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Bond Market Development in Select Asian Countries
Guilia Pace, Research Analyst, New York University and Milken
Institute
Susanne Trimbath, Research Economist, Milken Institute
Milken Institute Working Paper 2003-02
Table of Contents
INTRODUCTION ....................................................................................................................................................2
CAPITAL MARKET DEVELOPMENT IN ASIAN EMERGING MARKETS ......................................................2
THE MARKETS.......................................................................................................................................................2
PARTICIPANTS ......................................................................................................................................................2
ALTERNATIVE SOURCES OF FINANCING .......................................................................................................2
A SPECIAL LOOK AT BOND MARKET DEVELOPMENT.................................................................................2
INDIA .........................................................................................................................................................................16
INTRODUCTION ..........................................................................................................................................................2
EVOLUTION OF INDIAN CAPITAL MARKETS .................................................................................................2
CAPITAL MARKETS....................................................................................................................................................2
MAIN PARTICIPANTS .................................................................................................................................................2
BANKING SECTOR................................................................................................................................................2
ALTERNATIVE SOURCES OF FINANCING ....................................................................................................................2
INDONESIA ................................................................................................................................................................2
INTRODUCTION ..........................................................................................................................................................2
EVOLUTION OF INDONESIAN CAPITAL MARKETS.......................................................................................2
CAPITAL MARKETS....................................................................................................................................................2
MAIN PARTICIPANTS .................................................................................................................................................2
BANKING SECTOR................................................................................................................................................2
ALTERNATIVE SOURCES OF FINANCING .....................................................................................................................2
KOREA ........................................................................................................................................................................2
INTRODUCTION ..........................................................................................................................................................2
EVOLUTION OF KOREAN CAPITAL MARKETS...............................................................................................2
CAPITAL MARKETS....................................................................................................................................................2
MAIN PARTICIPANTS .................................................................................................................................................2
BANKING SECTOR................................................................................................................................................2
ALTERNATIVE SOURCES OF FINANCING ....................................................................................................................2
MALAYSIA .................................................................................................................................................................2
INTRODUCTION ..........................................................................................................................................................2
EVOLUTION OF MALAYAN CAPITAL MARKETS ...........................................................................................2
CAPITAL MARKETS....................................................................................................................................................2
MAIN PARTICIPANTS .................................................................................................................................................2
BANKING SECTOR................................................................................................................................................2
ALTERNATIVE SOURCES OF FINANCING ....................................................................................................................2
PHILIPPINES..............................................................................................................................................................2
INTRODUCTION ..........................................................................................................................................................2
EVOLUTION OF PHILIPPINE CAPITAL MARKETS ..........................................................................................2
CAPITAL MARKETS....................................................................................................................................................2
MARKET PARTICIPANTS ............................................................................................................................................2
BANKING SECTOR................................................................................................................................................2
ALTERNATIVE SOURCES OF FINANCING ....................................................................................................................2
APPENDIX ..................................................................................................................................................................2
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Table of Tables
TABLE 1: LARGEST EQUITY UNDERWRITERS IN INDIA, 2001..........................................................................................2
TABLE 2: LARGEST DEBT UNDERWRITERS IN INDIA, 2001 .............................................................................................2
TABLE 3: LARGEST EQUITY UNDERWRITERS IN INDONESIA, 2001 ..................................................................................2
TABLE 4: LARGEST DEBT UNDERWRITERS IN INDONESIA, 2001......................................................................................2
TABLE 5: LARGEST EQUITY UNDERWRITERS IN KOREA, 2001 ........................................................................................2
TABLE 6: LARGEST DEBT UNDERWRITERS IN KOREA, 2001............................................................................................2
TABLE 7- MALAYAN DEBT SECURITIES, AMOUNTS OUTSTANDING AS OF JULY 2002 ......................................................2
TABLE 9 – LARGEST EQUITY UNDERWRITERS IN MALAYSIA, 2001.................................................................................2
TABLE 10: LARGEST DEBT UNDERWRITERS IN MALAYSIA, 2001....................................................................................2
TABLE 12 – NON-BANK FINANCING ................................................................................................................................2
TABLE 13: LARGEST UNDERWRITERS IN THE PHILIPPINES, 2001....................................................................................2
APPENDIX TABLE 1: FIRM CONCENTRATION ..................................................................................................................2
APPENDIX TABLE 2: CORPORATE DEPENDENCE ON BANKING SYSTEM ..........................................................................2
APPENDIX TABLE 3: VENTURE CAPITAL FUNDS % GDP ...............................................................................................2
APPENDIX TABLE 4: COMPLIANCE WITH G30/ISSA RECOMMENDATIONS.....................................................................2
Table of Figures
FIGURE 2: NUMBER OF LISTINGS AND MARKET CAPITALIZATION__________________________________________2
FIGURE 3: OUTSTANDING DEBT SECURITIES _________________________________________________________2
FIGURE 5: TRADING STATISTICS FOR BSE ___________________________________________________________2
FIGURE 6: NUMBER OF NEW EQUITY ISSUES _________________________________________________________2
FIGURE 7: ASSET ALLOCATION OF THE MUTUAL FUND INDUSTRY, MARCH 2002 ____________________________2
FIGURE 8: INVESTMENTS OF COMMERCIAL BANKS ____________________________________________________2
FIGURE 9: HOLDERS OF INDIAN DEBT ______________________________________________________________2
FIGURE 10: FOREIGN PORTFOLIO INVESTMENT ($ MILLION) _____________________________________________2
FIGURE 11: MARKET CAPITALIZATION AND NUMBER OF LISTINGS ________________________________________2
FIGURE 12: NUMBER OF LISTED COMPANIES BY SECTOR AS PERCENTAGE OF TOTAL ___________________________2
FIGURE 13: TRADING STATISTICS FOR JSX __________________________________________________________2
FIGURE 14: FOREIGN PORTFOLIO INVESTMENT FLOWS IN INDONESIA ______________________________________2
FIGURE 15: NUMBER OF BANKS ACTIVE IN INDONESIA _________________________________________________2
FIGURE 16 - NUMBER OF LISTINGS AND MARKET CAPITALIZATION OF THE KSE ______________________________2
FIGURE 17 – AMOUNTS OUTSTANDING OF DOMESTIC DEBT SECURITIES LISTED ON KSE________________________2
FIGURE 18 - CORPORATE BOND OFFERING BY TYPE ___________________________________________________2
FIGURE 19 – EQUITY CAPITALIZATION BY INDUSTRY AS OF DECEMBER 2001________________________________2
FIGURE 20 – EQUITY HOLDINGS BY SHAREHOLDER TYPE AS PERCENTAGE OF TOTAL MARKET VALUE____________2
FIGURE 22 -VENTURE CAPITAL DISBURSEMENT BY INDUSTRY, AS OF JUNE 2001_____________________________2
FIGURE 23 - NUMBER OF LISTINGS AND MARKET CAPITALIZATION OF KLSE ________________________________2
FIGURE 24 -DOMESTIC DEBT SECURITIES (AMOUNTS OUTSTANDING) ______________________________________2
FIGURE 25 - TRADING STATISTICS FOR KLSE, DAILY AVERAGES _________________________________________2
FIGURE 26 - NUMBER OF NEW LISTINGS ____________________________________________________________2
FIGURE 29: FUND MANAGEMENT COMPANIES ASSET ALLOCATION ________________________________________2
FIGURE 30 - FOREIGN PORTFOLIO INVESTMENT FLOW __________________________________________________2
FIGURE 31 - NUMBER OF LISTINGS AND MARKET CAPITALIZATION OF PHILIPPINES EXCHANGE _________________2
FIGURE 32 - SECTOR DISTRIBUTION BY NUMBER OF FIRMS ______________________________________________2
FIGURE 33 - PHILIPPINES GOVERNMENT BONDS OUTSTANDING __________________________________________2
FIGURE 34 - FOREIGN PORTFOLIO INVESTMENT FLOWS IN THE PHILIPPINES _________________________________2
FIGURE 35 – SHARE OF TOTAL ASSETS HELD BY VARIOUS TYPES OF COMMERCIAL BANKS AS OF MARCH 2002) ______2
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APPENDIX FIGURE 1: DEVELOPMENT OF DOMESTIC CAPITAL MARKET. ........................................................................2
APPENDIX FIGURE 2: LOCAL MARKET PERFORMANCE FOR THE 12 MONTHS ENDING MAY 2002 ..................................2
APPENDIX FIGURE 3: GNI PER CAPITA, ATLAS METHOD (CURRENT UNITED STATES$) ..................................................2
APPENDIX FIGURE 4: AVERAGE VALUE TRADED DAILY ..................................................................................................2
APPENDIX FIGURE 5: CAPITAL RAISED IN 2001 BY DOMESTIC COMPANIES .....................................................................2
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INTRODUCTION
The goal of this report is to provide the reader with a general understanding of the evolution,
current stage of development and future prospects of capital markets in selected East Asian economies.
The first section provides an overview of the issues discussed in this study and gives a general
assessment on the level of development of securities markets in the region. Each of the following sections
looks at capital market development in five major developing countries, India, Indonesia, Korea,
Malaysia, and the Philippines. Each of these country specific sections is organized in three parts. The first
part provides the reader with a brief overview of the country’s recent economic performance and gives an
historical account of the development of the domestic equity and bond markets. The second part presents
information on market size and structure, trading statistics, clearing and settlement procedures, and the
types of protection available to shareholders and bondholders and relevant capital market regulation.
Finally, the third part profiles the main market participants in each country, with particular focus on the
issuers, buyers and underwriters of securities.
CAPITAL MARKET DEVELOPMENT IN ASIAN EMERGING MARKETS
Emerging markets are important because they have most of the world’s population. Over the next
several decades they will likely account for most of world economic output. As this process takes place,
financial flows within those markets and between those markets and the rest of the world will become
more important.
The early 1990s saw a record inflow of funds into developing countries and transition economies.
Foreign investment fueled record levels of economic growth in several Asian countries but did nothing to
change the structural weaknesses present in those economic systems. Poor regulation, ineffective
supervision, weak enforcement and inefficiencies in domestic capital markets persisted.
The Asian financial crisis brought to light the vulnerabilities of the banking systems of many
Asian countries, and their dangerous dependence on foreign capital to finance the high rates of economic
growth. On a positive note, the loss of access to international capital markets that followed the crisis
represented a perfect opportunity for local governments to begin the long overdue reforms of their
financial and corporate systems. The aftermath proved to be an ideal time for governments to push toward
the development of domestic securities markets. Well developed capital markets can provide a more
stable source of funding for the capital needs of sovereign and corporate entities.
Some countries, like Korea and Malaysia, took advantage of the crisis aftermath to implement
sweeping reforms and are now enjoying the fruits of these efforts. Others, like Indonesia and the
Philippines, were slow to enact solid reforms and have been unable to eliminate endemic barriers to
economic and financial development such as political instability, corporate transparency, corruption, and
swelling public deficits. Nevertheless, we feel confident that most Asian economies, although in different
degrees, are going to benefit from the structural reforms implemented as part of the restructuring of their
domestic economies in the aftermath of the crisis. Korea and Malaysia, for example, are benefiting from
the implementation of banking system reforms, corporate restructuring and the privatization of state-
owned enterprises. These improvements come at a propitious time. The prolonged sluggishness of the
United States economy, doubts about the sustainability of growth rates experienced by United States
companies in the 1990s, and a pervasive loss of confidence in accounting and reporting standards for
corporations in developed markets might propel domestic and international investors to take a closer look
at the opportunities presented by some Asian emerging market economies.
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THE MARKETS
Development of equity and bond markets
Capital markets were first developed in Asian countries by the colonial governments of Britain,
Spain, Portugal, and the Netherlands.
During the late 1980s and early 1990s, high levels of private capital inflows in the form of foreign
direct investment and portfolio investment reached the region. Capital flows were attracted by high
economic growth, financial market liberalization and the perceived stability of exchange rates.
Capital inflows went to support increasing levels of investment, but also brought about the
appreciation of real exchange rates, which in turn affected the competitiveness of Asian products. After a
period of hyper growth, in the second half of the 1990s exports began to slow and corporate margins
narrowed significantly. After the first bankruptcies after decades of stability in the region, a sudden flight
of private foreign capital threw the whole region into a liquidity crisis of unprecedented proportions.
The East Asian financial crisis was remarkable in several ways. The crisis hit the fastest growing
economies in the world, and prompted the largest financial bailouts in history. The crisis was a testament
to the shortcomings of the international capital markets and their vulnerability to sudden reversals of
market confidence. In a way, it can be understood as a “crisis of success” caused by a boom of
international lending followed by a sudden withdrawal of funds.
For this reason the experience led many observers to argue that emerging countries should
develop local securities markets as a source of funding complementary to banks and international capital
markets. Local securities markets would provide a stable source of funding for local entities. While the
emphasis has been mostly on the development of local bond markets, the need to reduce the leverage of
several large Asian companies, combined with the desirability of having more flexible financial structures
in volatile environments, has raised the issue of the stock market as a source of financing. In fact, while
small in absolute size, equity financing was a relatively resilient source of funds during the Asian crisis.
In the five countries we analyzed for this report, significant progress has indeed been made in
capital markets development and reform. Market structures and processes have been streamlined and
modernized, listing requirements have been reduced, clearing and settlement systems have been brought
in line with G30/ISSA guidelines and regulators have tried to project a higher degree of independence
from central governments.
In part, this restructuring has been in response to the globalization of capital markets. While in
recent years the internationalization of equity markets has helped top-quality emerging market
corporations raise cheaper capital, it may once again threaten the development of local equity markets as
an alternative source of finance if progress is not made in a timely fashion. The lower cost of raising
capital in the most advanced exchanges, combined with the integration of capital markets, has made
evident the inefficiencies existent in several local emerging equity markets. Consequently, several of the
markets we analyzed have reduced listing requirements and other costs associated with initial public
offerings, and have established alliances with other exchanges to increase the investor base for local
issues.1
While the calls for the development of local bond markets have been numerous, especially in the
aftermath of the crisis, a true secondary market for bond securities has failed to develop in most countries.
1
For example the New York Stock Exchange and the NASDAQ are involved in several partnerships.
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The absence of a secondary market for bonds translates into a lack of liquidity, which increases risk,
making debt issuance too expensive for most domestic corporations. In addition, the best credits in any
given country would choose to issue in the international market where the cost of capital is lower. This
catch-22 situation makes the development of deep, liquid and transparent domestic bond markets in Asian
emerging economies a difficult task.
Furthermore, another often-overlooked aspect of bond market development in Asia is the fact that
the demand side is almost non-existent. Since sustained corporate bond development is contingent upon a
legal system able to protect creditors, a condition not present in many Asian countries, significant changes
need to take place in the legal and judicial systems before bond investors will be attracted to these
markets.
Throught this report we will use total equity market capitalization to GNI as a measure of the
level of development of a specific equity market.2 As emerging economies, all countries in our study have
small outputs, represented by small GNI per capita. In all cases except for Malaysia, whose capital equity
market is already well developed relative to the size of the country’s economy, these countries have
relatively undeveloped securities markets. In addition the potential for growth in their capital markets
depends on their ability to generate and sustain high levels of economic growth.
Figure 1: Capital market development, a cross country comparison
HIGH
UK
United States
Malaysia
Mkt. Capitalization/GN
II III
EMU
Philippines Japan
I IV
India Korea
LOW
Indonesia
LOW GNI per Capita in $ HIGH
Source: The Milken Institute
Figure 1 summarizes our findings. Most of the countries in our study are located in the low/low
quadrant (I). These countries have relatively undeveloped securities markets. in addition, the growth of
their capital markets is limited and depends on their ability to generate and sustain higher livesl of
economic development. The one exception in our study is represented by Malaysia, whose capital equity
market is already well developed relative to the size of the country’s economy. Malaysian firms have
2
GNI measures the total domestic and foreign income claimed by the residents of the economy. It comprises GDP
plus net factor income from abroad, which is the income residents receive from abroad for factor services (labor and
capital) less similar payments made to non-residents who contributed to the domestic production. GNI in United
States dollars is calculated according to the World Bank Atlas method of conversion from national currency to
United States dollar terms.
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access to a deep and liquid market in order to raise capital as an laternative to traditional sources of
finacing such as foreign direct invesmtnet and bank debt.
Countries in the fourth quadrant (IV) are characterized by small equity markets as compared to
the size of their economies. Similar to the countries in the first quadrant, bank debt is still the main source
of capital for their domesitc private sector. This reliance on bank credit as a source of financing has the
potential to leave corporations vulnerable to liquidity crises of the kind experienced in the late 1990s. In
addition, investors in these countries suffer from a lack of the monitoring and transparency that healthy
capital markets provide, since banks (especially in countries where decions are made on a relationship
basis) are often tempted to cover up financial distress (principal/agent conflict). Indonesia, Korea and
India appear to be taking this path.
At this time we can envision two possible paths to financing economic growth.The first, more
“traditional” model followed by countries with entrenched reliance on bank financing (such as EMU
countries and Japan) is to keep their dependence on bank debt as the main source of capital for their
domestic private sector. Too much reliance on bank credit as a source of financing can potentially leave
corporations vulnerable to liquidity crise of the kind experienced in the late 1990s. In addition, investors
suffer from the lack of monitoring and transparency a healthy capital market provides, since banks
(especially in countries where decisions are made on a relationship basis) are often tempted to cover up
financial distress. Despite recent reforms of the local banking systems, Korea, India and Indonesia seem
all poised to follow this model to financing growth in their economies.
On the contrary, Malaysian firms have access to a deep and liquid market in order to raise capital
as an alternative to the most traditional sources of financing as foreign direct investment and bank debt.
