PERSPECTIVE

YOHEI KITANO

Nomura Institute of Capital Markets Research ()

Global Trends in Exchanges and Implications for Exchanges in ASEAN Countries

Brothers in 2008 have included mandato- ular on three trends that have implications ry clearing of standardized OTC derivative for exchanges in the region: (1) strengthen- contracts by a central counterparty. ing of initiatives promoting so-called ESG That said, cash equities remain an im- investment focused on environmental, so- portant source of revenues for exchanges. A cial and governance factors, (2) promotion look at the current scale of the world’s cash of the ETF market, and (3) development of Introduction equity markets reveals an ongoing shift in blockchain-based financial market infra- power from markets in the West to those in structure. the East. According to the World Federation of Exchanges (WFE), the Asia Pacific region accounted for only 21 percent of global mar- ket capitalization at end-2003, compared he power structure of the world’s ex- with 51 percent for the US and 28 percent Strengthening changes has been changed dramati- for EMEA. However, the Asia Pacific re- T cally by international restructur- gion’s share has risen to 36 percent at end- Initiatives Promoting ings that have taken place since around the 2017. This trend is expected to continue, turn of this century. More recent exchange supported by the sustained strong economic ESG Investment restructurings, such as the 2012 acquisition growth of countries in that region. Exchang- of the London Metal Exchange by Hong es in China have been the major contributor Kong Exchanges and Clearing and the 2013 to the Asia Pacific exchanges’ growing share purchase of NYSE Euronext by Intercon- of global market capitalization. Meanwhile, Exchanges have been strengthening their tinental Exchange, indicate that restruc- exchanges in ASEAN countries account for promotion of ESG investments in recent turing is being motivated not simply by a only three percent of global market capital- years. We see two main factors supporting desire to expand scale but also by a need ization despite their steady expansion. this trend. to diversify business portfolios. This need In addition to being small in scale, The first is the growing tendency reflects slow growth of trading volumes exchanges in ASEAN countries tend to among the world’s pension funds, invest- on cash equity exchanges and increasing lack depth and are behind the curve in ment trusts, insurance companies and competition among the world’s exchanges. financial infrastructure development. other institutional investors to base invest- As a result, cash equity transactions now However, viewed from a more optimistic, ment decisions not only on financial data account for a smaller share of exchange forward-looking perspective, these short- but also on ESG factors. The United Nations revenues while more profitable derivative comings indicate huge growth potential. introduced its Principles for Responsible trading is accounting for a higher share of The advances being made by the world’s Investment in 2006, and we have seen a those revenues. In addition, clearance and leading exchanges include many initiatives heightened awareness of ESG investment other post-trade operations are becoming that will be useful examples for the future starting from around 2010. According to more important for exchanges. Regulato- development of exchanges in ASEAN coun- the Global Sustainable Investment Alliance ry reforms of the over-the-counter (OTC) tries. Considering the current state of capi- (GSIA), an international organization that derivatives market following the financial tal markets in ASEAN countries, this article gathers data on ESG investment around crisis triggered by the collapse of Lehman focuses on the cash markets and in partic- the globe, total assets of socially responsible

