Asiaweek Article

August 30, 1999 PSE MEMO FOR BROKERS NO. 314-99 SUBJECT : Asiaweek Article We would like to provide, for your information and reference, a copy of a feature article from Asiaweek issue dated 13 August 1999, entitled "Survival of the Fittest What the rush to overhaul bourses in Hong Kong and elsewhere means for companies and investors." We hope that this will bring about a clearer understanding of our domestic market position vis-a-vis changes in the rest of the world. cdt (SGD.) ATTY. RUBEN L. ALMADRO Officer-in-Charge SURVIVAL OF THE FITTEST What the rush to overhaul bourses in Hong Kong and elsewhere means for companies and investors Capitalists! The revolution has started! If you're wired and have money to spare, you can be part of it. Across Asia, the growth of online stock trading means that it takes just a few clicks of a mouse to buy shares in your home bourse or in a market an ocean away. Soon, you will be able to link directly to networks that channel orders straight to the market of your choice and computer systems that automatically match buyer and seller in seconds. Already, there are "day traders" in Hong Kong who stay up all night buying and selling U.S. stocks as if they were in New York ( see story page 44 ). Hong Kong is at the epicenter of the region's financial seismic shift. Last week, after months of sometimes bitter, wrangling, its stock and future exchanges agreed on terms for a merger. If members approve the proposal next month, the two bodies would be demutualized management will be taken away from the member brokers, most of whom are small outfits, and handed to a board of directors. The two exchanges will continue to operate separately, but they will both be run by a single private, commercial enterprise which will eventually list itself. There's more. By the middle of the next year, the stock exchange will be running a new automatic matching and execution system software called AMS/3, which will allow investors to trade directly on the bourse instead of going through brokers as they do now. The futures exchange has completed testing a similar system for Hang Seng Index derivatives. One online outfit. Interactivebrokers.com, a subsidiary of the Timber Hill group of the U.S., has been letting clients directly trade Hang Seng 100 futures and options. Says Interactivebrokers.com, managing director David Friedland: "In an automated environment, you need only two people to handle 10,000 transactions a day. You have 50 operators in a non-automated bourse and lots of running around." Others in Asia are moving in the same direction. Singapore plans to demutualize late this year and list in 2004 ( see table next page ). The Australian Stock Exchange (ASX) did both last October London and New York are thinking things over. Meanwhile, alliances are being formed or mooted almost every week. In the U.S., the National Association of Securities Dealers Automated Quotation System or Nasdaq, which has already merged with the smaller American Stock Exchange, and the New York Stock Exchange are deep in talked. Nazdaq vs. Launching a venture in Japan with billionaire Son Masayoshi's Soltbank and is exploring partnerships with other Asian exchanges Bourses in London and Frankfurt are set to merge as are exchanges in Sydney and Auckland. These developments raise significant questions for the region, given our small market share of the world market," says Richard Humphry, managing director of the ASX. He notes that U.S. bourses account for more than half the world's total stock market capitalization, with European ones comprising a third and Japan 10%. If the ASX had not acted, he say, "you would have to wonder how long we could have survived in an era of global competition. We are already seeing virtually straight through ordering from investors to the market. When that happens across national borders, it will be a case of survival of the fittest." Humphry also worries that local companies may leave AXS and list instead in more liquid and better-run jurisdictions. So far, demutualization and listing seem to be working wonders in Australia. The All Ordinaries Index is up 18% since October. Market capitalization has soared 59% to $390 billion. "We changed from an organization structured primarily to serve its stockbroker-members to a company with a clear commitment to generating competitive returns for its shareholders, while having regard for the interests of all its customers and those of the broader economic community," says ASX's Humphry. The pay-off for investors more varied and cheaper products and services, and an exchange that strives for efficiency, transparency and responsiveness an example for other listed companies. CHANGE OR DIE Hong Kong will be among the world's most advanced exchanges if all its restructuring plans fall into place Demutualization/ Merger/ Public listing Purchase Alliances Hong Kong Demutualization should be Merging stock and futures Talking with Nasdaq; a future voted on in September exchanges deal with China is possible Plans to merge with Sydney Australia Demutualized and publicly Futures and New Zealand In discussions with Nasdaq (Sydney) listed in 1998 Stock Exchange Singapore Plans to demutualize in Will merge with SIMEX late Plans for trading system late 1999 and list in 2004 this year with Taiwan this year Tokyo Exploring the possibility of None In discussions with the New demutualization York Stock Exchange Deutsche Demutualized in 1994 and Derivatives and clearing Exploring deal with London. Borse considering a listing integrated into Deutsche Europe wide exchange may (Frankfurt) Borse in 1994 come later Stockholm Demutualized in 1992 Merged with Swedish May join with Osio, Helsinki derivatives market in 1998 and Copenhagen Nasdaq Considering going public Merged with American Stock Softbank in Japan; others in (New York) Exchange in 1998 Asia being considered NYSE Recently said it would May