Fertile soil for global investment?
To accommodate growing populations and booming economies, Asia needs to invest in its infrastructure. But this depends on the ability of its capital markets to channel global inflows.
While the American and European economies remain unattractive for growth investors, many eyes have turned to Asia. But pitfalls remain as public infrastructure development struggles to keep pace with economic growth and market structure poses impediments to investment.
“Many Asian economies could be building more infrastructure, at a lower cost and doing so much more quickly,” says James Hexter, senior partner at McKinsey & Company, chairman of the management consultancy’s Beijing office and leader of the firm’s global infrastructure practice. “There are available funds and many projects but poor project conceptualisation, market failure and inefficiencies constrain development of the many roads, freight rail networks, ports, airports and metros that Asian markets need to sustain their economic growth.”
Even once the finance is in place, projects often run over schedule and over budget, conditions which concern potential institutional and private investors. Hexter believes three issues determine the viability of Asian infrastructure projects for investors. “Are governments building only the infrastructure they need? Are they building to the right specifications? Are the projects managed to the proper time and budgetary constraints? Too often the answers to all these questions is: no,” he says.
This leaves potential investors from the west in a difficult position. “Infrastructure can be a very good investment and the number of infrastructure funds around the world is growing dramatically,” says Hexter. “If more Asian infrastructure development was more grounded in market needs and economics, more of this capital would likely be directed towards the region.”
Hexter explains that often infrastructure projects brought to market in the region take the shape of state-owned utilities, rather than privately-operated businesses, which typically increases the risk to private and institutional investors and increases the deal cycle.
“Investors often face long and expensive deal times,” he says, advocating what he terms centres of excellence within Asian governments to project manage infrastructure development and liaise with potential investors. But potential investors in Asia face other kinds of challenges too, namely, do the existing financial market mechanisms offer the access, protection and flexibility that is needed to confidently commit to the region?
Financial markets in Asia are at different stages of their development life cycle, says Donna Bales, managing director of Balmoral Advisory, a Singapore-based consultancy that provides advice to financial services companies and new businesses expanding in Asia.
“Emerging markets and Group of Seven countries occupy the same mix. Therefore, Asia cannot be looked at holistically but must be viewed as separate economies with their own economic goals, laws, regulations and investor base,” she says.
Bales says that Asian exchanges have the benefit of hindsight and can learn from the missteps of their peers in the west. A recent attempt by the Singapore Exchange (SGX) to take over the Australian Securities Exchange (ASX) demonstrates exchanges are beginning to look for global partnerships and business synergies beyond their borders.
“Many of the exchanges in Asia are already being responsive to changing market and global dynamics and are quickly developing ‘best practices’, upgrading their technology infrastructure and creating more innovative products and services,” says Bales. “Technology providers are also flooding into the region to absorb these growth opportunities.”
As economies in Asia mature and income levels rise, Bales says local financial markets will also expand and the composition of the region’s capital markets will change shape as a result.
“Exchanges are a key part of a country’s capital market structure, so it’s no surprise they are starting to invest in their infrastructure and that firms such as Chi-X Global, NYSE Technologies, Nasdaq OMX and others have moved to work with local players in the region,” says Bales.
For SGX president Muthukrishnan Ramaswami, better market structure in the region is an imperative to provide for the capital expenditure necessary to fuel Asia’s growth.
“The only way Asian countries will be able to continue their development is with increased expenditure on their basic infrastructure,” says Ramaswami, explaining that Asia’s top 20 cities all need better roads and sewer systems to accommodate growth.
Ramaswami says often major infrastructure developments, such as toll roads or car parks, find their way into real estate investment trusts (REITs) but that these vehicles are not enough to sustain infrastructure growth long term. The market structure in which these vehicles operate needs to be overhauled.
“It is often difficult to inject private capital into many planned works and in any event, it is not possible to domestically fund projects because the capital simply isn’t there,” Ramaswami says. “Asian markets need to find a way to better secure cross-border capital. Part of the solution is the evolution of the region’s market structures.”
Asia exhibits many different market structures, with each country offering its own distinct variant in terms of national exchange, capital market regulation and legal structure. Bales explains exchanges within the region are at different stages of commercial development.
“Some are demutualised and commercial and listed operations with public shareholders. Others are ‘not for profit’,” she says, adding markets such as India and Vietnam have two co-existing national exchanges, presenting some interesting dynamics.
“In India, two vertical silos operate side-by-side and compete head-to-head for business,” says Bales. “Regulatory change has been slow and the country only recently allowed smartorder routing between its two exchanges, which makes it easier for traders to choose the exchange offering a better price. But each exchange operates its own settlement system, which adds to the overall cost to trade in the Indian market.”
Vietnam’s two exchanges have recently revealed plans to merge. In October, it was announced the country’s ministry of finance was working on a plan to create a single bourse with Ho Chi Minh Stock Exchange merging with the smaller exchange in Hanoi to help the country’s capital markets compete on a global scale.
A fragmented monopoly
Peter Tierney, managing director, Asia, NYSE Technologies, characterises market structure in Asia as fragmented by geography but centralised by monopoly exchanges. He said without further market structure development, much needed capital raising could be stymied in the region. The sentiment is shared by many in the global investment community.
“Asset management opportunities in Asia have received substantial attention in recent years, and for good reason,” said Neeraj Sahai, global head of securities and fund services, Citi. “Nevertheless, after an initial gold rush, local and foreign managers have awoken to the sobering reality that Asia is a very complex heterogeneous region.”