This is the model we auspicate since developed capital markets allow companies of all sizes and credit
profiles to access varius sources capital to fund future growth. In addition, capital markets provide
monitoring and encourage transparency.
Finally we should emphasize that political stability, systematic enforcement of property rights,
and transparent corporate governance systems are necessary requirements for the existance of large and
efficient capital markets. The lack of these pre-requisites will make any efforts to develop domestic equity
and debt markets futile and will force domestic corporation to raise needed capital either on international
markets or through bank financing.
PARTICIPANTS
Issuers
Despite the sustained effort of local institution toward the promotion of local equity markets, a
sharp fall in domestic equity issuance has dominated the region over the last two years. It remains unclear
if these local efforts can compensate for global trends toward the consolidation of equity market activity
in the most efficient financial centers. A more stable macroeconomic environment and improved
corporate governance and transparency will be key elements in strengthening the role of local markets.
Underwriters
All markets in our survey have only recently allowed global financial institutions to be active
underwriters in their domestic market. Nevertheless, global banks are quickly establishing significant
positions where they have a presence and are now successfully competing with local institutions for
securities underwriting business. In some cases, the money center institutions may have a perceived
advantage in providing access to capital in the global centers.
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Buyers
One of the key issues in developing local securities markets as a stable source of funding for
corporate entities is the development of an adequate domestic and international investor base.
The rapid growth of equity markets in the region has failed to adequately broaden the investor
base. Investors in the region’s equity markets are predominantly individuals; with institutional investors
still in the minority. The creation of a legal and regulatory environment that is conducive to the growth of
contractual savings institutions appears to be the most important policy agenda for governments in the
region. The asset management industry has yet to develop fully, and appropriate quality controls and
external supervision seem to be lacking. Institutional investors could help revive the depressed equity
markets and the nascent bond markets. They could also help improve corporate governance by forcing the
adoption of adequate disclosure and accounting standards. The governments in the region should make a
special effort to give more operational freedom to the portfolio managers of institutional investors. They
should refrain from diverting institutional investors’ funds for market stabilization programs that are
either futile or costly, or both.
Mutual Fund Industry
Funds play an important role in mobilizing global and domestic capital flows, providing an
efficient way for many small investors to reach many firms. In the economies we analyzed, financial
systems are still dominated by banks. Mutual funds have grown slowly because of the perceived threat
they pose to banking sector deposits. Even so, the sector is growing and funds are becoming an
established method for making investments.
Relaxing the impediments that are keeping individuals or retail investors out of the capital
markets will help develop those markets. Each of the countries in our study has chosen different paths to
grow this sector. In India for example, where mutual funds have existed since 1964, regulations passed in
the 1980s have allowed several additional types of domestic financial institutions to establish funds. In
the Indian case, allowing the entry of foreign funds to increase competition will provide additional fuel
for growing the domestic equity market. Korea, which introduced the mutual fund industry in 1998, has
so far allowed only closed-end funds. In the Philippines, mutual funds have targeted primarily the less-
well-off sources of capital, instead of the high-net-worth individuals who are attracted by the high deposit
rates offered by the investment funds of banks. Since the portfolios of the less well off are not suited for
equity investments in which mutual funds specialize, this strategy is likely to lead to problems and stall
equity market advances.
Pension funds
A well-developed pension fund system is important to capital market development because, once
in place, it can accumulate long-term resources rapidly. In most Asian emerging markets, there are no
mandatory private pension funds. The provident fund systems in the region operate mainly at the national
level under public administration.
In Asia, which boasts the fastest population growth rates in the world, the development of
pension schemes represents an area of incredible opportunity. In Singapore, the resources of the Central
Provident Fund rose from 28 percent of GDP in 1976 to 73 percent in 1986 and 76 percent in 1990. In
Malaysia, provident fund assets grew from 18 percent of GDP in 1980 to 41 percent in 1990.
In the long term, the overall impact of pension funds on local capital market development
depends largely on their investment policies. Most emerging market funds invest primarily in money
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market products. Bank deposit pension funds have not become viable players in the development of local
bond and equity markets. The ability of governments to facilitate a transition of these assets toward
equities and bonds will be important in the effort to develop stable, liquid markets.
Insurance companies
With the exception of more developed markets such as Hong Kong and Japan, insurance
companies are not yet active participants in local capital markets. Most emerging market insurance assets
are invested in bank deposits or short-term securities. This duration mismatch might represent a serious
threat to the future solvency of local insurers in periods of economic instability or under extraordinary
payouts events.
To realize the potential contribution of the insurance industry to capital market development,
governments should review their policies regarding the asset allocation of insurance firms and allow more
freedom in investment decisions.
Foreign investors
The global investor base for emerging market equities includes dedicated emerging market
funds, global or international funds that allocate a portion of their assets to emerging market equities in
order to track regional indices, and tactical investors such as hedge funds. The global investor’s
perspective on emerging market equities is somewhat different from that of the local investor, in part
because the alternative investment opportunities facing the two are often rather different. The
international investor is typically interested in the foreign currency returns available from investing in
emerging market equities. Unlike local investors, they have access to several other classes of equities as
alternatives.
While the emerging market allocations of global equity funds are typically small—around 5
percent of total assets—the absolute amounts of these allocations can be sizable in relation to the market
capitalization of emerging stock markets. For instance, the emerging market exposure of global equity
funds (both dedicated and non-dedicated) is estimated to have reached about $108 billion last year (about
four times the size of the Indonesian market). For tactical investors in emerging markets, the objective is
to achieve high absolute returns through market timing, given the high volatility of this asset class. For
global equity funds, emerging market equities could provide a diversification play. Adding emerging
market equities to portfolios dominated by mature market equities can at times provide a more favorable
risk-return profile than investing exclusively in mature market equities, particularly when returns between
the two assets are not closely correlated.
ALTERNATIVE SOURCES OF FINANCING
Venture capital
For most East Asian developing countries, the level of venture capital available to entrepreneurs
is low compared to developed countries. There are two main obstacles to the development of venture
capital as a source of funding for start-ups. First, many venture capital firms lack the expertise to assess
the potential of start-up companies. Personal influence and trust than are more likely to be the basis of
investment decisions than rigorous analytics. Second, given the slow development of the public equity
markets, venture capital investors have limited exit options. The future development of a viable venture
capital market will depend on local commitment to market development, enforcement of existing property
rights and the establishment of more transparent corporate governance regime.
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Inter-company financing
In many Asian countries individuals, families, or coalitions of families often own a number of
related firms. In this type of organization, what we will refer to as ‘interlocks’, management and
ownership are usually tied. In times of financial distress, group-affiliated firms are less likely than other
firms to seek formal bankruptcy protection, relying instead on other group affiliates for loans. These
‘internal financial markets’, which developed from the need to fill the void left by the absence of external
financial markets, are now effectively hampering the development of capital markets by undermining the
markets ability to monitor firm behavior.
A SPECIAL LOOK AT BOND MARKET DEVELOPMENT
In the aftermath of the Asian financial crisis, the role of the debt market has received increased
attention. Historically the banking system has been the main provider of debt financing for local corporate
entities. Since Asian economies had the highest savings rates in the world, if local debt markets had
existed in the 1990s to channel domestic savings into domestic investment corporations could have had
access to a broader set of financing sources and may have been able to better fare the 1997 liquidity
crunch.
In addition to the financing patterns of Asian corporations, which have historically relied on easy
access to bank credit, other structural impediments to the development of efficient bond markets exist in
all the countries we analyzed. Inadequate availability and quality of market makers, underdevelopment of
clearing and settlement systems, and the absence of a government benchmark against which corporate
bonds can be priced are issues that need to be addressed in order to establish a market for corporate debt.
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INDIA
INTRODUCTION
India’s huge population, rising incomes and growing competitiveness in human capital-intensive
technology businesses make it a very interesting market for domestic and foreign investors. The country’s
recent success in information technology has revealed India’s enormous potential for growth in
knowledge based industries. If properly leveraged the country’s skilled and cost competitive workforce
could propel continued growth not only in other knowledge intense sectors such as biotechnology,
pharmaceuticals, agriculture, telecommunication and other service oriented industries. India has the
potential to achieve sustained economic growth if the local government will commit to proper
environment and policy steps. However, a large fiscal deficit in the range of 5 to 6 percent of GDP and
the government’s inability to implement a vast scale privatization plan cast a long shadow on the
country’s overall prospects in the immediate future.
This uneasiness is reflected in the poor performance of the local stock market, which in the
twelve months ending May 2002 lost 9.1 percent of its value.
EVOLUTION OF INDIAN CAPITAL MARKETS
Historical development of the market
The earliest records of security dealings in India are somewhat obscure. The East India Company
was the dominant institution in the country’s economy and it is presumed that transactions in its loan
securities first began in the eighteenth century.
By the 1830's, shares of banks and cotton companies were actively traded in Bombay. Though the
list of tradable securities kept increasing there were only half a dozen brokers recognized by banks and
merchants during the 1840s and 1850s. The number of brokers increased to about 250 shortly thereafter,
when a true 'share mania' took place in India. The stock boom was the result of a disruption in the cotton
supply from the United States to Britain due to the American Civil War. Later, in 1875, the Stock
Exchange of Mumbai (BSE) was established as "The Native Share and Stockbrokers Association". The
BSE is the oldest exchange in Asia.
The BSE has evolved over the years and is currently the largest stock exchange in the country
accounting for one third of trading volume and the largest share of listings and market capitalization.
In the 1980s, the number of exchanges grew dramatically and today there are 24 recognized stock
exchanges in the country. In addition to the BSE, the National Stock Exchange of India Ltd. (NSE) and
the Inter-connected Stock Exchange of India (ISE) are significant in terms of market capitalization and
trading value. The NSE was incorporated in 1992 and in 1994 began operations in the Wholesale Debt
Market (WDM) and the equities segment. Trading of derivative instruments was introduced on the
exchange in 2000.
ISE is a national-level exchange providing trading, clearing, settlement, risk management and
surveillance support to the inter-connected market system. Fifteen regional stock exchanges are currently
linked through ISE linkage and connectivity to all the participating exchanges to widen their market.
Assessment of local capital markets development
The Indian Capital Market has come a long way since the financial reforms adopted in the 1990s
opened up the economy to foreign investment. Almost 8 percent of total cumulative foreign investment
during the period between 1992 and 2000 was invested in growing the financial services sector of the
Indian economy. Consequently, domestic equity markets have seen the introduction of a wide array of
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new products and mechanisms such as derivatives and rolling settlement. Similarly, debt markets in India
have undergone considerable change in the last few years. Until the late 1980s, debt markets were
characterized by regulated interest rates, limited players and a lack of trading. They have now become
more integrated and less regulated.
Despite this progress, the size of the domestic capital market is still small even by emerging
market standards. Total market capitalization to GNI in 2000 was among the lowest in the region at 33
percent. Furthermore, unlike other less developed markets, India’s low level of GNI per capita suggests
that the domestic availability of funds for investment in the domestic capital market is small. Capital
market development will depend on foreign capital inflows, and on the ability of the government to
reduce poverty and create an environment fit to promote sustainable economic growth.
CAPITAL MARKETS
Market size
Equity
As of April 2002, 5,784 companies were listed on the BSE for a total market capitalization of
$127.85 billion (Figure 2).
A high level of concentration characterizes the local equity market, pointing again to the under
development of the domestic market and the inefficiency of the secondary market with regards to
allocating capital to smaller firms. In 1997-1998, the top 50 companies by market cap accounted for about
92 percent of total turnover on the BSE; this compares with 60 percent in 1995-1996.
Figure 2: Number of listings and market capitalization
7,000 200
180
6,000
160
Market Cap. ($ billion)
Numner of Listings
5,000 140
4,000 120
100
3,000 80
2,000 60
40
1,000
20
- 0
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Apr-02
No. of Companies Market Cap
Source: Emerging market database
Debt
The Indian debt markets are among the largest in Asia with nearly $130.1 billion worth of
outstanding securities. The market in government securities is by far the largest component, representing
98 percent of total outstanding value ($128 billion) at the end of 2001 (Figure 3).
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As of June 2002, the total number of securities listed and available for trading on the Wholesale
Debt Market (WDM) was 1,825. Figure 4 shows the composition of outstanding debt by value
outstanding and number of outstanding issues. The majority of Indian bond issuers choose to place bonds
privately instead of making a public issue, mainly to save on expenses. Trading in these bonds is quite
thin with most activity confined to financial institutions bonds, some PSU bonds and the top rated
corporations. Most Indian bonds trade over the counter.
Figure 3: Outstanding debt securities
140
120
100
80
$ Billion
60
40
20
0
93
94
95
96
97
98
99
00
01
19
19
19
19
19
19
19
20
20
Private sector Public Sector
Source: Bank for International Settlements
Figure 4: Composition of outstanding debt issues as of June 2002
By Value of Outstanding Debt By Number of Outstanding Issues
Other
4% Government
Bonds
State Govt. Bonds Corporate debt 6%
Government 10% 15%
Bonds Treasury Bills State Govt. Bonds
72% 4% State Enterprise 29%
Bonds
Financial
Financial 6%
Institutions Bonds Treasury Bills
Institutions Bonds 21% 2%
5%
Corporate debt State Enterprise
3% Bonds
23%
Source: NSE
Market structure and operations
At present, there are about 24 recognized stock exchanges in India. The Bombay Stock Exchange
(BSE) and the National Stock Exchange (NSE), which account for almost 90 percent all transactions, are
the biggest.
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The BSE accounts for over two thirds of total trading volume. The BSE, which had an open
outcry trading system, switched over to a fully automated computerized mode of trading known as the
BOLT (BSE on Line Trading) System in 1995. The system, which is now only order driven, facilitates
more efficient processing, automatic order matching and faster execution of orders. In October 1996, the
exchange obtained permission from the Securities and Exchange Board of India (see Regulators section)
for expansion of its BOLT network to locations outside Mumbai. In order to develop the reach of the
BOLT system network to centers outside Mumbai and support the smaller regional stock exchanges, the
BSE admitted subsidiary companies formed by 13 regional stock exchanges as its members in 2002. The
members of these regional stock exchanges work as sub-brokers to the member-brokers of the BSE.
The NSE introduced a screen based trading system for bonds in 1994. The system, known as the
National Exchange for Automated Trading (NEAT) allows for transparent pricing and allotment. Despite
the recent development in trading systems, the majority of trading in government securities takes place
through over-the-counter, negotiated deals.
Clearing and Settlement
The Clearing Corporation of India Ltd. (CCIL) was incorporated on April 30, 2001 and became
operational in February 2002. The corporation originally had six core promoters, but the number of
institutional shareholders has since risen to 28. Guaranteed settlement in government securities became
operational in the beginning of May 2002. The Reserve Bank of India (RBI) has made it compulsory to
route individual trades in government securities up to $4.12 million (approximately) through the CCIL. It
is believed that CCIL will provide much needed risk mitigation and liquidity to the market through
guaranteed settlement of trades in Government securities, other debt instruments and foreign exchange
transactions. The establishment of CCIL will likely facilitate the growth of a retail trade in government
securities.
Equity trades on the NSE and BSE are cleared through two clearing corporations that are wholly
owned subsidiaries of the exchanges: the National Securities Clearing Corporation Limited (NSCCL) and
the Stock Exchange Mumbai (BSE) Clearinghouse. Securities traded on the exchanges are classified into
different groups: specified shares or 'A' group, non-specified securities which are sub-divided into B1 and
B2 groups, an odd-lot group, and a group for debentures and debt instruments. Since January 2002 the
exchanges commenced settlement of trades on a rolling basis where the trades are settled on T+ 5. The
settlement of transactions was previously done weekly with the exchange using a carry forward facility.
Two depositories, the Central Depository Services Ltd. and National Securities Depository of
India Ltd. operate in the Indian market place. The clearing houses of the exchanges have linkages with
both depositories. Direct transfer of securities to and from the beneficial owner accounts is facilitated at
the clearing house level only. India is in compliance with 8 of the 18 ISSA guidelines. Plans are in place
to achieve full compliance (Appendix Table 4)
Annual trading value on the BSE dropped 51 percent in 2001 to $249.3 billion from a peak in
2000 of $509.8 in 2000 (Figure 5). Trading value remained depressed in 2002. For the first four months
of the year trading value on the BSE amounted to $69 billion.
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Figure 5: Trading statistics for BSE
600 60,000
Value Traded ($ Billion) 500 50,000
Million Shares Traded
400 40,000
300 30,000
200 20,000
100 10,000
- -
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
Ap 01
02
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
r-
Value Traded (US$) Shares Traded
Source: Standard & Poor’s Emerging Markets Data Base
Rating agencies
There are four rating agencies with offices in India: Credit Rating Information Services of India
(CRISIL), FITCH, ICRA Limited. Moody’s and Standard and Poor’s are present in the country through
strategic partnerships.
CRISIL was the first to launch the rating of financial instruments in 1987. In addition to ratings,
the company provides research and information services, databases, company analysis, capital markets
research, information and news services (through its subsidiaries). Since inception, CRISIL has rated over
1,800 companies and 3,600 instruments amounting to a debt volume of over $62.11 billion. Standard &
Poor's is CRISIL’s international strategic partner.
FITCH is the only international rating agency with a presence in India. It was initially set up as a
joint venture with Duff & Phelps Credit Rating Co. to provide high quality rating services in the Indian
debt market. FITCH is the first credit rating agency to introduce global standards to the Indian rating
industry.
ICRA Limited (formerly, Investment Information and Credit Rating Agency of India Limited)
was incorporated in 1991. ICRA is an independent and professional company providing investment
information and credit rating services. ICRA’s major shareholders include Moody's Investors Service and
leading Indian financial institutions and banks.
