A different sort of plan: The government identifies broad goals and trends in capital markets

The Capital Market Master Plan 2001-10 (CMP1) was a huge success. Of the 152 recommendations made, a full 95% were achieved. The second Capital Market Master Plan (CMP2), announced in April 2011, is not going to match that performance. This is not because Malaysia is not motivated to implement CMP2 or because CMP2 sets the bar too high. It is because unlike CMP1, CMP2 does not make specific recommendations. The first plan was a to-do list. The second is an expression of trends and themes.

DIFFERENT ENVIRONMENT: Weighing in at 300 pages, with a 54-page executive summary, the CMP1 was an impressive document. Chapter 4, the chapter that makes the recommendations, is itself 149 pages. While some of the items on the list could be described as vague and non-committal, most of its contents were fairly prescriptive in nature. It called for such things as allowing foreigners to majority-own unit trust companies by 2003, the liberalisation of broking commissions by certain set dates, the introduction of universal brokers, stock broking consolidation and the establishment of a single sharia advisory council. Strict benchmarks were set.

The basis premise of CMP2 is that the challenges now are not like those of a decade ago. When CMP1 was formulated, the issues were for the most part Malaysia-centric; the country had to correct the mistakes that had led to the collapse of 1997-98. Although CMP1 mentions liberalisation and development, it was in many respects a repair manual. CMP2 was written in a different environment, at a time when the world was undergoing a crisis and Malaysia itself was stable, and specific remedies were not needed. The new document is far more ambitious, driven in part by the more ambitious market it now is aiming to serve. “Investor risk tolerance and appetite for higher-yielding debt is growing substantially as the market is currently dominated by AAA-rated securities and government-backed paper,” Chung Chee Leong, CEO of Cagamas, told OBG.

GROWTH & STABILITY: CMP2 does offer some compelling projections. It forecasts that the country’s market capitalisation, debt and equity combined, will climb from RM2trn ($645.2bn) in 2010 to RM4.5trn ($1.5trn) by 2020. And it adds that successful internationalisation could result in even faster growth and leave the country with a RM5.7trn ($612.9bn) capital market by 2020. But while it is willing to set a course, CMP2 is not so eager to explain exactly how this is going to happen. It instead establishes a framework and general direction. To those ends, CMP2 offers two main categories of suggestions and observations, those related to growth and those related to governance arrangements, the former to extend the winning streak that started with CMP1 and the latter to defend against the troubles outside the country’s borders. It is important to note, though, that while the plan is concerned about the state of the world, it at the same time regards interaction with foreign institutions and markets to be key to the country's development.

The chapter entitled "Growth Strategies to Expand Role of the Capital Markets" starts by introducing the overarching concept that the development of the capital markets is related to the country’s economic transformation, and introduces the connection between expanding the capital markets and job creation, business financing, asset ownership and returns on savings. It then goes on to lay out a series of strategies and discuss how they will generate the desired results. While it shies away from defining exactly what should happen and when, it does push a number of campaigns in specific economic areas.

VC & BONDS: Venture capital (VC) is a subject of focus in CMP2. The Securities Commission recognises that while the country has done a good job of reforming capital markets, and even though plenty of funding avenues and opportunities are available, serious bottlenecks, gaps and inefficiencies exist. In particular, it notes that start-ups and other smaller enterprises may have difficultly obtaining financing. Malaysia has vibrant and liquid bond and equity markets, but funding tends to be skewed towards larger and more credit-worthy entities. CMP2 talks of formalising regulations and better defining the available structures for the VC industry, which is at this point relatively loose and informal, and encouraging more participation by institutions now biased toward investment-grade paper. It suggests that one of the main problems is the illiquidity of VC and other early-stage investments and calls for more study into developing ways to alleviate that risk.

The document makes the connection between Malaysia’s infrastructure successes and strong corporate balance sheets, and the well-developed domestic bond market. At the same time, it says that the bond market needs to be broadened to finance a wider range of businesses and projects and a larger variety of risks. The solutions it puts forth include: improved documentation, better credit rating agency standards and more transparency in the case of defaults. It also spends time discussing improvements in electronic trading, securities lending, market making, clearing, settlement and custody. Retail participation in the market is encouraged, as this sort of activity is seen as improving liquidity in a market dominated by large institutions. Methods of achieving it, including better education, documentation and investor protection, are discussed.

INSTITUTIONS & ASSET MANAGEMENT: CMP2 spends some time discussing the evolution of institutional investment. According to the plan, the giant pools of capital in the country, such as Permodalan Nasional, were started to a great extent to direct the country’s savings towards economic development. Over the years, the focus shifted and the institutions began to become market-oriented. CMP2 suggests that even though this may have improved efficiency and the allocation of resources, on the whole a worrying correlation of strategies has occurred and the nation’s savings still tend to end up in a narrow range of investments. CMP2 recommends careful assessment of the problem. The document argues that investment management is one way to more efficiently and safely deploy Malaysia’s savings and that the expansion of the asset management industry, especially given the growth of private pensions, will be key to getting capital to more risky, and potentially more profitable, opportunities.

DERIVATIVES & INTERNATIONALISATION: Importantly, the authorities have come to realise that derivatives are vital to the market in terms of price discovery and hedging and acknowledge that there is a gap in the market because of the lack of these instruments. CPM2 even suggests short-term oriented international investors are needed to breathe some life into and bring liquidity to a market dominated by large, conservative institutions, calling for the facilitation and active pursuit of cross-border flows. While internationalisation is seen as the key to overcoming the natural limitations of the domestic market, here CMP2 is particularly hesitant to call for major changes. It does mention tie-ups, strategic alliances and regional efforts at market integration, but it steers clear of recommending exchange mergers, the full opening of the capital markets and a centralised regional trading platform. Overall it says liberalisation of the capital markets is a healthy process, but concludes that too much competition must be avoided. It recommends continuous disclosure, risk-based regulation and more rigorous regulatory frameworks. The report argues that, while Malaysia is a disclosure-based market, the model must evolve and be enhanced to safeguard investors.

GOVERNANCE ARRANGEMENTS: Chapter four of CMP2 deals with the other half of the capital markets equation: stability. It recognises that since CMP1 the world has become a lot more complicated. Products now squeeze through gaps in regulation and exist between the jurisdictions of various regulators. New asset classes are being invented that defy classic definitions. Derivatives are packaged or assembled to mimic traditional products. Products evolve too fast without proper risk mechanisms in place. Orders are routed through alternative platforms. The result is possible regulatory vacuums. CMP2 warns that such outcomes must be avoided.

Critics of CMP2 say that its weakness is in the lack of direct instructions and straightforward recommendations. It is almost devoid of deadlines and has none of the urgency of CMP1. The document reads more like independent analysis, providing the lay of the land and a general sense of what needs to be done. In that way, CMP2 is not only dealing with a market that is far more advanced than the market that was the subject of CMP1, but is itself a sign of change. Malaysia is no longer in need of 10-year plans. It is too open, too free and too sophisticated. It is more in need of a solid examination of the state of affairs and some well-thought-out text on the way forward. That is CMP2 is offering the sector.