How Markets in Southeast Asia Can Attract Liquid

Since the creation of the ASEAN+3 group of China, Japan, and South Korea, along with the Association of Southeast Asian Nations, ASEAN capital markets have grown significantly.  

The number of companies listed on the region’s exchanges doubled in the two decades following the Asian Financial Crisis, with well over 4,000 companies listed today and a total market capitalisation of USD 2.6 trillion. This rapid growth has been matched by the development of an increasingly sophisticated corporate and financial ecosystem that has helped to strengthen domestic exchange groups and their ability to support their local economies. 

Today, Southeast Asia nations have a combined GDP of USD 3.5 trillion, are home to 670 million people, and attract almost one-fifth of global FDI inflow annually, reflecting the ever-greater need for deep, liquid markets to maintain their impressive growth trajectory. 

The desire to attract greater liquidity has long been a feature of the region’s vibrant markets, with exchange groups recognising that they can only realistically achieve growth by attracting international capital. However, achieving that requires a renewed focus on technological enhancement and structural reforms to offer global investors a standardised means of connecting to each market. 

In a recent global study of financial market infrastructures (FMIs) published by Nasdaq, Southeast Asia was viewed as the largest global centre for market disruption and offering the lowest regulatory burden. However, many ASEAN jurisdictions still face challenges attracting international capital to add greater depth and liquidity to their markets. 

Where Latin American exchanges have pursued integration to achieve scale, Southeast Asian markets are widely viewed as fragmented, conforming to local regulations with relatively little overlap. But attracting international liquidity isn’t simply a case of ‘achieving scale and capital will follow’. Rather, infrastructures operating in Southeast Asia must focus on making it easier for international and domestic investors to scale with them and incentivising activity by reducing the friction and costs associated with connecting to domestic exchanges. 

There are four significant steps that infrastructures can take to attract liquidity:

1. Standardise access: pre- and post-trade drivers for large, global participants to access domestic exchanges are focused on ease and cost of access. Offering the same technology and connection as large international exchange groups can standardise their means of connecting, thereby removing the cost and requirement to maintain a series of bespoke systems. 
2. Consistent and predictable regulation: Risk management is a key factor determining the degree of attractiveness of markets, driving decisions to invest and the ability to manage capital and enter and exit positions. The fundamental rule of law, predictability in regulation, and treatment of investors are key to that appetite.
3. Facilitate capital efficiency and collateralisation: Providing capital efficiencies in domestic markets and securities instruments, coupled with the ease of custody, is essential for effective participation and liquid securities markets. Effective cross-border exchange links such as the SGX Nifty, HKEX Stock Connect, and SGX/NZX dairy futures serve as stable and efficient channels for hedging and risk management.
4. Modernise wider ecosystem: Technology has long been a fundamental building block for growth in capital markets, and infrastructure providers must themselves be a driver of modernisation amongst exchange members. Engaging with local broker associations and networks to highlight the benefits of modernising their technology infrastructure, and coordinating upgrades with them, can help navigate resistance to positive change.

Our data shows that 40% of FMIs in Asia Pacific are operating with legacy systems that are more than ten years old. However, there has been a significant increase in appetite to upgrade this technology as projects put on hold due to COVID-19 have been restarted. The pandemic also starkly demonstrated the importance of having resilient systems capable of withstanding significant increases in volume, exposing operators that have allowed technical debt to build up over many years. 

However, addressing Asia’s liquidity challenges extends beyond the actions of individual FMIs in a region located at the start of the international clock, operating a broad range of national holidays and offering limited overlap in trading hours with major global hubs. The substantial periods of gap risk pose a significant barrier for many institutional investors, and the US shift to t+1 could drive even more flows away from the Asian market by further reducing the time available to effectively manage risk. 

Asian markets must, therefore, embark on more sizeable structural reform focused on increasing the ability to trade and settle out of hours to allow markets to trade global asset types and facilitate the hedging of risk. Crucial to this is embracing new payment technology, capable of pushing liquidity through national holidays and later in the day, allowing other global centres to take part in its markets. Central bank digital currencies and new payment rails will be critical enablers for the market, with emerging technologies capable of addressing the region’s long-standing liquidity deficit. 

Asia is home to some of the most innovative fintech and mobile technology in the world, and that presents a substantial opportunity to embrace and adopt emerging technology at scale in Asian capital markets. 

There are many steps exchange groups can take to enhance liquidity on their individual markets, but a more significant shift can only be driven by a collective effort amongst policymakers, infrastructures, and market participants. Examples such as the EU’s MiFID and Latam’s NuAM illustrate where cross-border efforts have successfully come together to drive capital market reforms.

There are a number of positive initiatives being led by the Asia Exchange Association looking to drive a similar agenda and ultimately capitalise on Southeast Asia’s almost unrivalled potential for growth.