Report and Recommendation of the President to the Board of Directors

Transcription

1 Report and Recommendation of the President to the Board of Directors Project Number: August 2010 Proposed Program Loan and Technical Assistance Grant Kingdom of Thailand: Capital Market Development Program

2 CURRENCY EQUIVALENTS (as of 30 August 2010) Currency Unit baht (B) B1.00 = $0.031 $1.00 = B31.33 ABBREVIATIONS ACMF ASEAN Capital Markets Forum ADB Asian Development Bank ASEAN Association of Southeast Asian Nations ATP alternative trading platform BMDF Bond Market Development Fund BOT Bank of Thailand CMDP Capital Market Development Program CMDWC Capital Market Development Working Committee DPA Deposit Protection Agency FPO Fiscal Policy Office FSAP Financial Sector Assessment Program GDP gross domestic product IOSCO International Organization of Securities Commissions IPO initial public offering LIBOR London interbank-offered rate MOF Ministry of Finance NESDP National Economic and Social Development Plan M&A mergers and acquisitions OIC Office of Insurance Commission P3F post-program partnership framework PDMO Public Debt Management Office SEC Securities and Exchange Commission SET Stock Exchange of Thailand SMC Secondary Mortgage Corporation SRO Self-Regulatory Organization S&P Standard and Poor TA technical assistance TASF Technical Assistance Special Fund TFEX Thailand Futures Exchange

3 NOTES (i) (ii) The fiscal year (FY) of the government ends on 31 December. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2010 ends on 31 December In this report, $ refers to US dollars. Vice-President C. Lawrence Greenwood, Jr., Operations 2 Director General K. Senga, Southeast Asia Department (SERD) Director J. Ahmed, Financial Sector, Public Management and Trade Division, SERD Team leader Team members Peer reviewers K. Bird, Senior Economist, SERD L. Abenojar, Administrative Assistant, SERD L. Attapich, Regional Economics Officer, Thailand Resident Mission, SERD E. Dizon, Administrative Assistant, SERD P. Jena, Senior Governance Specialist, SERD R. O Sullivan, Principal Counsel, Office of the General Counsel H. Omar, Senior Financial Sector Specialist, SERD D. Kertzman, Principal Financial Sector Specialist, Central and West Asia Department M. E. Khan, Principal Economist, Economics and Research Department V.V. Subramanian, Lead Professional Financial Sector, SERD was the mission leader for the Capital Markets Development Program prior to retirement on 31 May In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

4 CONTENTS Page PROJECT AT A GLANCE i I. THE PROPOSAL 1 II. THE PROGRAM 1 A. Rationale 1 B. Impact and Outcome 2 C. Outputs 3 D. Post-Program Partnership Framework 6 E. Program Cost and Financing 7 F. Implementation Arrangements 8 III. TECHNICAL ASSISTANCE 8 IV. DUE DILIGENCE 8 A. Governance 8 B. Poverty and Social 9 C. Safeguards 9 D. Risks and Mitigating Measures 9 V. ASSURANCES 10 VI. RECOMMENDATION 10 APPENDIXES 1. Design and Monitoring Framework List of Linked Documents Development Policy Letter Policy Matrix and Medium-Term Direction 21

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6 I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed loan to the Kingdom of Thailand for the Capital Market Development Program (CMDP). The report also describes proposed policy and advisory technical assistance (TA) for Capital Market Development Phase III, and if the Board approves the proposed loan, I, acting under the authority delegated to me by the Board, will approve the TA. The design and monitoring framework is in Appendix The CMDP will support the government s key reform priorities aimed at higher and sustainable investment growth and transformation to a higher income economy, sustained by an increased contribution of the domestic capital market. The reform priorities under the CMDP include efforts to enhance financial sector stability through better coordination between regulatory oversight agencies and measures to enhance transparency. The CMDP aims to increase capital market efficiency and depth through strengthening the capital market infrastructure (demutualization of the stock exchange), promoting competition in the securities market, developing the domestic bond market, and financial product development. The CMDP also aims to expand the investor base and support Thailand s efforts to integrate with regional capital markets. The development policy letter is in Appendix 3 and the policy matrix with the medium-term direction is in Appendix 4. II. THE PROGRAM A. Rationale 3. The challenge for Thailand is to transform from a middle-income to a high-income economy. This requires significant investments in productive activities, including infrastructure, as well as education and other social sectors. The 1997 crisis shows that absence of balanced growth of financial sector increases vulnerability to economic instability and this can result in a significant increase in poverty. The government recognizes these challenges and considers a well-developed capital market central to achieving longer-term economic transformation. The Thai capital market is underperforming on key indicators compared to its peers in the region. 1 The financial system remains highly regulated, fee structures are fixed in many areas, and market participants are subject to closely monitored rules-based supervision in both debt and equity markets. Capital flows are moderately restricted and the product choice for investors remains limited. The inclusiveness of the poorest 20% households is limited. Savings rates average about 3% for low income households and only about 8% of low income households have financial assets greater than $1,500. The government recognizes that, by addressing these structural and regulatory impediments and developing the domestic capital market and its integration with the Association of Southeast Asian Nations (ASEAN) markets, Thailand can expand sources of financing for the public and private sectors, improve inclusiveness, enhance the stability of the financial sector, and deepen its integration with the global economy. 4. The global financial crisis and its adverse impact on the Thai economy in 2009 exposed significant weaknesses in its domestic financial system, including insufficient depth of the domestic capital market to finance public and private sector investments. Countries with wellfunctioning and liquid local bond markets were better able to cope with shocks to the global credit markets. Key lessons from the crisis include the importance of strong coordination among financial sector regulators and sharing of information to detect systemic risks to the financial system and enforce financial regulations. The crisis provided additional momentum to the government and stakeholders to agree on the way forward for capital market development. 1 Sector Assessment (Summary): Finance Sector Assessment (Appendix 2).

