Muhammad bin Ibrahim: Perspectives and issues in navigating the
development of the Malaysian financial market
Remarks by Mr Muhammad bin Ibrahim, Governor of the Central Bank of Malaysia (Bank Negara
Malaysia), at the ASEAN Risk Conference 2017 "Perspectives and Issues in Navigating the
Development of the Malaysian Financial Market", Kuala Lumpur, 24 May 2017.
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Thank you ladies and gentlemen. Two years ago, I spoke at this very conference on ASEAN
integration. Two years on, I am pleased to share that we have achieved substantial progress on
this front. Among others, the ASEAN Banking Integration Framework and the bilateral
frameworks to settle trade in local currencies are two significant milestones for financial
integration.
Today, I intend to speak on a few issues relating to ASEAN integration and outline the latest
developments and challenges in the domestic financial market.
For decades, globalisation has been the cornerstone of global economic development.
Globalisation was a way to bring the countries of the world together to gradually flatten the
intercountry disparities in income, wealth and overall standard of living, in hope that the motivation for
war and conflict among countries would gradually reduce as disparities narrowed. Globalisation
expanded trade and the free flow of capital, allowing countries to reap the benefits of comparative
advantage while facilitating the growth of new sources of income and the transfer of knowledge
and technologies.
Truth be told, globalisation bore fruits that lead to greater economic growth, prosperity and
wealth. However, in the dogmatic pursuit of inter-country convergence, intra-country disparities
have become increasingly apparent. As nations across the globe were brought closer together,
citizens within each nation were pulled further apart, separated by the rising inequality, the
declining share of labour income versus capital, and the displacement of workers.
The unfettered market openness by advanced economies had caused unintended
consequences that have ignited the rise to populism, inward-looking tendencies and potentially
protectionist policies. If left to run its course, this will be a setback to global prosperity. In ASEAN,
we are no stranger to this perspective. Our own experience is highly relevant.
We learnt from the Asian Financial Crisis, that pushing countries to adopt policies when
readiness is suspect is a design for failure. Without the necessary preconditions of sound
institutional frameworks, adequate safeguards and capacity and robust domestic financial
markets, premature financial liberalisation will expose the economy to waves of destabilising
short-term speculative flows. When these flows leave, a trail of destruction is left behind. We
also learnt that proper sequencing and readiness of financial liberalisation is key.
The criticism that ASEAN's 'steam engine' may not be 'full speed ahead' does not capture the full
picture. This view fails to consider and understand that quality, not the speed and quantum of
integration, is what really matters. The focus of integration should not be on speed, but on
building the collective capacity, readiness and resilience of member countries.
ASEAN is committed to pursue market openness within this region, but also wants to remain
deeply integrated within the global economy. A 'Global ASEAN' is not an oxymoron - rather it is a
declaration of our inclinations, aspirations and direction for the future. Rather than a narrow
pursuit of openness for its own sake, experience taught us that balance, readiness and
inclusiveness is critical for the success for an open market economy. As a group, ASEAN has
been very mindful of the stage of financial and economic development of individual countries.
ASEAN pursues 'smart' integration that is based on the readiness and capacity of member
countries.
From the global financial crisis to the present
We are now entering a decade after the Global Financial Crisis (more apt to be called Trans
Atlantic Financial Crisis) and two decades after the Asian Financial Crisis. The implementation of
unconventional policies and a prolonged period of low interest rates, led to financial and
economic distortions, some severe, around the world. Emerging markets, including Malaysia,
witnessed large waves of capital inflows into capital markets, primarily in search of better yield.
For our onshore domestic market, we saw the ringgit strengthening following the demand for
ringgit assets. Between 2011 to 2013, the ringgit traded at its strongest levels since the Asian
Financial Crisis, between 2.90 to 3.30 against the US dollar. FX trading volume also increased,
contributing to the overall liquidity of the onshore FX market. At the same time, the increased
levels of non-resident investments in Malaysian financial assets had pushed non-resident
holdings of Malaysian government bonds to rise to the height of 33.6% in May 2013.
These heights came with costs, heightened risks and vulnerabilities. From the Taper Tantrum in
2013 onwards, our markets went through several bouts of volatility. These were largely driven by
volatile portfolio flows. During the Taper Tantrum in 2013 itself, we saw outflows of USD19.1
billion and a depreciation of 9.7% of the ringgit against the US dollar.
Despite this, our capacity, capability and resilience in managing these sizable and volatile
financial flows have been fortified in a number of ways. Our economic fundamentals have
remained healthy and our financial market is more diversified and well-developed. This enhanced
the ability of the financial system to absorb capital inflows and outflows, thereby minimising
disruptions while ensuring that these flows can be effectively intermediated to support real
economic activity.
Malaysia's exchange rate regime has also accorded the necessary flexibility for the exchange
rate to adjust to the changing conditions. This has provided a good balance between flexibility
and stability. Our ability to manage domestic liquidity has also improved significantly, supported
by a wider range of instruments to conduct monetary operations and strengthened surveillance
systems.
