The head and tailwind effects of global reforms on the ASEAN post-trade environment. Deutsche Bank Global Transaction Banking

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1 Deutsche Bank The head and tailwind effects of global reforms on the ASEAN post-trade environment Boon-Hiong Chan Head of Market Advocacy Asia Pacific & MENA Product & Technology Management

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3 The New Normal Set within a 'New Normal' environment in Asia, this white paper aims to offer insights into opportunities for the ASEAN securities post-trade environment and some practical issues and challenges that the ASEAN region could face in its journey towards achieving a more interconnected ASEAN capital markets and economic community. After the 2008 global financial crisis, the United States of America (USA) and the European Union (EU) were focused on addressing systemic risks, bank capital adequacy and transparency, while in the Asia Pacific region, there was a sense of economic growth. Although the USA and EU reforms captured the attention in the Asia Pacific region, frequent reviews and modifications made to these reforms have led to a wait and see approach in this part of the world. In the aftermath of the global financial crisis, Asia s stock markets reached record levels 1. China also started to liberalise its currency 2 and its capital markets, and was reporting strong GDP performance 10.3% in , while India s GDP grew by 10.4% the same year 3. Asia as a whole recorded 8.3% growth 4 and the Association of South-East Asian Nations (ASEAN) s GDP grew by 7.8% 4. However, from 2011, the environment in Asia began to change and market volatility became more pronounced. Some economies even feared another financial crisis in 2013 as global regulations and initiatives were implemented across borders. The potential and actual impacts on the Asian banking and finance industry became evident. Together with the more challenging economic environment, these factors have paved the way for a New Normal in the region. The 'New Normal' environment is characterised by higher levels of uncertainty, greater interdependency between financial markets and their participants, the need to understand and implement a diverse set of new and interconnected rules, and changing business approaches by financial market participants. The reactions of Asian markets and the industry to economic and regulatory challenges add to this changing environment. Therefore, the information and knowledge of global initiatives requirements combined with local market practices will be the catalyst for what will become Asia s future path Internationalisation of the renminbi, Haihong Gao and Yongding Yu, BIS ASEAN Finance and Macro- economic Surveillance Unit Database 3