7 2 5. The Government s Capital Market Development Master Plan, is the anchor for the CMDP. Development of the master plan was initiated in 2006 under the previous Government and it was formulated with private sector participation through representatives on the Capital Market Development Working Committee (CMDWC), demonstrating widespread stakeholder support across the political spectrum. This broad-based support was necessary to ensure the long-term sustainability of the reforms. A subcommittee under the CMDWC was established in late 2009, tasked with overseeing, monitoring, and implementing the master plan under the coordination of the Fiscal Policy Office at the Ministry of Finance (MOF). 6. The master plan embraces all relevant dimensions of capital markets, including the equity market, bond market, derivatives market (including commodities), and money market. It consists of eight key policy components, each time-bounded: (i) abolishing the monopoly and improving the competitiveness of the Thai stock exchange, (ii) liberalizing the securities business to promote market efficiency, (iii) legal reform, (iv) streamlining the tax system related to financial products, (v) developing financial products including those that help mitigate risk such as interest rate derivatives, (vi) establishing a national savings fund, (vii) developing a culture of investment and savings, and (viii) developing the domestic bond market. Implementation is under way and early successes include the government s approval of proposed legislation for demutualization of the Stock Exchange of Thailand (SET). 7. The CMDP is anchored to the master plan in four ways. First, it is a single tranche operation covering the reform period (1 October March 2010) that lays the foundations for longer-term development of the capital market. It also covers the first months of implementation of the capital market master plan. Second, although the CMDP is a single tranche operation, it is linked to a medium-term framework through the Post-Program Partnership Framework (P3F) covering the next 21 months of implementation of the capital market master plan signaling a commitment from both the government and the Asian Development Bank (ADB) to continue policy dialogue and support for capital market reforms. Third, ADB has actively collaborated with the government on capital market reform since 2006, including carrying out diagnostic studies on the capital market, providing input to formulation of the capital market master plan, policy recommendations on legislative and regulatory reforms, SET demutualization, and support for reform implementation. 2 The master plan is one of the principal outcomes of these TA projects. Fourth, TA associated with the CMDP is proposed to support the government in implementing critical follow-up policy measures under the P3F and the master plan (para. 27). B. Impact and Outcome 8. The impact of the CMDP is an expanded, diversified, stable and inclusive capital market leading to increased domestic financing of investment. By 2015, the CMDP is expected to have increased the size, depth, and liquidity of Thailand s capital market increasing the contribution of the capital market to domestic financing. This will be done through more robust competition in domestic capital markets, world class capital market infrastructure, better coordination among regulatory oversight agencies, and financial product and services innovation. By 2015, the CMDP is expected to have increased poor households participation in the finance sector development process through increased savings and holdings of financial assets. This will be done through product development, expanding coverage of pensions, development of the secondary mortgage market supplemented with public education programs on financial literacy. 2 ADB Technical Assistance to the Kingdom of Thailand for Supporting the Implementation of the Capital Market Development Master Plan. Manila; and ADB Technical Assistance to the Kingdom of Thailand for Capital Market Development Phase II. Manila.

8 3 9. The outcome of the CMDP will be an improved and prudentially sound capital market where market participants operate efficiently and innovatively. This will be reflected in a strengthened policy, regulatory, and agency coordination framework. C. Outputs 10. The CMDP supports the government efforts in four core reform areas: (i) strengthened regulatory coordination and enhanced investor protection; (ii) increased market efficiency, liquidity, and transparency; (iii) strengthened market infrastructure and intermediaries; and (iv) new products and an expanded investor base through enhanced education and improved risk management. 1. Output 1: Strengthened Regulatory Coordination and Enhanced Investor Protection 11. The CMDP supports the government s agenda to improve the regulatory framework for the capital markets and to provide better coordination among the key regulatory oversight agencies. The main objective is to ensure financial sector stability. The following measures toward achieving these goals were accomplished before the Board s consideration of the CMDP. 12. Development of the Capital Market Development Master Plan. The government developed and on 9 November 2009 approved its medium-term Capital Market Development Master Plan, ADB provided input to the formulation of the master plan through TA (footnote 2). The plan covers eight critical reform areas, many of which the CMDP supports. To monitor implementation of the master plan, a subcommittee for implementing and monitoring was created at the end of It has met three times and is facilitating the implementation of key reforms. Its first success was to facilitate cabinet approval of draft legislation covering demutualization of the SET, which includes measures to inject competition in this sector. The CMDWC is responsible for coordinating among the key regulators. Over the medium term, it is to become a formal body responsible for coordinating issues on financial system stability. 13. Enhancing the surveillance and enforcement capabilities of the Securities and Exchange Commission. In 2008, amendments were made to the Securities and Exchange Commission (SEC) legislation to enhance the SEC s operational effectiveness. Key amendments include (i) revised criteria for selecting the SEC board and setting up a management board to concentrate on the issuance of rules and regulations governing day-today operations; (ii) cooperation between the SEC and foreign regulators regarding information disclosure and the suppression of cross-border securities fraud to allow the SEC to sign the International Organization of Securities Commissions multilateral memorandum of understanding and to become a fully compliant A signatory; and (iii) enhanced protection of the rights of minority shareholders of publicly listed companies. Over the medium term and by 2012, the SEC proposes to submit legislation to Parliament to use civil laws and penalties as well as administrative sanctions in enforcement actions and to provide legal immunity for the SEC and its commissioners in performing their official duties. 14. Deposit insurance. The government introduced measures to strengthen the stability of the financial system. Deposit insurance was a key measure, achieved through the enactment of the Deposit Protection Agency Act in February 2008 and the establishment of the Deposit Protection Agency (DPA) in August This reform was timely as it was critical to mitigating the risks of the financial crisis that intensified in September The blanket guarantee on bank deposits was extended to 2011, aligned with the phase-in of the deposit insurance

