The Challenge of Financial Globalisation Address by Richard G. Humphry, Managing Director and Chief Executive Officer, Australian Stock Exchange, to CEDA Capital Markets Seminar

Today is, I think, the deadline that astrologers set for world financial markets to collapse, or world war three to start, or the world itself to come to an end, depending on your choice of astrologer. At the time I left the office we seemed to have survived, but of course it's still early in the day on the other side of the Pacific, where these astrologers reside. It's encouraging, though, that so many of us thought it worthwhile to spend the worst (or possibly last) day of the 20th century discussing the future of Australian financial markets in the 21st. I'll try to sustain that mood of optimism. That isn't made any easier by an article in The Economist this week which asked whether stock exchanges were coming to grips with what it described as the threat from technology, or whether, on the other hand, they were in their death throes. Its point was that electronic communication networks, often owned by stockbroking forms or global financial information providers, are a significant threat to the established exchanges; one published figure is that ECNs are taking 30 per cent of the business that used to go through the Nasdaq market, and two of the biggest are now seeking registration as exchanges which will enable them to attack the New York Stock Exchange as well. Indeed, ECNs are a principal reason why both the New York Stock Exchange and Nasdaq are rushing to follow ASX's lead and demutualise. It is no news to you that ASX and the ACCC are light years apart in our view of how real and immediate is the competition from ECNs and other technology based advances in the financial services industry. In expressing concern about ASX's bid for the Sydney Futures Exchange, the ACCC assured us, and I quote, that "the ACCC's inquiries revealed that electronic communication networks do not appear to pose a significant competitive threat." The ACCC also does not believe that the forces of globalisation are going to generate serious competition for the immediately foreseeable future either. On this issue I think it is prudent for those of us actually involved in the financial markets to take a more cautious approach, particularly in the light of the U.S. experience. Perhaps we would be better advised to base our competitive strategies on the findings of the Wallis Inquiry. Let me quote a couple of relevant sentences from its final report: Australia has actively and irreversibly embraced globalisation. A consequence is that competition in many financial markets occurs globally, rather than at the national or regional level, presenting both opportunities and challenges for Australian financial service providers. While globalisation of wholesale markets is already well advanced, most retail financial markets have scarcely been affected. It is clear, however, that the new technologies and techniques which will stimulate change are now imminent. Advances in the means of achieving secure electronic transactions and the critical mass of electronic network coverage are now well within sight. Global electronic financial transactions are likely to emerge in the near future and will almost certainly flourish over the period to 2010 if the regulatory environment is accommodating. That, I suggest, is the realistic environment within which we in the financial markets should be planning, if we don't want to have some unpleasant surprises in very near future. It is certainly the basis of our forward planning in ASX, and it is the reason why you are seeing so much innovation. It was why the Sydney Futures Exchange approached us last year with their merger proposal. It is why other stock and futures exchanges are merging around the world - in the United States, in the European Union, in Sweden, in Hong Kong and in Singapore. Until very recently, it seemed that there were two ways that the stock exchange world could adapt to its increasingly global environment. One possibility was that a single exchange would become dominant in each of the world's three major time zones, trading the shares of major companies from throughout the region, while national stock exchanges were relegated to a secondary role, trading the shares mostly of smaller companies. The other was that exchanges would form alliances across national borders, and even across time zones, leading to mutual access to each other's markets. It now seems likely that the merger option is going to be largely confined to futures exchanges, either with each other as the Chicago Mercantile Exchange and Chicago Board of Trade have been talking about and the Swiss and German exchanges have consummated, or with their national stock exchanges. As for stock exchanges, or merged stock and futures exchanges, the emerging preferred option seems clearly to be cross-border alliances. The most striking example of this within a time zone is in Europe, while Nasdaq has been by far the most active in forging alliances across time zones, including with ASX. We ourselves have been pursuing the alliances option in both of these forms, initially within our own time zone and more recently across time zones, starting with our alliance with Nasdaq. This activity of ours has had particular publicity recently, but in fact it is more than three years ago that we signed our first memorandums of understanding with the Malaysian and Korean exchanges, which have now grown to seven throughout east Asia. These are arrangements that will probably develop bilaterally, according to the wishes of the partners in each case, and it remains to be seen whether they will lead to such things as mutual market access. In the case of ASX and Nasdaq, that is very definitely the intention. We propose to start quite quickly with co-listing of companies, while we create the communications and other infrastructure and obtain the regulatory approvals needed for co-trading of each other's major stocks. This is undoubtedly a healthy development. The alternative would have seen ASX expending significant resources competing with other stock exchanges in the region for dominance, while the region competed with North America and Europe. And if we achieved that, what would it mean? The whole of the Asia-Pacific region, including Japan, accounts for just over 14 per cent of the Morgan Stanley Capital International world index of stock markets. That is the index that is widely used by global institutional investors for capital allocation purposes. Australia