after TARP was passed, an article in the New York Times posed an interesting question: Was Karl Marx right after all? Marx has argued that capitalism is prone to self-destructive forces, and is thus, ultimately doomed. In the current gloomy financial and economic environment, which some consider to be worse than the 1929 Great Depression, many may well feel that capitalism has failed. But it is worthwhile to reflect on a phrase of Winston Churchill: that the free market is the worst way to allocate resources, except for all other forms that have been tried before. I think most of you will agree with this. It is difficult to be in the investment management business and not believe in the underlying benefits of free markets. But Marx is not wrong in that left to themselves, free-market forces can spiral, both virtuously – and often viciously – and in the case of the latter, the consequences can be catastrophic as what we have seen.
7 The speed and depth of the unraveling of global economic activities have taken many by surprise. It was just over a year ago that the world saw new highs being set in financial markets all over the world. Credit was plentiful and readily available. Most economies were growing strongly. Investors sought and sometimes demanded high returns, encouraging the pace of innovation across the financial industry. With the price of oil and other natural resources rising at a rapid rate, the main concern up to July last year was that of inflation.
8 Now, we are confronted with a different set of macroeconomic conditions and the business environment in the first half of last year appears like some unfamiliar distant past. The banking sectors in US and Europe have faltered under the weight of massive write-downs. This has resulted in a sharp tightening of credit conditions and a loss of confidence in the capital markets. In turned, growth outlook has dimmed dramatically. World growth is projected to fall to Â½ percent or less, a new low since the Second World War. According to the latest IMF report, output for advanced economies is forecast to contract for the first time in the post war period. As growth slows, non-performing loans will increase, putting further stress on the banking sector. It is not just in the private sector but sovereign credit risks have also come under greater investor focus.
9 Asia has not been spared. With the collective drag of falling export demand, lower commodity prices, and much tighter external financing terms, the growth of emerging economies is expected to slow sharply. The decoupling theory between Western and Asian economies has been proven wrong.
10 An important lesson from this crisis is that it is not only how big a financial institution is that matters, but also how connected it is to others in the global financial system. We now know for example that Lehman’s failure led to a run on US money market mutual funds, who in turn were the largest suppliers of US Dollar funding to non-US banks – a subject of a recent BIS study. The banking problems, credit market problems, US$ funding issues and other financial stability concerns have taken on global dimensions via a complex network of inter-connectedness, and therefore have to be tackled in a concerted manner. There are some concerns over what has been described as ‘financial protectionism’ as the quick or easy fix, and indeed, this can have negative consequential effects on the global economy.
11 As one example of increased global coordination, some of you will have read that MAS entered into a FX swap arrangement with the Federal Reserve with a swap line of US$30 billion created. The Fed also set up other swap lines, with 13 other central banks including Bank of England, European Central Bank, Bank of Japan, and Reserve Bank of Australia. For us and the marketplace here, this is important because most cross-border transactions in Asia are still denominated in dollars. As a major funding centre, it is helpful that global financial institutions operating in Singapore continue to have access to US dollar liquidity. The Federal Reserve on its part also recognized the importance of an enhanced ability to provide US dollar liquidity round the globe through central banks in sound and systemically important financial centres. Since our swap arrangement, global US dollar squeeze pressures have since alleviated and we have not had to use the swap line, nor see any impending need to do so. But this coordinated and precautionary measure has been helpful.
12 There are also some things we can do on our own. We have put in place new initiatives to better manage Singapore Dollar liquidity in the banking system. Thus far, our markets have functioned smoothly and orderly notwithstanding the global financial stresses. On its part, the Government has taken proactive steps to address credit flow from banks to corporations via different schemes to co-share some of the risks with banks. There are other schemes relating to trade finance and SMEs, for examples, all of which will help mitigate some of the negative downside effects from the global market turmoil.
13 Let me now turn to the asset management industry. In the wake of this crisis, severe risk aversion has taken hold in many investors. The result has been an increase in withdrawals and redemptions, particularly from retail or high net worth investors. Confidence has been badly shaken and will need to be restored. Let me highlight 3 key areas.
