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Good morning distinguished ladies and gentlemen. I am delighted to be part of this conference that has brought together such a vast array of industry professionals, and I thank Citigroup for giving me this great opportunity to speak to all of you. I am definitely looking forward to hearing the many interesting discussions to follow.
My talk today will be about how the global financial crisis has affected the business of exchanges and what may be in store for us. The first half of my discussion will focus on opportunities in our home country of China and in the second half I will address some of the issues facing Asian exchanges at large.
From meltdown to upturn
We have just passed the anniversary of one of the defining events in the current global financial crisis. It was on 15 September 2008 that Lehman Brothers filed for Chapter 11 bankruptcy protection which, as we all know, set off a chain of events the scale of which we could not imagine.
The crisis, which emanated from sub-prime mortgage and credit bubble in the US did not leave any market untouched. And our region was no exception. We witnessed meltdowns as confidence evaporated and unemployment rose.
Governments and central banks around the world intervene and pumped massive liquidity into the markets. The downward spiral was slowly but surely halted. The stimulus measures stabilised markets which then became liquidity driven.
Since then, markets seem to have regained some optimism, not only with talks of green shoots but indeed a bullish recovery. Whether we have really turned the corner I will leave up to the experts. We have experienced a powerful equities rally without an equivalent turn in the global economy. As you know, the G20 finance ministers agreed earlier this month that monetary and fiscal policies would remain expansionary until recovery is secured. This demonstrates that we are not out of the woods yet. G20 leaders will meet in Pittsburgh in about one week. I do not think there will be any surprises.
Obviously a return in the appetite for risk means better business for exchanges in terms of trading activity and fund-raisings.
At the beginning of the year, the average daily turnover in Hong Kong's cash market was under US$6.4 billion. By August it had recovered to US$9.0 billion. While in terms of funds raised, we have recorded a close to 80 per cent jump in the first half of this year compared with the same period last year. For 2009, up to now, both in terms of IPO fund raising and of total fund raising including post-IPO fund raising, HKEx ranks either second or third.
Meanwhile, the broader benchmark Hang Seng Index has gained about 40 per cent year to date. Not only has the Hong Kong market fared well but the Mainland, Indian and other regional markets have also seen a strong recovery. These rises have helped boost HKEx's own stock price and in terms of HKEx's own market capitalisation we are now one of the three top listed exchanges in the world.
In fact, since the lows in late October last year, the major emerging markets have significantly outperformed the developed markets. This has given rise to discussions again about decoupling - a theory that was dismissed as all markets collapsed following the Lehman bankruptcy.
According to some reports, emerging market equity funds had seen inflows in excess of US$10 billion since Beijing announced its stimulus package in November up to the middle of this year, while developed market equity funds had seen an outflow of more than US$40 billion. This fund flow is an indication that investors believe the economic prospects in Asia is better than its Western counterparts.
China - a growth driver and window of opportunities
One market that captures more interest is Mainland China, with hopes that its robust financial conditions will lead us out of the global economic crisis.
The World Bank expects the global economy to contract 2.9 per cent this year and the US economy to shrink by 3 per cent but that developing economies would collectively grow by 1.2 per cent and that were it not for China and India the figure would be a negative 1.6 per cent.
Today I will focus more on China as it is where we are based and where HKEx has extensive experience. One of HKEx's goals is to ensure that HKEx and indeed Hong Kong will not disappoint investors. What we can offer through our platform are opportunities the rising Chinese economy presents to issuers, intermediaries and investors.
Earlier this year the Mainland revised its output data, showing it overtook Germany as the world's third largest economy in 2007 and could catch up with Japan in second place in the next few years. The revision raised Chinese GDP to RMB25.7 trillion or about US$3.5 trillion at 2007 exchange rate. That was ahead of Germany's 2007 GDP of US$3.3 trillion. Japan's GDP was US$4.4 trillion. Also, China's comparative resilience throughout this financial crisis has not gone unnoticed. Some have commented on an accelerated shift in economic gravity from the West to the East.
Indeed, the Mainland market has a significant financial cushion to withstand external shocks. Despite a hit to its exports, there is room for the country to develop domestic consumption as witnessed by more overseas companies setting up shop there coupled with the rise of more Mainland ones.