CARE, founded in 1993, is the latest addition to the rating agency offerings in India. As of 2001,
CARE had completed 1,536 instrument ratings and 76 credit analysis ratings.
Regulators
The Securities and Exchange Board of India (SEBI) was established in 1988 to regulate and
develop the growth of the capital market. SEBI regulates the working of stock exchanges and
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intermediaries such as stock brokers and merchant bankers, accords approval for mutual funds, and
registers foreign institutional investors who wish to trade in Indian securities.
SEBI's functions include: regulating the business of stock exchanges and any other securities
markets, registering and regulating the working of collective investment schemes (including mutual
funds), prohibiting fraudulent and unfair trade practices relating to securities markets, prohibiting insider
trading in securities (with the imposition of monetary penalties). In addition SEBU regulates takeovers,
inspects and audits stock exchanges, intermediaries and self regulatory organizations in the securities
market.
SEBI has the powers of a civil court with respect to discovery and can levy fines for violations
related to failures to submit information, to redress investor grievances, for violations by mutual
funds/stock brokers and for violations related to insider trading, takeovers and other securities law
regulations.
Bankruptcy laws, creditors rights
The regulated method of informal administration envisaged by Chapter 11 under the American
Insolvency Law is not available in India.
If there are few creditors, then it is possible for an informal administration to be worked out with
their consent provided the creditors believe in the veracity of the submissions of an insolvent debtor.
These situations are rare in India. Normally, creditors try to obtain an attachment before judgment or an
injunction to prevent misuse of the assets of an insolvent firm.
Other than in those rare cases, the insolvency of a company has the same effect as an insolvency
of a natural person and suspends the rights of the directors or the company in dealing with its assets other
than with the regulation of the court. Fraudulent preferences or transfers made during the insolvency or
transfer of shares are voided.
Upon initiation of insolvency proceedings an official liquidator is nominated by the court. Only
the official liquidator can enter into contracts on behalf of the company. Under the provisions of the
Companies Act, the debts due to workers or secured creditors have an overriding preferential claim (or
priority) to all other debts. There are other statutory preferential payments for taxes, revenues, wages or
salary due prior to winding up or for a period not exceeding four months when there is a continuing
employment for the beneficial winding up and for provident funds, pensions and other claims as
stipulated under the Companies Act.
Each high court that has a company court has an official liquidator and has a formal organization
to support the procedures of insolvency. Insolvency proceedings by the company court are quite effective
though the detailed procedures of insolvency are often time consuming.
According to a survey conducted by the Asia Development Bank, the usual period between the
commencement of formal insolvency proceedings and the declaration or imposition of a formal
administration on the corporate debtor is usually one day to four months. After that, the winding up
process is usually long and expensive.
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MAIN PARTICIPANTS
Issuers
Equity financing was a very important source of funds for Indian firms prior to 1995. After
reaching a peak in 1995 with 1,638 new issues for an aggregate value of $ 9.5 billion, equity financing
has decreased dramatically. Only a handful of companies have entered the capital market for raising fresh
capital since then. In 2001, corporations raised $212.6 million through 28 new issues.
The decline can be attributed to several factors; among these the poor performance and
uncertainties of the secondary market, negative investor sentiment, the global crisis in the technology and
telecommunication sectors, institutional problems and corruption among government officials.
Figure 6: Number of new equity issues
1,800
1,600
1,400
1,200
1,000
800
600
400
200
-
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Apr-
02
Source: Standard & Poor’s Emerging Markets Data Base
While equity has become a less important source of financing since the mid-1990s, debt has
emerged as the favorite instrument for raising fresh capital. In 1999, debt accounted for 99 percent of total
resources mobilized in the primary market. However, given the high costs and the large amounts of
financial disclosure associated with public subscriptions, corporations are resorting for the most part to
private placements instead of public issues.
The corporate bond market is small when compared to the government securities market both in
terms of the primary as well as to the secondary market. The corporate bond market consists of issuers in
three different categories: government owned financial institutions (FIs), government owned public sector
units (PSUs) and private corporations. The FIs, which do not have access to retail deposits like banks,
depend on bond issues for raising funds. They are highly rated and hence offer low yields. Due to their
poor financial condition, only the better managed PSUs approach the markets to raise funds, and many of
the PSUs’ issues are in the high-risk category. The PSUs have an advantage in that they can offer tax-free
bonds. Private corporations have also recently increased their access to the bond market to raise funds.
Underwriters
The main underwriters of equity and debt are commercial banks. Table 1and Table 2 show the ten
largest underwriters of equity and debt issues for 2001. Merrill Lynch was the top underwriter of equity
with 87.2 percent of total deal value. In 2001, underwriters worked on 28 new equity issues. Debt
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issuance was significantly higher, both in the number of deals and deal value. Standard Chartered PLC
was the largest underwriter of debt with 25.3 percent of total deal value.
Table 1: Largest Equity Underwriters in India, 2001
NEW ISSUES -EQUITY % TOTAL VALUE # DEALS
MERRILL LYNCH & CO. 87.2% 2
CENTRUM FINANCE LIMITED 1.7% 1
SBI CAPITAL MARKETS 1.7% 1
FEDEX SECURITIES 1.2% 4
ENAM FINANCIAL CONSULTANTS PRIVATE LTD 1.0% 1
MORGAN STANLEY 1.0% 1
SMIFS CAPITAL MARKETS 1.0% 4
KARVY INVESTOR SERVICES 0.9% 2
CANARA BANK 0.8% 2
UTI BANK LIMITED 0.7% 1
OTHER 2.9% 9
TOTALS 100.0% 28
Source: Bloomberg
Table 2: Largest Debt Underwriters in India, 2001
NEW ISSUES - DEBT % TOTAL VALUE # DEALS
STANDARD CHARTERED PLC 25.3% 54
SBI CAPITAL MARKETS 18.1% 112
ICICI SECS & FIN 6.6% 47
DARASHAW & CO 5.7% 50
DSP MERRILL LYNCH 5.6% 34
ABN AMRO 5.4% 34
A.K. CAPITAL SERVICES 5.1% 58
DEUTSCHE BANK AG 4.8% 17
CENTRUM FINANCE LIMITED 3.7% 50
RR FINANCIAL CONSULTANTS LIMITED 2.9% 33
OTHER 16.8% NA
TOTAL MARKET SIZE 100.0% NA
Source: Bloomberg. Includes securities issued on BSE, NSE and ISE.
Buyers
The total number of shareholders in India is approximately 25 million. Individual investors are
the largest group of equity holders, followed by financial institutions and mutual funds.
The Indian debt market more or less retains the structure of a wholesale market with participation
being restricted to the banks and other institutional players. There has been a significant increase in the
participation in the wholesale market over the past few years with the entry of many smaller wholesale
entities like the provident and pension funds, co-operative banks, housing finance companies, private
trusts, non-banking finance companies, etc.
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Mutual Funds
The Indian mutual fund industry has a long history. It began with the Government creation of the
Unit Trust of India (UTI) in 1964. During the last 36 years, UTI has grown to be a dominant player in the
industry and currently accounts for 50.3 percent of total industry assets.
Beginning in 1987, public sector banks and insurance companies were permitted to set up mutual
funds. Accordingly, six public sector banks and two large insurers have set up mutual funds since that
time. With the Mutual Fund Regulation of 1993, SEBI established for the first time a comprehensive
regulatory framework for the mutual fund industry. Since then, several mutual funds have been set up by
the private sector.
Debt securities make up 45 percent of the asset allocation of the mutual fund industry followed by
equities with 31 percent (Figure 7).
Figure 7: Asset Allocation of the Mutual Fund Industry, March 2002
Government
Securities
17%
Debt
45% Money Market
7%
Equity
31%
Source: Association of Mutual Funds in India
Banks, financial institutions, insurance companies, provident funds and trusts
Commercial banks make up another important group of buyers. The vast majority of Indian
banks’ assets are invested in government securities (Figure 8). Before 1997, banks faced a 5 percent
ceiling on their investment in corporate debentures. The ceiling has been lifted since and banks now hold
16 percent of their investment in corporate equities and debt. The remainder of their assets is allocated in
trust securities (7 percent), fixed deposits, mutual funds and other investments.
Banks, financial institutions, insurance companies, provident funds and trusts are required to hold
a certain part of their investments or liabilities in government paper. This creates a captive market for the
government debt and enables the Indian government to finance its running deficits. Until recently a
majority of these investors held government securities to maturity. This has been changing of late, with a
good number of banks setting up active treasury departments to trade government bonds. Indian banks are
the largest holders of debt with 36 percent of total outstanding amount, followed by brokers and primary
dealers with 24 percent and 23 percent each. Foreign banks also hold a significant chunk of Indian bonds
with 13 percent of total (Figure 9).
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Figure 8: Investments of Commercial Banks
Trust Securities
Indian Government 7%
Securities
Fixed Deposits
71%
1%
Domestic Equities
and Corporate
Debt
CDs & CPs 16%
1%
Others
Mutual Funds
3%
1%
Source: Reserve Bank of India
Figure 9: Holders of Indian debt
PRIMARY
DEALERS BROKERS
23% 24%
MUTUAL FUNDS
2%
FIN. INSTITUTIONS
FOREIGN BANKS 2%
13%
CORPORATE
BODIES
0%
INDIAN BANKS
36%
Source: NSE
Foreign Investors
In September 1992, the Government of India announced the opening up of the country's stock
markets to direct participation by foreign institutional investors, such as pension funds, mutual funds,
investment trusts, asset management companies, and institutional portfolio managers. To undertake these
activities foreign institutional investors are required to obtain an initial registration with SEBI. The
opening up of the stock market to foreign investors led to a surge in portfolio inflows. Foreign investment
grew from $1.8 billion in 1995 to $ 7.3 billion in 2000. Portfolio investment in the Indian securities
market has been quite diversified, with $2.1 billion invested in over 600 equities in 2000.
Equities represented the preferred investment vehicle in the early 1990s but have since been
replaced by debt. In 2000, 70 percent of foreign portfolio investment was channeled into debt. Until 1997
foreign portfolio investment in India took mostly the form of equity investment. Investment in debt
securities increased significantly in 1998 and after a retreat in 1999, foreign investors continued to prefer
debt investments to the more risky equity securities.
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Figure 10: Foreign Portfolio Investment Flows ($ million)
5,000
4,000
3,000
2,000
1,000
0
(1,000)
(2,000)
1995 1996 1997 1998 1999 2000
Bonds Equity
Source: World Development Indicators Database, the World Bank 2002 Edition
BANKING SECTOR
The Indian banking sector is still the backbone of the domestic financial system. For the year
2000, bank assets were 2.9 times larger than total equity market capitalization. This compares to a ratio of
0.61 for the United States and an average of 1.1 times for the other emerging countries in our analysis
(Appendix Table 2).
The banking system in India is significantly different from that of other Asian nations because of
the country’s unique geographic, social, and economic characteristics. India has an extensive banking
network, in both urban and rural areas. All large Indian banks are nationalized, and all Indian financial
institutions are in the public sector.
The banking system has three tiers. These are: scheduled commercial banks; regional rural banks
which operate in rural areas not covered by the scheduled banks; and cooperative and special purpose
rural banks.
There are approximately 80 scheduled commercial banks, Indian and foreign; almost 200 regional
rural banks; more than 350 central cooperative banks, 20 land development banks; and a number of
primary agricultural credit societies. In terms of business, the public sector banks, namely the State Bank
of India and the nationalized banks, dominate the banking sector.
Although the banking industry is currently dominated by public sector banks, numerous private
and foreign banks have made inroads in this sector. The performance of the PSU banks, in recent times,
has been mixed, with a few being consistently profitable. Several public sector banks are being
restructured, and government has already started to reduce its stakes.
The health of the Indian banking system has been questioned recently . Of particular concern is
the difficulty of assessing banks’ non-performing loans.
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ALTERNATIVE SOURCES OF FINANCING
Venture Capital
The venture capital industry in India is still at a nascent stage. As of June 2002 there were 37
domestic and 5 foreign registered venture capital funds in India. These funds as percentage of GDP for
2000 were 0.06 percent, among the lowest of the countries in our study (Appendix Table 3). The growth
of venture capital in the country will be crucial in order to harvest India’s potential in information
technology and other knowledge-based industries.
CONCLUSION
India’s recent success in the area of information technology has shown that there is a tremendous
potential for growth in knowledge-based industries. This potential is not confined to information
technology but is equally relevant in several areas such as biotechnology, pharmaceuticals and drugs,
agriculture, food processing, services, etc. Given the inherent strength by way of its skilled and cost-
competitive work force and entrepreneurship, with proper environment and policy support, India can
achieve rapid economic growth and competitive global strength in a sustainable manner.
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INDONESIA
INTRODUCTION
Political instability, a heavy external and domestic debt burden, high inflation and vulnerability to
a global economic slowdown have precluded the Indonesian economy from recovering after the East
Asian crisis of the late 1990s.
More than four years after the crisis, Indonesia’s gross output remains smaller than it was in 1997
and market activity is below 1993 levels. Projections calling for a narrower current account surplus
threaten the stability of the country’s financial system which in order to pay down debt is in constant need
of foreign currency. In addition, a high interest rates environment induced by the need to shore up the
currency and contain money supply growth, are hindering growth in investments and consumer demand.
More important to longer-term prospects, there has been a widespread perception that the policy
environment for investment in Indonesia has turned harsh and unsupportive. For example, local
authorities have approved only $6 billion in foreign projects in the first ten months of 2001, roughly one
third of the amount approved for the same period one year earlier. This fall seems to be part of the
broader, longer-term capital flight seen in Indonesia since the late 1990s. Continuing problems of
financial governance, lack of credibility of the legal and judicial system, and political uncertainty have all
discouraged investors from making longer-term commitments. The political problems holding back
attempts to sell state-controlled assets are one of the symptoms of the broad negative investment
sentiment. Continuing privatization of large banks and other state owned enterprises could be an
encouraging sign for the investment community. The implementation of banking and corporate sector
reforms would signal the government’s dedication to stimulating private sector development, and would
persuade the investment community that needed changes will be made and future investments in the
country will have a fair chance of success.
Given the magnitude of these problems, capital market development will have to lag behind more
urgent political and security issues on the government’s agenda.
EVOLUTION OF INDONESIAN CAPITAL MARKETS
Historical development of the market
In Indonesia, a former Dutch colony, securities trading began in the 19th century. In 1912, the
Netherlands colonial government established a capital market in order to trade shares and bonds of firms,
plantations, and local government securities.
Between 1912 and 1940, the two active Indonesian exchanges experienced stunning growth. In
1940, the government forced the liquidation of the stock exchanges, creating difficulties for the
stockowners and massive layoffs in the financial sector. In 1952, seven years after Indonesia declared its
independence, a new stock exchange was opened in Jakarta. Stocks and bonds issued before the war by
Dutch enterprises were bought and sold on the exchange until a nationalization program launched in 1958
halted trading once more.
The Indonesian market was reactivated in 1976 but trading activities remained sluggish until the
enactment of two government reform packages in 1987 and 1988. These reforms were aimed at relaxing
stocks and bonds issuance procedures, eliminating existing limits in price fluctuation, and provided for
the creation of private stock exchanges.
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The rate of growth following the reforms was impressive. In 1988 there were 24 companies listed
on the country’s exchange. Less then ten years later, at the inception of the 1997 Asian crisis, the number
of listed companies had risen to 282 with market capitalization of $29.1 billion – an annualized growth
rate of 131 percent.
Like the equity market, the Indonesian bond market during the period after WWII alternated
between periods of very low activity and a complete suspension of trading. A lack of an interest rate
benchmark (caused in part by the absence of any domestic government bond issuance), and the high
interest rate environment resulting from the government macroeconomic policies were two important
factors that contributed to delayed the growth of a domestic debt market.
The 1988 reforms, with the opening of the Jakarta Stock Exchange that followed and the
issuance of floating interest rate bonds marked the resurgence of a domestic bond market. By 1992 and
1993, several issues were coming to market each year; and between 1992 and 1997 the amount of listed
bonds increased by 700 percent.
Assessment of local capital markets development
The Indonesian capital markets are not well developed. A total equity market capitalization to
GNI in the low twenties points to a very low level of maturity of the domestic equity market (Appendix
Table 1). Political instability, weakness in the financial system, and the lack of a clear effort on the part of
government are the major obstacles to domestic capital market development. Political turmoil and a shaky
financial system have kept out foreign investment, which was responsible for the late 1990s boom in the
equity market.
The small size of the domestic bond market is even more troubling in light of the precarious
financial conditions of the local banking system. Future development of equity and bond markets will
largely depend on the ability of the Indonesian government to implement promised restructuring for
domestic banks, and to create an institutional and regulatory environment attractive to foreign investment.
CAPITAL MARKETS
Market size
Equity Market
The Jakarta Stock Exchange (JSE) is the main exchange in the country, accounting for more than
90 percent of all transactions. After a contraction following the Asian crisis Indonesian equity markets
expanded in 1999. Domestic and foreign investors where lured back by a growing technology sector and
hopes of a more stable political environment. (See Foreign Buyers section for a more detailed discussion
of foreign investment patterns.) As of April 2002, JSE listed 321 companies with a total capitalization of
approximately $37 billion.
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Figure 11: Market capitalization and number of listings
350 100
90
300
80
Mrket Cap ($ billion)
Number of listings
250 70
200 60
50
150 40
100 30
20
50
10
0 0
89
90
91
92
93
94
95
96
97
98
99
00
Ap 1
02
0
19
19
19
19
19
19
19
19
19
19
19
20
20
r-
Number of Stocks Market Capitalization ($ bill)
Source: Standard & Poor’s Emerging Markets Data Base
Firm concentration has been historically high. In April 2002, the ten largest Indonesian
companies by market capitalization accounted for 54.2 percent of total market capitalization and 67.4
percent of total trading value; indicating that the market for equities of smaller companies might be rather
illiquid.