buy an electronic trading Exploring possible alliance consider demutualization system for online dealing with Tokyo exchange Hong Kong hopes to reap the same rewards. When he announced the reforms, in March. Financial Secretary Donald Tsang said they were meant to improve the markets' efficiency and competitiveness. Minimum commissions to protect small brokers, no one can charge clients lower than 0.25% of a transaction's value will be replaced by negotiated fees. That's the key to lowering costs in Hong Kong, says market analyst David Webb in his Webb-site.com commentary. "A truly liberalized, discount brokering market depends on minimum commissions being abolished." Adds Patrick Henry, the Hong Kong based partner in the financial services practice of consultants Deloitte Touche Tohmatsu: "The changes will make the brokering community more competitive. And it will also make Hong Kong more competitive." Small brokers that currently dominate the stock and futures exchanges will be greatly affected, but they are likely to vote for the reforms because of the sweeteners ( see story page 46 ). The government has made clear it will not hesitate to ram the changes through if needed. As Humphry says, it's a matter of survival. "Globalization of markets can't be reversed because it would require uninventing the Internet and undoing the whole computer and communications revolution," says the ASX chief. The Internet boom has widened access to all sorts of information, increasing the knowledge and sophistication of the investing public. The launch of electronic communications networks or ECNs, among them Island, Reuters' Instinct and Archipelago in the U.S., is creating virtual alternative markets to the established exchanges. These high-speed systems allow direct matching of buy and sell orders almost instantaneously, opening trading even to non-professional players. ECN trades now account for more than one of five transactions on the Nasdaq board. New York-based Island ECN has even applied to the U.S. Securities and Exchange Commission to be recognized as a full-fledged stock exchange. Says Andrew Sheng, chairman of the Hong Kong Securities and Futures Commission: "ECNs are luring trades away [from existing exchanges] by offering quick service and miniscule fees. Older markets are fighting back by offering longer trading hours, demutualizing, investing in technology and establishing alliances aimed at making themselves more competitive." That is why Hong Kong is pulling out all the stops to allow direct trading. (In the region, only Australia has a direct-trade system in place.) Once AMS/3 is launched, investors can do straight-through ordering via the Internet or any brokerage dealings system. The flow of transactions will be regulated only by the speed of data lines and computer modems. The trading hall in Exchange Square can practically be turned into a museum. "This is a trend stock exchanges cannot stop," says Chan Yi-ping, vice president for strategic planning and business development at Italade Technology Ventures in Hong Kong. "There's definitely no avoiding the tremendous impact. Investor demand will come when the gateway is opened." And perhaps more volatility? Says Chan: "If a lot of retail investors come in, the volatility would be offset by volume." Hong Kong brokers, financial-service providers and other players must sustain the momentum. "Whatever Hong Kong does, major U.S. brokers will offer online trading in U.S. and London-listed stocks, bonds and mutual funds to Asian investors," says Henry Birdseye Weil, a senior lecturer at the Massachusetts Institute of Technology's Sloan School of Management. He was commissioned to produce a study on the consequences of Internet services for the Hong Kong market. By 2010, Weil expects 30% to 40% of Hong Kong's total retail trading volume to be online. "Overall, the profitability of traditional brokerage services will be-seriously damaged," he warns. "The traditional service providers who proactively anticipate and exploit new technologies will fare well, but many will be slow to react." Foreign brokers offering online services are making inroads. U.S. discount brokerage Charles Schwab is estimated to account for as high as 70% of all Asian online trades. "Besides as usual is not an option," Weil concludes. "A cautious or complacent wait-and-see attitude will cause Hong Kong to be marginalized. Hong Kong faces a very serious threat that its retail market will be 'cherry-picked' by foreign financial-services groups." These rivals will aim to lure wealthy and active investors as customers, shrinking Hong Kong's retail investor base. Says Weil: "If nothing is done, erosion on the demand side will lead to reactions on the supply side, and vice versa. Red chips would increasingly list in London and the U.S. More fund managers would shift their base out of Hong Kong. As a result, Hong Kong would lose substantial trading volume and asset balances to other financial centers." More initiatives are needed, Regulations must be adapted for the Internet Age. Exchange and broker attitudes must be reoriented so that the customer whether an investor or a company in search of funds is king. At the moment, Hong Kong seems to be pulling ahead of its Asian rivals. In addition to demutualization and direct trading, it is also forming a second board to list small and medium-sized companies and launching a mandatory pension fund scheme. There are plans as well to make stock market trading available through mobile phones. "More people will see that investment in equities produces higher returns than their conventional savings accounts," says James Eng, executive director of Guoco Management. Its subsidiary, Dao Heng Bank, recently announced it would offer bank services via hand phones. Still, Hong Kong (and other Asian bourses) cannot afford to be complacent. Nowadays, the arena is everywhere and the fight for survival never ends.