4 | NOMURA JOURNAL OF ASIAN CAPITAL MARKETS | Spring 2018 Vol.2/No.2 Figure 1: Global IPOs and Follow-on Offerings Luxembourg, London, Oslo and Stockholm exchanges, have established dedicated Proceeds raised via IPOs (lhs) Proceeds raised via follow-on offerings (lhs) USD Billion green bond markets. No. of IPOs (rhs) Another ESG initiative supported 1,000 2,000 by participating exchanges is the Sustain- able Stock Exchange (SSE) Initiative. The 800 1,600 SSE Initiative was launched in 2009 by the United Nations with the aim of strengthen- 600 1,200 ing collaboration between exchanges and investors, corporations, and regulatory 400 800 authorities. As of end-2017, 68 exchanges were participating in the Initiative, which 200 400 holds its SSE Global Dialogues every two years to promote common best practices 0 0 for ESG initiatives. SSE Initiative partner ex- 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 changes also conduct joint research aimed Source: EY, Thomson Reuters at contributing to the development of sus- tainable and transparent capital markets worldwide. In the years ahead, we think ex- investment (SRI) increased from USD 18.3 In this environment, efforts to im- changes can be expected to strengthen their trillion in 2014 to USD 22.9 trillion in 2016.*1 prove ESG disclosure and performance ESG-related efforts. A geographical breakdown shows Europe have become increasingly important for leading the way in SRI, with assets totaling exchanges as a means of enhancing the val- USD 12.0 trillion (52.6 percent of the total), ue of their most important product – listed followed by the US at USD 8.7 trillion (38.1 companies – and attracting investors. Ac- percent). SRI assets are still rather small in cording to a joint survey by the WFE and Promoting the the Asia Pacific region. UNCTAD, 32 exchanges were providing With institutional investors in the US guidance on ESG reporting to their listed Development of the ETF and Europe showing greater interest in ESG companies as of September 2017, and that investment, exchanges in those parts of the number is expected to increase.*2 Market world have introduced ESG indices. In ad- Needing to expand their offerings dition to exchange-developed indices, ESG of listed products, the exchanges are also indices have been developed by such major actively promoting the listing of so-called index providers as FTSE-Russell, MSCI, Stan- green bonds, the proceeds of which must be Investors have shown an increasing in- dard & Poor’s and Thomson Reuters. Ac- used to finance businesses or projects that terest in low-cost, highly liquid and highly cording to the WFE and the United Nations are environmentally friendly. Green bonds transparent exchange traded funds (ETFs) Conference on Trade and Development have attracted greater attention around since the global financial crisis. Securities (UNCTAD), as of September 2017 there were the world against the backdrop of stronger firms, which previously had not promoted more than 100 ESG indices in use on 38 ex- efforts to respond to climate change since these funds very aggressively, have come changes around the world. In this environ- the 1992 adoption of the United Nations to regard them as a more strategic product ment, the number of institutional investors Framework Convention on Climate Change, offering. Investors’ increasing needs for using ESG indices is growing. For example, an international treaty targeted at reducing more diversified and sophisticated portfolio Japan’s Government Pension Investment greenhouse gas emissions.*3 According to allocation have spurred the development Fund (GPIF), the world’s largest pension the Climate Bonds Initiative, a nonprofit in- of a wide variety of ETF types and driven fund, announced in July 2017 that it had be- ternational organization that is establishing the growth of a global ETF market.*5 The gun passive investment in Japanese equities industry standards, green bond issuance wide variety of ETFs available today include that tracked three selected ESG indices. has increased rapidly in recent years and leveraged ETFs constructed to generate a The second factor encouraging ex- outstanding issues as of end-2016 reached multiple return on the tracked index, ac- changes to strengthen initiatives promot- more than USD 874 billion. Of this total, tively managed ETFs that undergo portfo- ing ESG investment has been a relatively unlabeled bonds that earmark proceeds lio adjustments targeted at outperforming low level of corporate fundraising through for climate or environmental projects but the tracked index, target-date ETFs that initial public offerings (IPOs) and follow-on have not been labeled as green by the issu- undergo automatic portfolio revisions at a offerings. The number of IPOs and the pro- er amounted to more than USD 694 billion, specified future date, and smart-beta ETFs ceeds raised both fell drastically during while the outstanding balance of labeled that add value, scale and other factors into the global financial crisis that followed the bonds that the issuer declared would be their index-based portfolio construction. collapse of Lehman Brothers in 2008, and used for green projects was USD 180 bil- Institutional investors that aim to generate while they have since been in a recovery lion. Forty-four percent of the unlabeled excess returns while relying on index-based trend, neither has returned to the levels bonds and 72 percent of the labeled bonds investments are expanding investment in seen in 2007 (Figure 1). Proceeds raised were listed on exchanges.*4 The world’s first smart-beta ETFs in particular. through follow-on offerings peaked in 2009 green bond was officially issued by the Eu- According to ETFGI, an independent and has since followed an up-and-down ropean Investment Bank and listed on the research firm covering the ETF market, pattern that lacks any signs of turning into Luxembourg Stock Exchange in 2007. To- total assets under management (AUM) of a strong upward trend. day, a number of exchanges, including the ETFs have expanded from USD 417 billion