High concentration should not come as a surprise since broad conglomerates exhibiting very
complex corporate structures are at the core of the Indonesian economy. Most Indonesian companies are
very tightly held, with the founder’s family group holding 70 percent3. A study of block holdings
(holdings of 5 percent or more) published by Claessen, Djankov, and Lang in 1998 showed that Indonesia
67 percent of Indonesian equities are in such holdings, second only to Thailand’s 73 percent. Cross
ownership represents a problem for the long-term development of the market since it does not encourage
transparency and the efficient allocation of capital.
As far as sector concentration, industrial firms make up 36 percent of the total number of listed
firms, followed by finance and services firms with 16 percent of total each (Figure 12).
Debt Market
The combination of high interest rates and inflation creates serious problems for the development
of a domestic corporate debt market. Corporate bond issuance expanded in the pre-crisis years only to
come to a halt in 1998. With domestic bond markets closed, Indonesian blue chip issuance costs are
lower. Generally, bank financing is still the main form of non-equity capital.
Secondary trading takes place either over the counter or on the Surabaya Stock Exchange (SSX).
Exchange data suggests that the bond market is largely illiquid. As of April 2002, 96 issues were listed on
the SSX for a total value of approximately $3 billion.
3
Stephen Wells, Moving Toward Transparency: Capital Market in Indonesia; publish as part of “The Rising to the
Challenge in Asia: A Study of Financial Markets: Volume 6 – Indonesia”. Asia Development Bank, 1999
26 of 74
Figure 12: Number of listed companies by sector as percentage of total
Trade and Services
16% Consumer Goods
13%
Finance
Infrastructure and
16%
Transportation
4%
Agriculture
Property, Real Estate, 3%
Building and Mining
Construction 2%
10%
Industry and
Miscellaneous industry Chemicals
17% 19%
Source: Jakarta Stock Exchange, Milken Institute
Market structure and operations
Shares are traded on the country’s two exchanges: the Jakarta Stock Exchange (JSE) and the
Surabaya Exchange (SSX). JSE is the country’s principal exchange, the Surabaya exchange was opened
in 1989 because of the 1988 government reform package. While companies can choose to be listed on one
or both exchanges, SSX tends to have more relaxed listing requirements; consequently, the exchange
attracts smaller firms.
The JSE is the primary market in the country, accounting for more than 90 percent of total trading
value. Shares listed on the SSX can be traded on the JSE and vice versa. Trading on the exchanges has
been fully computerized since 1999.
Clearing and Settlement
The Indonesian clearing and settlement structure has been overhauled in the past few years and is
now largely compliant with G30/ISSA recommendations. See Appendix Table 4 for a detailed
compliance status as of 2001. The Indonesian Central Securities Depository and the Indonesian Clearing
Guarantee Corporation are the only depository and clearing systems for listed equities. The central bank,
which was at the center of the old payment system structure, maintains central depository functions for
certificates of the Bank of Indonesia and government recapitalization bonds.
Trading on the exchange has been rather volatile. In the first five months of 2002 trading value
reached $5.2 billions up 93.4 percent from the same period of 2001. While trading volume is increasing
(and in 2002 is projected to reach 1997 highs), overall trading value is still well below that registered in
1999 (Figure 13).
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Figure 13: Trading Statistics for JSX
300,000 50
45
Number of Shares Traded 250,000 40
Value Traded ($ billion)
35
200,000
30
150,000 25
20
100,000
15
50,000 10
5
- -
1995 1996 1997 1998 1999 2000 2001 2002
est.
Shares Traded Value Traded (US$ billion)
Source: Standard & Poor’s Emerging Markets Data Base
Rating agencies
Only companies with a rating are allowed to issue bonds and only companies with investment
grade rating are allowed by the Bank of Indonesia to issue commercial paper. The requirement for rating
every listed bond has contributed to the growth of the rating agency business and has encouraged
acceptance of ratings by the corporations.
Indonesia’s first credit agency, Perfindo, was formed in 1994. Since inception, Perfindo has rated
180 companies and more than 250 securities. A second agency, Kasnik Duff and Phelps was licensed in
1997. Perfindo is nominally independent of the government, although the Capital Market Supervisory
Agency (see Regulators section below) appoints its steering committee. The agency shareholders include
securities firms, pension funds and the country’s two stock exchanges. Perfindo has generally been
regarded as stricter than other credit agencies in the region. This fact, combined with the agency’s
partnership with S&P, has contributed to building Perfindo’s credibility in the region.
Regulators
The Capital Market Supervisory Agency or Bapepam regulates all aspects of capital market
activity. It grants licenses and regulates trading, investment, settlement and issuance; it is responsible for
day to day guidance, regulation and supervision of the market; and sets accounting standards. Moreover,
by setting the budgets for the other self regulatory organizations such as the stock exchanges, the Clearing
and Guarantee Corporation and the Settlement and Depository Agency, Bapepam exercises significant
influence on the country’s entire financial system.
As part of the Ministry of Finance, Bapepam is not independent of the government; its chairman
is appointed by the minister of finance and approved by the president for an unspecified term.
28 of 74
Bankruptcy laws, creditor rights
Indonesia had no bankruptcy law until 1998. Failed companies continued to operate and creditors
had no way of enforcing contractual rights.
Under guidance of the International Monetary Fund a new bankruptcy code was drafted after the
1997 crisis. Despite this step forward, enforcement of insolvency proceedings on Korean debtors remains
weak and so far Indonesian courts have delayed stalled or dismissed creditors seeking protection under
the new law.
Indonesian legal system allows for two types of insolvency procedures. Debtors and creditors
alike can choose to file for a bankruptcy petition with the commercial court. In addition, debtors have the
option of filing for an application for suspension of loan payments. The commercial court can decide to
accept the petition by declaring that the debtor is bankrupt, reject the petition, or approve the suspension
of loan payments proposed by the debtor.
If the court accepts the petition for bankruptcy, an appointed receiver will undertake the
settlement of all repayments under the supervision of a supervisory judge. Within the settlement process,
the bankrupt firm can be restructured and/or reorganized in order to increase the value of its assets. After
the settlement has been completed the bankrupt firm can be liquidated or remain in existence as a legal
entity.
If only one creditor files a bankruptcy petition, bankruptcy proceedings may be stayed if the
debtor makes an application for a suspension of payments with the Commercial Court. Before the
establishment of the Commercial Court, insolvency cases were handled by the ordinary civil courts. To
date the experience has been disappointing to investors since major cases have been decided against
lenders for no apparently good reason..
MAIN PARTICIPANTS
Issuers
Equity
According to the JSE, new equity capital raised decreased 76 percent for 2001. New equity issues
were $0.53 billion in 2001 down from $2.2 billion in 2000. Of the money raised in 2001, $339.4 million
were raised by already listed companies and $128.8 million were raised through 31 new listings. New
equity issuance has been hurt by declining investor confidence due to the unstable political environment
and the decline in demand for the country’s exports.
Debt
Domestic debt issuance in Indonesia is almost non-existent. Most of Indonesian debt is placed
privately and traded privately. The Indonesian national government is required to submit a balanced
budget each year and therefore has no need to issue debt. In addition, no municipal or provincial entities
are debt issuers. Foreign aid, instead of debt, provides the financing for any shortfall between domestic
revenues and expenses.
Due to the high cost of issuance, the main issuers of bonds in Indonesia have historically been
large government owned companies. Before 1986 all of the bond issuers were state owned enterprises
except for PT Jasa Marge, a large toll road operator. With the capital market reforms of the late 1980s
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privately owned conglomerates began issuing bonds and were soon followed by some smaller private
companies. Corporate issuance has declined significantly after 1997 and outstanding issues are mostly
illiquid.
The number of issuers who could and would issue bonds in the domestic market is limited high
issuance costs and by a mandatory rating requirement on bonds. The few companies that can meet rating
requirements are precisely those able to tap the cheaper international markets making durrent prospects
for growth in debt issuance rather bleak.
Underwriters
Underwriters need to be licensed by Bapaepam. As of January 2002 Bapepam had issued 116
licenses. Most of the large global financial services firms are present in Indonesia, since foreign
ownership of financial services is allowed up to 85 percent.
Underwriting firms range in size from large to very small, but business is rather concentrated. In
2001 the ten largest underwriters were responsible for more than 90 percent of all new equity deals. All of
the top ten equity underwriters were domestic firms (Table 3). Only seven firms underwrote new debt
issues. Local firms also dominated bond underwriting with 69 percent of deal value nevertheless
international financial institutions were responsible for a significant amount of new debt issuance (Table
4). Since Indonesia lacks an active secondary debt market most of the debt issued is placed and traded
privately.
Table 3: Largest equity underwriters in Indonesia, 2001
NEW ISSUES - EQUITY % TOTAL VALUE # DEALS
DINAMIKA USAHAJAYA PT 50% 1
DANAREKSA 11% 2
TRIMEGAH SECURITIES 10% 7
ASJAYA INDOSURYA SECS 6% 1
BHAKTI INVESTAMA 4% 1
RIFAN FINANCINDO SEKURITAS PT 3% 1
MAHANUSA KAPITAL PT 2% 1
VICTORIA KAPITALINDO INTERNATIONAL PT 2% 2
HARITA KENCANA SECURITIES 2% 2
PRIDANA FUTURA CENTRA INVESTAMA PT 2% 1
OTHER 9% 12
TOTAL MARKET 100% 31
Source: Bloomberg
Table 4: Largest debt underwriters in Indonesia, 2001
NEW ISSUES - DEBT % TOTAL VALUE # DEALS
DANAREKSA 27% 6
ANDALAN ARTHA ADVISINDO SEKURITAS PT 25% 8
SALOMON SMITH BARNEY 18% 1
CITIBANK NA 14% 2
DEUTSCHE BANK AG 8% 1
AGUNG SECURITIES INDONESIA 4% 1
TRIMEGAH SECURITIES 3% 2
Total Market/Total Deals 100% 14
Source: Bloomberg
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Buyers
Much of the data observed shows that domestic investors have increased both as a percentage of
the total number of investors and as percentage of total market value held.
Individuals make up the most numerous group among domestic investors. The recent expansion
of a domestic mutual fund industry has contributed significantly to increasing individuals’ participation in
the market. In addition to individual investors, pension plans (public and private) and insurance
companies are important participants on the demand side of the market.
Pension Funds
Indonesia has a mix of pension provision arrangements. Besides the compulsory state pension
system and company pension funds, financial institutions are beginning to introduce private pension
funds. The total number of workers covered by pensions was 16 million in 1996, which means that most
of the 80 million Indonesian workers have no formal pension coverage. Private pension funds are the only
ones invested in equity; government program funds are almost exclusively in short-term fixed income
assets (government debt and time deposits).
A distorted asset allocation leaves pension systems vulnerable to volatility and inflation. In
addition, the lower birth rates associated with increasing prosperity will result in an aging of the
population which could endanger the viability of existing pension schemes. Projections show that the
proportion of population aged 65 and above in Indonesia will rise to 10 percent by 2025, an increase of
230 percent over the 1990 level. This could contribute to a future crisis for the national pension system if
more appropriate investment vehicles are not created to channel these funds. A more developed and
efficient capital market could provide a solution to this looming problem.
Life insurance companies
Life insurance companies have been growing rapidly. Their funds are primarily invested in short
term deposits and CDs.
Mutual funds
Mutual funds were first allowed in 1988 but began to develop only after the approval of the 1995
Capital Markets Law. Investment funds are now an established method for making investments and the
sector has grown rapidly. There were 108 mutual funds active in Indonesia as of April 2002, compared to
25 in 1996. The development of the mutual fund industry has been accompanied by an increase in the
number of investors active in the market. Between 1996 and 2001 total assets managed by the industry
tripled. At the end of 2001 mutual funds managed $0.8 billion. The number of investors in the funds
increased significantly also from 2,441 in 1996 to 51,723 as of December 2001.
The growth of the investment fund industry is driven by several dynamics. Market liberalization
has encouraged increased investor confidence. The growth of pension funds and life insurance companies,
big investors in funds has also had a major impact. Finally, the recent privatization of large state owned
companies has increased the supply of assets.
Mutual funds asset allocation is still skewed toward fixed income investments (58 percent of total
assets) and money market instruments (28 percent). Only a marginal 6 percent is allocated to domestic
equities.
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Foreign Investors
A large part of the growth experienced in the equity market between 1995 and 1997 was due to
foreign buyers (Figure 14). Foreign buyers accounted for 67 percent, 60.3 percent and 52.2 percent of
transaction value in 1995, 1996 and 1997, respectively. In general, foreign investors have been
significantly less active after the 1997 crisis, accounting for less than 10 percent of transaction value in
the first four months of 2002. The diminished presence of foreign money in the market can be attributed
to a general uneasiness about the country’s economic prospects, political uncertainty, and a generalized
uneasiness about emerging markets.
Foreign ownership of stocks is restricted only for listed companies in the banking and financial
services sector and in non listed companies in sectors deemed strategic such as distribution and minerals.
Foreign investors, because of the size of their transactions and their lack of familiarity with smaller
companies, tend to be invested in the best known blue-chip stocks.
Figure 14: Foreign portfolio investment flows in Indonesia
5,000
4,000
3,000
2,000
$ Million
1,000
0
(1,000)
(2,000)
(3,000)
1995 1996 1997 1998 1999 2000
Bonds Equity
Source: World Development Indicators Database, the World Bank 2002 Edition
BANKING SECTOR
A huge infusion of liquidity credits designed to recapitalize the banking system was provided by
the government in the aftermath of the crisis but has not been very successful. More than 80 private banks
were closed or forced to merge (Figure 15). Despite these measures the domestic banking system has not
yet recovered. The sector fragmentation only contributes to increase the problem of undercapitalization
of many financial institutions. More than 180 banks in 1999 held only 30 percent of the sector’s total
assets. While many of the smaller banks are having significant difficulties in increasing deposits, other
cater mostly to a few customers (usually related companies) which limits their sources of funding.
Even so the banking sector is still at the center of the Indonesian financial system. The ratio of
bank assets to total market capitalization , at 1.76, is the highest in the region (Appendix Table 2). The
domestic private sector (outside of the largest firms that can access international capital markets) is still
32 of 74
overly dependent on bank credit and very vulnerable to a liquidity crisis of the type experienced in the
late 1990s.
Figure 15: Number of banks active in Indonesia
1997 2002
180
160
Number of Banks
140
120
100
80
60
40
20
0
State Banks Regional Banks Private Banks Foreign & Joint
Banks
Source: Bank of Indonesia
ALTERNATIVE SOURCES OF FINANCING
Venture Capital
The level of Venture Capital (VC) in Indonesia is low, as is the case for most East Asian
developing countries. In 2002, VC Funds accounted for $ 353.6 million, or 0.26 percent of GDP
(Appendix Table 3). There are several flaws to the existing venture capital industry. First many VC
firms lack the expertise to assess the potential of start-up companies and like for many other Asian
countries investment decisions tend to be founded on personal trust rather than analytics. In addition, VC
investors have limited exit options given the difficulties and the reluctance of Indonesian companies to
enter the public equity markets. The future development of a viable VC market will depend on the
government’s commitment to enforce existing property rights and the establishment of more transparent
corporate governance regime.
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KOREA
INTRODUCTION
Five years after East Asia’s financial crisis the Korean economy fared better than most in the
region. Despite a recent significant decrease in export growth, Korea did not experience as severe a shock
as economies that are heavily dependent on information and communications technology exports. As a
result, GDP growth decelerated to 3 percent in 2001 from 9.3 percent in 2000. This modest expansion was
due in part to Korea’s broad industrial base, small reliance on technology related exports and sustained
domestic demand, in contrast to the broad-based domestic and external demand expansion in 2000.
Strong domestic demand is expected to continue to drive growth for the rest of 2002 and 2003.
For the twelve months ending May 2002 the equity market gained 48.5 percent (Appendix Figure
2). The encouraging trend of domestic demand points to higher GDP growth for 2002 of approximately 5
percent. This expectation prompted the Bank of Korea to enact the first tightening of monetary policy in
two years. The move reflected the Bank’s confidence that economic recovery is well underway.
Furthermore, despite relative price stability, the Bank sees the need to be pre-emptive, citing concerns on
the sharp rise in property prices and household debt4.
EVOLUTION OF KOREAN CAPITAL MARKETS
Historical development of capital markets
Equity
Securities trading in Korea can be traced back to March 1956 when the Korea Stock Exchange
(KSE) opened its market with twelve listed companies.
The early 1990s witnessed a variety of regulatory changes that helped speed up growth of
domestic markets. Guidelines were passed in order to allow foreign securities firms to establish branches
in Korea; and foreign brokers were allowed to gain membership in the KSE. As a result direct foreign
portfolio investment started to flow into the country at an unprecedented pace. Ceilings on foreign
investment were progressively lifted and finally eliminated in 1998.
In 1996 the KOSDAQ Stock Market was formed in order to facilitate corporate financing for
knowledge-based ventures, high-tech companies and small- to medium-sized enterprises. KOSDAQ has
been a key catalyst in promoting economic growth in Korea in the late 1990s. It played a significant role
in Korea's recovery from the economic crisis of 1997.
Other important steps for the growth of the capital markets were taken in the 1990s. These are:
the introduction stock index futures and options markets, the completion of the transition to a fully
computerized trading system and the consolidation of financial regulation under the Financial Supervisory
Commission.
Bonds
The Korean government has issued bonds since the inception of the Republic of Korea in 1948.