9 4 scheme. The new scheme, which came into effect in August 2008, will be phased in over 5 years. The deposit insurance ceiling will be phased down from the blanket guarantee to B1 million. The DPA will collect a premium to fund the deposit insurance and the government funded the initial capital of B1 billion. The DPA will act as liquidator in case of failed and closed financial institutions. 2. Output 2: Increased Market Efficiency, Liquidity, and Transparency 15. The CMDP supports the government s agenda to liberalize the domestic capital markets to improve efficiency, as well as efforts to increase liquidity through development of the domestic bond market. The following measures toward achieving these goals were accomplished before the Board s consideration of the CMDP. 16. Domestic bond market. The government introduced a series of measures to develop the domestic bond market, create deeper government benchmark yields to price corporate securities, and improve transparency. The amended Public Debt Management Act, November 2007 enabled the Public Debt Management Office (PDMO) to undertake debt market activity for bond market development; prior to the amendments, the PDMO was only permitted to issue debt to finance the national government deficit set within prudential debt limits. In March 2010, the government established the Bond Market Development Fund (BMDF) and issued the operational criteria of the BMDF and investment strategy to deal with issuance of government bonds generating surplus cash. The BMDF is separate to, but will be overseen by, the PDMO. This will enable the PDMO to adopt cash management systems to permit prefunding of government bond maturities to reduce the refinancing risk the first step toward more active public debt management. As part of this strategy, the government issued B80 billion savings bonds of 5-year maturity targeted at retail customers in July Capital controls. The government recognizes the need to relax restrictions on capital flows to support deepening of the domestic capital market. Since the 1997 Asian financial crisis, Thailand has introduced a number of restrictions on capital, most recently in ADB TA assisted the BOT to undertake a review of restrictions on capital flows that have a negative impact on capital market development (footnote 2). Based on the review s recommendations, the BOT introduced some relaxations on the capital account in February 2010 easing restrictions on capital controls to allow Thai investment abroad and foreign exchange hedging transactions. It plans to adopt and implement suitable options during that will address exchange control issues impeding capital market development. The government s approach will be cautious and will involve a sequenced plan to ease restrictions on cross-border restrictions and other impediments. 18. Regional capital markets integration. Thailand is actively collaborating with other ASEAN member states in promoting capital market integration in ASEAN to develop deep and liquid bond markets in Asia and improve cross-border capital flows in the ASEAN region. Thailand s SEC is the secretariat of the ASEAN Capital Markets Forum, which leads the integration drive. In April 2009, based on ADB TA, the Thai SEC coordinated and submitted a report detailing recommendations on regional capital market integration to the ASEAN finance ministers. The ASEAN Capital Markets Forum approved the Implementation Plan 2015, which sets out a broad framework to strengthen ASEAN capital market development and integration by It offers key initiatives under three broad themes: (i) creating an enabling environment for regional integration, (ii) creating market infrastructure and regionally focused products and intermediaries, and (iii) strengthening the implementation process. The plan has six working groups and the Thai SEC chairs the cross-border liberalization for products and services. The Thai SEC presented the working group s implementation progress report at the 12th ASEAN