Pervasive impact of the offshore markets
However, one noticeable observation over the years was that, for each episode of volatility we
faced, the subsequent calm would see an even larger build-up of risks. In particular, with the high
non-resident investors' participation in the onshore financial market, we saw significant growth in
the ringgit NDF market. More recently, in November 2016, non-resident investors' holdings
reached a record high of 34.7% of Malaysian Government Bonds. While some argue that the
ringgit NDF market is used by non-resident investors to hedge their ringgit assets, the reality is
far more sobering. It is mostly used for speculative purposes.
These speculative activities have shown to have adverse negative spillovers to the onshore
financial market due to its volatility. More importantly, the sheer volume of this market, which
surpassed over 300% of GDP in 2015, underscores the extent of disconnect between NDF
trading and economic reality. Given the size, onshore markets were vulnerable to the arbitrary
and unpredictable nature of the offshore market.
Besides this vulnerability, there was an even larger long term challenge that we faced. The
offshore market was developing and thriving at the expense and detriment of the onshore market
and domestic stability. The recent developments following the US presidential election have
attested to this fact. Following the results of the presidential election, the ringgit NDF was traded
as high as 2168 pips away from the onshore market close during the New York trading hours.
Such a significant move is obviously driven more by speculative activities and misplaced market
sentiment rather than any significant change in the economic fundamentals of the country.
Given the divergence between offshore and onshore ringgit prices, arbitrage opportunities for
non-resident investors persisted. To make things worse, even our own market players, began to
consistently take the cue from the NDF market. This placed unwarranted downward pressure on
the ringgit. Most unfortunate is the lack of concern by regulators where the NDF activities were
thriving despite of the adverse impact on the affected currencies.
With the extreme destabilising effects of the offshore ringgit NDF market on domestic ringgit
pricing, we took a broad spectrum of measures to reduce the speculative and damaging
influence of these activities. Part of this was our stricter enforcement of non-facilitation rules for
offshore derivatives. The long-standing prohibition on domestic players to facilitate transactions
of offshore markets was extended to non-resident financial institutions via a compulsory
attestation requirement. We also facilitated and managed the exit of significant short-term
positions related to the NDF market. Certainly, these aggravated the immediate pressures on the
ringgit but were very necessary to any eventual stabilisation of the currency.
I am pleased to share that a number of global financial institutions have complied with our
requirements. But, there are still a few holdouts. We are perplexed as to how these financial
institutions can continue to operate or facilitate an activity that clearly contravenes our rules and
regulations. We will continue to enforce our measures and look at avenues to deal with those
who facilitate the ringgit NDF activities.
The destabilising implications arising from the offshore activities gave a bad name to the
marketbased mechanism. It corrupted the idea of market openness and the liberalisation process. Such
destabilising risks bear upon the integration process among financial markets of this region.
Developing long term solutions through the Financial Markets Committee
Addressing the speculative impact of the NDF market is only part of the solution. Of greater
importance is the need to put in place sustainable long-term solutions. With this in mind, the
Financial Markets Committee (FMC) was established in 2016, and tasked with the responsibility
to look into the overall development and strategy for the Malaysian financial market. The FMC
also looked into the factors that caused imbalances in the demand and supply of foreign
currencies in the domestic market, including the reduced capacity of the market to provide
liquidity to intermediate the portfolio adjustment by non-residents.
The underlying motivation of the FMC is to create a deeper and more liquid onshore market that
will enhance its capacity to intermediate these flows and strengthen our resilience against
excessive volatility. Despite the havoc caused by episodes of volatility from the opaque,
unregulated and value destroying activities of the NDF market, the FMC in identifying the possible
remedial measures have concluded that market based mechanism and solutions is still the best
way forward.
Through close consultation with various stakeholders, including corporate entities and small and
medium size enterprises, the FMC developed a series of targeted initiatives to develop the
onshore financial market. The first series of initiatives announced on 2 December 2016, seeks to
provide greater room for the onshore ringgit hedging for both resident and non-residents. The
focus was on ensuring better access to the onshore financial market.
In particular, residents can now hedge without providing underlying documents up to certain
limits, while registered non-resident investors have the flexibility to carry out dynamic hedging. At
the same time, the scope of the appointed overseas office framework was widened to provide
greater avenues for non-residents to access the onshore financial market.
The second series of initiatives announced on 13 April 2017, introduced greater flexibility for
investors to manage currency and interest rate risks. Registered investors can now conduct full
dynamic hedging and resident investors can now conduct short-selling for Malaysian government
securities. All these flexibilities are expected to increase the ease of hedging business risks. The
aim is to promote a two-way liquidity in the onshore financial market. At the end of the day, we
envision that the implementation of these initiatives will make the domestic financial market a
market of choice, where prices are determined by the real economy devoid of speculative and
damaging activities. In this respect, we have introduced initiative that enables non-resident
investors to access and hedge ringgit assets in the domestic markets.
