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Evolving Emerging Markets

Andy Maynard of CLSA outlines the development of Asian markets and the dynamics that will drive further innovation.
Andy MaynardExchange-traded volumes on emerging Asian markets have increased dramatically over the last ten years, but their full potential will not be realized without change in domestic regulations and global buy-side allocations.
Europe, the US and Japan have been the biggest markets for some time and as a result, they clear trades independently. Within developed Asia, Taiwan to a certain degree, trades independently but now it is included in investors’ China exposure. ASEAN went through a euphoric run based on ballooning GDP growth, with similar stories in individual markets such as Indonesia, Thailand and the Philippines.
If you take the Philippines, for example, ten years ago that market traded USD5 million a day, and now it trades half a billion. It has become a bona fide market compared to what it was, as have Malaysia and Thailand, but they have been in a second tier. Within global portfolios, exposure to emerging Asia has either been a relatively small part of the overall allocation, or contained within a country-specific fund.
As the growth story evolved, so did the equity markets, but the economic backdrop has also changed. The exchanges as well as the regulators are still very independent in each jurisdiction. More cohesiveness amongst the regulators, especially as regards technology and new exchange technologies would help brokers.
Using Japan as a case study, the exchanges have changed themselves to compete in modern trading, including merging the exchanges to narrow spreads. They have done much to ensure the main board is as competitive as it can be and limit the proliferation of exchanges/venues/pools. Expanding it to Korea and Taiwan, the markets are relatively efficient and evolved.
Taken together, developed Asia (Singapore, Hong Kong, Australia, New Zealand, Japan, Korea, Taiwan) has critical mass, as the exchanges evolved and the regulators produced a playing field for all participants.
In the rest of Asia, including India, the myriad nuances of exchange rules and regulations mean the majority of a broker’s work is on market microstructure. Our client offerings in places like Indonesia, Thailand, and the Philippines are all materially different, so the best execution suite differs market-by-market. Because these markets have gone from famine to feast relatively quickly, volumes have increased and market participants, whether international, retail, institutional or mutual, are more diverse.
The progression in the Philippines is amazing considering how quickly the Philippines went from the smallest Asian market in the 1990s to where most buy-sides now have a few stocks in their portfolio that are listed in Manila. A growing domestic community trades actively and has begun to look outside the Philippines.
By default, the exchanges tend to play catch-up. Not long ago the Philippine Stock Market closed for technical glitches on a relatively frequent basis. Now, with international interest in the market, market failures due to technical glitches have an unacceptable effect on investor confidence, so they will have to upgrade their whole exchange system at some point.
Asian markets will evolve at their own pace, but the overall direction is very clear. The lines between emerging, frontier and developed markets in Asia are blurring. They will retain idiosyncrasies, but interactions in and out of the market will slowly homogenize. Malaysia’s market structure is well developed in so far as brokers know what the regulator does and does not allow.
To this day, many governments are the principal owners of the national exchanges, which is viewed as a crown jewel. This complicates the necessary exchange modernization that investors are looking for. Innovation and increased functionality are requirements to be internationally competitive. India is a huge market, but it lags behind the evolution of similar markets because market activity and structure are impeded by the regulator.
These domestic developments often come back to whether there is a need for it. In those markets where the government owns or operates the exchange, the regulator is frequently prohibited or discouraged from introducing competition.
The burden is on the domestic community to request change. If the exchanges do not think they need to innovate or the regulator is not producing a legal framework for change, usually the market participants have not been asking for it. When these markets evolve and their international presence grows there is a tipping point where portfolios start to include local names. Then, almost by default, the exchange will upgrade to continue to attract flow.
In the last few years, we received numerous requests from a range of big buy-sides for frontier market access, from Mongolia to Pakistan to Sri Lanka. Investors want to know who is on the ground, who offers comparable services/structures across markets, and who has the heavy lifting in these smaller markets. As a result, we now have a daily order pack for the smaller markets in the region and a dedicated team covering frontier markets.
The overarching trend is buy-side firms offering dedicated global frontier funds. The money associated with them does not compare to the larger emerging funds, but most asset managers have some level of frontier activity. Investors see the upside versus the risk of investing in markets, so the conversation is shifting to formerly obscure places such as Laos and Mongolia.
The outlier in all of this is China, which despite its size remains an anomaly. The Chinese market is massive in its own right such that any mention of innovation in the market, either from the exchange or the regulator, makes everyone jump. The market is still cheap relative to its global peers, and the Stock Connect is already showing investor attraction. Moreover, the influence coming out of China through Hong Kong could eventually outweigh the northbound flow.
20 years ago a global portfolio meant investing in an Aussie banker and a handful of Asian brokers. Today, it means stocks in Taiwan, car manufacturers in Korea, and a range of regional firms in your investable universe. At some point it will include names in Malaysia, Thailand, Indonesia, the Philippines and India. That matrix of pressure on markets, exchanges and regulators is going to continuously grow as Asia takes a bigger share of the GDP pie. Regulators and exchanges will have to evolve.

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