Listing prospects
These Mainland companies will continue to need funds to grow as consumption levels rise. Since 1993 when the first H-share was listed, Mainland firms have raised over US$250 billion on the HKEx.
We have already seen a pick-up in fund-raisings in our market, mostly by Mainland enterprises, and expect the pipeline to continue in foreseeable future. To prepare ourselves for continued IPO and post-IPO activities from Mainland enterprises as well as overseas enterprises, especially those with businesses in the Mainland, at HKEx, we are strengthening our offerings and services. For example, we have launched a strategic review of our Listing Rules with the aim of streamlining the listing process. We are also reviewing the Listing Rules applicable to mining and resources companies to facilitate their fund-raising and will consult the market on related proposals.
We are also working closely with our counterparts in the Mainland in terms of information sharing and collaboration. HKEx has signed Closer Cooperation Agreements with both the Shanghai and Shenzhen Stock Exchanges and is keeping abreast of the needs of Mainland market participants and investors.
The Mainland market remains a domestic one, and for Mainland enterprises interested in raising foreign capital or gaining exposure to international standards and practices, we would like to think Hong Kong would be their preferred choice.
The other side of the coin, of course, is that many international companies are also interested in listing in the Mainland, when such policies permit, in order to tap the Mainland investor base and the rapidly expanding stock exchanges there. This, of course, will contribute to the economic growth of the Mainland markets and economy which Hong Kong will benefit from as well.
Expanding investments
There are undoubtedly vast opportunities for growth in the financial sector given the Mainland's large and increasing affluent population, high savings rate, as well as ongoing economic liberalisation efforts.
These efforts include gradually allowing more savings to be invested overseas. We have already witnessed fund flows being facilitated by the QDII programme, with over US$50 billion in approved quotas. Recently we also learned of the increased QFII limits.
Here in Hong Kong our free-trade agreement with the Mainland or the Closer Economic Partnership Arrangement - CEPA as it known for short - has also enhanced opportunities in the banking sector for both sides, facilitated Renminbi services, and expanded the scope of brokerage operations.
For example, Mainland brokerage firms are allowed to set up branch offices in Hong Kong after obtaining approval from the China Securities Regulatory Commission, while qualified Mainland and Hong Kong securities companies can set up joint venture securities investment advisory companies in Guangdong Province. To date, we have about 30 official Exchange Participants in our cash market and 18 in our derivatives market from the Mainland, and hope to recruit more to our platform.
These days more investors are also able to access Greater China opportunities with the proliferation and popularity of exchange traded funds (ETFs).
With the recovery in the markets this year, some of the most rapid growth has been seen in ETFs investing in the stock markets of China, Taiwan, South Korea and Brazil. Globally, there are reported to be more than 250 emerging market equity ETFs with total assets of more than US$130 billion, up from US$70 billion in January.
Last year, Hong Kong's ETF market was the largest in the Asia-Pacific region in terms of turnover value. Turnover of Hong Kong-listed ETFs has posted strong growth in recent years, and among the most popular products are those based on China-related indices.
We are continuing to add to our ETF offering, and just last month listed another Taiwan ETF following the signing of a mutual recognition agreement between the Hong Kong and Taiwan regulators facilitating the cross-listing of such funds. Meanwhile, a number of Hong Kong ETFs have also received approval to list in Taiwan. We are also working with the Mainland exchanges to facilitate mutual ETF listings, and there is no reason why such cross-listings could not be extended to other regional bourses.
This all means that investors have better access to Greater China stocks than ever before through their own home markets, and this should advance the development of regional stock exchanges while strengthening ties among them.
The benefits of China's ongoing economic transformation will accrue to numerous markets, not just one. The pie will continue to grow and will be big enough for many to play a meaningful role. I remain convinced it is not a zero-sum game.
Obviously China's rise as a pre-eminent economic giant will not happen overnight, and further challenges may still lie ahead. But there are definite opportunities for regional exchanges and market players to expand their businesses and take advantage of expanding fund flows.
Road ahead for Asian exchanges
To be successful, however, exchanges must continuously enhance the integrity of their markets whilst adapting change in the global financial arena. Some of the challenges we face include those related to the interconnected issues of technology, regulation and investor demand.