We are mindful that for the NDF market to truly reduce in significance and adverse influences,
the onshore market must become highly competitive, not just the foreign exchange market but
also all aspects of the financial market. We are determined to realise the idea of having a market
that possesses the breadth and depth to cater to the increasingly complex and diverse needs of
the economy, and a market that is able to sustain and weather volatilities that contribute to the
overall wellbeing of the economy.
The early positive results of the measures speak for themselves. The onshore foreign exchange
market now regularly records a healthy daily volume. In addition, the ringgit exchange rate has
remained stable with volatility reducing by half since the introduction of these measures. The
domestic bond market is now more resilient as speculative positions have mostly exited the
market. There is a larger composition of stable and longer term investors. This fact is much
more important than just looking at the percentages or size of non-resident holdings. Our
experience suggests that there is a threshold where non-resident investors will become a
destabilising force.
The success of our measures and our continued faith in the market mechanism is now validated
and restored.
Ensuring trust, confidence and integrity of the financial market
There are many lessons that we ought to learn. Some of the disruptions were caused from the
uncompetitive market behaviors and questionable conduct by players. More evidently in recent
times, cases of market manipulation and illegal fixing of interest rate and foreign exchange
benchmarks have surfaced globally. These cases were only possible because of collusion and
have collectively undermined the trust, integrity and confidence in the global financial market. The
consequences are dire. As the saying goes, 'trust takes years to build, seconds to break, and
forever to repair'.
One significant example of such far-reaching incidents that undermined trust, was the
manipulation of the LIBOR benchmark, a benchmark rate used to price a market estimated at
USD450 trillion. Ineffective due diligence in the case of a rogue trader of a French bank and the
'London Whale' incident has also tarnished the credibility of some international institutions.
Closer to home, two Australian banks were charged for manipulating the NDF ringgit fixing rate in
Singapore.
For the Malaysian market, we have recently introduced the Principles for a Fair and Effective
Financial Market (Principles) on 13 April 2017 as part of our market development strategy to
uphold and maintain the trust, integrity and confidence. These principles represent the universal
overarching ideals for a fair and effective financial market. It complements the rules-based
guidelines and regulations, including the recently revised Code of Conduct.
I wish to highlight these principles;
1. Professionalism and integrity, through universal adoption of best market practices;
2. Full transparency and accountability, in all aspects of market participation;
3. A competitive environment that is free from collusive, fraudulent and manipulative activities;
4. Good internal governance and due diligence, supported by robust internal surveillance and
reporting mechanisms; and
5. Compliance to prevailing rules, regulations and market codes while extending full
cooperation to the authorities.
The Principles should be universally applied, internalised and practiced by all parties that transact
in the Malaysian financial market. These Principles must be demonstrated consistently in the
daily conduct of market participants.
Outcomes of the Adherence to the Principles will result in a well-functioning market
The Principles are intended to result in a fair and effective financial market that efficiently
intermediates the funding needs of the economy and resilient in the face of shocks. One
particular aspect of the Principles is on the adherence to rules and regulations, a critical pillar of
financial stability, and a Code of Conduct expanded to explicitly prohibit transactions in
unauthorised markets. This includes, in particular, the NDF market.
These Principles ought to result in three key outcomes:
1. Firstly, balanced perspectives when formulating policy and assessing market development.
Such balance is needed between growth and stability, whereby growth of the financial
market must be consistent with economic fundamentals. We have seen in many instances
how the size of the financial market can be disconnected, and has grown too large for the
real economy.
Most of the activities in these outsized markets do not contribute to sustainable growth and
consist mainly of speculative activities. Speculative activity is a major source of vulnerability
not only for the financial market but also to the real economy, which if left unattended, could
lead to devastating financial crises. Arguments expounding that these activities provide
liquidity are delusional, and at best deflective.
2. Secondly, the outcome of the Principles is to level the playing field among market players.
This means a market that cannot be distorted by any institution or individual. All participants,
either large or small will have fair access to the market, without fear of being subjected to
market collusion and manipulation. It ought to create an efficient, competitive and
transparent market that will contribute to economic prosperity.
3. Thirdly, the outcome of the Principles is a strengthened regulatory framework. The
Principles of transparency, accountability and good governance will promote market
discipline. The Principles will serve as guidepost for us to effectively supervise and regulate
the market and is necessary, given the increasing complexity of the financial market,
exacerbated by the disruptions arising from technological innovations and greater
interconnectedness.
Achieving these three outcomes is central to our development strategy and policies for the
financial market. Together with the various FMC measures and initiatives already announced, we
have laid the foundations to redirect the growth and development of the ringgit foreign financial
market from the offshore to the onshore market.
After all, a thriving, open and robust onshore financial market is a prerequisite for a stable
financial system and sustainable economic growth.
Conclusion
This year is the 20th anniversary of the Asian Financial Crisis and close to the 10th anniversary
of the Global Financial Crisis. Anniversaries such as these are opportunities to pause, reflect and
ponder on the past, present and future. There are many lessons to be learnt from recent
episodes, and let us not repeat them. For if we do, only misery and hardship await us.