10 5 Capital Markets Forum in February 2010 in Bangkok. Thailand has also completed harmonization of ASEAN Plus standards on disclosure requirements for cross-border equity and offerings, mutual recognition frameworks for market professionals, offering documents, and the provision of products and services by market intermediaries Simplify taxes on financial transactions. One of the core components of the capital market master plan is to simplify taxes on financial transactions that impede capital market development. Measures accomplished under the CMDP include the following: (i) the business tax on treasury portfolio activities of financial instruments traded on exchanges has been reduced from 3.30% to 0.01%, and (ii) the Revenue Department in the MOF has set up a working committee to review recommendations under ADB TA (footnote 2) for rationalizing tax on financial instruments during implementation of the capital market master plan. 3. Output 3: Strengthened Market Infrastructure and Intermediaries 20. The CMDP supports the government s goals of strengthening the market infrastructure and increasing intermediaries by liberalizing the sector. Critical reforms include efforts to demutualize the SET and increase competition in providing alternative trading platforms and liberalizing the securities market, among others. The following measures toward achieving these goals were accomplished before the Board s consideration of the CMDP. 21. Stock Exchange of Thailand demutualization and competition in platforms. The government and the SET recognize that the current structure of the SET is increasingly inappropriate for a modern capital market. The government s aim is to corporatize the SET and to increase competition in trading venues. The government, the SET, and the SEC have agreed to the following sequence of reforms: (i) the SET is to initiate the demutualization process through internal reorganization; (ii) the SEC is to conduct public consultation on the main proposals for SET demutualization; and (iii) the SEC is to draft legislation covering demutualization leading to an initial public offering of the SET allowing competing trading venues, allowing competing providers of settlement infrastructure, and allowing the SET to provide more open access and remote access to others who are not market intermediaries. The SEC drafted legislation that was approved by the cabinet in February 2010 and will be submitted to Parliament later in the year. The SET expects the corporatization to take place in 2010 and the initial public offering in ADB TA and staff support has been provided to the government and the SET over the policy period Liberalizing the securities market. The SEC has introduced measures to enhance competition in the capital market by (i) publishing a timetable for removal of the SET rule controlling brokerage commissions, and (ii) publishing its intention to remove restrictions on the number of brokerage licenses by The SEC intends to follow through on these initiatives by liberalizing the brokerage commission for all investors during The Financial Institutions Business Act passed in February 2008 allows companies other than financial institutions to provide housing finance for low- and middle-income earners. Over , the Secondary Mortgage Corporation (SMC) plans to develop pass-through models or equivalent that incorporate incentives for commercial banks to develop the secondary mortgage market. Supported by ADB TA (footnote 2), strategies for improving the operational efficiency of the SMC were developed under the CMDP, including new business models built on the 3 ADB Technical Assistance for Supporting Enhanced Cooperation among Southeast Asian Equity Markets. Manila; and ADB Technical Assistance for Strengthening Southeast Asian Financial Markets. Manila. See also ADB Regional Technical Assistance for Bond Financing Infrastructure Projects in ASEAN +3. Manila. 4 See final report (November 2007) for ADB Technical Assistance to the Kingdom of Thailand for Supporting the Implementation of the Capital Market Development Master Plan. Manila.

11 6 restructuring exercise of the SMC. The demutualization of the SET, liberalization of the securities market, development of the bond market and secondary mortgage market will improve access to finance and this should indirectly benefit small and medium-sized enterprises. 4. Output 4: New Products and Expanded Investor Base through Improved Education and Improved Risk Management 23. The CMDP supports the goals of the government and industry groups of promoting financial product and service innovations and expanding the investor base. Enhancing the financial literacy of the public and better risk management of wealth are critical components of innovation and longer-term poverty reduction. The following measures were accomplished or are ongoing prior to the Board s consideration of the CMDP. 24. Interest rate derivatives. To satisfy the Thailand Futures Exchange (TFEX) on the demand for interest rate derivatives and its introduction, the CMDP recognizes the importance of involving the customer base bank treasurers and long-term bond investors in design and feasibility discussions. The BOT, in consultation with the SEC and industry groups, completed an assessment in February 2010 under ADB TA of the demand for interest rate and bond futures. The study was coordinated with TFEX and based on its findings, interest rate and bond futures are proposed to be introduced by the end of TFEX launched gold futures on 2 February Securitization of cash flows. The government proposed a draft amendment to the securitization law to Parliament in January 2010 to permit securitization of future cash flows. From July 2009 to September 2010, the SEC has been consulting with the industry to examine impediments to and possible resolutions for introducing a range of new bond instruments such as covered bonds. The SEC approved the issuance of sukuk bonds (Islamic finance product) in November Public education. The government and industry recognize the limited investor base and the need for greater social inclusiveness in capital markets via individual investments as well as pensions. A number of activities have been carried out to improve the public s financial literacy. At the start of 2009, the SET reorganized its educational activities (including professional education) within a separate subsidiary, the Capital Market Development Fund, to provide investor education and industry training. The Fiscal Policy Office conducted public education programs in September 2009 and March 2010 to deepen understanding of how individuals can meet their pension needs with public programs, and an education strategy was implemented to raise awareness of the need for savings and capital market investments (both equity and fixed-income products) as vehicles for pension savings. D. Post-Program Partnership Framework 27. The Development Policy Letter (Appendix 3) sets out the government s reform agenda for the next 2 3 years, building on the reform momentum supported by ADB TA since 2006 and the program. To ensure the sustained momentum of the reforms, the government and ADB have agreed to a P3F for the next 30 months, creating the basis for continuous policy dialogue to follow through on policies required for long-term structural adjustments under the capital market master plan. The P3F focuses on 10 policy measures to be implemented in the short term (April 2010 March 2011) and nine policy measures to be implemented over the medium term (April 2011 December 2012) advancing reforms under the capital market master plan,