has the second-largest weighting in the region, after Japan, with 1.32 per cent. Compare those figures with 32 per cent of the world represented by Europe and 54 per cent by North America. We are surely much better placed having alliances with the other two time zone regions than trying to compete with them. At first sight, that might seem to argue against the possibility of Australia's becoming a regional financial centre, and even against the concept of regional financial centres. I don't believe that is true. Financial markets have been affected far more than most sections of the economy by developments in computer technology and communications. Even die-hard traditionalists like the New York Stock Exchange are moving to electronic markets. It's not before time, according once again to The Economist, which described the NYSE last week as a potential Titanic, whose fattest rats (as it unkindly described large stockbroking firms) are preparing to jump ship in favour of electronic trading networks run by themselves. If you accept that financial markets are unique in this respect, then I don't believe the way they are developing does argue against the concept of particular cities' becoming global centres for financial services. Such centres obviously need financial markets of high integrity that are liquid, strong in regional terms and strong in terms of the alliances they have forged with other regions, but they need much more than that. They need a financial services industry that creates highly sophisticated products. Sydney has no competition in that respect outside New York and London. They need a stable and mature political and economic environment. They need high-quality infrastructure in legal and accounting and communications and similar services. They need low-cost business conditions but a well-educated workforce. No problem with any of those. Australia was ahead even before east Asia's recent economic troubles, and it is further ahead now. But two other things that global financial centres also need are sound but not excessive regulation and an internationally competitive tax system. It's not that we have poor regulation but we must guard against excessive regulation. CLERP is making some headway in simplifying aspects of it, although CLERP6 has some proposals that could actually make things worse rather than better if they aren't changed. The answer, as we said at the time of the Wallis inquiry, is to tear the thing up and start again if we want to have an internationally competitive regulatory structure. Tax is an even greater problem, although there are grounds for hope that some of its least competitive aspects might be redressed in changes stemming from the Review of Business Taxation. In our submissions to that review, ASX emphasised strongly that the most important requirement of our taxation system is that it should be internationally competitive, which means that the outcome of the review cannot be subject to the constraint of revenue neutrality. That concept is a very slippery one in any case. You may remember the dire predictions from state governments after Queensland halved the rate of stamp duty on financial transactions, and they had to follow. Millions of dollars were going to be lost to revenue, we were told, and smokers paid the price. In fact the stamp duty cut boosted turnover to such an extent that the states' revenues from this duty were soon as high after the cut as they were before it. We have argued that the same is true of initiatives such as a large cut in capital gains tax, because a lower rate will both stimulate new investment and lead investors to sell assets that they are currently holding simply because of the punitive tax rate that would apply on their sale. To support that proposition, we commissioned a study from the Hudson Institute in the United States, which concluded that there was little risk that a reduction in the capital gains tax rate to 30 per cent, indexed for inflation, would cost a single dollar in revenue because of this unlocking effect. Even a 30 per cent rate would not be truly competitive internationally, particularly if it is offset by abolition of indexation, as some soothsayers are predicting. It is interesting to compare what is happening in the United States, for example. Last week, the U.S. Congress passed a bill to make a number of reductions in present taxes. One of them is to cut the capital gains tax rate on investments from the present 20 per cent, tapering to 10 per cent, down to 18 per cent, tapering to 8 per cent, and on top of that to introduce indexation for inflation. Yet here are we in Australia regarding a 30 per cent rate as a good outcome of the review, with some of us even prepared to sacrifice indexation in return. Admittedly President Clinton is likely to veto this particular bill, but most commentators expect significant tax cuts to be agreed soon in America. We still have a long way to go. One area where we have made substantial progress towards international competitiveness is in harmonisation of Australian accounting standards with the core set of international accounting standards that have now been completed, except for one on investment property, by the International Accounting Standards Committee. This accelerated work on harmonisation has been largely funded by ASX and our listed companies. It is vital that we don't insist on parochial standards that no one else in the world understands, particularly now that the International Organisation of Securities Commissions - IOSCO - is in the final stages of evaluating the international standards for use in cross-border offerings and listings. In summary, then, Australia has made substantial progress in meeting the challenge of financial globalisation. There are exceptions, such as the ACCC's misunderstanding of how far globalisation and the computer and communications revolutions have changed Australia's previously comfortable isolation, but on the whole we can take heart from the progress we have made. With just 141 days to go until the year 2000, there are encouraging signs that Australia also has the millennium bug under a reasonable degree of control. Since the experts are saying that the opposite is true of a substantial part of Asia, the next few months may well see a strengthening of our regional position. In my view, Australia - and the financial services sector in particular - can look forward to 2000 and beyond with quite a high degree of confidence. If you want confirmation of that, perhaps I could suggest an appointment with your astrologer.