When the stock exchange opened in 1956 most of the trading volume was represented by government
4
Asian Development Bank, 2002-2003 Economic Outlook Report
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securities since trading in the twelve listed securities was minimal. Bond trading was not very active until
the 1970s as the government and corporate sector depended heavily on foreign borrowings and bank
loans.
The 1968 passage of the capital markets promotion act and the establishment of the Korean
Investment Corporation (KIC) marked the beginning of the expansion of the bond market. The KIC was
the first organization to introduce a guarantee system for the issuance of corporate bonds. As a result,
until the KIC’s dissolution in 1977, bonds issued exceeded equity financing in periods of depressed stock
prices. In the 1980s the bond market enjoyed a period of rapid growth. Floating rate long term corporate
bonds, and transactions through REPOs, were introduces at that time.
Assessment of local market development
While the history of capital markets in Korea is long, their development has been somewhat
weak. At 35 percent, the ratio of total market to GNI for the country, while higher than that of Indonesia
and India, is well below that of more developed markets in the region (Appendix Figure 1) such as
Malaysia and Japan. The comparison to Malaysia shows that there is significant room for growth of the
Korean equity market, since Korean per capita GNI is 2.6 times larger than Malaysia who has a ratio of
market capitalization to GNI of 149.
CAPITAL MARKETS
Market size
Equity Market
Following a year of positive performance for the domestic economy, total market capitalization of
KSE-listed firms reached $220 billion in 2001, a jump of 33.1 percent over the previous year.
Accumulated trading volume amounted to 206.2 billion shares, more than 2.6 times the amount of shares
traded on the exchange in 2000. The first four months of 2002 added an additional $76.5 billion to the
Korean market.
Of the 31 companies de-listed in 2001, twelve merged into other entities and 12 declared
bankruptcy or failed to reorganize. Figure 16 below shows market capitalization and listings on KSE
since 1986.
The Korean equity market concentration ratio is high relative to that of larger, more developed
markets such as the NYSE and Euronext. This concentration markets can be attributed to the chaebol
system still prevalent in the Korean economy. Appendix Table 1 gives a complete cross-country
comparison of concentration ratios. The ten largest companies by market capitalization accounted for 56.4
percent of total market capitalization and 37.5 percent of total turnover value in 2001.
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Figure 16 - Number of listings and market capitalization of the KSE
900 450
800 400
Market Capitalization ($ billion)
700 350
Number of Listings
600 300
500 250
400 200
300 150
200 100
100 50
- -
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
Ap 1
02
0
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
r-
No. of Companies Market Cap ($ billion)
Source: Standard & Poor’s Emerging Markets Data Base, KSE
Debt Market
In terms of bonds outstanding, Korea's market is the second largest in Asia, surpassed only by
Japan’s. Since the end of 1997 the size of the bond market has dramatically increased as the government
has continually injected liquidity into the system by issuing government and public bonds in an effort to
accelerate restructuring of the domestic economy. By the end of 2001, the domestic bond market
comprised 39.7 percent of the nation's aggregate market value with an outstanding value of $384 billion.
Public sector issues accounted for more than 70 percent of total bonds outstanding.
At the end of 2001, the number of bonds listed on the KSE totaled 7,891; of which 5,585 were
public issues and 2,306 were corporate issues. Despite the increase in the number of bonds listed, 2001
saw trading value on the KSE decrease by 52 percent from $20.7 billion to $10.8 billion. On the other
hand, trading value on the OTC market increased from $736.8 billion to $1,089.5 billion.
Market structure
The KSE became a private company in 1998. The KSE market is conceptually divided into 5
areas - a stock market, a bond market, a beneficial certificate market, a stock index futures market, and a
stock index options market. In addition, a warrant market was opened in mid-2000.
All orders are transmitted via a screen-based trading system from brokers' offices directly
to the KSE. For the majority of stocks, trading is fully automated via the KSE's Stock Market
Automated Trading System (SMATS), which was set up in 1998.
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Figure 17 – Outstanding domestic debt securities listed on KSE
300
Amounts Listed on KSE ($ Billion)
250
200
150
100
50
-
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
Public Bonds Corporate Bonds
Source: KSE
Clearing and Settlement
As of 1999, Korea had complied with all G30 recommendations except for the adoption of the
standard for securities messages developed by the International Organization of Standardization. The
Korea Securities Depository (KSD), a subsidiary of the KSE, serves as the settlement agent. All parties in
institutional transactions are linked by the Institutional Affirmation and Settlement system.
Rating agencies
Three credit rating agencies were established in the 1980s, in addition the the Korea
Management Consulting and Credit rating Corporation, the Korea Investors Service and the National
Information and Credit Evaluation Corporation. In addition all global rating agencies rate Korean some
Korean issuers. Despite the abundance of credit rating services, a credible rating system was slow to
develop due in part to the fact that the vast majority of corporate bonds issued before 1998 were
guaranteed either by a third party (usually a financial institution) or by collateral (Figure 18). Following
the 1997 crisis, bond rating systems have grown in importance with the increased issuance of non-
guaranteed bonds. As of 2001, 98.2 percent of corporate bonds issued were non-guaranteed. By contrast,
in 1997, 85 percent of corporate bonds issued were guaranteed.
Currently Korean securities regulations require that all public issues of non-guaranteed corporate
debentures have credit ratings from two rating agencies. The majority of corporate bonds are issued on a
non-guaranteed basis (Figure 18).
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Figure 18 - Corporate bond offering by Type
1996
2001
Non-Guaranteed
Guaranteed
8%
2%
Non-Guaranteed
Guaranteed 98%
92%
Source: KSE
Regulators
All financial institutions are subject to the supervision of a single supervisory body, the Financial
Supervisory Commission (FSC) and its executive arm, the Financial Supervisory Service (FSS) which
were established in 1998.
The FSC consolidated the earlier four financial supervisory authorities: the Office of Bank
Supervision, the Securities Supervisory Board, the Insurance Supervisory Board, and the Non-bank
Supervisory Authority. In addition to the FSS, the Securities & Futures Commission (SFC) was set up
under the FSC to oversee securities and futures markets. The SFC’s main function is to investigate insider
trading and market manipulation in the securities and futures markets, and to oversee accounting
standards and audit reviews.
Since its inception as integrated financial regulatory body, the FSC has also played a pivotal role
in restructuring the financial and corporate sector in the wake of the 1997 financial crisis that had
weakened the stability of Korea's financial industry.
In addition to these governmental regulatory bodies, the Korea Securities Dealers Association
(KSDA) and the KSE are self-regulatory entities. The KSDA became a legal self-regulatory entity
in1997. The KSDA is mandated with maintaining fair trading practices among members, protecting
investors, operating the KOSDAQ Stock Market, and managing securities professionals. In addition to
maintaining a market for securities, the KSE is also mandated with regulating and supervising its member
firms.
38 of 74
Box 1 - Relevant regulations for bankruptcy and reorganization
Bankruptcy: bankruptcy proceeding may be initiated by the insolvent debtor, creditors or other
interested parties. Once the application is filed and accepted, the court may issue an order to
preserve the assets of the debtor. A bankruptcy administrator is appointed to oversee the
bankruptcy process. The aim of the bankruptcy law is to liquidate and distribute the remaining
assets to the creditors in an equitable manner. In general, the bankruptcy regime provides that
management no longer has power of management, shareholders have the right to the remaining
assets after distribution to creditors and interested parties with priority over the shareholders.
Creditors under contracts with the corporate debtor will be part of bankruptcy claimants.
Reorganization: reorganization proceeding may be initiated by the insolvent debtor, creditors or
shareholders. Once the application is filed and accepted, the court may issue an order to preserve
the assets of the debtor. A receiver is appointed to oversee the reorganization process. The aim of
the reorganization law is to restructure the debt and fix a reorganization plan that would promote
the rehabilitation of the debtor. Under reorganization, management no longer has power of
management, shareholders no longer have shareholders' rights and creditors under contracts with
the corporate debtor will be part of the reorganization claim. Executory bilateral contracts can be
terminated by the reorganization receiver.
Composition: Creditors and the court can initiate composition proceedings, In this case a
composition administrator is appointed to oversee the composition process with the goal of
designing a ‘composition’plan that would promote the rehabilitation of the debtor. Under
composition proceedings management retains power of management for the ordinary course of
business, and shareholders have rights, with the administrator's consent.
Source: ASIAN DEVELOPMENT BANK; REGIONAL TECHNICAL ASSISTANCE PROJECT
NO:5795-REG (Report on Korea)
Bankruptcy laws, creditors rights
Three types of insolvency procedures are available: bankruptcy, reorganization and composition.
A company in reorganization may be put into bankruptcy proceeding. Composition is aimed at
rehabilitating the insolvent firm and unlike in bankruptcy and reorganization proceedings, in composition
management remains in charge of day-to-day operations and shareholders rights are maintained. A
company in composition cannot move on to bankruptcy. Box 1 details some of the provisions included in
the current insolvency regulations.
MAIN PARTICIPANTS
Issuers
In 2001, capital raised through stocks and bonds totaled $75.6 billion, up $20.8 billion from 2000.
The primary force behind this increase was not the stock market. Rather, corporate bonds dominated the
statistics for capital raised as interest rates fell in 2001 and made bond issuance a cheaper method for
raising funds. In fact, of the total funds raised in the public market, $66.5 billion were raised through debt
issuance and $ 9.3 billion through new equity.
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Between January 2001 and July 2002 there were 30 new listings on the KSE. With several
chemical product companies, financial and engineering firms, new listings reflect the general sector
distribution of the market as a whole (Figure 19).
Figure 19 – Equity Capitalization by Industry (December 2001)
Food and
Other Beverage Chemicals
5% 2% 6%
Financial
Iron and Metal
Companies
Products
21%
6%
Electrical and
Communication
ElectronicEequipm.
16%
25%
Transport
Contruction Equipment
2% 6%
Other
Electricity and Gas Distribution Manufacturing
6% 3% 2%
Source: KSE
Corporate bonds made up the bulk of new issues for 2001 with new issuance totaling $66.4
billion. To address varied investor needs, corporations have begun to issue new types of securities
throughout the years. Currently convertible bonds, bonds with warrants, exchangeable bonds,
participation bonds, and bonds with embedded options are regularly issued and traded on the KSE.
Government bond issuance amounted to a total of $23.4 billion in 2001. Of these $16.6 billion
were issued by the treasury, and an additional $4.1 billion and $2.7 billion were Foreign Stabilization
bonds and National Housing Bonds, respectively. (See Box 2 for a detailed description of the various
bonds types.) For 2002, the Korean government plans a 3.6 percent decrease in bond’s issuance.
Box 2: Types of government bonds
Treasury Bonds are issued under the Budget and Accounting Act and Public Finance Bond Act.
Treasury Bonds, with the primary objective of managing the national treasury, are issued with maturities
of three-, five- or ten-years. One-year treasury bonds have not been issued since July 2001. Among the
different maturities, the three-year treasury bonds are currently the most popular but the five-, and the ten-
year treasury bonds are quickly gaining. This increase in interest in longer term instruments comes as a
result of the government’s drive to develop Treasury bonds as a liquid benchmark and to lengthen their
maturities. An indication of this drive can also be found in the government’s plan to issue 65 percent of
its treasury bonds with maturities of 5 to 10 years and its further plans to introduce 20 and 30 year bonds
in 2002.
National Housing Bonds (NHB) are issued, either as Type I or II, according to the Housing Construction
Promotion Act and are used to raise funds for housing construction. Type I holds a 5-year maturity and
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companies seeking commercial construction licenses and permits, bidding rights for contracts on national
construction projects or registering real estate are required to purchase set amounts of Type I bonds. Type
II, having the longest maturity of all government bonds (20-years), are sold to those purchasing
apartments through the bond-bidding system.
Foreign Exchange Stabilization Bonds (FESB) are issued under the Foreign Exchange Stabilization
Fund Act to purchase foreign currencies and manage overseas capital. The face value of FESBs can be
denominated in foreign currency.
Underwriters
As of December 2001, the number of securities companies in Korea including domestic and
foreign firms totaled 62, of which 44 were domestic and 18 foreign. Of the 44 domestic companies, 36
engage in underwriting. Of the 18 foreign companies, 13 are underwriters. Underwriters can be securities
firms, investment trust companies, merchant banks and commercial banks and must maintain a minimum
capital of 50 billion won (approximately $38 million).
Domestic securities firms have underwritten the majority of debt and equity issues in 2001. In
fact, the top ten underwriters of equity were all domestic firms (Table 5 ).
Table 5: Largest equity underwriters in Korea, 2001
NEW ISSUES - EQUITY %TOTAL VALUE # DEALS
HANWHA SECURITIES 17% 8
DAEWOO SECURITIES CO LTD. 15% 17
MIRAE ASSET SECURITIES 9% 7
HYUNDAI SECURITIES 7% 13
DONGWON SECURITIES 7% 14
KYOBO SECURITIES 5% 10
WOORI SECURITIES 5% 13
TONG YANG INVESTMENT BANK 5% 13
DAISHIN SECURITIES 4% 8
KOREA INVESTMENT TRUST MANAGEMENT & SECS C 3% 5
OTHER 24% 56
TOTAL MARKET SIZE 100% 164
Source: Bloomberg
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Table 6: Largest debt underwriters in Korea, 2001
NEW ISSUES - BONDS % TOTAL VALUE # DEALS
KOREA DEVELOPMENT BANK 14% 218
LG INVESTMENT SECURITIES CO LTD 14% 158
SAMSUNG SECURITIES CO LTD 11% 68
DAEWOO SECURITIES CO LTD. 8% 129
SK SECURITIES 8% 86
HYUNDAI SECURITIES 5% 120
HANA SECURITIES 4% 79
DAISHIN SECURITIES 4% 66
SALOMON SMITH BARNEY 3% 14
BOO KOOK SECURITIES 3% 27
OTHER 25% 481
TOTAL MARKET SIZE 100% 1,446
Source: Bloomberg
The largest underwriter of corporate debt was the Korean Development Bank, which underwrote
14 percent of all corporate debt issues. The Bank, which is a government entity, facilitated the
restructuring of Korea’s companies after the 1997 crisis and continues to play a pivotal role in the
domestic economy. As the center of the privatization process many state owned companies are
undergoing, the bank advises and supports these companies during the privatization.
Nine of the top ten underwriters of corporate debt for 2001 were domestic securities firms. The
only foreign firm, Salomon Smith Barney ranked number nine with $ 1.8 billion equivalent to 3 percent
of the total corporate bond amount issued.
Buyers
Domestic buyers hold 70 percent of the KSE total market capitalization (Figure 20). Individuals
make up the largest group of domestic investors. As of December 2001, 3.2 million Koreans held 7.5
billion shares in companies listed on the KSE, accounting for 20 percent of the local market capitalization
and 38.5 percent of total shares outstanding. The number of individual investors more than doubled after
the 1997 crisis indicating sustained confidence in the public capital markets. Domestic corporations are
the second biggest investor group. Over 7,000 corporations held approximately 22 percent of total market
value and 21 percent of total shares outstanding at the end of 2001. During the same period domestic
institutional investors, such as banking institutions, securities companies, investment trusts, insurance
companies and other finance related companies held 13 percent of total market value and 18 percent of
shares outstanding.
Investment trusts companies held more than half of the private institutional holdings. As of
December 2001, there were 48 trusts operating in Korea. Among these, seven are collaborations between
foreign and domestic firms and two are foreign owned. The three main types of investment trusts are: 1)
equity investment trusts; 2) bond investment trusts; 3) Money Market Funds, which are mainly invested
in short-term financial products such as commercial paper and CDs.
Corporate-type investment trusts (similar to mutual funds available in the United States) are a fast
growing portion of institutional money. These corporate investment trusts were first introduced in 1998
through the Securities Investment Company Act in order to offer investors diverse investment vehicles
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and promote securities investment. Corporate-type investment trusts consist of 5 types of companies:
securities investment companies, asset management companies, asset custodians, distributors, and general
administration trustee companies.
The Korean government and other public entities also play an important role on the demand side
of the domestic capital markets. As of December 2001, 10 government entities held 14 percent of total
market capitalization. The largest government entity active on the demand side of capital markets is the
National Pension Fund. As of September 2001, the National Pension Fund managed $65 billion in assets.
Of these, 45 percent were invested in government securities, 54 percent were invested in public and
private bonds, stocks, beneficiary certificates, money in trust, and securities. The fund allocates the
remaining 1 percent to loans to insureds and for construction of welfare facilities for children and elderly
people.
Figure 20 – Equity Holdings by Shareholder Type as Percentage of Total Market Value
Foreigners
30%
Government And
Public Entities
14%
Banking Institutions
3% Securities
Companies
1%
Investment Trusts
Individuals 7%
Insurance
20%
Companies
1%
Other Finance Co
Corporations
2%
22%
Source: KSE
Foreign Investors
Foreign investors are a significant part of the domestic capital markets. In 2001, 1,112 foreign
investors newly registered with the Financial Supervisory Service, bringing the total number of foreign
investors to 12,860. Of those, 8,066 were institutional investors and 4,794 were individual investors
The $7.5 billion of net foreign portfolio investment in equities for 2001 was the second largest
amount since 1992 when the stock market opened to foreigners.
The value of trading by foreigners increased to 9.7 percent of the total trading value from the
previous year’s 8.3 percent. Foreign investors’ shareholdings of listed stocks reached 2.9 billion shares,
with a market value of $71.4 billion, accounting for 14.7 percent of the total outstanding shares and more
than 30 percent of total market value at the end of 2001.
In the wake of a series of interest rate cuts in the United States, foreigners continued to bring their
investment funds into Korea in expectation of an economic recovery, thus raising the foreigners’
shareholdings to over 30 percent for the whole year.
