Zeti Akhtar Aziz: Asian market integration and financial innovation
Keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the
International Conference on "Asian market integration and financial innovation", Tokyo,
10 February 2012.
* * *
The world economy and international financial system is entering into a new phase of
globalisation. Far from having an effect of slowing the pace of globalisation, the recent global
financial crisis has intensified the process, resulting in a more connected and interdependent
world. While - previously - globalisation manifested itself in the form of trade and investment
between the emerging and developed world, emerging economies are now becoming more
connected with each other within and across regions. This trend is being reinforced by similar
changes in the pattern of financial flows. While previously, financial flows were predominantly
between the developed and emerging world, greater financial integration among the
emerging economies is facilitating the intensification of this connectivity.
While unable to be in Tokyo, it is my pleasure to speak at this international conference on the
topic of Asian Financial Integration. My remarks will touch on the main motivation for
pursuing financial integration in Asia, despite the fact that its absence has not previously
hindered economic integration in the region. Whilst Asia may draw lessons from the
European experience, I will discuss the different approach that is being pursued in Asia. The
growing internationalisation of Islamic finance is also contributing to strengthened economic
and financial ties among emerging economies including in Asia and the Middle East. Finally,
I will discuss the current global regulatory reform and its possible implications for regional
financial integration in Asia.
The aspiration for greater economic and financial integration in Asia is to achieve greater
shared prosperity that is mutually reinforcing for the economies in the region. Regional
financial integration will achieve more efficient and effective intermediation of funds to enable
at least some part of the surplus savings of the region to be channeled to productive
investments in the region, and at lower costs with improved risk diversification. Improved
access to financing would also support intra-regional trade while a more cohesive region will
facilitate greater collaborative efforts on safeguarding financial stability. Collective actions
would also enhance the ability to better manage and respond to risks to the region. And
finally, as a cohesive group, our perspectives and position would be better represented in the
governance structure and processes in the international financial system.
Approach of financial integration in Asia
Asia comprises a highly heterogeneous group of countries that are different in terms of
economic structure, natural resources, degree of market orientation, stage of development,
size and degree of openness. Asian economies have however, recognised the respective
individual comparative advantages and have leveraged on the prevailing complementarities.
Given the diverse nature of the region, it would be highly ambitious and challenging to
achieve the necessary preconditions for achieving an integration that is similar to that in
Europe.
The integration process in Europe was taken forward with the establishment of supranational
institutions with mandates to promote common approaches and frameworks across the
member states in the union. In contrast, Asia is adopting a more flexible approach. Regional
financial integration in Asia has manifested itself mainly in the form of greater regional
presence and participation in domestic financial systems. This is taking place with the
gradual and sequenced liberalisation of the financial sector and the capital account. Capital
account liberalisation in particular is prompting increased intra-regional investment and
portfolio flows which in turn contributes to the deepening of the financial markets.
By itself, the liberalisation of the financial sector and the capital account will however, not be
sufficient to achieve regional financial integration. Most important, is the development of
regional financial markets, the financial infrastructure including the regional payments and
settlement systems, harmonising the financial standards and practices including the
regulatory and supervisory regime and building the institutional capacity of the domestic
financial intermediaries. For the ASEAN region, an agreement has already been reached to
allow for different speeds of integration depending on the state of readiness of the respective
member countries. This is being reinforced by arrangements for surveillance for
assessments of risks to the region and regional frameworks for crisis management and
resolution, including arrangements for mutual assistance. Equally important in this process is
the cooperation and collaboration among regulatory authorities for sustaining regional
financial stability. Much of this work has focused on putting in place strong and effective
institutional arrangements to preserve regional financial stability.
In the decade following the Asian Financial Crisis, most of Asia has accelerated the pace of
financial sector development and reforms. Several of the Asian economies have made
significant strides in improving the soundness and efficiency of financial institutions and in
developing domestic financial markets. At the regional level, key initiatives have included the
development of the regional bond markets through the creation of various Asian Bond Funds
and the ASEAN+3 Bond Market Initiatives, the regional arrangements for crisis management
that includes liquidity support, and the collaborative efforts advanced under EMEAP to
facilitate liquidity management for financial institutions operating in the region through
CrossBorder Collateral Arrangements. Currently, while intra-regional cross-border portfolio
investments within Asia is relatively small, it has already increased to 28 percent of total
assets holdings in 2011 compared with 21 percent in 2001.