Global Trends in Exchanges and Implications for Exchanges in ASEAN Countries | 5 PERSPECTIVE

at end-2005 to USD 4.7 trillion at end-2017 Figure 2: Number of ETFs Listed on Global Markets and Total AUM (Figure 2). The US accounts for 71 percent of this global ETF market, followed by Europe USD Billion AUM (lhs) Number of ETFs (rhs) at 16 percent. Expansion of the ETF market 6,000 6,000 is an important source of revenues for ex- changes as it leads to an increase in listing 5,000 5,000 fees, trading commissions, and fees charged 4,000 4,000 for the provision of index and market data. Major exchanges are therefore aggressively 3,000 3,000 promoting the development of the ETF mar- 2,000 2,000 ket. For example, the Japan Exchange Group (JPX) has positioned ETFs as an important 1,000 1,000 financial product for expanding the base of individual investors and has undertaken 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 various initiatives to foster the growth of the Source: ETFGI ETF market, including (1) expanding its ETF offerings, (2) developing new indices, such as a smart-beta index, and (3) examining and introducing measures to increase its recent years, their underlying blockchain Exchange in January 2016 began cooper- liquidity. technology is finding applications beyond ating with a startup on R&D of blockchain The increased focus on ESG invest- the realm of cryptocurrencies.*6 Accord- technology that it now plans to use in a new ment which was noted earlier has led to the ing to a Goldman Sachs report, the appli- clearing and settlement system scheduled introduction of ETFs linked to ESG indices. cation of blockchain technology to post- for introduction by March 2018. Going forward, exchanges’ need to expand trade settlement and clearing processes Of course, in practice, blockchain listed product offerings and investors’ need in the world’s cash equities markets could technology will need to be accompanied for more diversified and sophisticated in- generate annual savings of more than USD by measures to prevent potential risks. For vestment instruments are likely to propel 6 billion.*7 one, exchanges will need to be prepared to the global growth of ESG-linked ETFs. That prospect has an increasing num- respond to system risks. In addition to re- ber of exchanges looking into the potential sponding promptly to network breakdowns application of financial market infrastruc- caused by system failures, the exchanges ture that makes use of blockchain technolo- will need to secure their systems against Development of gy (Table 1). For example, in December 2015 cyberattacks and to establish IT governance Nasdaq announced that its Nasdaq Linq frameworks. Another important response Blockchain-based blockchain technology enabled an issuer to will be compliance with regulatory frame- successfully complete and record a private works. The exchanges will need to ensure Financial Market securities transaction, and it is now test- that systems based on blockchain technol- ing a fund trading platform based on that ogy are in compliance with each country’s Infrastructure technology. In February 2016, JPX began existing regulations, including laws protect- experimenting with blockchain technology ing confidential information, intellectual with the aim of achieving more efficient property and investor privacy. However, While Bitcoin and other cryptocurrencies post-trade settlement and clearing process- the huge potential benefits of blockchains have been taking the world by storm in es. Elsewhere, the Australian Securities seem to outweigh these risks and challeng-

Table 1: Major Exchanges’ Blockchain Initiatives for Financial Market Infrastructure

Exchange Initiatives – Announced that an issuer was able to use its Nasdaq Linq blockchain technology to successfully complete and record a private securities transaction (December 2015). Nasdaq – Announced a new integrated payment solution by connecting the Linq Platform to the CitiConnect® for Blockchain connectivity platform (May 2017). – Initiated a joint project with Nordic financial services group SEB to test a new fund trading platform based on blockchain technology (September 2017).

