London’s capital markets offer key insights for Asian financial centres
This pieces was contributed by Yiannis Anagnostopoulos, Salma Ibrahim and Emmanouil (Manolis) Noikokyris, Capital Markets Research Group, Kingston University, UK.
Despite the uncertainties in the United Kingdom (UK), London’s capital markets operating through the London Stock Exchange (LSE) have remained vibrant with a healthy average daily trading value of around £5 Billion in Q1 2019, according to information from the bourse.
The robust performance of the second largest bourse in Europe, despite the market turmoil and uncertainty over Brexit, offer insights that policymakers and market influencers in Asian financial centres such as Singapore can draw upon.
This continuity in London’s capital markets despite turbulence — the LSE continues to thrive as it prepares for a no-deal Brexit — and how it continues to thrive can offer the UK experience.
While London will contend with other global financial centres post-Brexit, the LSE is also set to contend with Bloomberg in the financial information services space, following its acquisition of Refinitiv for ~US$27 billion, in a deal set to close sometime in 2H2020.
Regulation and Governance
The leading role of London’s capital market can be attributed to a regulatory commitment to maintaining deep, liquid and well-governed capital markets, especially in a competitive market with global firms seeking flexibility in financing options. The term “flexibility” features quite prominently in LSE’s communications depicting the importance of a current, adjusted and forward-looking regulatory framework for capital markets.
The UK is also a leader in corporate governance, with one of the earliest established corporate governance codes, following recommendations by the Cadbury Report in 1992. Now well established, it sets out standards of good practice for listed companies on board composition, remuneration, shareholder relations, accountability and audit. Operating under the principle of ‘comply or explain’ which provides further flexibility for firms, its mission is to ‘promote transparency and integrity in business.’
Additionally, the UK was a pioneer in establishing a stewardship code, which sets out engagement terms between companies and institutional investors — such as pension fund trustees and other asset-owners — to help improve long-term risk-adjusted returns to shareholders.
London’s regulatory environment focuses on two crucial aspects of a fair market — transparency and accountability — and the commitment from UK regulators towards these goals with the element of ‘flexibility’ embedded can be seen as a fundamental part of the appeal of the LSE to national and international enterprises, as well as global investors.
Tech-enabled market liquidity
Furthermore, the rapid development and integration of technology-assisted trading in the UK has resulted in low quoted spreads, high speed and high likelihood of execution as well as market depth. Considered together, these can be referred to as a measure of execution quality.
Data from Statista and the LSE shows that while the UK still lags behind the US equity market in terms of comparative trade execution, the percentage of total volume of equity, cash and derivatives’ market traded through algorithms and automated trading has increased to approximately 75% in the space of just 10 years from less than 10% in 2009.
This trend is set to continue given the proven return benefits of investing in ever-faster and cheaper execution systems. Furthermore, with the emergence of financial technology (fintech), retail financial institutions and open banking, the incumbent banks and legacy financial institutions are locked in a technology arms race for customer loyalty, business generation, proprietary and retail investing. The latter is also a prime driver behind the establishment of online platforms for amateur and/or part-time quantitative traders.
These competitor startups leverage by tying together and exploiting the technological nous and skills of thousands of technologically articulated individuals from the advanced markets of the US, Europe and Asia.
Institutions that have invested in data and technology aiming to increase execution speed, reduce costs and reduce network latency will not only retain their market position but will also have the competitive edge and first mover advantages. Barclays for example, has reportedly had a 30% year-on-year increase in trading volume, after investing in electronic trading, wholesale and retail trading platforms.
Electronic trading nowadays also accounts for over 50% of all fixed income trades and over 63% of foreign exchange trades (FOREX) in all developed markets bar the US.
Furthermore, they account for at least 50% of the trade volume in many commodities and commodity futures: such as grain and oilseed; livestock futures; precious metals and crude.
Arguably, all of the above asset classes are well below the levels seen in equity markets. In the UK, banks such as Barclays, HSBC and other highly reputable institutions are battling to grab their share of the market in this lucrative domain that, as it seems, has not realised its full potential.
Stock exchange alliances
Global alliances remain at the forefront of LSE’s agenda with its current chief executive officer, David Schwimmer, stating that it is ‘well positioned to develop its growth opportunities further in the evolving macroeconomic landscape.’
Reflecting this, the LSE took a 4.92 percent stake in Euroclear in January 2019 and recently increased its stake in LCH, the world’s largest clearing house for interest-rate swaps.
LSE has also forged the London-Shanghai Connect, connecting the well-established LSE with the more recently established Shanghai Stock Exchange (SSE).
While it might initially appear to be a successful model to widen the reach of Chinese firms in global markets, this isn’t without problems. In fact, the launch of the platform was delayed in December 2018 due to concerns with Brexit in the UK in addition to technical issues related to currency conversion.
Arguably, the SSE may not be the obvious match with LSE, as concerns remain about practices of trade dumping, investment liberalization, market access, and protection of intellectual property (IP) rights in China.
Whereas the UK would gain from increasing its investment base and looking beyond the EU and US, it is unlikely to garner support for this link from its traditional allies. It is expected that the UK will come under pressure from both the EU and US when it comes to China dealings.