Another important development that has contributed to greater regional financial integration
is the increasing role of Islamic finance in the international financial system. In its early
stages of development, Islamic finance was highly domestic-centric in its orientation. This
recent decade has seen the rapid internationalisation of Islamic finance resulting in
significant growth in cross border financial flows. The development of Islamic financial
markets, in particular, the sukuk market, the progressive financial sector liberalisation, and
the establishment of international arrangements and institutions to safeguard financial
stability, cumulatively have contributed to enhance the international dimension of the
industry. There are now more than 600 Islamic financial institutions operating in more than
75 countries.
Given that Islamic financial transactions require an underlying economic transaction, it is a
form of financial intermediation that is well anchored to serve the real economy. With its
internationalisation, it has become an increasingly more important channel for the efficient
allocation of financial resources across borders and for the diversification of risks. This new
international dimension of Islamic finance has facilitated stronger financial ties between Asia
and the Middle East. The sukuk market in particular has become an important avenue for
international fund raising and investment activities that generate significant cross border
flows.
While the efforts to put in place these pre-conditions will continue, equally important is the
role of the private sector in driving the Asian regional financial integration agenda, particularly
in building the institutional capability to effectively intermediate funds in the region. While
foreign presence throughout our region facilitates this process, it needs to be complemented
by strong domestic regional intermediaries whose operations would be more inclusive and
thus increase the potential for balanced growth in our region.
Asia has demonstrated its resilience to the many shocks from the international financial
markets and the global economy during this recent global financial crisis. As highly open
economies, most economies in Asia have been highly affected by these developments.
Stronger domestic demand, greater intra-regional trade and investment, reinforced by
resilient financial systems and strong macroeconomic fundamentals, have supported the
economic performance of our region. There have been tremendous payoffs for the region
from the decade long of financial reforms, institutional building and development of financial
infrastructure. Despite the highly challenging environment of slower trade and volatile
financial markets, financial intermediation in Asia has continued uninterrupted and financial
markets, while more volatile, have remained orderly. It is thus on these strong foundations
that the regional financial integration in Asia is not being set back. On the contrary, despite
these global developments, the integration process has continued and regional financial
cooperation and collaboration has strengthened, reinforced by the increased regional
participation and presence of the private sector.
Global regulatory reforms
Let me now turn to the global regulatory reforms and its implications for Asia. The global
regulatory response to the financial crisis is now moving into the implementation phase. At its
core are the reforms to build a stronger global regulatory framework to significantly raise the
level of resilience of the banking system. While that work has now been largely finalised, the
complex task of implementing the new global capital and liquidity standards is just beginning.
Indeed, this implementation is proceeding at a time of a difficult global financial and
economic environment. Several countries have however, announced their timelines, with
some that are moving faster and further than the Basel III standards.
Asia is in a relatively stronger position to transition to the new standards. We are, however,
vigilant over the global economic and financial consequences of its implementation in other
parts of the world. As open economies, we are not insulated from these consequences.
While the work of the Basel Committee suggests that the effect of tightening conditions on
economic growth will be modest, the highly dynamic global financial conditions imply that
regulators will have to continue to proceed cautiously, and on a fully informed basis, in
implementing the new standards. Of importance is the need to recognise the point beyond
which the costs to the real economy exceed the desired benefits of greater systemic
resilience.
The reform agenda has also focused on the fundamental and no less significant changes to
institutional arrangements and market structures. Some of these, such as reforms involving
the OTC derivatives markets and policy frameworks for systemically important financial
institutions (SIFIs), are being advanced through global platforms, notably the Financial
Stability Board (FSB). Other reforms, such as the structural changes to banking models that
are being contemplated in the UK and the implementation of wide-ranging reforms under the
Dodd-Frank Act in the US, although not being imposed outside these countries, are
nevertheless charting a path forward that is likely to have wider ramifications, given the
significant cross-border operations of affected institutions, including in Asia.