– Announced an agreement to test the potential of blockchain technology in cooperation with IBM Japan (February 2016). Japan Exchange – Published a working paper on the potential application of blockchain technology to financial market infrastructure (August 2016). Group – Published a working paper on the trend for exploring use of blockchain technology in the financial market (September 2017). London Stock – Group member Borsa Italiana teamed up with IBM to build a blockchain solution digitizing the issuance of securities for small and medium-sized Exchange Group enterprises in Europe (September 2017). Deutsche Börse – Presented a functional prototype for the blockchain technology-based settlement of securities in cooperation with the Deutsche Bundesbank (November 2016). Group – Developed a concept for riskless transfer of commercial bank money for post-trade processing via an infrastructure based on blockchain technology (January 2017). – Opened Korea Startup Market (KSM) with blockchain technology for document and identity authentication in partnership with a blockchain startup Korea Exchange Blocko (November 2016). – Announced tie-up with US-based Digital Asset Holdings (DAH) to develop solutions for the Australian equity market utilizing blockchain technology Australian Securi- (January 2016). ties Exchange – Announced a plan to replace its decades-old settlement and clearing system, using blockchain technology developed by DAH (December 2017).

Source: Exchanges’ press releases

6 | NOMURA JOURNAL OF ASIAN CAPITAL MARKETS | Spring 2018 Vol.2/No.2 es. We therefore expect exchanges to step nounced the ASEAN Green Bond Standard the issuance process be simplified, distri- up their promotion of the use of blockchain in November 2017. The standard conforms bution channels expanded, new types of technology to improve the financial market to the Green Bond Principles introduced by ETFs introduced, and incentive schemes for infrastructure. the International Capital Market Associa- market makers added. In the US and Japan tion in January 2014. At the national level, for instance, the push to establish ETF mar- the Monetary Authority of Singapore (MAS) kets with rich content was led by securities in June 2017 introduced a grant scheme firms and institutional investors. Individual aimed at promoting the issuance of green investors jumped on the bandwagon later, Implications for bonds, and in July 2017 saw the helping to drive market expansion. Consid- issuance of the world’s first green Sukuk ering this experience, active participation Exchanges in ASEAN (Islamic bond) under the Sustainable & Re- of securities firms and institutional inves- sponsible Investment Sukuk Framework tors will be crucial to the early stages of the Countries established jointly by the Securities Com- development of the ETF market in ASEAN mission (SC) Malaysia, Bank Negara Ma- countries. Over the longer term, however, laysia and the World Bank. With financial expanding the individual investor base will regulatory authorities supporting the issu- play an important role in ETF market devel- This section considers the state of ASEAN ance of ESG-related financial products as opment. Toward that end, exchanges will exchanges’ efforts in the three trend areas shown above, ASEAN exchanges can be ex- be expected to take the lead in educating discussed above and presents some impli- pected to play a greater role in promoting investors about ETFs. cations based on the initiatives being taken ESG investment by domestic and overseas Lastly, the application of blockchain by the world’s leading exchanges. investors, including efforts to develop and technology has already proven to be useful Starting with ESG-related efforts, the provide ESG indices. in financial transactions such as interbank ASEAN exchanges recognize the impor- Turning to the second global trend, transfers, trade finance, and verification tance of ESG investment although it is not the ASEAN countries have been behind of customer identity when opening bank yet mainstream. The region’s exchanges the curve in the promotion of ETF markets, accounts. However, there are as yet only have been promoting stronger ESG-related which are still rather new and of small a few examples of blockchain technology disclosure from listed companies, and sev- scale in ASEAN countries. Singapore with being used for capital market transactions. eral have been rising in global rankings for the largest ETF market in the region has One such example is a MAS-supported ESG disclosure. The progress made by the grown its market by listing foreign domi- project at the focused Stock Exchange of (SET) is partic- ciled ETFs, but its AUM was still only USD on using blockchain technology to realize ularly notable (Table 2). In addition, some 3.3 billion at end-2017. The ETF market in a more efficient transaction and settlement of the ASEAN exchanges are participating ASEAN countries has failed to expand for cycle for fixed income securities. In addi- in the SSE Initiative. three main reasons; (1) Financial institu- tion, the SET is preparing to launch LIVE, Regional financial regulatory author- tions have little incentive to sell ETFs be- a blockchain-based fund-raising platform ities are also promoting ESG investment. cause of low sales commission rates, (2) Ef- for startups. The new platform is expected The ASEAN Capital Market Forum (ACMF), forts to educate local investors about ETFs to begin operating in the first half of 2018. an organization comprising the financial have been insufficient and, as a result, lo- Improving the efficiency of finan- regulators from all ASEAN countries, intro- cal investors are largely unaware of ETFs, cial market infrastructure is important for duced the ASEAN Corporate Governance (3) Low commission rates for asset manag- all market participants regardless of the Scorecard in 2012, with the cooperation of ers provide them with little incentive for degree of development and scale of the the Asian Development Bank (ADB). The launching new ETFs. individual capital market. The concrete scorecard assigns scores to listed compa- In this environment, talk about devel- benefits and risks of using blockchain tech- nies in five areas: shareholder rights, eq- oping the ETF market has picked up steam nology are not entirely clear at this point uitable treatment of shareholders, role of in Malaysia recently. An ETF task force in time, but from a longer-term perspective stakeholders, disclosure and transparency, chaired by SC and comprising Bursa Ma- exploring the possibilities of blockchain and responsibilities of the board of direc- laysia and other market participants issued technology while observing the more ad- tors. The six main ASEAN countries have a set of key recommendations to enhance vanced initiatives of the world’s major ex- seen their scores improve since the score- the ecosystem and drive further growth of changes should have great significance for card was introduced. The ACMF also an- the ETF industry. They recommended that exchanges in ASEAN countries.