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5 Headwind effects of global reforms and initiatives on the ASEAN Exchanges post-trade environment The ASEAN region has been increasing its momentum towards achieving its goal to become an ASEAN Economic Community by 2015, and enhancing its identity as another pillar of Asian growth. Today, the ASEAN s GDP represents USD2.3 trillion. Meanwhile, a number of key global reforms and initiatives have been passed, with effective dates starting from Some of them have significant impacts on the ASEAN banking, finance and securities servicing industry. This paper will focus on the Committee on Payment and Settlement Systems (CPSS) and the International Organisation of Securities Commissions (IOSCO) s Principles for Financial Market Infrastructures (PFMI), Foreign Account Tax Compliance Act (FATCA) and Basel III, which all require implementation in the ASEAN region. We will examine their potential impacts on the ASEAN Exchanges post-trade environment including the market infrastructure, as well as its participants such as investors, broker dealers and banks. While these global reforms were being finalised in 2012, the ASEAN Exchanges Trading Link consisting of the stock exchanges of Singapore, Malaysia and Thailand, was launched. The combined USD2 trillion domestic market capitalisation of the seven bourses 5 in the six participating countries would rank it as one of the top 10 exchanges in the world 6, alongside bourses from China and India. In addition, plans were announced to foster greater connectivity between these stock exchanges post-trade financial market infrastructures which refers to securities clearing and settlement in order to gain more efficiencies in cross-border transactions. This pan-asean initiative creates new synergies by aggregating the individual members strengths, which otherwise would only co-exist side by side. However, the ASEAN Exchanges post-trade initiative will now have the additional task of taking into account the effects of global reforms. Indeed, if implementation is not looked at holistically across the different ASEAN jurisdictions, it could impact the overall goal of these countries to become a closer community. Principles for Financial Market Infrastructures (PFMI) and their impacts on ASEAN post-trade interconnectivity Financial market infrastructures including payment systems, Central Counterparties (CCPs) and Central Securities Depositaries (CSDs) play an important role as they centralise post-trade activities that involve liquidity. They also help to reduce counterparty risks and to ensure certainty of settlement and effective transfer of ownership. Their ability to effectively support the fulfilment of transactions became evident in the aftermath of the 2008 global financial crisis. On the other hand, it became clearer that they could also pose systemic risks arising from the close linkages between them. To address these risks, foster transparency and promote greater financial stability within market infrastructures, a revised set of PFMIs was published in April 2012 by CPSS-IOSCO. The related risks pertain to infrastructures stability, tiered participation, asset ownership, credit and stressed situations, and they can affect the direct and indirect participants of financial market infrastructures. The comprehensive PFMIs seek to mitigate these risks and their potential sources. For example, CCPs are recommended to maintain sufficient financial capabilities, margins and other resources to cover credit risk exposures from direct participants default under extreme but plausible situations. The PFMIs recommendations on operational best practices to offer individual segregated or omnibus accounts with goals to protect assets vis-à-vis available legal framework, can in turn lead direct participants to extend similar choices to their clients who are indirect participants of the CCPs. The risks in an interconnected CCP and CSD posttrade system are also stressed in the PFMIs. As a result, even though interconnectivity within the ASEAN region s financial market infrastructure is at an early stage of development, applying the PFMIs could still influence market participants services, costs and risk management, as they relate to clearing and settlement. In addition, PFMIs have a certain Disclosure Framework to ensure transparency. In April , CPSS-IOSCO announced that they would begin monitoring PFMI implementation globally. The ASEAN jurisdictions included in their announcement were Indonesia and Singapore World Federation of Exchanges, as at 31 December

6 Foreign Account Tax Compliance Act (FATCA) compliance and ASEAN market participants need for additional internal resources Introduced in 2013 by the USA s Internal Revenue Service (IRS), FATCA aims to prevent the evasion of US taxes by identifying USA taxpayers who hold US-sourced income and financial assets in foreign financial institutions (FFIs) and other offshore accounts. FATCA will have a significant impact on financial institutions globally as it imposes legal entity registration, a series of due diligence, as well as withholding and reporting obligations. FFIs operating in countries that have entered into the Intergovernmental Agreement (IGA) Model 1 with the USA will need to report information on US account holders to their national authorities, who will then liaise with the IRS. In the IGA Model 2, FFIs will report information directly to the IRS rather than their local jurisdictions. For countries that do not sign an IGA, the failure of entities in these countries to meet these obligations could result in a 30% withholding tax on fixed or determinable annual or periodical payments and gross proceeds. 8 Significantly-Strengthen-Framework-for-International-Tax-Cooperation.aspx FATCA has a phased-in implementation timeline that starts from 1 July 2014 until In the ASEAN bloc, as of June 2013, Singapore 8,9 is the only jurisdiction that had formally announced its intention to enter into an IGA. The resources needed to comply with FATCA could compete with anticipated changes in the ASEAN Exchanges clearing and settlement landscape. This would include legal, tax and compliance resources in reviewing IGAs details and legal entity registrations, operational changes in client on-boarding and technology implementations to ensure reporting and withholding compliance. Driven by IGAs, brokers may need to be FATCAcompliant if they are holding assets on behalf of funds and if they are receiving US-sourced income on behalf of these funds. Therefore, this could create challenges during the allocation of stakeholders internal resources required to incorporate changes to IT systems, operational procedures and legal arrangements. In this era of global reforms, regulators and market participants in various jurisdictions are faced with the challenge of ensuring that they have a holistic view of all these changes when information is surfacing sporadically. Changes are unavoidable, so being able to efficiently adapt to these changes is important, especially when internal resources are limited. It could otherwise affect a market s attractiveness and shareholder value. As a result the importance of forming such a coherent view over the implementation of these global reforms cannot be overemphasised.