Technology has always played a key role in the evolution of stock exchanges and indeed the broader financial markets, especially in the past couple of decades. It has not only helped effect change in market structure but also greatly facilitated growth in the scale of activities conducted.
And although it sounds basic, it is vital for exchanges to ensure that our platforms are reliable, and can securely cope with extremes in volatility and changes in volume.
HKEx is fortunate to have recorded 100 per cent operational system uptime in all its major infrastructure. We continuously upgrade and increase capacity of our trading systems in both the securities and derivatives markets to ensure we are able to meet demand.
Changing competitive landscape
Basics aside, advances in technology coupled with deregulation in many major markets have heated up competition in global exchanges.
Legislation such as the European Union's Markets in Financial Instruments Directive (MiFID) and the US's Regulation National Market System (Reg NMS) - which deal with best execution and specify that orders be sent to the venue offering the best price - have had a profound impact. They, in effect, have reduced the barriers to entry and given rise to more competition with the creation of alternative trading platforms, often funded by institutional investors themselves, bypassing the established exchanges.
These alternative trading platforms with the attractions of low cost and speed of execution have taken same market share from the established exchanges. In the US, for example, the market share of Nasdaq and the New York Stock Exchange (NYSE) have continued to fall while the market share of alternative platforms such as BATS and Direct Edge have risen.
NYSE's market share of all US equities stood at about 28 per cent in July this year, down from 34 per cent last year. This compares with 78 per cent in 2004. Nasdaq, the London Stock Exchange and other incumbents in Europe have also seen market share erosion due to new players.
In Asia, the situation is somewhat different. Strict regulation in many countries has restricted the setting up of such alternative share trading platforms. Also the vertical silo model in many Asian markets, with exchanges offering integrated clearing and settlement services, form an additional hurdle for newcomers.
Nevertheless, Asian exchanges have still been affected by the wave of global market consolidation brought on by increased competition. More and more global exchanges are tying up and seeking to grow inorganically. We have seen this with mergers, the acquisition of stakes in other exchanges, alternative trading platforms, technology companies, and even with the development of their own dark pools.
Although outright mergers such as the well-known ones of the NYSE and Euronext as well as the London Stock Exchange with Borsa Italiana have not been seen in this part of the world as much as in the US and Europe, more global alliances are definitely taking place. Indeed full-scale integrations are fraught with difficulties and obstacles, and amid difficult market conditions we have heard some of these larger merged entities have been seeking to restructure, cut costs and lay off staff.
Nevertheless, strategic collaborations are definitely taking place in Asia like the CME Group teaming up with Bursa Malaysia to launch a palm oil contract, Singapore Exchange (SGX) and Chi-X intending to launch a dark pool. Prior to these developments, SGX already has a strategic investment in the Bombay Stock Exchange, while the Bombay Stock Exchange in turn has a strategic partnership with Deutsche Borse.
Apart from Asia, the Middle Eastern and Brazilian markets have also been targeted. Nasdaq, for example, has a stake in the Dubai International Financial Exchange and NYSE has a stake in Qatar's Doha Securities Exchange. CME has launched an oil contract with the Dubai Mercantile Exchange. It also has a stake in Brazil's BM&F Bovespa. There are more such examples I could cite, but the tie-up trend is clear.
For incumbent players that either lack experience or the global scale, tying up with bigger counterparts could strengthen their operations - including helping them to acquire technical expertise, while offering their partners new growth opportunities.
Also, we should bear in mind that the barrier regulatory structures form are not set in stone and could evolve to adjust to new competitive forces.
Just last month, for example, officials in Australia said supervision of market participants would fall under the domestic financial regulator, the Australian Securities and Investment Commission, which will take over the role from the Australian Securities Exchange. The proposed change is widely seen as the first step to allowing alternative equity trading venues to be launched in the country and compete with the Australian Securities Exchange. What implications this could have for other markets in the Asia-Pacific region remain to be seen.
I am sure the panel discussions to follow will have much more to say on this topic and I look forward to their insights.
Evolving trading practices & investor demands
Apart from greatly facilitating business expansion and opening up the field to competition, technology has also led to new methods of trading. Some of the hot topics these days include dark pools, high-frequency trading, flash orders, co-location, and the effect they have on fairness and transparency.