14 First, the issue of risk of fraud. The Madoff and Stanford frauds in the US highlight the undesirable outcomes when business practices of asset managers fail to adhere to basic principles of fairness, transparency and ethical conduct. The idea of allowing a fund manager to act as his own fund administrator and broker is absolutely ludicrous. Yet, Bernie Madoff fooled not just the ordinary man-in-the-street but also professional fund of funds managers. The industry will surely move to one where there will be increased emphasis on areas such as the safekeeping and handling of customers’ monies and assets; and independence of fund administration and custodian functions. It is in the interest of every bona fide fund manager to take these issues very seriously.
15 Second, the demise of the “free-lunches”. Let me explain. In the run-up to the financial meltdown, there were many examples of apparent “free-lunches” offered by money managers to the clients. Money market funds that were considered as liquid and risk-equivalent to bank deposits but yield a higher rate of return; or synthetic ‘AAA’ securities that yield a higher return than ‘AA’ bonds; or super-senior debt securities, that were purportedly even safer than ‘AAA’ government bonds. These free-lunches are now a thing of the past – at least, I hope for a long while to come. A crucial lesson learnt by investors is that at the end of it all, there is no such thing as a free lunch. Investors who want a higher rate of return must now accept a higher level of risk – be it market, credit or liquidity risks. Likewise, investment managers who had relied on these free lunches to grow asset base will no longer be able to do so. They will need to generate real value-add for their clients through superior investment return, and this means a back-to-basic focus on creating value via good investment talent and a robust investment process. Indeed, some market commentators believe that many fund managers will bifurcate along 2 broad groups – one, marketing liquidity with no gating policies and investing in more liquid public markets; while others marketing above-normal returns in exchange for lock-ups and higher volatility of expected returns.
16 Let me touch on a third observation, where traditional assumptions about asset class returns have been severely challenged. One example is the so-called equity risk premium. Peter Bernstein – the respected economics consultant and author - wrote an interesting article in the Financial Times recently, entitled ‘The flight of the long run’., In essence, he noted that equities – contrary to popular expectations - have underperformed bonds in the last 5, 10 and 25 years; and by substantial amounts! I checked and that is true, given the long periods of bond market rallies and the multiple periods of stock market collapses in past 3 decades. He also observed that the volatility of equity prices tend to increase, not decrease as the time period grows. Bernstein himself ended his article by stating that the long run is an impenetrable mystery and always has been. Now, his commentary can generate different interpretations. One such interpretation is that the conventional wisdom that in the long run, equity investors will always be rewarded, may well not be true. Another inference is that the projected return on any asset, even over a long-period, is closely related to the point of investment entry.
17 I have a third interpretation of Bernstein’s comments. Perhaps passive investment in equities may not always pay. Indeed, the better-performing half of the stock market typically has significantly different performance than the worse performing half. If the equity managers among you somehow have the ability to pick the top 20 stocks in the Dow for your clients compared to a passive investment in the MSCI-World Free or the Dow Jones Industrial Average Indices, you would beat the respective benchmark handsomely even over the turbulent past 1-year period – over 20% outperformance against the MSCI and over 13% outperformance against the Dow Jones. If an investor had bought into an alternative fund manager that not only can buy these outperforming stocks but also able to sell the underperforming counters, his returns would have been even far better. When one considers corporate credits, the story line is the same. The top outperforming sectors can beat the typical benchmark by some 6 to 10% points depending on the time horizon. This explains why some – but few – asset managers and hedge fund managers have delivered much superior returns compared to their peers. The big caveat here is, of course, that these fund managers can continue to identify winners and losers consistently given the relative return distribution.
18 The thrust of this observation is that in my view, there will be some renewed attention on good and consistent alphas. Just having a passive allocation of equities and bonds, whether 20-80 or 40-60 (whatever the relative distribution), may not suffice to protect the portfolio in periods of market stress. This will also suggest that the crisis of confidence affecting many hedge funds and fund-of-hedge funds, will not spell the end of the hedge fund model. Rather, the survivors who have a good value proposition, strong risk management processes and a stellar track record can be positioned to do even better in an industry that will downsize considerably.