12 7 formalizing regulatory coordination, implementing SET demutualization and competition in alternative trading platforms. 5 E. Program Cost and Financing 28. The government has requested a loan of $300,000,000 to finance the CMDP from ADB s ordinary capital resources, with interest to be determined in accordance with ADB s London interbank-offered rate (LIBOR)-based lending facility; a 15-year term, including a grace period of 3 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft loan agreement presented to the Board. The government has provided ADB with (i) the reasons for its decision to borrow under ADB s LIBOR-based lending facility on the basis of these terms and conditions, and (ii) an undertaking that these choices were its own independent decision and not made in reliance on any communication or advice from ADB. 29. The size of the CMDP loan is based on a number of factors required to support implementation of reforms. 6 The key considerations include: (i) the relative importance of the sector to the economy, the weight or benefits of the reform program, and the leverage necessary to counter resistance from interest groups; (ii) the policy adjustment costs incurred by the government and relevant financial statutory agencies (i.e., SEC), and financial institutions and corporations in implementing and complying with reforms; and (iii) the development financing needs of the government. The finance sector accounts for a sizeable proportion of the economy and its development and stability is critical to support Thailand s economic transformation, growth and poverty reduction. 7 ADB staff estimates that the complete long run static benefits of the reform program are estimated at $5.3 billion or 2.2% of GDP highlighting the importance of the reform program to the economy (footnote 6). The reform program includes several politically sensitive policy and institutional reforms that have been resisted in the past, such as SET demutualization and gradual relaxation of capital controls. To support the reforms, the program amount loan provides leverage to the executing agency (PDMO) and implementing agencies to support implementation. The policy adjustment costs to the government, statutory agencies and financial institutions are conservatively estimated at $51.8 million or alternatively $171.5 million if lost tax revenue flows from the reforms are calculated as present value lump sums (footnote 6). These include the administrative, enforcement and fiscal costs to the government in implementing and enforcing the reforms (estimated at least $48 million or $168 million if foregone tax revenue flows are calculated as present value lump sums). The policy adjustment costs to these entities are likely to be higher if the enforcement costs incurred by the SEC under its legislative amendments could also be quantified. The policy adjustment costs also include the increased business costs borne by financial institutions and corporations from complying with the reforms (estimated at least $3.8 million). 30. The program loan also reflects the government s development financing needs. The Government has targeted a deficit of 4.1% of gross domestic product in FY2011 (about $11 billion $12 billion) taking into account the need to provide a modest fiscal stimulus at this stage of the economic recovery and to protect critical development spending. Under the FY2010 and FY2011 budgets, the government is close to its legislated debt limits on domestic debt financing but it has borrowing space under its limits on foreign debt financing so it requested ADB and the World Bank to finance part of the development financing gap. ADB has coordinated with the World Bank support for a single tranche Development Policy Loan (DPL) to Thailand in the amount of $1 billion for public financial management reforms. The World Bank is 5 Policy Matrix and Medium-Term Direction (Appendix 4). 6 Summary Program Impact Assessment (Appendix 2). 7 Summary Poverty Impact Assessment (Appendix 2).

13 8 expected to support its DPL to its board of directors in mid-october ADB and World Bank combined financing of the government budget amounts to $1.3 billion (or about 12 percent of the budget deficit). The remaining 88% of deficit financing will be domestically sourced. F. Implementation Arrangements 31. The PDMO is the executing agency for the CMDP. The MOF, the BOT, the SEC, the DPA, the SMC, and the Office of Insurance Commission are the implementing agencies. The MOF established the CMDWC comprising representatives from its Fiscal Policy Office, the BOT, the SEC, the SET, and market participants to be responsible for implementing and sustaining the program components. The CMDP was implemented from October 2007 to March The proceeds of the program loan will be disbursed in accordance with the provisions of ADB s Simplification of Disbursement Procedures and Related Requirements for Program Loans. 8 The program will provide for the retroactive financing of eligible expenditures incurred up to 180 days prior to loan effectiveness. ADB will retain the right to audit the use of the loan proceeds and to verify the accuracy of the withdrawal application certification. III. TECHNICAL ASSISTANCE 32. An associated policy and advisory TA grant for Capital Market Development Phase III is proposed. This is the third of three TA projects for capital market development since 2006 that have been designed in sequence based on progress in capital market reforms. The first TA commenced in 2006 to support implementation of the capital market development plan. The second TA in 2008 (capital market development phase II) supported analytical and policy advice on capital market reforms. The third TA will support implementation of the P3F and selected components of the master plan. The TA is estimated to cost $1,250,000 equivalent, of which ADB will provide $900,000, to be financed by ADB s Technical Assistance Special Fund (TASF- Other Sources). 9 IV. DUE DILIGENCE A. Governance 33. Fiduciary assessment. Thailand s financial management systems and the overall fiduciary environment of the public financial management system are deemed to be satisfactory. The public expenditure and financial accountability assessment, the first of its kind, is a comprehensive diagnosis covering the overall public financial management system in Thailand undertaken by the World Bank in December The public financial management systems are underpinned by a strong legal and institutional framework. Accounting standards based on international standards are applied, and financial statements are prepared on a modified accruals basis. Thailand s tax system is well established and efficiently run, and public debt is efficiently managed with prudent limits. External audit by the Office of the Auditor-General is wide-ranging and performed to international standards; its jurisdiction covers all elements of central government, state-owned enterprises, and all local authorities. 34. Anticorruption. The government was advised of ADB s Anticorruption Policy (1998, as amended to date) and Policy on Combating Money Laundering and the Financing of Terrorism (2003). Thailand s anti-money laundering (AML) legislation was approved in 2003, and ongoing efforts are enhancing the effectiveness of its AML regime. 8 ADB Simplification of Disbursement Procedures and Related Requirements for Program Loans. Manila. 9 Technical Assistance Capital Market Development Phase III (Appendix 2).