There are concerns that those with better resources can benefit from asymmetric information, getting data about orders a fraction of a second before their rivals. Worries have also been expressed that dark pools are not transparent enough, and could pose risks to the system - risks we have become more wary of in the wake of the recent financial crisis. Some also believe that high-frequency trading exacerbates market volatility. There have been calls for greater regulation of related activities.
While these issues are currently not as prevalent in Asia as in the US or Europe, it is clear that investors, especially institutional ones, are seeking better services for increasingly computerised methods of trading which exchanges or regulators in Asia cannot ignore.
While protecting investors and maintaining market integrity, we have to find ways to improve our platforms and functionality to offer best execution to accommodate new trading strategies in a fair manner, as well as offer efficient pre- and post-trade services in order to stay competitive and continue to attract volumes.
Value of exchanges
One of the advantages exchanges have versus the new trading platforms is the capability to help companies raise capital via listings. New listings not only form a source of income for exchanges, but also attract more participants and help to create more liquidity and better market depth. In contrast, the mushrooming of alternative trading platforms runs the risk of liquidity fragmentation and increased opacity.
Indeed, regulated exchanges have proven their worth in the global financial crisis in terms of effective risk management, mitigating counterparty and settlement risk, as well the provision of ongoing and transparent price discovery for financial assets, and much needed liquidity in the credit crunch. The unique value offered by regulated exchanges is increasingly being recognised by governments, market participants and investors.
Reducing systemic risks
The recent crisis showed the high degree of leverage in the system. The large OTC positions taken by various firms could not be monitored because of the lack of transparency and disclosure. One way of better monitoring and managing possible systemic risk is to offer the trading and clearing facilities of regulated exchanges for such products.
Apart from reducing counterparty and operational risk, central clearing also facilitates regulatory oversight by providing a single location for access to information on the extent of market participants' potential liabilities.
There are moves in the US and Europe to better regulate OTC products, such as CDSs. Among the proposals are to have the trades occur on-exchange or have them cleared through a central counterparty.
In the US, for example, legislation has been proposed that would require central clearing and trading of standardised OTC derivatives, to reduce risks, improve transparency and price discovery. Regulators would also work to prevent the use of "spurious customisation" so as to avoid central clearing. Similar moves to better regulate OTC trades are being looked into in Europe.
I believe there are also opportunities in Asia to have OTC transactions go through the regulated exchanges but there are also hurdles given the customised nature of some products.
In Hong Kong, we believe further work can be done, for example, to introduce options with flexible features to our derivatives market and we aim to release an information paper regarding such products later this year.
While supporting measures to bring stability to the financial system, exchanges must ensure they have the requisite risk management capability to take on complex products.
Conclusion
Ladies and gentlemen, although exchanges were affected by the recent financial storm they have fared relatively well and have continued to offer their services without disruption. In the past few months, the business of exchanges have benefited from renewed confidence in the market.
What the new financial order might be immediate horizon holds, I cannot predict but I am confident of the long-term prospects the rising China market has much to offer to investors and market participants. Fund-raisings, wealth management, and growth in related investment products are but a few opportunities.
Capital markets and exchanges in Asia as well as those with ties to them will benefit from China's growth and growth of other emerging markets. While the business of Asian exchanges has been relatively more sheltered than those in the US and Europe it does not mean things cannot change, nor is it a reason for complacency. We need to be aware that investors want better, faster, and cheaper services. Also competition should not be feared as it helps drives innovation and spurs improvement.
What we need to work on is growing liquidity and the overall pie. And we can only do so by maintaining investor trust in us and offering them a good value proposition. Integrity, reliability, proper regulation and effective risk management are all part of this equation. Exchanges can help strengthen the global financial system and need to continue to work on introducing improvements while helping to allocate capital to its most productive and efficient use.
In the long run we all benefit and achieve success by ensuring confidence in our markets. There are significant opportunities for both organic and inorganic growth, especially in this part of the world. To be successful, exchanges need to manage the changes well.
Ladies and gentlemen, where the next danger lurks no one can say for sure. We need to remain vigilant and work with one another.
I thank you for having me here today and look forward to hearing your views.