Table 2: ASEAN Exchanges’ Global Ranking on ESG Disclosure

Exchange 2013 2014 2015 2016 2017 The Stock Exchange of Thailand 40 27 17 13 10 Local and Regional 24 23 19 17 15 Singapore Exchange 18 22 15 18 16 Perspective Stock Exchange 37 38 31 34 25 The Philippine Stock Exchange 39 33 28 32 29 Hochiminh Stock Exchange N/A N/A N/A N/A 53 Note: A total of 55 exchanges were included in the 2017 rankings. As discussed above, the further develop- Source: Corporate Knights ment of exchanges in ASEAN countries

Global Trends in Exchanges and Implications for Exchanges in ASEAN Countries | 7 PERSPECTIVE

can draw many lessons from the initia- ronment, interest in methods that enable *3 The Paris Agreement that was adopted in tives being undertaken in the world’s quick and efficient financing directly December 2015 and put into effect in No- leading exchanges. At the same time, how- from investors is on the rise. One such vember 2016 aims to hold the increase in ever, it will be important for each coun- method is equity crowdfunding (ECF). ECF the global average temperature to well be- try’s exchange to maintain a local and re- in the region is still small in scale based on low 2 degrees above pre-industrial levels. gional perspective. a study that estimates total funds raised in One area where this perspective the region via ECF at about USD 56 million *4 Climate Bonds Initiative. (2017) “The Role of Exchanges in Accelerating the Growth of will be important is the effort to increase in 2016.*8 However, the regulatory frame- the Green Bond Market.” IPOs. Increasing the number of listed work for ECF in the region is a rather re- companies is one of the most important cent development of the past two to three *5 Another factor contributing the expansion issues facing ASEAN exchanges, and they years. If more companies begin operating of the ETF market has been the prolifera- accordingly are pursuing a variety of ini- the ECF platform and financing volume tion of robo-advisors, a service that uses tiatives to promote IPOs. However, IPOs increases as a result, it can become a com- algorithms to propose portfolios that meet on ASEAN exchanges are not only few- petitive challenge to the exchanges’ dedi- the needs of investors and often focus on er in number than in the mature equity cated platforms for SMEs. the ETF asset class. markets of advanced countries but are A third area where a local and re- also smaller in scale, with few large IPOs. gional perspective will be important is the *6 Blockchain technology is a foundational Meanwhile, some countries in the region strengthening of collaborations among technology that mutually authenticates the still have many state-owned enterpris- exchanges. One of the initiatives under transfer of rights among participants in a es (SOEs) with a majority or all of their the ACMF is the ASEAN Trading Link peer-to-peer network and uses encryption shares owned by the government. These launched in 2012 by ASEAN Exchanges, to enable the sharing of ledgers in a form SOEs include some large unlisted compa- a collaboration of seven exchanges in six that cannot be altered. nies. The listing of such companies on the ASEAN countries. However, this link has exchange could not only enhance their unfortunately not produced the expected *7 The Goldman Sachs Group. (2016) “Profiles management efficiency and transparency result of facilitating cross-border trading in Innovation – Blockchain Putting Theory into Practice.” but could also contribute to expanding the across the connected exchanges. At pres- investor base, a major aim for the capital ent, it would be difficult to describe the *8 Cambridge