14 9 B. Poverty and Social 35. The CMDP has a positive impact on poverty reduction through the creation of direct and indirect benefits to poor households (footnote 7). It will contribute to sustainable reduction in poverty through three channels. The first channel is through supporting higher and sustained longer term economic growth. By developing the domestic bond market, expanding the stock market, relaxing exchange rate controls, and introducing new financial sector products, domestic financing of public and private investments will increase thereby supporting higher economic growth. The second channel is through inclusiveness of the poor in the modern financial sector. By developing new savings products (such as the retail savings bond) and the national pension scheme and expanding its coverage to the poor, the savings rate and holdings of financial assets of low income households will increase over time. 10 Developing the secondary mortgage market will generate financing for lower cost housing and benefiting the poor. The CMDP and the government s Capital Market Master Plan includes planned activities and programs for increasing Thai households financial literacy and awareness of savings products will complement these reforms. The third channel is through improving the regulatory framework for financial sector stability. The CMDP includes several measures for strengthening financial sector stability including enhancing the surveillance and enforcement capabilities of the SEC, establishing the deposit insurance agency, and establishing a coordination mechanism comprising the key financial sector regulators to better detect systemic risks to the domestic financial sector and more effective enforcement of financial sector regulations. C. Safeguards 36. The CMDP will not entail any involuntary resettlement or have a negative impact on indigenous people or the environment. It is classified category C for involuntary resettlement, impact on indigenous people, and impact on the environment. 11 D. Risks and Mitigating Measures Table 1: Summary of Risks and Mitigating Measures Risks Macroeconomic stability. The global economy is recovering slowly and global credit markets remain modestly vulnerable. Government stability. This is a significant constraint on development of the capital markets sector. Since 2006, frequent changes in government have resulted in regular ministerial changes. While recurrent political turmoil does not appear to have derailed Thailand s economic recovery, it remains a key risk to the country s longer-term economic growth. Sustaining reforms. Reforms being undertaken by the government may draw opposition from those with vested or competing interests. Source: Asian Development Bank. Mitigating Measures While there is moderate fiscal stress, the government is undertaking fiscal consolidation and expects to return to balance its overall budget by 2015 and achieve surpluses thereafter. The banking system is well capitalized and nonperforming loans are low. Past and present governments are strongly committed to development of the capital market; the new government is a particularly strong supporter. These reforms include the passage of core legislation on conferring a greater degree of autonomy and accountability to the regulators of banking and securities markets, endorsement of the capital market master plan in November 2009, and its implementation in To mitigate or reduce resistance from vested interests, the government decided on extensive and broad-based stakeholder consultation and input into the formulation of the capital market master plan, which is the anchor for reforms in this sector. 10 Currently, low-income households savings rates are about 3% of income and only 8% of low income households report holding financial assets more than $ Summary Poverty Reduction and Social Strategy (Appendix 2).

15 Assumptions underlying the CMDP include macroeconomic stability and the Government s commitment to pursue reforms and effective implementation of TA recommendations. Mitigation measures have been put in place for some key risks. Political stability over the longer term remains a key risk (Table 1). 12 A. Specific Assurances V. ASSURANCES 38. In addition to the continued compliance and implementation of the actions specified in the program policy matrix and standard assurances, the government has given the following specific assurances: (i) (ii) (iii) Continuity and coordination of reforms. The government will (a) carry out the policies and actions in accordance with the schedule of policy reforms contained in the policy matrix and ensure sustainability of the reforms beyond the program period, (b) carry out all of its obligations as stipulated under the loan agreement in a timely manner, and (c) ensure that the agreed actions are sustained with respect to each policy achievement. Policy dialogue. The borrower will keep ADB informed of, and the borrower and ADB will from time to time exchange views on, sector issues, policy reforms, and additional capital market reforms that may be considered necessary or desirable, including the progress made in carrying out policies and actions set out in the policy letter and the policy matrix, P3F, and TA project. Counterpart funds. The government will ensure that the counterpart funds will be used to support financial sector reforms, to meet the financing costs associated with the program and the P3F, and the financing of the budget expenditures, notably the stimulus package focused on infrastructure development. VI. RECOMMENDATION 39. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the loan of $300,000,000 to the Kingdom of Thailand for the Capital Market Development Program from ADB s ordinary capital resources, with interest to be determined in accordance with ADB s London interbank-offered rate (LIBOR)-based lending facility; a term of 15 years, including a grace period of 3 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft loan agreement presented to the Board. 30 August 2010 Haruhiko Kuroda President 12 ADB Governance Risk Assessment Thailand Capital Market. Manila (April).