7 Basel III s impacts on the ASEAN post-trade ecosystem Basel III aims to strengthen global capital, liquidity and counterparty risk management rules by incorporating lessons learned from the global financial crisis. But at the same time, it can indirectly increase the cost of capital, which in turn can affect the availability and cost of credit from banks. These impacts could spread to broker dealers, as borrowers also have their own needs to manage the requirements of Basel III. In a region like the ASEAN where business is still predominantly dependent on bank financing, Basel III in its current form could have repercussions on the growth of cross-border trading volumes even as the region moves towards greater financial market interconnectivity. Under Basel III s regulatory capital requirements, banks now need to maintain a minimum 8% of Tier 1 Common Equity Ratio and Capital Conservation Buffer starting in 2013, with a targeted goal of 10.5% by In addition, capital for the Countercyclical Buffer and Global Systematically Important Financial Institution and Domestic Systematically Important Bank designations is also required. These requirements aim to make banks more capable of absorbing sudden shocks and put them in a better position to manage systemic risks. The Leverage Ratio has been introduced to ensure that banks do not become over-leveraged, which also helps to increase the banks motivation to ensure that assets and liabilities are matched. Consequently, sudden short-term high value deposits could impact a bank s Leverage Ratio if an appropriate liability cannot be matched with it in time. The Ratio s current non-risk-adjusted approach could incentivise banks to focus more on higher return lending, which could add to the challenges faced by borrowers seeking low-risk products that would typically be low margin as well. With the ASEAN region example, the implementation of Basel III is representative of the need to adapt and balance the costs and effects of the New Normal environment where necessary. Basel III indirectly increases the cost of the credit and liquidity used by clearing members, which increases in tandem with transaction volumes. It can also add to the demand for and costs of eligible collateral that would already be required for clearing activities. Therefore, any future ASEAN post-trade interconnectivity may also need to outweigh these indirect costs, which market participants will need to manage as part of their cross-border trading activities. Over time, if brokers become unwilling to regionalise due to higher barriers of entry, or become more selective in the interbroke counterparties they adopt, the aggregated effects could lead to a limited growth of scale and entry of new participants in cross-border activities, at a time when the ASEAN Exchanges trade and post-trade interconnectivity have the potential to spur this growth. Basel III has adopted a phase-in implementation starting from January 2013 until Thus far in Asia, Basel III standards have been formally adopted by Australia, Mainland China, Hong Kong, India, Japan, and in the ASEAN region by Indonesia, Malaysia, Singapore and Thailand. The Philippines have announced plans to adopt the standards in With such a complex and long implementation period, ASEAN capital markets could benefit from more high profile communication from ASEAN regulators on Basel III, to foster a regional and holistic understanding of the possible implications in the securities markets. To mitigate liquidity risks, banks will also need to maintain high quality liquid assets required by Basel III s Liquidity Coverage Ratio and Net Stable Funding Ratio. As these ratios emphasise the concept of stable funding, they could lead to banks preferences for longer-tenor client deposits and to increased costs from short-tenor deposits. Broker dealers aiming to optimise the returns from their banks could also gradually consolidate more business with a smaller group of liquidity providers/banks for a relationship-driven approach. While credit relationships will become easier to manage, the technique of risk diversification through the use of more banks by itself may become ineffective. 7