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Investment funds were the largest group of foreign investors making up 43 percent of total,
followed by individuals with 36 percent and pension funds with 6 percent (Figure 21). Foreign
investments came mainly from the United States (39 percent) followed by the U.K., Japan and Taiwan
with less than 10 percent each.
Figure 21- Foreign Investors by Type and Nationality
Pensions U.S.
Funds 39%
Institutional
43%
Investors
6% U.K.
9%
Securities Co. Japan
3% 8%
Taiw an
Other
5%
11%
Other
Individual Investors
39%
37%
Source: FSS
BANKING SECTOR
The Korean banking sector is undergoing thorough structural reform, overseen by the
Government in close collaboration with the IMF and the World Bank. The reforms aim at increasing
transparency and investor confidence, and generally purging the sector of moral hazard.
During the economic crisis, the Korean Government nationalized its largest commercial banks. In
the subsequent years the government has actively worked to recapitalize the banks and non-bank financial
institutions, close or merge weak financial institutions, resolve non-performing assets, introduce western
accounting standards, and end the policy-directed lending of the past. Currently, four banks remain
nationalized.
Through this process of deregulation and structural changes, Korean banks have gone from
traditional banking to full service financial institutions, offering securities products and a variety of fee-
based activities considered outside their interests only a few years ago.
ALTERNATIVE SOURCES OF FINANCING
The role of Venture Capital
Venture Capital (VC) in Korea is a relatively new phenomenon. Almost eighty percent of Korean
VCs were established after the 1997 financial crisis.
VC has grown at a rapid pace thanks in part to the success experienced by the KOSDAQ market
in establishing a reliable exit option. At the end of June 2001, there were 146 VC firms and 4 new-tech
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financing companies. Corporations founded more than half of all Korea’s VC firms, with individual
investors and financial sector enterprises funding the remaining 38 percent and 10 percent respectively.
As of June 2001 the industry managed $5.69 billion in assets. Of the $2.5 billion supplied to
6,012 companies in the same year, most took the form of equity investments (79 percent).
Technology related companies have been the main beneficiaries of VC capital disbursements in
Korea so far (Figure 22). The movement to diversify investment from the Internet and information
technology sector to a wider range of fields is a recent trend in the domestic VC industry.
Figure 22 -Venture Capital Disbursement by Industry, as of June 2001
Machinery and
Bio
Metal
11%
10%
Others
7%
Textiles
3%
Chamicals
IT-Related 3%
63%
Distribution
3%
Source: Korean Venture Capital Association
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MALAYSIA
INTRODUCTION
In Malaysia, a former British colony, stock markets have existed since the 19th century, but had
almost no capital procurement function. The domestic equity market began to expand following the
country’s independence and a market for bonds was created when the national government began to issue
debt securities in the 1950s.
Like many other countries in the region, Malaysia’s economy experienced unprecedented growth
in the 1980s and 1990s. This boom, largely fueled by foreign investments, pressed for further
development of the country’s financial market and the creation of a more investor-friendly regulatory
environment. The Asian crisis of 1997-1998 and the flight of foreign capital that followed created the
need for the government and private sectors alike to restructure. More importantly, it required the
country’s corporations to search for a more organic path to future growth.
Five years after East Asia’s financial crisis Malaysia seems to be doing well. Government
initiatives aimed at restructuring corporate and bank debt, and policies geared at restoring domestic
demand have helped the Malayan economy bounce back with newfound vigor. A sustained effort in
undermining the prominence of corporate conglomerates coupled with the reliance by healthier firms on
equity and debt markets for funding has fueled growth in capital markets and somewhat diminished the
profile of the banking sector.
Access to capital and developed capital markets are necessary to fuel entrepreneurship and the
kind of “organic” growth that has been the mark of Malaysia’s recent success. Malaysia will benefit from
its markets which are already among the most developed in the region. If market forces are allowed to
work and the allocation of capital takes place in an efficient manner the recent positive performance will
continue in the near future.
EVOLUTION OF MALAYAN CAPITAL MARKETS
Historical development of the market
The securities industry in Malaysia effectively began in the late 19th century as an extension of
the presence of British companies in the rubber and tin industries. The first Malayan Stockbrokers
Association was founded in 1927. Shares were traded privately until the establishment of a Malayan
Stock Exchange in 1960. A strong link existed between the Malayan Stock Exchange and Stock Exchange
of Singapore (SES) until the secession of Singapore from Malaysia in 1965. Malayan incorporated
companies were in fact listed and traded through the SES, and vice-versa for Singapore incorporated
companies. After the 1965 secession the common stock exchange continued to function but as the Stock
Exchange of Malaysia and Singapore (SEMS).
The Kuala Lumpur Stock Exchange (KLSE), as we know it today, was established in 1973 when,
following the termination of currency interchangeability between Malaysia and Singapore, the SEMS was
separated into the KLSE and the SES. Malaysian companies continued to be listed on SES and vice-versa.
A significant milestone for the KLSE was achieved in 1990 with the delisting of Singapore incorporated
companies from the exchange and vice-versa. This move heralded the growth of the KLSE as a stock
exchange with a truly Malayan identity.
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Debt markets, as often is the case, developed later than the equity market, with the issuance of
securities by the government in the 1950s. Government issuance increased substantially and by the 1970s
the market in government securities was well developed.
The private bond market began to grow with the 1987 establishment of Cagamas Berhad, the
national mortgage corporation. Cagamas was established in an effort to develop a secondary mortgage
market and promote the development of a private market for debt securities. Cagamas borrows money by
issuing debt securities and then uses the funds to finance the purchase of housing loans from financial
institutions, corporations and the Government. Cagamas is the largest private bond issuer in the country.
The success of the Cagamas experiment encouraged some of the country’s larger corporations to
issue term notes on a fixed or floating rate. Bond issuance continued to increase at a sustained rate
throughout the 1990s. Immediately after the 1997 financial crisis, bond markets experienced diminished
government issuance and increased issuance on the part of corporations.
One peculiar aspect of Malayan financial markets is the existence of a parallel Islamic Banking
system in addition to conventional debt and equity markets. Separate Islamic legislation and banking
regulations exist side-by-side with those for the conventional banking system. The legal basis for the
establishment of Islamic banks was the Islamic Banking Act (IBA) which came into effect in 1983.
Islamic financial practices are founded on the belief that money is not an earning asset in and of itself and
therefore cannot earn interest.
The Islamic financial sector is represented by two Islamic banks, 47 conventional banking
institutions offering Islamic banking products, an Islamic money market, two mutual guarantee
companies and a broad range of financial products. Mutual guarantee companies provide for defined risks
to life and property. Islamic banking institutions can be further subdivided into commercial banks, finance
companies, merchant banks and discount houses. Discount houses are non-banking institutions that deal
in the business of receiving short term deposits and funds and investing those funds by trading in
Malaysian Government Securities, Treasury Bills or such other investments as may be prescribed by the
Malaysian central bank. The government of Malaysia issues government securities based on Islamic
principles called Government investment certificates (GIC). Islamic banks invest in the GIC to meet the
liquidity requirements prescribed by the central bank as well as to invent their surplus funds. Malaysia has
seen the rapid growth of Islamic debt securities and equity markets and is trying to establish itself as the
primary Islamic financial center in Asia.
Assessment of local capital markets development
Several indicators point to the fact that Malayan capital markets are among the most developed in
the region. The average ratio of market capitalization to GNI for G7 countries was 121 percent;
Malaysia’s was a stunning 149 percent indicating an advanced stage of development of the domestic
markets (Appendix Figure 1).
With real GDP growth forecasted at 5 percent for the year 2002 and 6.7 percent for 2003 the
potential for the continued development of a large, transparent and liquid capital market in Malaysia is
significant.5 GDP will continue to increase thanks to a renewed expansion of capital investment. In
addition, increases in productivity will come as a consequence of better allocation of resources following
the relaxation of controls on foreign ownership of Malayan firms and improvements in technology.
Mirroring the positive performance of the Malayan economy, the local stock market price index was up
5
The Economist Intelligence Unit, June 16th 2002
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37.2 percent for the twelve months ending May 2002, as compared to a negative 15 percent for the S&P
500 (Appendix Figure 2).
CAPITAL MARKETS
Market size
Equity Market
As of April 2002, 832 companies were listed on the KLSE for a total market capitalization of
$141.8 billion.6 As shown in Figure 23 below, while total market capitalization is still well below the
1996 highs, firms have continued to tap public markets with new issues.
A low firm concentration ratio (ratio of market capitalization of top ten companies to total market
capitalization) again points to a mature stage of development for the Malayan capital market and the
ability of small- and medium-sized firms to raise capital from the investing public. With the top ten
companies making up 37.8 percent of total market capitalization in 2001, the ratio places Malayan
markets in line with G7 countries (Appendix Table 1). For the same period, turnover value7 of the top ten
companies was 12 percent, the lowest among any of the neighboring countries, indicating again that
Malayan equity markets are among the most liquid and advanced in the region.
Bond Market
The bond market in Malaysia has grown significantly since the 1980s. Development is evident
not only in terms of market size, but also in the wider range of instruments and products available and a
high level of market efficiency. The progress made has enhanced the bond market’s role in supporting
economic growth and transformation.
Instruments are issued both under conventional and Islamic financing principles. Islamic
instruments usually involve a Note Issuance Facility (NIF) at a fixed rate, structured according to the
Islamic principle of deferred payment sale. Under this arrangement investors purchase assets from the
borrowers that are to be refinanced at an agreed purchase price. The same assets are then resold to the
same borrower at an agreed selling price, which includes a profit margin.
6
MESDAQ listings are included in these figures. In March 2002 the KLSE incorporated the Malayan Exchange of
Securities Dealing and Automated Quotation (Mesdaq) which was formed in 1997 to provide a platform for high
growth companies to raise capital.
7
Total value of equity traded in top 10 companies divided by total value traded in the market.
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Figure 23 - Number of listings and market capitalization of KLSE
900 350
800
300
700
Market Cap. ($ billion)
Number of Listings
250
600
500 200
400 150
300
100
200
50
100
0 0
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
Ap 01
02
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
r-
Listings Market Cap )
Source: Standard & Poor’s Emerging Markets Data Base
As of July 2002 the value of bonds outstanding amounted to $79,076 million. Of total outstanding
bonds 79 percent were conventional-type bonds and 21 percent were Islamic bonds. Government
securities accounted for 44 percent of conventional bonds outstanding followed by corporate bonds with
35 percent of the total. Corporate issues constitute the largest type of Islamic type bonds with 76 percent
of total amount outstanding (Table 7). Corporate issues, after increasing steadily throughout the 1990s
(Figure 24) currently make up 35.4 percent of conventional bonds outstanding and 79.5 percent of Islamic
issues.
Overall, conventional-type instruments still make up the vast majority (79 percent) of outstanding
debt but growth of Islamic-type securities issuance is expected to be strong as Malaysia moves forward to
establish itself as the largest Islamic capital market in the world.
Market structure and operations
The KLSE is the only stock exchange in the country.8 Equities can be listed on the main board, on
a secondary board and on the MESDAQ.
With the increasing emphasis on corporate governance, the KLSE is moving towards
implementing a disclosure-based system in order to inculcate higher standards of disclosure and
accountability for listed companies. This move is largely aimed at improving the transparency of public
listed companies and ensuring that small investors are better protected.
8
The KLSE has several subsidiaries that serve the purpose of facilitating trading activities. Among these
SCANS (Securities Clearing Automated Network Services) and the Malays Central Depository (which operates the
Central depository system and the exchange script-less trading system) are described in detail in the clearing and
settlement section of this report.
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Figure 24 -Domestic debt securities (amounts outstanding)
Amounts outstanding ($ billion)
60
50
40
30
20
10
0
1994-03
1994-09
1995-03
1995-09
1996-03
1996-09
1997-03
1997-09
1998-03
1998-09
1999-03
1999-09
2000-03
2000-09
2001-03
2001-09
PUBLIC SECTOR PRIVATE SECTOR
Source: Bank for International Settlements
Table 7- Malayan debt securities, amounts outstanding as of July 2002
Instrument Conventional % Conventiona Islamic % Islamic
Asset Backed Securities 309.91 0.5% 0 0.0%
Asset-Backed Commercial Paper 15.53 0.0% 0 0.0%
Bank Negara Malaysia Bills (BNB) 2,500.00 4.0% 526.32 3.2%
Corporate Bonds 22,120.48 35.4% 12,976.79 79.5%
Cagamas Bonds 5,588.42 9.0% 0 0.0%
Cagamas Notes 780.26 1.3% 0 0.0%
Commercial Papers (CPs) 894.40 1.4% 1,168.68 7.2%
Government Investment Issues (GII) 0 0.0% 1,052.63 6.4%
Malaysian Government Securities 27,250.01 43.7% 0 0.0%
Malaysian Treasury Bills (MTB) 1,186.84 1.9% 0 0.0%
Medium-Term Notes (MTNs) 362.63 0.6% 597.37 3.7%
Other 1,405.76 2.3% 340.53 2.1%
Total 62,414.25 100.0% 16,321.80 100.0%
Source: Bank Negara Malaysia.
Trading on the KLSE was fully computerized in 1992 with the full implementation of the System
on Computerized Order Routing and Execution (SCORE) automated trading system. SCORE eliminated
the need for a trading floor at the Exchange’s premises. Trading is facilitated through the Exchange’s
member brokerage companies located all over the country. These companies are equipped with the
KLSE’s enhanced broker front-end system, WinSCORE, whereby each dealer operates from an integrated
terminal providing real-time market information dissemination as well as order and trade routing and
confirmation.
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In addition to the KLSE, the market structure for debt securities includes the market in
government debt and Cagamas bonds, where trading occurs among the principal dealers, approved dealers
and other participants in the Interbank Funds Transfer System (described in detail below).
Clearing and Settlement
There are two main clearing and settlement systems in Malaysia for stocks and bonds: the central
bank SPEEDS system and the KLSE clearing and settlement system.
The SPEEDS system provides settlement and clearing arrangement for securities as well as
money market funds. It consists of two systems. The first, the Interbank Funds Transfer System (IFTS), is
a completely computerized on-line interbank funds transfer and settlement system. IFTS was
implemented in December 1989 to handle all transactions within the banking system. The second system,
the Scripless Securities Trading System (SSTS), is an on-line book entry system that effects and records
the trading of Government securities, Treasury bills, Cagamas papers, unlisted private debt securities and
Bank Negara Certificates and Bills. A sale or purchase of securities from one account to another involves
a book entry. Intra-day settlement is undertaken through the cash settlement account. At the end of the
day, balances in cash settlement accounts are transferred to the clearing account of the member institution
maintained with the Central Bank. In SPEEDS, securities settle gross throughout the day and funds settle
net at the end of the processing cycle.
The Central Depository System (CDS), implemented in 1993, is the automated clearing and
settlement system of the KLSE. The CDS replaced the practice of holding and moving physical scrip of
quoted shares with a computerized book entry system.
Brokers settle net amounts of stock and money through SCANS, which will perform
multilateral netting of contracts and notify market participants of the net amounts they owe one
another. Payment of net amounts is effected through a local commercial bank, where all
members of SCANS maintain accounts, with physical or book-entry delivery of the securities
occurring with a lag. Settlement of interbank payments is end-of-day on a net settlement basis
through SPEEDS.
KLSE trading volume statistics for 2001 reflect the same decline observed in most major
markets. Trading value for the full 2001 year was approximately $22 billion which represented a
64 percent decline from 2000. The number of shares traded daily also fell significantly from 63
billion in 2000 to 38 billion in 2001 (Figure 25). In 2002 both trading value and volume have
recovered somewhat from these lows.
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Figure 25 - Trading statistics for KLSE, daily averages
120 200
180
100
Number of Shares Traded
160
Value Traded ($ billion)
140
80
120
60 100
80
40
60
40
20
20
- -
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Shares Traded Value Traded
Source: Standard & Poor’s Emerging Markets Data Base
Rating agencies
Rating Agency Malaysia Berhad (RAM), Malaysia's first credit rating agency, was established in
November 1990. RAM is privately owned and reportedly a completely independent organization. A
second rating agency, MARK, was incorporated in 1995.
In 1992 the central bank of Malaysia made rating mandatory for private debt securities in an
effort to promote the development of the local bond market and attract investments from domestic and
foreign investors. In addition, all new issues had to receive a BBB or higher rating. These restrictions,
which were material in establishing market confidence, were subsequently lifted in July 2000.
RAM and MARK rate several types of products and institutions including: conventional and
Islamic private debt securities, senior debt, asset backed securities, the claims-paying ability of insurance
companies and financial institutions. RAM rates 154 corporate debt issues, 27 financial institutions, 49
Islamic debt issues, and 6 senior debt issues. Similarly, MARC issues 148 ratings with a similar
distribution by product type.
Regulators
The KLSE is a self-regulatory organization that governs the conduct of its members and member
companies in securities dealings, enforces listing requirements, and is responsible for surveillance of the
market place.
The Securities Commission (SC) was established in 1993 to provide for regulation on all matters
relating to the securities and futures contracts industries. Prior to 1993, there was no single authority in
Malaysia entrusted with the responsibility of regulating and systematically developing the capital market.
Supervisory powers were shared between industry organizations like the stock exchange and government
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institutions. Since July 2000 the SC is also the single approving and registering authority for prospectuses
on all private debt securities.9
The Foreign Investment Committee (FIC) was formed in 1974 to implement the Government's
guidelines on the regulation of the acquisition of assets or interests, mergers or takeovers of companies
and businesses, and is responsible for major issues on foreign investment. Although it is not directly
related to any of the regulatory bodies in the securities industry, the FIC has a bearing on the industry as
"investment" includes securities listed on KLSE.