A recent report from research firm Cerulli Associates noted growth in assets under management in the region was due in part to a shift of extremely large populations into the middle class across the region, bringing with them not only more disposable income but increased investment sophistication.
“Emerging Asian nations are steadily building considerable institutional investment presences on three fronts: well-resourced sovereign wealth funds, fast-developing pension funds and increasingly a presence from home-grown insurers,” says the report, entitled ‘Picking highhanging fruit: Competition intensifies between Asian managers and foreign firms’. “The overriding message is clear: Everything points toward dramatic growth in assets in Asia for many decades to come.”
And at the heart of this growth is resource-hungry China. Recently, the International Monetary Fund predicted Chinese economic growth would come in at around 9.5% in 2011, followed by 9.0% in 2012. But Agnes Deng, head of Hong Kong China equities at Baring Asset Management, says despite the positive long-term outlook, ongoing inflation concerns have been a drag on Chinese equities. The Chinese authorities have actively raised rates in a bid to manage liquidity and temper growth in Asia’s largest economy.
Open door policy
For Asian exchanges to furnish the region with the capital inlays needed to accommodate the region’s infrastructure needs, Dato Tajuddin Atan, chief executive of Bursa Malaysia, is urging local bourses to change their business models.
“Regulation in Asia shields exchanges from competition but an exchange is just a marketplace, and the barriers must eventually come down,” he said. “When they do, Asian exchanges need to already have a game-plan in place.”
Atan is concerned Asia’s exchanges cannot presently compete for capital on a global scale. But by modifying their business strategies, they will be better placed to serve their local and international clientele.
“Once more, Asia has been caught in the slipstream of a western drop in the markets, but emerging markets now have more weight on a global scale,” Atan said, explaining that most Asian economies now possessed superior cash reserves, stable balance sheets and increasing wealth – qualities which will help them fund infrastructure requirements. Now is the time for Asian nations to take advantage of the global flow of funds from Europe and the US, he says.
Atan also called on exchanges to review their offerings to domestic clients.
“Investors want good pickings, low cost of entry, protected – but not restricted – markets and freedom of choice. Otherwise, they will go somewhere else to invest,” he said, warning that a local source of potential capital was not necessarily a captive market. “Asian exchanges need to be more aware of alternative venues. They no longer operate in an insular domestic market.”
William Barkshire, senior advisor to the chairman of the Hong Kong Mercantile Exchange, is also concerned exchanges run the risk of forgetting their local prospects.
“Platforms need to adapt and modernise if they are to continue to attract increasingly sophisticated local investors,” said Barkshire.
China’s thirst for commodities will continue to drive demand for commodity products and growth in Asia, but for Barkshire, there is also a growing need to better cater for global participants looking to invest in the region.
“Risk management and efficient price discovery are two elements which trouble investors from London and the US,” Barkshire says. “The global wallet is open and ready for Asia, but the region needs to make markets more attractive.”
One recent regional initiative to attract greater international capital flow is the new ASEAN Exchange agreement, formally launched 8 April, 2011. Seven exchanges in six countries have signed up to cooperate: Bursa Malaysia; Hanoi Stock Exchange; Ho Chi Minh Stock Exchange; the Indonesian Stock Exchange; the Philippines Exchange; Singapore Exchange; and the Stock Exchange of Thailand.
Bursa Malaysia’s Atan believes the new partnership will only bear fruit if it represents “clear value” for customers. He warns Asia not to follow the same “high regulation” path as Europe and the US, insisting good governance and integrity is critical for confidence.
“Regulation needs to help economies thrive, rather than limit innovation and capital development,” he said. “The regulatory framework must move fast. ‘Cookie cutter’ regulation is not right for Asia. Regulation needs to look at what the customer needs – and that is speed, access, freedom and protection.”
The new link electronically interconnects the participating ASEAN exchanges to facilitate cross-border order routing and trading, allowing investors and members to access multiple ASEAN markets from their domicile country. The network lets participating ASEAN exchanges connect to external order routing networks to attract new order flows. However, the ASEAN Exchanges partnership is yet to tackle more complex structural issues, such as clearing.
“The cost of running a domestic exchange will likely increase over the next decade,” said Tierney. “The new network will help provide long-term cost benefits and greater access to southeast Asian markets.”
Seth Merrin, chief executive of buy-side-focused block-crossing network Liquidnet, believes cooperation is only part of the answer.
In Merrin’s mind, Asian exchanges can remain national and protected but they need better access to a network of international liquidity. While he believes the trend towards fragmentation is not a do or die issue for national exchanges, the real need is for Asian bourses to broaden their global strategy.
Merrin notes that less than 13% of global assets under management are invested in the region. The bulk of the global wallet – 80% – is still invested in Europe and the United States.
“I’m very concerned that when Asian exchanges eventually start to compete with pan-European and global exchanges for capital, they will not be up to the task because their market structure won’t be as conducive to institutional investment,” he said. “Unless Asian exchanges eventually raise their competitiveness, they will not be able to grow to the levels needed to continue the capital growth required in the region.”
He also warned Asian exchanges not to forget their institutional customer base in favour of chasing transaction fees from high-frequency trading (HFT). While potentially positive for volumes on exchanges, HFT can often be perceived as a negative for institutional investors who are more interested in long-term investment growth and creating value.
Merrin says the main issues restricting growth are the varying regulations in Asian countries, the disparate levels of technology in exchanges and brokers, and market infrastructure – in terms of varying levels of sophistication and connectivity.
While changes in global investment flows are offering Asia-Pacific exchanges increased sources of capital, more needs to be done to cater for the needs of global institutional investors, he implores.