Overcoming poor market depth and liquidity is crucial for Asia’s capital markets to grow and remain attractive to investors. A coordinated approach addressing regulatory frameworks, market infrastructure, and risk management is essential for building resilient, diverse, and efficient markets.
Since the Asian financial crisis of the late 1990s, authorities in jurisdictions around the region have aimed to deepen their domestic capital markets. And capital markets have indeed grown: funds raised in equity markets grew from 1.3% of GDP in 1990‒1998 to 1.6% in 2008‒2016. In the bond markets, they tripled from 1.6% to 4.5% of GDP.
Over the last three years, however, poor market depth and liquidity have impeded market development and reduced the attractiveness of the region as an investment destination, according to the Asia Pacific Capital Markets Survey by the Asia Securities Industry and Financial Market Association.
Issuers of securities in emerging markets also face more volatile primary markets, incur higher costs of capital, and have limited funding diversity compared to developed markets. And the investors face narrow and fewer investment opportunities across asset classes.
Few dispute the importance of capital markets to economies. They transfer capital to productive economic activities and enable low-cost allocation of savings while minimizing the risks.
The liquidity and resiliency of the domestic capital market buffers financial intermediation activities when the banking system is under severe stress and provides an alternative to international financing.
A deep and liquid capital market features several factors. It offers a variety of investment instruments, a clear regulatory and transactional framework enabling low-cost access, and pricing efficiency in both primary and secondary markets, all while minimizing information asymmetry.
A deep and liquid market also provides avenues to hedge or mitigate the risk associated with financial instruments, and is able gather vast and diverse participation from capital providers with differing investment objectives and risk appetites.
In Asian corporate bond markets, the typical issue size is below $200 million and transaction size in the secondary market is relatively small. In the limited primary market, meanwhile, distribution further limits availability of instruments for secondary market trading and the behavior of market intermediaries and investors. Such factors contribute to poor secondary market activity, low market depth, and resiliency.
The absence of active repurchase, securities lending and borrowing, short-selling or derivatives further hampers market depth and liquidity, effectively creating a one-way market that cannot adjust itself to rising interest rates or falling prices. Asia Securities Industry and Financial Market Association respondents rank these as the second most important market impediment.
Availability of long-term funding is another important factor. Less developed markets in Asia tend to rely more on short-term debt than mature markets such as Singapore or Malaysia. Indonesia and the Philippines for instance have an average maturity of less than 5 years in their corporate bond markets.
Several constraints continue to impede capital market development in this region. Chief among them is the preference of corporations to seek funding from internal sources and the banking system.
This is a natural consequence of firms maximizing cost of capital and the complexity of accessing public markets, which remains mostly only in the reach of larger firms. The imbalances between applying the right regulatory framework to support effective disclosure and promote market conduct and investor protection can significantly affect access and market confidence.
The lack of diversity and capacity of the investment community may also hinder development if the regulatory environment does not facilitate effective risk-taking behavior, apply unnecessary constraints that affect financial returns, or inhibit free flow of capital.
Technologically outdated market infrastructure and intermediary models that do not incentivize or appropriately reward participation that promotes liquidity and resiliency may compound these problems.
Addressing the challenges to capital market deepening, amid these complexities, therefore requires a consolidated approach across many interrelated markets and great coordination among development partners.
The building blocks of development areas will entail careful consideration of the multifaceted needs of investors, issuers, and intermediaries in meeting their investing, financing, and risk hedging requirements.
Development will be dictated by the decision-making infrastructure, the cost and efficiency factor of market access, and the preferred intermediation model. Policy makers guidance through capital market development plans helps promote transparency in the sequencing of policy reform measures.
Also high on the agenda is a facilitative regulatory environment that eases access to funds, that is moving towards a market-based disclosure regime complemented by strong oversight. This must be complemented by sufficient issuer side strategies to incentivize access supported by a strong regulatory, legal, and judicial system.
This can protect investors, prevent market abuse, and enhance predictability and efficiency of insolvency matters. Stronger information infrastructure—reporting and disclosure, ratings, accessibility of pre- and post-trade data, research information, and the development of benchmark markets—significantly contribute to market depth and facilitate pricing efficiency.
Building the right market architecture is likewise critical. It needs to consider the role of market intermediaries, its risk-taking behavior, access and distribution channels, and choose the right execution or market operators (exchange/electronic trading facility/over the counter market).
These can ensure suitability of products to the type of trading venue. Proper design of the supporting intermediary model that can efficiently execute trades, minimize price disequilibrium, and reward participation is also paramount in building liquid, broad, deep, and resilient markets.
Authorities should also promote competition among intermediaries and market operators to improve service quality and reduce intermediation cost. Policy makers must also embrace and facilitate use of technology to transform market infrastructure in trading, depository, settlement, and payments with global integration capabilities.
Development of supporting markets such as repurchase and securities borrowing and lending and derivatives, meanwhile, is critical to facilitating hedging and funding activities. And this must be supported by a legal and regulatory environment that provides netting certainty, allows short selling, and currency convertibility.
Finally, efforts must concentrate on deepening the domestic investor base, doing so prudently and complemented by strong and continuous investor education. Authorities must also promote institutional investor penetration and increase sophistication.
Asia’s capital markets require a comprehensive strategy that includes strengthening market infrastructure, enhancing regulatory frameworks, and fostering competition among intermediaries to achieve greater liquidity and depth. Coordinated efforts from authorities, market participants, and policymakers are critical to unlocking the full potential of capital markets and creating sustainable economic growth.