Bankruptcy laws, creditors rights
Malayan corporate insolvency law is contained in the Companies Act of 1965. The Companies
Act is modeled after British law and therefore provides for corporate reorganization (scheme of
arrangement) as well as liquidation processes. Box 1 provides a summary of some important elements of
the Act.
In the context of a scheme of arrangement or liquidation, the time frame is approximately one
year. The Courts are only moderately effective in their handling of formal insolvency proceedings as
procedures can be cumbersome and there is some element of delay owing to heavy judicial schedules.
There is no distinction under Malayan law between claims of foreign creditors and local creditors.
Box 3- Selected provisions of the Companies Act of 1965
Liquidation
Creditors can initiate winding up proceedings by filing a winding up petition under sections 217 and 218
of the Companies Act. The ground relied on in all such cases would be the inability of the corporate
debtor to pay its debts. If a winding up order is made by the court, a liquidator will be appointed to
oversee the liquidation process to ensure an orderly realization of assets and repayment of creditors and
members.
Court Approved Schemes of Arrangement
A scheme of arrangement requires the sanction of the High Court, and before such sanction is sought, the
scheme has to be approved by three-quarters in value and a simple majority in number of each class of
creditor present and voting, creditors being divided into classes according to their communality of
interests. Various arrangements can be sanctioned by the High Court, including a sale of assets to a third
party. The company that is proposing a scheme can apply to the High Court to grant an order staying all
proceedings against the company while the scheme is pending. This would apply to all forms of
proceedings. Companies have extended the concept of proceedings to "extra-judicial" measures such as
the appointment of a receiver and manager under a debenture. All creditors of the company are bound by
this statutory scheme and must comply with the terms of the arrangement.
Private and Court Appointed Receivers
A secured creditor may appoint a receiver under the terms of a debenture. The receiver takes possession
of the assets that are subject to the debenture instrument and may sell those assets. The creditor has to
9
Prior to 2000, bond issuance was regulated by the central bank.
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initiate formal court based foreclosure proceedings. A court appointment is made where there is no
express contractual power to appoint but assets of the debtor are in danger. The powers of a court
appointed receiver are always made explicit in the order appointing him. In the case of a private
appointment, the object is to ensure the interests of the debenture holder are protected and returns to that
particular creditor are maximized.
Source: Asian Development Bank, Regional Technical Assistance ProjectNO:5795-REG. Report on Malaysia
MAIN PARTICIPANTS
Issuers
Equity
After a significant drop in new issuance following the 1997 crisis, IPO activity has resumed in
recent years at a healthy pace. In the first half of 2002, 33 new companies have been listed on the KLSE
with an additional 11 IPOs scheduled for the months of July and August (Figure 26). This number
compares very favorably with 20 total new issues of 2001 and 38 in 2000.
For 2001, new capital raised in the public equity market amounted to $707 million. Of this, $295
million was raised by newly listed companies.
Figure 26 - Number of new listings
57
60
50
38
40
28
30
20
21 20
10
0
1998 1999 2000 2001 2002* * Projected
Source: KLSE
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Table 8: New listings by sector 2001-2002
S ec to r # N ew % T o tal
L is t in g s
B ld g a n d C o n s t r u c t io n 8 12 .5 %
M e t a l, C e r a m ic , R u b b e r , S t e e l 7 10 .9 %
P ro d u c t s
P a s t o r a l& A g r ic u lt u r a l 6 9 .4 %
R etal 6 9 .4 %
E n g in e e r in g / R & D S e r v ic e s 5 7 .8 %
A u t o / T r k P r t s & E q u ip - O r ig 4 6 .3 %
T e c h n o lo g y 4 6 .3 %
S e r v ic e s - M is c . 4 6 .3 %
C o n s u m e r & H o u s e h o ld 3 4 .7 %
P ro d u c t s
R e a l E s t a t e O p e r / D e v e lo p 3 4 .7 %
T e le c o m 3 4 .7 %
W ater 3 4 .7 %
C ir c u it B o a r d s 2 3 .1%
Food 2 3 .1%
T e x t ile 2 3 .1%
M e d ic a l- D r u g s 1 1.6 %
R e n t a l A u t o / E q u ip m e n t 1 1.6 %
T o tal 64 10 0 %
Source: KLSE, Milken Institute
Since the beginning of 2001, building products and construction companies made up 12.5 percent
of IPO activity, pointing to strong activity in the real estate market and sustained investment in
infrastructure projects. Metal and other industrial products companies made up 10.9 percent of new IPOs
and agricultural and retail products 9.4 percent each (Table 8).
The industrial product sector, with 29 percent of total listed companies, is the largest group of
issuers followed by trading and service firms (19 percent) and consumer products (Figure 27).
Figure 27: Largest sectors (total number of companies) on the KLSE
Infrastructure; 1% Hotel; 1%
Technology; 2% Mining; 1%
Trusts and Funds; 1%
Plantation; 5%
Finance; 7%
Industrial Products; 29%
Contruction; 8%
Properties; 10%
Trading/Services; 19%
Consumer Products; 16%
Source: KLSE, Milken Institute
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Debt
Issuers in the Malayan bond market are the government, Cagamas Berhad (discussed earlier), and
private corporations.
The national government and Cagamas are by far the largest issuers of bonds in Malaysia.
however the number of potential issuers has increased significantly after the minimum credit rating
requirement for issuance of private debt securities was removed and below investment grade private debt
securities can be issued. Despite recent positive development corporate issuance of bonds remains
depressed because of the lack of a true secondary bond market and narrow investor base. Nine new
domestic private sector debt securities were listed on the KLSE in 2001. No foreign corporation issued
debt on the Malayan market during 2000 or 2001.
Underwriters
Merchant banks, commercial banks and discount houses are the main underwriters of debt and
equity issues. The Malayan central bank exercises supervision on all underwriters. As of December 2001,
it oversaw 31 commercial banks, 12 merchant banks and 7 discount houses.
Local merchant banks underwrite and advise the majority of deals involving companies listed on
the KLSE. They are also the main underwriters of Islamic issues which are becoming an increasingly
important set of instruments available to firms in need of capital.
In 2001 local banks underwrote the majority of equity and bond deals (Table 9 and Table 10) by
both number and dollar volume. Commerce International Merchant Bankers, one of the largest Malayan
investment banks was the top underwriter of both equity and debt securities with more than 90 percent of
all equity IPOS and 17 percent of new bond issues. While global investment banks did not participate in
any equity underwriting, they were quite active in the debt market underwriting almost 40 percent of all
domestic issues.
Table 9 – Largest equity underwriters in Malaysia, 2001
NEW ISSUES- EQUITY % TOTAL VALUE # DEALS
COMMERCE INTERNATIONAL MERCHANT BANKERS 91% 4
ASEAMBANKERS MALAYSIA BERHAD 6% 5
K & N KENANGA SDN BHD 1% 2
AMMERCHANT BANK BHD 1% 3
HWANG-DBS SECURITES SDN BERHAD 1% 2
AMANAH MERCHANT BANK BHD 1% 1
PERWIRA AFFIN MERCHANT BANK BERHAD <1% 1
AFFIN MERCHANT BANK BHD <1% 1
SOUTHERN INVESTMENT BANK BHD <1% 2
SBB SECURITIES SDN <1% 1
OTHER <1% 1
TOTAL MARKER SIZE 100% 23
Source: Bloomberg
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Table 10: Largest debt underwriters in Malaysia, 2001
NEW ISSUES- DEBT # DEALS
COMMERCE INTERNATIONAL MERCHANT BANKERS 17% 36
DEUTSCHE BANK AG 14% 19
RHB SAKURA MERCHANT BANKERS BERHAD 12% 25
ASEAMBANKERS MALAYSIA BERHAD 10% 22
BANK UTAMA (MALAYSIA) BHD 7% 12
NOMURA SECURITIES CO LTD 5% 1
LEHMAN BROTHERS 4% 1
ABRAR DISCOUNT BERHAD 4% 5
KAF DISCOUNT BERHAD 4% 16
HSBC 4% 12
OTHER 18% 103
TOTAL MARKET SIZE 100% 252
Source: Bloomberg, Milken Institute
Buyers
Domestic buyers are the Employees Provident Fund (EPF), unit trusts, discount houses, domestic
financial institutions, insurance companies and private pension funds.
Ample data is available on the holders of federal government securities and Cagamas bonds, but
there is little information on the holders of private corporate debt. Equity holders are mainly financial
institutions, domestic investment funds and pension funds.
Pension Plans
EPF is the largest investor in the Malayan capital markets. As of December 2000 the EPF had a
total asset base of $ 48.81 billion. The fund has a ceiling of 25 percent in equities, and invests the balance
in bonds, cash and direct lending (Figure 28). Other government sponsored provident and pension funds
manage an additional $29.47 billion in assets.
Figure 28: EPF Asset Allocation
Money Market Property
Instruments 0%
23% Government
Securities
34%
Equity
22%
Bonds/Debentures
21%
Source: Normandy Research
The Malayan tax laws make it very attractive to set up private pension plans. Current tax
regulation makes pension contributions a tax-free roll up for employees and tax deductible for the
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employer. Growing private pension fund schemes have higher ceiling for equities, a 25 percent floor in
Malayan Government Securities, and a ceiling of 20 percent in non-Malayan assets.
Trusts and Insurance Companies
Unit trusts and insurance companies also manage a significant portion of Malayan domestic
assets. According to Bank Negara Malaysia at the end of 2001 unit trusts had $22.49 billion in assets and
insurance companies had assets of $13.73 billion.
Fund Management Companies
As financial intermediaries making asset allocation decisions, fund management companies are a
key player on the demand side of equity and debt markets. As of the end 2001, there were a total of 75
licensed fund management companies and 231 fund manager's representatives in Malaysia The fund
management industry held $13.73 billion in assets. Of these, $13.5 billion were local funds and $80.2
million foreign. The Malayan fund management industry allocated the majority of funds in equities (67.3
percent). A further 11.4 percent and 18.1 percent of assets were invested in fixed income and cash,
respectively (Figure 29). Other financial intermediaries, such as commercial banks, merchant banks and
discount houses hold a significant amount of government securities.
Figure 29: Fund management companies asset allocation
67.3% 62.9%
70%
60%
50%
40%
18.7%
30% 18.1%
11.4% 15.8%
20%
3.3% 2.7%
10%
0%
Fixed Income Equities Cash Others
2000 2001
Source: Normandy research
Individual Investors
In addition to institutional demand, domestic individual investors are active participants in
Malayan capital markets and their influence in price setting is believed to be quite strong.
A survey conducted in the mid-1990s profiled the typical individual investor in Malaysia as:
highly educated, an overseas Chinese, a professional or manager, and a short-term investor. Forty percent
of Malayan individual investors hold stocks for less than one week during bull markets.
According to the Executives’ Meeting of East Asia-Pacific Central Banks, in the mid-1990s
individual investors accounted for 95.3 percent of the total number of investors. Of this amount 83.7
percent were Malaysians and 11.6 percent foreign. As percentage of total market value, individuals held a
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much smaller 16.7 percent, of this 13.3 percent was held by Malaysian and 3.4 percent by foreign
investors.
With Malaysia becoming a less important market to international institutional investors after
1997, it is expected that the portion of equity held by domestic individual investors will expand over time.
Foreign Investors
Foreign buyers are mostly mutual funds and institutions. After the 1997 financial crisis, foreign
investment has been slow to return (see Figure 30), due in part to a series of restrictions on capital flows
imposed by the government. In 2000 the government eliminated a 10 percent tax levied on investment
profits which were sent out of the country. The tax, established after the crisis, was the last remaining
control over foreign investment in Malaysia’s stock market. Despite positive economic performance,
strong returns in the equity market and the elimination of capital controls, foreign portfolio investment
has not returned to pre-crisis levels.
Figure 30 - Foreign portfolio investment flow
4,353
4,500
4,000
2,503
3,500
2,440
3,000 2,299
2,062
2,500
$ Million
2,000
592
1,500 747 522
1,000
500
- (489) (314)
(500)
1995 1996 1997 1998 1999
Bonds Stocks
Source: World Development Indicators Database, the World Bank 2002 Edition
BANKING SECTOR
The sustained development of capital markets in Malaysia has been material in undermining the
relative importance of banking in the Malayan financial system. Malaysia’s bank assets to market
capitalization ratio is in fact among the lowest in the region (Appendix Table 2).
The Malayan banking system includes a broad spectrum of institutions: commercial banks,
financial companies and discount houses. Commercial banks make up the lion’s share of assets with 73
percent of total and loans with 75 percent of total. Finance companies. A detailed profile of the Malayan
banking sector is provided in Table 11 below.
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Table 11 – Malayan banking institutions
COMMERCIAL FINANCE MERCHANT DISCOUNT ISLAMIC
BANKS COMPANIES BANKS HOUSES BANKS
Assets $ Billion 131.45 28.79 9.71 5.55 3.68
Deposits $ Billion 92.55 21.74 21.74 - 2.97
Loans $ Billion 78.18 20.00 4.58 - 1.68
# Companies 31 19 12 7 1
# Branches 1742 930 22 122
Source: Bank Negara Malaysia
ALTERNATIVE SOURCES OF FINANCING
Venture Capital
Though there has been significant progress in development since the first venture capital (VC)
firm was funded in 1984, Malaysia’s VC industry is still in its infancy. With total funds of $450 million,
the industry accounts for a mere 0.39 percent of assets held by non-bank financial intermediaries.
Recognizing the importance of VC as an alternative form of financing, the Government has over
the years been very supportive of the industry and efforts have been focused on creating a favorable
environment for VC activities to thrive. Box 5 profiles the various initiatives recently undertaken by the
Malayan government and the private sector in order to foster growth of the local VC industry.
Other sources
Additional sources of non-bank financing for domestic corporations come from leasing, factoring,
development finance, housing credit and insurance (Table 12 ). Most of the assets of non-bank financial
intermediaries are held by pension funds (EPF and other government and private pension schemes),
insurance companies and unit trusts. Pension funds and unit trusts combined hold 78.5 percent of non-
bank assets. The vast majority of these assets are invested in capital markets, with a small percentage
invested in real estate. Funds available through traditional financing tools for small- and medium-sized
firms (such as factoring, leasing, development financing and credit cooperatives) amounted to $16.5
billion in December 2000.10 An additional $7.7 billion was held by urban and rural credit cooperatives.
Table 12 – Non-bank financing
VENTURE DEVELOPME PENSION UNIT HOUSING
LEASING CAPITAL FACTORING NT FINANCE FUNDS TRUSTS CREDIT INSURANCE
Assets $ Billion 1.66 0.45 0.53 6.61 78.32 11.39 1.74 13.74
# Companies/institutions 43 33 13 8 4 33 2 64
Source: Bank Negara Malaysia
10
According to Bank Negara Malaysia
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Box 4 -Venture capital initiatives
GOVERNMENT INITIATIVES
Special Funds for VC Industry
• A fund of $52.6 (RM200) million was launched to finance high-tech projects.
• Two VC funds for high-tech projects of $39.5 (RM150) million were launched. BNM channeled $ 26.3 (RM100)
million each to Mayban Ventures Capital Company Sdn Bhd and Commerce Technology Ventures Sdn Bhd. These
two companies contributed another $13.1 (RM50) million each. Total funds available for start-up companies
amounted to $78.5 (RM300) million.
• A $31.6 (RM120) million fund, MSC Venture One, was launched by the Malaysian Development Corporation Sdn
Bhd (MDC) to provide VC financing to information technology and multimedia companies.
Tax Incentives
VC funds are given full income tax exemption for a period of 10 years or the lifespan of the fund, whichever is
shorter, provided that 70 percent of the funds invested in venture companies are at start-up, seed capital and early
stage financing.
Infrastructure and regulation
The Government has sponsored several infrastructure projects aimed at catalyzing the development of a venture
capital community. These are:
• the Multimedia Super Corridor initiative (an infrastructure project designed to attract domestic and foreign high-tech
research and development companies ) including Cyberjaya and smart schools;
• Technology Park Malaysia and incubation centers;
• the acceleration of the university building program, including technology universities
• the establishment of research institutes such as MIMOS Berhad and SIRIM Berhad;
• an effective legal framework to protect intellectual property rights, including the implementation of Cyberlaws;
• the establishment of the Malaysian Technology Development Corporation;
• the establishment of MESDAQ to provide a viable exit mechanism;
• the establishment of the Human Resource Development Fund; and
• the development of the knowledge-based economy Master Plan.
PRIVATE SECTOR INITIATIVES
• Establishment of the Malaysian Venture Capital Association;
• the first business plan competition, Venture 2001, was launched on November 3, 2000, with the objective of
converting potential ideas into actual businesses, attracting venture capital companies and fostering an entrepreneurial
environment in Malaysia.
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PHILIPPINES
INTRODUCTION
The Philippines is one of the poorest countries in the Pacific Rim region. Despite the economic
slowdown of 2001, the country’s economy has been performing relatively well in the past year. GDP
growth for 2001 was 3.4 percent. Expansion was fueled by favorable performance of the agriculture
sector which grew 3.9 percent). For the Philippines, agriculture remains important both in terms of its
contribution to production and overall employment. Many manufacturing and services sector activities in
the country are in fact related to agricultural production.
The development of domestic capital markets will be a necessary step in order to expand the
country’s industrial base and reduce the country dependency on agriculture and exports.
The Philippines financial sector has grown a lot since its inception. The banking sector which has
historically held a focal point in all of the Philippine financial system, is still the prominent source of
financing for domestic firms. Recently however investment houses, stock brokerage firms, money market
funds and other fund management institutions have emerged. As a share of GNP, however, bank
resources remain the largest.