16 Appendix 1 11 DESIGN AND MONITORING FRAMEWORK Design Summary Impact An expanded, diversified, stable and inclusive capital market leading to increased domestic financing of investment Performance Targets and Indicators with Baselines By December 2013: Expanded capital market measured by: (i) Increase of 30 percentage points in financial assets to GDP (baseline = 217% in 2007) with increase in ratio of non-bank financial assets to bank assets (baseline = 1.1 in 2007 (ii) Increase number of investors (base line = 2 million in 2007) Diversified capital market by measured by: (iii) Increase in ratio of stock market capitalization/gdp to bank credit/gdp (base line in 0.8 in 2007) (iv) Increase in ratio of stock value traded/gdp to credit/gdp (baseline =1.9 in 2007). (v) Share of private domestic bond stock to GDP increased by 20 percentage points (baseline = 30% in 2007) (vi) Increase number of corporations issuing bonds (baseline in 2007) Data Sources and Reporting Mechanisms Financial and monetary data from BOT and SET. Data from the National Household Socio- Economic Survey, Thailand National Statistics Office, and ADB estimates Assumptions and Risks Assumption Macro economy remains stable and continues to withstand new external shocks to the economy. Risks The global economy recovers only slowly and global credit markets remain modestly vulnerable to new shocks. Government instability remains a risk given recurrent political tensions and frequent changes in government since Outcome Improved and prudentially sound capital market where market participants operate efficiently and Inclusive capital market measured by: (vii) Share of households reporting financial assets higher than $1,500 (real terms) increase (baseline = 8% of low income households) (viii) Low income households share of income from non-deposit financial assets to total income increase (baseline = 1% in 2007) By December 2013: (i) World Economic Forum Financial Development World Economic Forum Financial Development Assumption There is strong political will and commitment to pursue reforms.

17 12 Appendix 1 Design Summary innovatively Outputs 1. Strengthened regulatory coordination and enhanced investor protection Performance Targets and Indicators with Baselines Index global rank and score improve from 35 and 3.35 respectively By December 2012: (i) Implementation of capital market master plan on track (ii) Improved assessments of financial sector regulators by international credit rating agencies (baseline 2008 S&P) Data Sources and Reporting Mechanisms Index Progress report of the CMDWC on implementing and monitoring International credit rating agencies reports Assumptions and Risks Risk Reforms undertaken by the government may draw opposition from vested or competing interests. 2. Increased market efficiency, liquidity, and transparency 3. Strengthened market infrastructure and intermediaries 4. New products and investor base through enhanced education and improved risk management (iii) Government issues securities starting with a limited number of benchmark maturities initially 5 and 10 years followed by 15 and 20 years (iv) Increase of 15% in the number of companies listed on the SET (baseline = 475 in 2007) (v) Increase of 40 percentage points in market capitalization to GDP (baseline = 83% in 2007) (vi) Increase in daily turnover (from B17.01 trillion in 2007) and reduced bid-ask spread (baseline in 2007) (vii) Initial Thai links set up for the ASEAN trading board, which involves 30 stocks from each participating stock exchange from ASEAN, implemented through common exchange gateway completed (viii) Demutualization of the SET completed (ix) New financial products launched including the following: (a) TFEX/ATP launches interest rate and bond futures (b) TFEX launches gold futures Published report and website of the Bond Market Agency Thai Bond Market Association SEC and SET website and report Press releases by the ASEAN Secretariat SEC/SET reports; IPO TFEX reports

18 Appendix 1 13 Design Summary Performance Targets and Indicators with Baselines (c) Derivatives market expands with introduction of new hedging instruments Data Sources and Reporting Mechanisms Activities with Milestones 1. Strengthened regulatory coordination and enhanced investor protection 1.1 Capital market development master plan approved by Capital Market Development Committee with subcommittee established to manage and coordinate implementation of the plan (Nov. 2009) 1.2 Subcommittee to organize activities to create public awareness on the master plan and its implementation (Mar. 2008) 1.3. Amendment to the SEC Act approved by Parliament in February 2008 to (i) enhance the operational independence of the SEC consistent with its mandated objectives, (ii) enable the SEC to provide investigative assistance to foreign regulators in line with the IOSCO multilateral memorandum of understanding, and (iii) enable the SEC to implement amendments to the SEC Act (Nov. 2009) 1.4. Capital Market Development Committee established with all regulators as members (Nov. 2009) 1.5. SEC Act amended in February 2008 to (i) enhance the additional responsibilities of directors of listed companies to strengthen corporate governance, and (ii) enhance the protection and rights of minority shareholders (effective in Aug. 2008) 1.6 SEC adopted enhanced procedures to protect the rights of minority shareholders of public listed companies (Aug. 2008) 1.7. Move initiated toward objective-based regulation by the SEC to provide greater responsibility to industry associations or SROs to develop industry standards and practices to be adopted by their members (Aug. 2008) 1.8. Passage of the Deposit Protection Agency Act to legislate deposit insurance (Aug. 2008) 1.9 Deposit Protection Agency established in August (Aug. 2008) 2. Increased market efficiency, liquidity, and transparency 2.1 Public Debt Management Act amended in November 2007 to permit issuances of public debt for market development and create deeper government benchmark yield curves to price corporate securities (Mar. 2008) 2.2 Operational criteria defined for Bond Market Development Fund (Mar. 2008) 2.3 Investor base expanded through retail bond issuance (Jan. 2008) 2.4 BOT, in consultation with PDMO, imposed market making obligations on all nine primary dealers to improve transparency and maximum spread 5 bps involving two-way quotes on benchmark government securities once a day on fixed-income exchange since November (Nov. 2007) 2.5 BOT/PDMO initiated study of primary dealers privileges and obligations to address perceived imbalance (Sept. 2009) 2.6 BOT initiated study to review foreign exchange regulations to balance the policy objectives of the development of financial markets and ensure financial market stability in Thailand 2.7 BOT amended rules and regulations on exchange control to facilitate capital flows (Feb. 2010) 2.8 Working group set up by the Revenue Department to review recommendation for rationalization of tax on financial instruments (April 2009) 2.9 Specific business tax reduced from 3.3% to 0.01% for Treasury portfolio activities of financial institutions (Jan. 2008) 2.10 Period of reduced tax rates for listed companies extended (Jan. 2008) 2.11 FPO to complete a study on M&A taxation (Feb. 2010) 2.12 A report detailing recommendation on capital market integration submitted to the ASEAN finance ministers in April 2009 by SEC as the secretariat of the ASEAN Capital Markets Forum (Apr. 2009) 2.13 Harmonization of ASEAN+ standards on disclosure requirements completed by SEC (June 2009) 3. Strengthened market infrastructure and intermediaries 3.1 Demutualization process through internal reorganization initiated by SET (Jan. Assumptions and Risks Inputs ADB: $300 million under the program loan TA: $900,000