An LSE-Singapore Alliance?
The alternative is seeking alliances with more aligned bourses, such as the much smaller Singapore Exchange (SGX), which could be a possible link in the Asia Pacific. The SGX’s regulatory activities are aimed at ‘operating a fair, orderly and transparent market’, and the bourse has a history of seeking international recognition.
For example, both SGX Derivatives Clearing and The Central Depository (CDP) have high compliance with the Principles for Financial Market Infrastructures (PFMI), which are the latest international standards for payment, clearing and settlement.
Furthermore, both the UK and Singapore corporate governance environments are similar. The governance code in Singapore has at its core, as in the UK, stakeholder engagement as the starting point for value creation and purports to follow a principles-based approach where the Monetary Authority of Singapore (MAS) and SGX take on roles as advisors and enforcers of good corporate governance.
SGX’s trading strengths can also complement those of the LSE, given they lie in the financial services industry; with growth in the real estate, healthcare, and Information Technology (IT) sectors.
This does not differ significantly from the UK’s strengths, where the financial sector constitutes the most meaningful sector of the UK’s largest 100 companies. Specifically, in May 2019, the market capitalization of firms in the financial sector, including insurance companies, represented 18% of the FTSE100 market capitalization.
Rebuilding Singapore’s liquidity
However, there is the issue of lacklustre liquidity in Singapore’s equity market. Data from Refinitiv indicates that as of May 2019, average daily securities turnover at SGX was US$791 million, US$1.8 billion for Bangkok bourse, and US$12.4 billion for Hong Kong.
The monetary policy of the Monetary Authority of Singapore (MAS), the city-state’s centra bank, is unusual. It predominantly aims to manage the exchange rate (NEER: the Nominal Effective Exchange Rate) between the Singapore dollar and the US dollar, rather than domestic interest rates.
While this action is justifiable on the grounds that major inflation factors are imported (e.g. both food and fuel) and hence exogenous shocks can be better managed, it also provides for a relative loss of control over domestic interest rates. As a result, US interest rates wield considerable influence.
The Singapore swap offer rate (SOR) yields are at a decade high. In a scenario where the MAS decides to deviate from following US policy, a decision to leave the S$/NEER neutral could send SOR returns higher. An increase to the S$NEER slope can pull SOR rates down. However, both weak economic data and muted inflation are likely to negatively impact investor expectations regarding future Singapore dollar appreciation.
Coupled with slowing growth, lower exports, weakened private domestic consumption and higher unemployment, this will reduce the availability of local liquidity and paradoxically push SOR yields higher over the long-term. Hence the implications for Singapore dollar cash investors emanating from MAS policy can be huge.
For Singapore to rebuild liquidity, the MAS needs to reflect on a few domestic market changes, as well as addressing asset valuation uncertainties. For instance, from a ‘localised’ return point of view, for Singapore dollar cash investors, the recent higher SOR yields are welcome following an extended period of low returns and negative real yields.
Increasing diversification across asset classes trading in Singapore and extending further out the curve where possible should help maximise both liquidity and potential Singapore dollar cash returns. As things currently stand, the local market seems rigid and inflexible.
With a developed fintech hub — it was appraised to be a global leader in fintech policy support & regulation in a 2018 in a a report, “The Future of Finance is Emerging:New Hubs, New Landscapes”, by the Judge Business School of the University of Cambridge — MAS should continue to invest in FinTechs and regulatory compliance sandboxes that spur electronic trading.
This has already been shown to provide for lower transaction costs, tightening further bid/ask spreads, greater liquidity and ease of market access. Despite the efforts and steps taken earlier to increase transactional efficiency there is still room for tighter bid-ask spreads and further lowering of transaction costs.
MAS regulations regarding banking liquidity in some respects go beyond what is required under Basel III guidelines. Arguably, to some extent there is also a self-inflicted liquidity conundrum.
Specifically, in addition to the all-currency requirement, a 100% Liquidity Coverage Ratio (LCR) requirement is imposed on the S$ as well in order to build up ‘sufficient’ S$-denominated liquid assets as a buffer for their S$-denominated net outflows.
In addition, MAS has also imposed an additional cap of 5% of total High-Quality Liquid Assets (HQLA) on equities and residential mortgage-backed securities as well as sovereign, central bank and non-financial corporate debt securities rated between BBB+ and BBB–.
On the one hand, imposing a higher/additional S$ LCR requirement can ensure that there is adequate S$-denominated HQLA within the total HQLA pool in terms of liquidity risk.
Yet, Singapore seems to be at the other end of the spectrum; there is not a problem of ‘excess’ liquidity but rather a shortage. Domestic bank regulatory requirements thus can constrict asset growth and liquidity. There is evidence that markets with greater asset liquidity also have on average higher stock liquidity.
Also Read:
The London Stock Exchange & Brexit: Future & opportunities outside the EU
Regulatory, capital market reforms needed to revive Singapore’s stock market
Commentary: MAS equity investments in ETFs can revitalise Singapore’s stock market
Why publicly listed companies need to invest in business storytelling
