Asia and the Future of Finance: Restoring Trust Is an Urgent Task

Paul Smith, CFA

Throughout Singapore and elsewhere in Asia where it operates, we see an advertisement from one of the region’s biggest banks that says, “Asia’s safest bank.” Five years after the global financial crisis, depositors, investors, and the general public still worry about risk, and assurances seem necessary for them to trust the financial system.

Surveys conducted by various organizations have shown similar findings: The public has ranked the financial services industry rock bottom in trustworthiness. If collateralized debt obligations (CDOs) did not kill off confidence in the financial markets, the Libor-rigging scandal probably did. In the eyes of the investing public, financial markets have been manipulated by a few for their own benefit and have ceased to serve society’s needs.This erosion of trust has far-reaching effects — on pensions, capital allocation, investments, and ultimately, the welfare of society. Globally, lack of trust has led some people to invest less or very conservatively, creating a savings gap that could put even greater pressure on pension systems in the future. This investing trend also affects the availability of credit because lenders become less willing to invest in large, risky projects such as infrastructure.

A failure to spend for the future — especially in growth drivers such as power, transportation, education, and information technology — diminishes competitiveness and slows the social and economic mobility of future generations.

Asia holds an eminent position in the post-crisis global financial order. Its banks have relatively robust balance sheets and many of its economies are more fiscally sound than their Western counterparts. The region is also poised to lead global economic growth this century: The Asian Development Bank forecasts that Asian economies will account for half of global GDP and about half of the world’s financial assets, banks, and equity and bonds markets by 2050. About 3 billion people in the region will start earning middle-class incomes over that period. All of these estimates point to a region that has a large stake in restoring trust in the global financial system and in shaping its future.

How can Asia lead this transformation? CFA Institute believes ethics, sustainability, and properly functioning capital markets are the building blocks of a stronger financial system. These areas are good starting points.

Shaping Global Regulations to Ensure Market Efficiency

Governments and international policy-making bodies such as the G20 have created a host of regulations to help fix the global financial system and restore trust. However, some industry groups are worried that these regulations will hurt the efficient allocation of capital and stunt growth and innovation.

In Asia international regulations could set back the development of the region’s capital markets. As regulators in Hong Kong, Singapore, and Australia noted in a joint letter to the US Commodity Futures Trading Commission last year, the new over-the-counter (OTC) derivatives rules under the Dodd-Frank Act that extend outside the United States could have unintended negative consequences in these Asia-Pacific markets. Asia’s active OTC markets account for an estimated 8% of global OTC derivatives volume, but it is a sector that these economies are eager to develop to become global financial centers.

In addition, these new financial regulations could potentially worsen existing market distortions in Asian economies that tend to be guided by state capitalism and could exacerbate the inefficient allocation of capital. There are also concerns that overregulation could lead to a credit squeeze, pushing some borrowers to use the unregulated “shadow” banking system to access capital. In some countries such as China, this shadow banking system is estimated to rival or even surpass the size of the formal sector, representing a hidden source of systemic risk.

For decades, global policy making has been led largely by the West, with regulators in Asia Pacific aligning local rules with international regulations. As the center of global economic power shifts, Asia will have to exercise its growing role to ensure that global regulations take into account the needs and demands of its emerging markets. The region is not immune to the risks of overleveraging or systemic shocks; at the same time, a hard push back on new regulations may lower standards and hurt capital market development. The real question we need to address is how to balance sound risk management and local capital market growth.

Ultimately, the issue boils down to trust. Government intervention can do some good, but equally important is the commitment of investment professionals to a fairer and more trustworthy financial system, thereby offsetting the need for additional rules.

Developing a More Inclusive Financial System

Bankers have been criticized for creating and selling complex, synthetic products such as CDOs that did not create value for ordinary people and only benefited a few wealthy investors.

In Asia financial services penetration is low; millions of people don’t have bank accounts. Mainstream banks tend to serve larger customers, while smaller customers are forced to borrow from family members or money lenders that may charge excessive interest rates to start or grow businesses.