19 At the same time, the traditional benchmark-based investors will also challenge the old paradigm that a benchmark is a long-term structure that is best left alone whatever the market cycle. A more dynamic process of reviewing investment benchmarks depending on material shifts in market conditions may be warranted.
20 As the industry strives to regain its footing, MAS remains committed to supporting its development here in Singapore. We will continue to be an important hub. Let me cite a few areas:
21 Firstly, it is important that Singapore’s reputation as a premier fund management centre is maintained, and that long term confidence in Singapore is not compromised.
22 Internationally, there are calls for enhanced regulation of ‘unregulated’ financial institutions, in particular hedge funds. The European commission, for instance, is poised to publish its recommendations on how to reform financial oversight. This will include areas such as enhancing disclosure to investors as a means of better facilitating investor due diligence, and managing the global flow of credit which contributed to the build up of undesirable levels of leverage by institutions such as hedge fund managers. These topics, and others, are likely to be at the agenda when the G-20 leaders meet in London in April.
23 Recently, AIMA has also launched a Major Transparency Initiative, pledging its support for the principle of full transparency and supervisory disclosure of systematically significant positions and risk exposures by hedge fund managers to their national regulators. It has voiced its support for authorisation and supervision of fund mangers based on the model of the UK’s FSA and called for a unified global standard for the industry.
24 The challenge for regulators and supervisors now is to decide on the appropriate levels of intensity for supervising the financial industry, bearing in mind the different types and levels of risks posed by the variety of financial intermediaries. Our own guiding principle is to fine-tune the level and intensity of supervision in a way that will foster sustained recovery in the short to medium term, and growth over the long term for the asset management industry.
25 Secondly, we will improve the business environment for fund managers to operate in. For the first time, qualifying funds managed by a prescribed fund manager in Singapore will be allowed to claim input GST on prescribed expenses. We have also introduced an Enhanced Tier to the existing fund management incentives for funds with a minimum size of S$50 million.
26 Thirdly, talent development for the industry remains a key focus for the MAS. We have encouraged these efforts through the enhancement of MAS’ training incentives.
27 We have recently increased the funding support for qualifying training programmes under the Financial Training Scheme (FTS) for training programmes which are accredited under the Financial Industry Competency Standard (FICS). These enhancements extend to the development of customised in-house training and assessment programmes. In addition, the range of Masters programmes that qualify for support under the Finance Scholarship Programme (FSP) has also been broadened beyond the current areas of financial engineering, risk management and actuarial science. They now include programmes in the areas of finance, applied finance and financial economics.
28 Beyond these training scheme enhancements, we also see the need to catalyse the creation of job and attachment opportunities for fresh graduates. I am pleased to announce that MAS will be setting aside S$15 million funding support to provide fresh local university graduates with meaningful industry internships and attachment opportunities over the next 1-2 years.
29 More details on this new scheme will be released shortly. I hope that our efforts will spur financial industry partners like yourselves to continue investing in talent even as you adjust your business plans and manpower needs, to weather the current crisis and to position for the future upturn.
30 Equally important is the role played by industry associations like IMAS in leading its participants to discuss and share views on issues of common interest and to promote industry best practices.
31 In conclusion, let me turn back to the analogy of a financial storm that has battered economies and financial markets worldwide. In the current stormy sea of investment management, some fund managers like sailboats may be grounded. Some will be damaged especially when they sailed into uncharted waters without knowing the risks. Others may have capsized or be rescued by more steadfast boats. But for those boats that survive, having been built on solid foundations with a great crew on board, there is no reason why this crisis cannot hold important lessons for future strategies. As a popular saying goes, we cannot direct the winds but we can adjust the sails. So what sails to put up, and which ones to take down - that is something all of us have to address as individual organizations and as a financial community - to restore market confidence and to move forward.
32 May I wish all of you a fruitful seminar.