19 14 Appendix 1 Performance Targets Design and Indicators with Data Sources and Assumptions and Summary Baselines Reporting Mechanisms Risks 2009) 3.2 (i) SET completes a study to develop a road map for CMDF to design education, industry development, and research pillars to meet the needs of the Thai capital markets; (ii) SEC conducted public consultation on principal proposals for SET demutualization; (iii) legislation drafted by SEC covering (a) demutualization leading to IPO of SET, (b) allowing competing trading venues, (c) allowing competing providers of settlement infrastructure, and (d) allowing SET to give more open access and remote access to others who are not market intermediaries (Dec. 2009) 3.3. SEC introduced measures to enhance competition by (i) publishing a timetable for removal of the SET rule concerning brokerage commissions, and (ii) publishing its intention to remove restrictions on the number of brokerage licenses in 2012 (Jan. 2010) 3.4 Financial Institutions Business Act, February 2008 removed prohibition on companies other than financial institutions from carrying out the housing finance business, thereby facilitated housing finance to low- and middle-income groups (Feb. 2008) 3.5 SMC initiated strategies for improving operational efficiency by (i) adopting a 5- year development strategy on the strength of its quality of assets and competitive funding to play its intended role in development of the secondary mortgage market; (ii) developing new business models built on its recent initial restructuring; and (iii) proposing changes to the board in the SMC Act to allow greater flexibility in its operation, including a higher guarantee limit and wider scope of operation (Nov. 2009) 3.6 Develop regulation related to mortgage credit insurance for commercial banks (Mar. 2009) 4. New products and investor base through enhanced education and improved risk management 4.1 Public education programs implemented to ensure deeper understanding of individuals pension needs (Mar. 2010) 4.2 BOT in consultation with SEC, SET/TFEX, and related industry regulatory groups carries out assessment of demand for interest rate futures, best structure for futures, and trading venue alternatives (Feb. 2010) 4.3 TFEX to introduce other hedging instruments (Feb. 2009) 4.4 Cabinet approved in principle an amendment to the securitization law to permit securitization of future cash flows (Jan. 2010) 4.5 SET reorganized to provide a clear focus to investor education and industry training (Aug. 2008) 4.6 Amend regulation providing insurance companies with more flexibility to invest in new fixed-income securities such as subordinated debt/hybrid instruments etc. drafted by the Office of Insurance Commission for public comments (Jan. 2008) 4.7 Trust for Transactions in Capital Market Act, 2008 clearly defines ownership and the role of trustees in the capital markets, and aims to enhance markets for securitized offerings and real estate investment trusts (Jan. 2008) 4.8 SEC drafted necessary regulations for implementation (July 2009) 4.9 Support development of infrastructure sector (July 2009) 4.10 Develop alternate investment products (Dec. 2009) ACMF = ASEAN Capital Markets Forum, ADB = Asian Development Bank, AEC = ASEAN Economic Community, ASEAN = Association of Southeast Asian Nations, ATP = Alternative Trading Platform, BOT = Bank of Thailand, CMDF = Capital Market Development Fund, CG-ROSC = Corporate Governance - Report on the Observance of Standards and Codes, DPA = Deposit Protection Agency, FPO = Fiscal Policy Office, FSAP = Financial Sector Assessment Program, IOSCO = International Organization of Securities Commissions, MOF = Ministry of Finance, OIC = Office of Insurance Commission, PDMO = Public Debt Management Office, RBC = risk-based capital, REIT = real estate investment trust, SEC = Securities and Exchange Commission, SET = Stock Exchange of Thailand, SMC = Secondary Mortgage Corporation, TFEX = Thailand Futures Exchange, TIA = Thai Investors Association. Source: Asian Development Bank.