8 The need for a cohesive view on global reforms and the tailwinds in ASEAN countries As global reforms continue to evolve over time, they will add layers of cost and complexity for market participants in different ways. However, not all of the effects of global reforms on the ASEAN Exchanges are about costs and challenges. They can also bring new opportunities within and outside the post-trade ecosystem. The implementation of PFMIs is a good opportunity for the region s financial market infrastructures to enhance the perception of the ASEAN as a resilient asset class from global investors, and enable markets and participants to offer new capabilities to these investors. Malaysia and Singapore for example, have announced their adoption of PFMIs. Clarity of PFMI implementation can lend to broader considerations of the different impacts of other global initiatives, and support the launch of innovative ASEAN Exchanges' post-trade interconnectivity models. This would help the ASEAN region to progress closer towards its 2015 goals and help participants to realise the early benefits of CCP and CSD linkages. Over time, a service such as Third-Party Clearing (TPC) could allow brokers to strategically manage their cost structure and ensure the availability of liquidity in the market for clearing. In addition, by using regional clearing providers to manage their collateral, liquidity and processing costs, some of the effects of global regulations previously explained can potentially be minimised. Complementary to the growth of the ASEAN post-trade ecosystem is the additional collateral requirements driven by Basel III and other regulations that could lead to an expansion of acceptable high-quality securities markets in the region, and eventually deeper and more liquid markets to attract investors and services. Compliance with global initiatives and regulations can also present new opportunities for the markets and the industry by enabling greater cost effectiveness, operational efficiencies and strategic leverage. For example, with FATCA, new services can be provided to fund managers to help them become FATCA-compliant. These benefits and possibilities, with convergent ASEAN regulatory policies, could collectively move the region closer to the larger goal of regionalisation and deeper markets, making the ASEAN region a more seamless, integrated and attractive asset class for all participants. 8

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10 Conclusion With regulators and the industry sharing insights and feedback with each other, the lack of clarity in some areas and the headwinds associated with some of the global reforms, which aim to reinforce the resilience of the world s financial markets, will most likely be addressed in the near future. However, to mitigate any risks coming from unintended consequences, it will be important to see cohesive ASEAN views on the different impacts of global reforms on the region s initiatives and participants. Such approach could also help the industry to address any matters that could influence their participation in the ASEAN Exchanges post-trade interconnectivity. It could also enable the introduction of complementary services such as agency securities lending, treasury/fx management and other related services to enrich the overall ASEAN post-trade ecosystem. About Deutsche Bank Through our wide range of cash management, trade finance, trust and securities services, our business helps companies all over the world to focus on achieving their business goals. Every day, in multiple locations, we process and clear domestic and cross-border payments, facilitate transactions for global trade and act as trustee, agent and custodian for clients. In transaction banking, the visibility we gain on our clients financial landscape puts us in a unique position to identify risks as well as opportunities for bottom line growth. By working in close partnership with the rest of the Bank, we help our clients optimise every opportunity. However, it is also important to focus on the cost effectiveness and efficiency of the region's post-trade environment in order to enhance its overall attractiveness. This is being looked into through other exciting developments such as the ASEAN initiative in cross-border funds offering, and the ASEAN+3 Bond Market activities. These benefits would be multiplied by the confluence of global, regional and local market knowledge, which can greatly contribute to the issues surrounding these topics during privatepublic sector discussions. The resulting transparency can only bode well for the region s future. Ultimately, cooperation, transparency and consistency can reinforce the establishment of ASEAN as an asset class and promote an environment where regional financial market participation is not determined by the participant s size itself. 10

11 Contact Information Mrugank Paranjape, Asia Pacific Head of Trust & Securities Services and Cash Management Financial Institutions Christina Ang, Head of Direct Securities Services Singapore Elwin Karyadi, Head of Direct Securities Services Indonesia Hannah-Vina Nunez, Head of Direct Securities Services Philippines, Jacqueline William, Head of Direct Securities Services Malaysia, Jaroungpon Hoonsiri, Head of Direct Securities Services Thailand, Pham-Tran-Thu Ha, Head of Direct Securities Services Vietnam, Author Boon-Hiong Chan, Head of Market Advocacy Asia Pacific & MENA, Product & Technology Management, Co-Author Cherine Yeo, Assistant Vice President, Market Advocacy Asia Pacific & MENA, Product & Technology Management, Contributors Thibaud de Maintenant, Global Head of Direct Securities Services Samba Sivan, South Asia Head of Direct Securities Services Marko Niederheide, Market Advocacy Europe, Product & Technology Management, 11

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