Poor access to reasonably priced credit hurts an important sector — small and medium enterprises (SMEs), which form the linchpin of Asia’s economies. In India SMEs contribute about 40% of the gross industrial value added in the economy. In China SMEs are estimated to contribute 60% of GDP, 50% of tax revenues, and 80% of urban employment. Despite this contribution, as long as SMEs remain on the periphery, this wealth of talent remains underutilized.

The integration of smaller entrepreneurs is an important step in reconnecting the financial system with the community it is supposed to serve. But banks need to come up with new business models to serve their needs as nonfinancial services firms begin to encroach into this area. For example,, the largest e-commerce group in China, competes against mainstream banks in the SME financing space. Banks see the business sense in innovative models; the question is whether they are nimble enough to adapt.

Strengthening Ethics, Ensuring Sustainability

Regulatory reforms and innovative business models can only go so far to fix the financial system and restore trust. During the 1997 Asian financial crisis, the region was criticized for weak corporate governance, cronyism, corruption, and lack of transparency. While several measures have been taken since then to strengthen governance and internal controls, evidence suggests that weaknesses remain, especially at the top.

Last year, the president of the Japanese money manager AIJ Investment Advisors admitted to covering up losses of $1.3 billion in clients’ pension money. In 2011 the board of Japanese camera and medical equipment maker Olympus (7733:JP) dismissed company president Michael Woodford after he exposed a $1.7 billion accounting fraud that hid losses over more than a decade. Management complicity is suspected in the fraudulent IPO of Chinese company Hontex (946:HK), which was forced to return HK$1.03 billion in IPO proceeds to investors last year.

In Asia’s highly intertwined economies, in which large conglomerates controlled by families or state agencies own the biggest financial services firms, weak corporate governance poses a dangerous systemic risk.

Behavioral change is needed. In the CFA Institute 2013 Global Market Sentiment Survey, our members in this region affirmed that improved ethical culture encouraged by top management is the most-needed action at the firm level to restore trust. They also said that improving corporate governance, enforcement of existing laws, and improved regulation and oversight of global systemic risks are the most-needed industry actions.

As international investments move beyond the mature markets of the region into less-developed economies with relatively weaker investor protection regulations and enforcement, ethics and sustainability will matter even more. Asia can lead by incorporating proven international best practices in corporate, social and environmental governance into financial business models.

China, for example, implemented “green lending” guidelines in 2012 that Chinese banks have to comply with when it comes to environmental risk assessment. International best practices — such as the Equator Principles, currently adopted by 78 financial institutions worldwide, and the CFA Institute Asset Manager Code of Professional Conductare available to guide decision making on corporate, social, and environmental governance matters at the firm level. An increasing number of asset management firms globally have chosen to adopt the Asset Manager Code, and more and more pension funds are considering including questions about compliance with the code when hiring fund managers.

Our codes and standards, our work with regulators and educational institutions to develop ethics training and investor awareness courses, and our educational programs, including the CFA Program and the newly introduced Claritas Investment Certificate, which is designed for those who support investment decision makers, cover a wide swath of the finance industry.

But ultimately, real cultural change starts with individuals. For 50 years, the CFA Program has produced CFA charterholders trained in their ethical responsibilities and who subscribe to a strict Code of Ethics and Standards of Professional Conduct. The CFA designation is considered the gold standard in the industry. With around 18,000 charterholders, Asia Pacific is the fastest-growing region globally for CFA Program candidates.

This growth not only indicates the rapid development of the region’s financial industry, but it also signals that the region has a cadre of highly skilled and trustworthy professionals who can make the right decisions for their clients and lead the industry forward.

Restoring trust in the financial system is an urgent task. The “Asian Century” will be brighter if Asia’s financial market participants come together to ensure that the financial system not only withstand future shocks but also function fairly and efficiently.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

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