Asia has been working on a capital markets union for almost two decades. Why is this process challenging? And is it fair to draw parallels between the Asian and European experience? Stefania Palma reports.

Asia's capital markets union struggle embedded

The idea of a capital markets union in Asia has been on the table for almost two decades, but progress has been slow and often limited to the region’s more developed countries. This is understandable given that advanced financial markets such as Singapore occupy the same economic bloc as Myanmar, which had a dysfunctional financial system for most of the 50-year period of military rule that ended in 2011.

Pundits often cite the EU, which is itself working towards a capital markets union, as a template for Asia. But is this parallel fair or even useful?

Small sample

So far, Asia’s capital markets union mainly involves the Association of South-east Asian Nations (Asean) as well as China, Japan and South Korea. But progress has been limited to specific sectors or countries within this group. “We are at the initial stages of trying to harmonise a regional market. I wouldn’t think of Asean as a single capital markets union today by any stretch of the imagination,” says Frederic Neumann, co-head of Asian economic research at HSBC.

On the bond market front, Japan, Malaysia, the Philippines, Singapore and Thailand have agreed to a single submission form with a standardised disclosure template for issuances in the professional market, which is dominated by institutional investors.

Noritaka Akamatsu, senior adviser for sustainable development and climate change at the Asian Development Bank, says the professional bond market is the best place to start pushing for integration because regulatory requirements are quite flexible. “Standardising [Asian] public markets, [however], is a daunting task because of very different levels of market development and investor sophistication across the region,” he says.

Other countries are keen on joining this initiative, but not everyone is ready. South Korea is interested but only has a private placement sector rather than a professional bond market. Vietnam and Indonesia are also keen but lack a professional market.

Meanwhile, Singapore, Malaysia and Thailand have signed a memorandum of understanding that, when fully implemented in September, will allow companies issuing bonds or stocks to use a single prospectus that complies with common standards across these markets.

Selective progress

Agreements such as these show that capital markets integration in Asia is still driven by and is mostly limited to more developed economies. It is likely that Singapore or Kuala Lumpur will become capital markets hubs while less developed markets trail behind. “If you have a truly integrated financial market, there is a tendency to have high concentration in a more advanced hub. Economies of scale in capital markets are just vast,” says Mr Neumann.

Mr Akamatsu adds: “In capital markets, liquidity generates more liquidity. If you link several markets, the most advanced markets will attract more and more liquidity with more and more investors and issuers.” 

But a higher concentration of liquidity in more developed markets is not necessarily a bad thing if it means local firms have access to cheap financing, argues Mr Neumann.

Deepening local currency markets could give sophisticated markets a more central role in Asia’s capital markets union. Regional banks, such as Japanese lenders, expanding in Asean countries could deepen local bond markets, printing local currency bonds to fund their corporate clients’ expansion across Asia.

But Keith Pogson, global assurance leader of banking and capital markets at EY, says liquidity in local currency bond markets will not build quickly. He gives Thailand as an example. “Thai investors often think of the world in US dollars,” he says. “Local currencies are not thought of as free-floating currencies or yield curves but more as connected to a US dollar bloc. Professional investors and the private wealth community are the bulk of bond buyers and they generally do not take domestic country risk. They are more likely to buy a local name in US dollars.”

According to Mr Pogson, market volatility, which skyrocketed after the UK voted to leave the EU in a referendum in June, is dampening investor appetite for high-yielding emerging market currencies. “As rates remain low both in the US and in Europe, and especially now that the EU is in disarray, why would someone issue a 4% Thai baht bond instead of a 1% US dollar at volume and liquidity?” he asks. “If investors want more yield, you can put money in a bank deposit for a bit more than 1% or you can buy bank stocks instead of baht bonds.”

Hurdles for all

But integration hurdles are not limited to Asia’s less sophisticated markets. The entire region has a bias towards bank lending over capital markets. “Local banks have very strong relationships with local corporations and that is unlikely to go away,” says Mr Neumann. “Having intimate knowledge of companies is better for banks to assess risk. Some regional companies might not be known to a bond investor in Singapore, [for example].”

Relaxing barriers to cross-border investment across Asia is also key to reaching a capital markets union. While in the EU investment thresholds are no longer a problem, foreign ownership of local firms or sectors is still restricted in many Asean countries.

“[This] means you could be crowded out as a foreign buyer, or that there might be a pricing differential versus domestic investors,” says Mr Pogson. In addition, some large institutional investors in Asia are still expected to invest in local assets, as in the case of Malaysian pension funds.

Taxation is a further hurdle to establishing an Asian capital markets union. “Every Asean country has entered an avoidance of double taxation treaty with various other countries. But two different treaties may not be identical,” says Florence Yip, Asia-Pacific tax leader of financial services and asset management at PricewaterhouseCoopers.

Ms Yip believes tax authorities are often brought in too late in international cross-border projects. “Finance ministers come together and shake hands and then they remember there is stamp duty and withholding tax,” she says. In the EU, there is no withholding tax because all member states’ domestic laws comply with the regional directive. In Asia, there is no such organisation, which means withholding tax and transaction costs still limit investment flows.

But it would be untrue to say the EU has ironed out all taxation issues. Filing for national financial transaction taxes (FTT), for instance, is still uncoordinated across countries and it is a headache for international investors. An EU-wide FTT is still being discussed but is considered unlikely to happen. “Unless governments decide a specific institution [is responsible for] FTT, stock exchanges or brokers will never [take it on],” says Ms Yip.

Extra caution

In Asean countries, the relatively slow pace of capital markets integration is due in part to the sense of caution that has dominated the continent since the Asian financial crisis of 1997 and the global financial crisis of 2008. This still stifles cross-border payments and foreign exchange flows. “Retaining influence over foreign exchange is still a desired policy goal [in Asia]. [But] unless you fully liberalise foreign exchange transactions and cross-border payments, it is tough to establish an Asean capital markets union,” says Mr Neumann.

Caution is also one of the reasons Asean countries opted for a hub-and-spoke settlement model. Implementing the region-wide Euroclear model would have required a lot of capital, an answer to the politically thorny question of headquarters location and central banks to fund settlements in their currency outside their jurisdictions. Central banks in Asean countries were not willing to do so as it was seen as relinquishing control over monetary policy. If reserves built up outside their own country, money would flow in when the central bank raises interest rates, effectively pushing rates back down again.  

It is also worth noting that Asia faces more hurdles than the EU in establishing a capital markets union because it does not have a single currency, supranational agencies, a regional central bank nor a regulator that sets directives.

“EU integration was very much top-down. Asean and Asia more broadly are definitely not going to do that in the foreseeable future,” says Mr Akamatsu. “Asia wants bottom-up, market-based integration. Authorities will agree on principles to guide the process and create an enabling environment, but they will let the markets follow.”

Using the EU as a template for Asean’s capital markets union is inaccurate, adds Mr Neumann. “The process is more ad hoc and is usually for those that would like to opt in. It is a menu kind of approach,” he says. “To some extent it is justified because there are vast differences of per-capita income and access to financial services across Asean countries.”

Although this bottom-up approach might slow integration, Asia has a trick up its sleeve when it comes to capital markets growth. “If China really opens up its capital markets, it will not be inconceivable for a Thai company to raise financing by printing a bond in Shanghai, raise renminbi and swap it back into baht. It could be one of the most cost-effective ways to raise financing,” says Mr Neumann. After all, China’s bond and equity markets are some of the biggest in the world. Mr Neumann adds: “If you ask me where this is all headed, I wouldn’t underestimate China.”

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