The 1990s saw some growth in the stock market in terms of volume turnover, capitalization,
number of listed shares, and investor participation. Despite this progress though, domestic capital markets
remain largely illiquid. Small number of listings, modest trading activities, and very limited demand for
equity and debt securities remain major barriers to further development of a viable capital market in the
country.
EVOLUTION OF PHILIPPINE CAPITAL MARKETS
Historical development of the market
The Manila Stock Exchange was established in 1927 by five American businessmen in order to
“promote and inculcate just and equitable principles of trade and business." A local Securities and
Exchange Commission was established in 1936 making the Philippines one of the first Asian countries to
have a regulatory body for securities. A second exchange, the Makati Stock Exchange was organized in
1963 and, after much opposition, started operations in 1965. Although the two exchanges remained
separate entities, they were trading the same listed issues. In 1993 the two exchanges merged to create the
Philippines Stock Exchange (PSE). Growth on the PSE has lagged considerably behind that of other
exchanges in the region and the market remains mostly illiquid.
The Philippines does not have a bond market per se. The government is the only issuer and
buyers usually hold issues until maturity. Government issuance has been relatively large. However, the
progress of the domestic bond market has been lackluster, with secondary trading almost non-existent.
Bond instruments are mostly illiquid.
Latest developments in the Capital Market
With per capita GNI in 1999 of $1,040, the Philippines is among the poorest countries in the
Pacific Rim region. Market capitalization to GNI is larger in the Philippines than in other poor countries
such as India and Indonesia and surprisingly larger than that of Korea. This is probably due to a smaller
62 of 74
role played by Philippine banks in financing the private sector of the economy as compared to Korea
(Appendix Figure 1).
Recently, market performance has been negatively affected by the economic recession. In the first
five months of 2002, the 30-stock composite index declined 12.8 percent for the year. For the 12 months
ending May 2002, the local market saw a decline of 11.7 percent compared to a decline of 15 percent
forthe S&P 500 in the same period.
The potential for domestically driven growth of capital markets will not increase until restrictions
on foreign portfolio investment are lifted and efforts are made to fuel the growth of the public securities
market.
CAPITAL MARKETS
Market size
As of April 2002, 235 companies were listed on the PSE for a total market capitalization of $46.7
billion. Trading on the exchange decreased dramatically in 2001 to 164.4 billion shares versus 659.2
billion shares traded in 2000 – a decrease of 75 percent. Trading value for the same period dropped 65
percent from $8.2 billion to $3.1 billion.
Figure 31 - Number of Listings and Market Capitalization of Philippines Exchange
90.00 250
Market Capitalization ($Billion)
80.00
70.00 200 Number of Listings
60.00
150
50.00
40.00
100
30.00
20.00 50
10.00
- 0
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
Market Capitalization (US$) Number of Stocks
Source: FIBV
Firm concentration in the Philippines is among the highest in the region and almost twice that of
the developed countries’ average, indicating a low level of progress for the market as a whole. The ten
largest Philippines companies made up 61.4 percent of total market capitalization and 64 percent of total
turnover value in 2001 (Appendix Table 1).
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Diversified holding companies are the largest type of firms both by number of listings (28 percent
of total) and market capitalization. These are followed by manufacturing, distribution and trading with 10
percent of listings each (Figure 32).
Figure 32 - Sector distribution by number of firms
Holding Hotels
28% 4% Manufacturing,
Distribution, Trading
10%
Mining
Food 6%
6%
Oil
Financial services 4%
3%
Other
Construction 1%
6% Banks
8% Pow er and Energy
Communications 2%
7%
Property
12%
Transportation
3%
Source: Philippines Stock Exchange
A requirement that two thirds of the company’s shareholders approve the issuance of bonds has
been a major impediment to the development of a local market for corporate debt securities. In fact, while
the largest Philippines private firms have been fairly active in the international bond market, they have
not been able to issue in the domestic market.
No significant bond listing or trading activity takes place on the exchange. No bonds were listed
on the exchange between 1998 and 2000. One government issue of $594 million was listed in 2001 and is
currently the only listing on the exchange. The secondary market for bonds comprises banks, investment
houses, and securities firms. As of March 2002, there were $17.2 billion outstanding in government
securities. These securities are mostly held and traded by the country’s financial institutions.
Market structure
The PSE is the only exchange in the country and the center of activity for transactions in
domestic equity. The exchange has gone through a process of modernization in recent years. In 1995, the
PSE launched its automated trading system, referred to as MakTrade, which was developed by the
Chicago Stock Exchange. The system routes, stores and automatically matches orders. It also maintains
market regulation and surveillance databases.
Government bonds are mostly traded between Accredited Government Securities Dealers
(AGDS) and other financial institutions. The operations of the AGDS are computerized and for settlement
are linked to the central bank book-entry transfer system. Most corporate bond issues are placed privately.
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Figure 33 - Philippines Government Bonds Outstanding
20
18
Amount Outstanding ($ Billion)
16
14
12
10
8
6
4
2
0
Mar-94
Mar-95
Mar-96
Mar-97
Mar-98
Mar-99
Mar-00
Mar-01
Mar-02
Sep-98
Sep-99
Sep-00
Sep-01
Sep-93
Sep-94
Sep-95
Sep-96
Sep-97
Source: BIS
Clearing and Settlement
The PSE has its own clearing house. As of 2001 clearing and settlement procedures were mostly
in compliance with G30/ISSA requirements (Appendix Table 4). Trading statistics for 2001 and 2002
show that activity on the exchange was light, with an average monthly turnover ratio consistently below
1%.
Rating agencies
Philrating is the only rating agency with offices in the country. It evolved from the Credit
Information Bureau, Inc. (CIBI), which was formed in 1982 through the joint efforts of the Central Bank
of the Philippines, the SEC (see below) , and the Financial Executives Institute of the Philippines. CIBI
was set up primarily to serve as a business and credit information center. Later on, CIBI was given the
mandate to implement the Government's policy of establishing and maintaining an efficient credit
evaluation and monitoring process in the financial system. The company, through its ratings group, began
credit rating commercial paper debt issues of Philippines companies in 1985. Since then Philrating has
rated 350 commercial paper issues. Commercial paper issuers come from a cross section of Philippine
industries. Moody’s, Standard & Poor’s and Fitch also rate Philippines bonds.
Regulators
The Security and Exchange Commission (SEC), established in 1936, is responsible for the
supervision and regulation of the domestic capital market. The SEC’s core functions are capital market
regulation, enforcement, company registration and monitoring,
In addition to registering traditional and non traditional securities, the SEC is responsible for
licensing and regulating market participants such as exchanges, broker dealers and traders.
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Bankruptcy laws, creditors rights
Three types of insolvency procedures are available: suspension of payments petition, voluntary
and involuntary bankruptcy.
The SEC has had jurisdiction over suspension of payments petitions since 1981. The agency
appoints a rehabilitation receiver, or a management committee, for corporations in distress. Upon the
appointment of the receiver all actions for claims against the corporation are suspended. The SEC also has
authority to evaluate the feasibility of continuing operations and of restructuring and rehabilitating
distressed corporations.
Jurisdiction over petitions for voluntary and involuntary insolvency resides with the court system.
The regular courts are hardly used for insolvency proceedings as corporations prefer to seek debt relief
from the SEC.
Corporations can file their debt relief petitions with the SEC by one of two ways. They can file a
petition for suspension of payments. This option is available when the debtor has enough assets to cover
all its debts. If a corporation does not have sufficient assets to cover its liabilities, it can file a petition for
suspension of payments accompanied with a request for the appointment of a management committee or
rehabilitation receiver.
Corporations normally resort to a petition for suspension of payments and the appointment of a
management committee, or rehabilitation receiver, for two basic reasons. First, the SEC is viewed as more
debtor-friendly than the court and that faster relief can be obtained from SEC, as its rules of procedure
and evidence are not as strict as those of the regular courts. Second, because upon appointment of a the
management committee, all actions by either secured or unsecured creditors are suspended.
There have been a lot of criticisms about the way the SEC has been handling debt relief cases. In
addition to widespread allegations of corruption the SEC has been accused of delaying insolvency
procedures and of being too lenient toward insolvent corporations..
MARKET PARTICIPANTS
Issuers
Equity
New issuance in the domestic equity market has been small in the past few years and is declining.
According to the international federation of exchanges, in 2001 a total of $143 million dollars were raised
in the domestic equity market. Of these, $4.7 million were raised by three newly listed companies and the
remaining $138.5 from already listed companies. The amount of new equity issues decreased by 83
percent from the 2000 when corporations issued equity for $831.6 million.
Underwriters
The main underwriters of equity and debt in the Philippines are large global financial services
firms. The ten largest underwriters in 2001 were all foreign banks (Table 13). More than half of the total
deal value in 2001 was generated by new debt issuance by domestic corporations in foreign markets.
Domestic corporations raised $34 billion in the international bond market through ten deals.
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Domestically, due to the slow development of capital markets, the majority of corporations raised
capital in the form of bank loans.
Table 13: Largest Underwriters in the Philippines, 2001
NEW ISSUES - DEBT AND EQUITY % TOTAL VALUE # DEALS
J.P. MORGAN 33% 6
SALOMON SMITH BARNEY 23% 4
HSBC 8% 1
CREDIT SUISSE FIRST BOSTON 7% 2
UBS WARBURG 5% 1
DEUTSCHE BANK AG 5% 1
CITIBANK NA 3% 1
ING 3% 1
CREDIT AGRICOLE INDOSUEZ 3% 1
WESTDEUTSCHE LANDESBANK GZ 2% 1
OTHER 6% 10
TOTAL MARKET SIZE 100% 29
Source: Bloomberg
Buyers
Domestic individual investors make up the largest group of equity investors.
The main investors in the bond market are the banks, insurance companies and in some cases,
corporate and institutional investors which have funds that they are willing to place in longer-dated issues.
As described in the market structure section of this report, these institutions either hold the issues to
maturity or trade them over the counter.
Educational plans, life insurance, and pension funds are a increasingly important participants in
the domestic capital market. In the Philippines, these types of firms are known in aggregate as the pre-
need industry. Pre-need firms amass a substantial amount of funds from the lower-income segments of
society and invest these funds in capital market instruments. Their success and development will be tied
to a successful development of the local capital markets.
The popularity of these products has grown significantly in the last few years. Between 2000 and
2001 the number of plans sold increased 41.3 percent from 582,003 to 822,494. The industry had $738.3
million in assets under management as of June 2001. Thirty-one percent of the total assets under
management were allocated to government bonds, 24 percent in equities and the rest in real estate and
other types of investments.
Foreign Investment
Foreign investment in the Philippines is subject to several restrictions. A separate classification
of shares is done to monitor the equity ownership of both Philippines and foreigners.
Common shares are classified into Class A and Class B; both classes have the same privilege and
receive the same amount of dividends. Filipinos can own both classes while foreigners can only purchase
Class B shares. Under the Philippines Constitution, at least 60 percent of the capital stock of a company
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must be owned by Philippine citizens with the remaining 40 percent open to foreign ownership. Some
industries such as mass media, rural banks and retail trades are reserved solely for Filipinos. There is no
reliable data on the composition of foreign investors in the country. Foreign portfolio investment in the
Philippines equity market is still significantly below the pre-1997 crisis levels (Figure 34).
Figure 34 - Foreign portfolio investment flows in the Philippines
4,210
4,500
4,000
3,500 2,631
3,000 2,498
$ Million
2,500 1,961
2,000 1,333
1,500 1,110 797
1,000 454 422 290
500 73 151
0
1995 1996 1997 1998 1999 2000
Portfolio investment, bonds Portfolio investment, equity
Source: World Development Indicators Database, the World Bank 2002 Edition
BANKING SECTOR
The banking system lies at the heart of the Philippines financial system. Bank assets as a
percentage of GDP are nevertheless among the lowest in the region, due in part to the fact of the country’s
dependency on foreign investment and government spending.
There are four types of banking institutions in the Philippines: commercial banks, government
banks, thrifts and rural banks. Commercial banks are by far the largest type of institutions holding more
than 90 percent of total assets for the sector. Thrifts and rural banks hold 7 and 2 percent of total assets
respectively. In addition to performing traditional banking services, so called “universal” commercial
banks can exercise the powers of investment houses, invest in the equity of companies engaged in
businesses not related to banking and own up to 100 percent of the equity of financial firms other than
commercial banks.
Of the total assets in the commercial banking system,, 83 percent are held by domestic banks and
17 percent are held by foreign banks (Figure 35).
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Figure 35 – Share of total assets held by various types of commercial banks (March 2002)
Foreign (Regular
commercial)
14%
Private Domestic
(Regular
commercial)
8%
Foreign
(Universal)
3%
Private Domestic
Government
(Universal)
(Universal)
62%
13%
Source: Philippines Central Bank
ALTERNATIVE SOURCES OF FINANCING
In addition to the banking institutions mentioned above the central bank regulates a host of non-
banks with quasi-banking functions. These included 52 finance companies, 8,566 pawnshops, 11
investment companies, 13 lending investors, 171 non-stock savings and loan associations, 8 venture
capital corporations, 6 mutual building and loan associations and 2 government non-bank financial
institutions.
The role of Venture Capital
Venture capital financing has not yet developed in the country. Venture capital as a percentage of
GDP remains among the lowest in the region. The Philippines’s government has not shown a
commitment in fostering the development of a domestic venture capital industry or in attracting foreign
investment through the construction of technology parks or similar projects. According to the Board of
Investments, 232 new projects were approved in 2001, mostly in the infrastructure and industrial services
sector, plus public utilities and information technology firms.
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APPENDIX
Appendix Figure 1: Development of Domestic Capital Market.
HIGH
UK
United States
Malaysia
Mkt. Capitalization/GNI
EMU
Philippines Japan
India Korea
LOW
Indonesia
LOW GNI per Capita in $ HIGH
Source: Milken Institute
Appendix Figure 2: Local Market Performance for the 12 Months Ending May 2002
Indonesia, 70.3%
Korea, 48.5%
Philippines, -11.7%
Malaysia, 37.2%
India, -9.1%
Dow Jones,
-9.0%
S&P 500, -15.0%
NASDAQ, -20.14%
Source: Emerging Markets Database, Local Exchanges
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Appendix Table 1: Firm Concentration
2001
Country Market Cap. of Turnover Value of
(Exchange) Top 10 companies Top 10 companies
Korea 56.4% 37.5%
Malaysia 37.8% 12.0%
Philippine 61.4% 63.6%
Singapore 60.0% 27.9%
NYSE 23.1% 13.4%
Euronext 32.9% 19.0%
U.K 45.7% 36.3%
Hong Kong 64.1% 44.7%
Thailand 42.7% 23.1%
Japan 21.5% 21.0%
Source: International Federation of Stock Exchanges
Appendix Figure 3: GNI per capita, Atlas method (current United States$)
India 450
Indonesia 570
Korea, Rep. 8,910
Malaysia 3,380
Philippines 1,040
European Monetary Union 21,730
United States 34,100
United Kingdom 24,430
Japan 35,620
Source: The World Bank
Appendix Table 2: Corporate dependence on banking system
Bank Assets/ Total Mkt Cap.
India 2.95
Indonesia 1.46
Korea 1.25
Malaysia 0.84
Philippines 0.79
US 0.61
Source: International Financial Statistics May 2002
71 of 74
Appendix Table 3: Venture Capital Funds % GDP
VC Funds /
Country
GDP
India 0.06%
Indonesia 0.26%
Malaysia 0.05%
Philippines 0.07%
South Korea 0.27%
U.S. 0.49%
U.K. 0.70%
Source: Milken Institute Capital Access Index
72 of 74
Appendix Table 4: Compliance with G30/ISSA Recommendations
Compliance with G30/ISSA Recommendations:
Philippines
Indonesia
Malaysia
Korea
India
Recommendation
1a Trade comparisons between direct market participants by T+0
1b Matched trade details should be linked to the settlement system
2 Indirect market participants to achieve affirmation by T+1
3a Central depository, broadest possible participation
3b Widest possible range of depository eligible instruments
3c Immobilisation/dematerialisation to the utmost extent possible
3d Compatible rules and practices in case of multiple CSDs
4a Real Time Gross Settlement system
4b Trade netting system as per "Lamfalussy/Recommendations"
5 Delivery versus Payment (DVP) as defined by ISSA
6a Same Day Funds for securities settlement
6b Same Day Funds for the servicing of securities portfolios
7a A rolling settlement system should be adopted by all markets
7b Final settlement for all trades by T+3
8a Securities lending and borrowing should be encouraged
8b Existing regulatory and taxation barriers should be removed
9a ISO Standard 7775 (Securities messages)
9b ISO Standard 6166 (ISIN numbering system)
Implemented 16 14 14 15 8
Not Implemented 2 4 4 3 10
Implemented
Not Implemented
Planned
Source: G30/ISSA Recommendations Status Review
73 of 74
Appendix Figure 4: Average value traded daily
376.1
400
350
284.4
300
250
US $ Million
216.7
200
126.7
150
85.5
87.4
100 63.2
38.7 32.7
50 12.7
0
Jakarta Malaysia Philippine Singapore Thailand
2000 2001
Source: International Federation of Stock Exchanges
Appendix Figure 5: Capital raised in 2001 by domestic companies
16,917
18,000
16,000
14,000 12693
11295
12,000
Us$ Million
10,000
8,000
6,000 4047
2836 3204
4,000
707 143
2,000 528 439
0
a
p.
n
nd
na
a
ia
e
ng
es
si
or
di
pa
es
Re
in
i
la
Ko
ay
Ch
In
ap
Ja
n
pp
ai
a,
al
do
ng
ng
Th
i li
re
M
In
Si
Ho
Ph
Ko
Capital raised by newly listed companies
2001 Capital raised by listed companies
Source: International Federation of Stock Exchanges
74 of 74