Centre for Alternative Finance markets of ASEAN countries. In addition collaborative effort by the exchanges as at University of Cambridge, Australian Cen- to promoting large-scale IPOs that result sufficient for promoting cross-border in- tre for Financial Studies at Monash Univer- in the privatization of SOEs, exchanges in vestments in the region. Furthermore, to sity, and Tsinghua University. (2017) “Culti- the region have an important role to play attract investors from outside the region, vating Growth: The 2nd Asia Pacific Region in supporting improvements in corporate the exchanges need to raise the value of Alternative Finance Industry Report.” governance and disclosure. the “ASEAN” asset class and strengthen A local and regional perspective is collaborative efforts. For example, the also important to the promotion of fund- exchanges could engage in joint develop- raising by small and medium-sized enter- ment of new products in the high-growth prises (SMEs) from the capital markets. ESG domain and undertake joint FinTech Financial services for SMEs in the ASEAN projects. region are insufficient, and various mea- Lastly, the longer-term development YOHEI KITANO sures to improve this situation are under of ASEAN capital markets will require consideration. Exchanges are expected to greater efforts to increase the numbers of contribute to these efforts by improving listed companies and investors, and the Senior Analyst, Nomura Singapore Limited access to the capital markets. Exchanges role played by the exchanges in achieving NICMR could reap huge benefits from their ef- these goals will only grow larger. Going forts to support fundraising by SMEs if forward, how each country’s exchange Yohei Kitano has been Senior Analyst at they result in an increase in IPOs. In July fulfills this role while maintaining a bal- Nomura Institute of Capital Markets Re- 2017, Bursa Malaysia launched the Lead- ance between global and local/regional search (NICMR) in Singapore since 2015. Pri- ing Entrepreneur Accelerator Platform perspectives will merit close monitoring. or to joining NICMR in 2014, he was second- (LEAP) Market to expand fundraising op- ed to the Ministry of Finance Japan and was tions for SMEs in Malaysia. As previously engaged in enhancing financial cooperation with ASEAN countries as well as the Asian noted, the SET is preparing to launch its Notes Bond Markets Initiative (ABMI) from 2012 LIVE platform, and other bourses in the to 2014. He was also seconded to the Japan region are considering introducing new *1 Global Sustainable Investment Alliance. Bank for International Cooperation (JBIC) financing platforms for startups. (2017) “2016 Global Sustainable Investment where his main responsibility was provid- While these developments are most Review.” ing loans to companies in India from 2007 to welcome, attention must also be paid to 2009. He was an equity analyst covering Jap- the need to ensure investor protection *2 World Federation of Exchanges and United anese small and mid-cap stocks from 2004 to and enhance corporate governance at Nations Conference on Trade and Develop- 2006. He joined Nomura Securities in 2002. SMEs. ASEAN countries have many fam- ment. (2017) “The Role of Stock Exchanges ily-owned enterprises that are inclined to in Fostering Economic Growth and Sustain- Kitano earned a bachelor’s degree in eco- avoid calls for more proactive disclosure. able Development.” nomics from Keio University in 2002. He is a In addition, some startups may prefer not CFA® charterholder. to raise funds through IPOs. In this envi-

8 | NOMURA JOURNAL OF ASIAN CAPITAL MARKETS | Spring 2018 Vol.2/No.2