Like most jurisdictions, the options for central clearing for domestic OTC derivatives are also
being examined. These reforms are already under way in the world's larger financial markets
to meet the G20 mandate for standardised OTC derivatives transactions to be centrally
cleared by the end of 2012. For smaller OTC derivatives markets in Asia, the effects on
domestic market efficiency and stability are key considerations in contemplating a move
towards central clearing arrangements. A key concern is the potential for the offshore central
clearing of transactions in key domestic markets to increase the stability risks to the domestic
financial system. There will also be limited scope for domestic regulatory authorities to have
oversight on such offshore central counterparties (CCP) and to respond during periods of
financial stress. Domestic central clearing arrangements, however, could have negative
effects on efficiency and the functioning of the market, in particular for cross border
transactions. In addition, fragmented clearing arrangements could reduce netting
opportunities and collateral efficiencies, in turn raising costs to participants. There is also a
need to close important information gaps on the rules that will govern global CCPs, including
the criteria for mutual recognition of CCPs and membership conditions, as well as details on
the arrangements to mitigate the concentration of risk to the CCP itself or its members.
These gaps are currently limiting a more complete assessment of domestic and regional
options for central clearing.
The global reforms for the most part would contribute to the promotion of more consistent
approaches to regulation which is an important precondition for greater financial integration
in Asia. In a number of countries, the global reforms have had a role in accelerating further
domestic priorities to strengthen financial resilience. Initiatives that are being advanced at the
global level also work to strengthen regional financial stability arrangements. This includes
putting in place more robust frameworks for the oversight of systemically important financial
institutions at a regional level. Within Asia, a clear evolution of such frameworks can already
be seen in the operationalisation of cross-border supervisory colleges for financial institutions
with a significant regional presence. The reforms have further encouraged closer
coordination and communication on financial stability developments between countries in the
region. This has been borne out of common perspectives and challenges shared among
countries in the region on the direction and impact of the reforms, and the need to bring
forward the collective views of the region. These implications will further strengthen the
foundations for regional financial integration in Asia.
Policy shifts and the proliferation of binding "one-size-fits-all" regulatory prescriptions
however, goes against the grain of regulation that is proportionate to risk which has been a
well established principle of sound regulation. There is therefore considerable risk to simply
following new "trends" which may lead us down yet another potentially misguided path. In
particular, the significant efforts made in the region over the recent decade to bolster
financial sector efficiency and innovation, which in turn promotes financial integration, could
be disproportionately curtailed.
In addition, it has only been recently that the global attention has also turned to enhancing
supervisory intensity and effectiveness as an essential component of the financial reform
effort. This is a welcome move and will add a critical dimension to the consideration of future
reforms by national authorities. In Asia, financial reforms were already accompanied by a
significantly strengthened supervisory approach and safety net arrangements, which served
to check unfettered innovation and reckless risk-taking behaviours and promote strong
incentives for prudent risk management. For these reasons, our banking systems have been
resilient through the global financial crisis and have continued to remain strong since, despite
continued risks in the global economy. As we contemplate the raft of reforms that will
continue to occupy the global agenda in the next few years, our considerations should be to
pursue domestic and regional solutions that will deliver a more resilient financial system
without impairing the continuous provision of efficient financial services that are vital for our
economies.
Let me conclude my remarks. While many challenges remain, Asia is at the cusp of
experiencing significant collective economic growth and development. Asia should however
significantly draw important lessons from the global financial crisis and recognise the
implications of greater interdependence. In addition, the sovereign debt crisis in Europe
relates not only to fiscal matters but to debt management which has significant implications
for financial markets. While fiscal issues may remain a national matter, its financing and its
broader consequences needs to be addressed. Given the positive environment in Asia, the
opportunity needs to be taken to put in place the necessary arrangements to best address
these challenges. The world is increasingly now looking towards Asia. With these enabling
conditions, Asian economies would be better positioned to collectively strive and work
towards achieving the shared vision of financial and economic integration that will not only
unlock our potential but also enhance the prospects to contribute towards a more balanced
and sustainable global economy.